-----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, ONWr9p5TL/upg4wcpDw5SNuhvvtYgr9Cq7+n8wieXcZ2E+wWd0P1XBI2kra6Ee9u DpTeV4+3Hue7kbnbThir9A== 0001047469-98-020391.txt : 19980518 0001047469-98-020391.hdr.sgml : 19980518 ACCESSION NUMBER: 0001047469-98-020391 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FOUNDATION HEALTH SYSTEMS INC CENTRAL INDEX KEY: 0000916085 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE CARRIERS, NEC [6399] IRS NUMBER: 954288333 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12718 FILM NUMBER: 98622121 BUSINESS ADDRESS: STREET 1: 21600 OXNARD ST CITY: WOODLAND HILLS STATE: CA ZIP: 91367 BUSINESS PHONE: 7195420500 MAIL ADDRESS: STREET 1: 225 N MAIN ST CITY: PUEBLO STATE: CO ZIP: 81003 FORMER COMPANY: FORMER CONFORMED NAME: HEALTH SYSTEMS INTERNATIONAL INC DATE OF NAME CHANGE: 19940207 FORMER COMPANY: FORMER CONFORMED NAME: HN MANAGEMENT HOLDINGS INC/DE/ DATE OF NAME CHANGE: 19931213 10-Q 1 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________ COMMISSION FILE NUMBER: 1-12718 ------------------------ FOUNDATION HEALTH SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 95-4288333 (State or other jurisdiction of (I.R.S. Employer identification incorporation or organization) No.) 21600 OXNARD STREET, WOODLAND HILLS, CA 91367 (Address of principal executive offices) (Zip Codes) (818) 676-6978 Registrant's telephone number, including area code ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of May 11, 1998, 111,761,431 shares of Class A Common Stock, $.001 par value per share, were outstanding (exclusive of 3,194,374 shares held as treasury stock) and 10,297,642 shares of Class B Common Stock, $.001 par value per share, were outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FOUNDATION HEALTH SYSTEMS, INC. INDEX TO FORM 10-Q
PAGE ---- PART I--FINANCIAL INFORMATION Item 1--Financial Statements Condensed Consolidated Balance Sheets--March 31, 1998 and December 31, 1997................................................................. 3 Condensed Consolidated Statements of Operations for the First Quarter Ended March 31, 1998 and 1997........................................ 4 Condensed Consolidated Statements of Cash Flows for the First Quarter Ended March 31, 1998 and 1997........................................ 5 Notes to Condensed Consolidated Financial Statements................... 6 Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................. 9 Item 3--Quantitative and Qualitative Disclosures About Market Risk....... 16 PART II--OTHER INFORMATION Item 1--Legal Proceedings................................................ 18 Item 2--Changes in Securities............................................ 20 Item 3--Defaults Upon Senior Securities.................................. 21 Item 4--Submission of Matters to a Vote of Security Holders.............. 21 Item 5--Other Information................................................ 21 Item 6--Exhibits and Reports on Form 8-K................................. 24 Signatures............................................................... 31
2 PART I--FINANCIAL INFORMATIONPART I--FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS)
DECEMBER 31, 1997 MARCH 31, ------------ 1998 ------------ (UNAUDITED) ASSETS Cash and cash equivalents.......................................................... $ 343,940 $ 559,360 Securities available for sale...................................................... 603,498 553,001 Premiums receivable, net........................................................... 243,469 224,383 Amounts receivable under government contracts...................................... 269,043 272,060 Deferred taxes..................................................................... 205,930 213,695 Reinsurance and other receivables.................................................. 109,453 130,875 Other assets....................................................................... 236,863 223,900 Net assets of discontinued operations.............................................. 299,181 267,713 ------------ ------------ Total current assets............................................................. 2,311,377 2,444,987 Securities held to maturity........................................................ 13,821 12,885 Property and equipment, net........................................................ 435,070 427,149 Goodwill and other intangible assets, net.......................................... 1,039,387 1,044,727 Other assets....................................................................... 147,231 146,602 ------------ ------------ Total Assets..................................................................... $ 3,946,886 $4,076,350 ------------ ------------ ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Reserves for claims and other settlements.......................................... $ 917,824 $ 967,815 Unearned premiums.................................................................. 132,700 244,340 Notes payable and capital leases................................................... 3,498 3,593 Amounts payable under government contracts......................................... 95,912 78,441 Accounts payable and other liabilities............................................. 392,505 470,483 ------------ ------------ Total current liabilities........................................................ 1,542,439 1,764,672 Notes payable and capital leases................................................... 1,353,420 1,308,979 Other liabilities.................................................................. 123,625 106,725 ------------ ------------ Total Liabilities................................................................ 3,019,484 3,180,376 Stockholders' Equity: Common stock and additional paid-in capital........................................ 630,120 628,735 Retained earnings.................................................................. 396,632 370,394 Unrealized investment gains and (losses), net of taxes............................. (3,519) (7,324) Common stock held in treasury, at cost............................................. (95,831) (95,831) ------------ ------------ Total stockholders' equity....................................................... 927,402 895,974 ------------ ------------ Total Liabilities and Stockholders' Equity....................................... $ 3,946,886 $4,076,350 ------------ ------------ ------------ ------------
See Notes To Condensed Consolidated Financial Statements 3 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
FIRST QUARTER ENDED MARCH 31, -------------------------- 1998 1997 ------------ ------------ Revenues Health plan premiums................................................................ $ 1,844,484 $ 1,419,745 Government contracts................................................................ 213,627 246,034 Specialty services.................................................................. 91,113 78,030 Investment and other income......................................................... 26,150 26,210 ------------ ------------ 2,175,374 1,770,019 ------------ ------------ Expenses Health plan services................................................................ 1,584,503 1,181,008 Government health care services..................................................... 163,291 190,912 Specialty services.................................................................. 73,208 65,259 Selling, general and administrative................................................. 258,408 214,535 Amortization and depreciation....................................................... 30,841 24,684 Interest............................................................................ 21,861 14,938 ------------ ------------ 2,132,112 1,691,336 ------------ ------------ Income from continuing operations before income taxes................................. 43,262 78,683 Income tax provision.................................................................. 17,024 31,059 ------------ ------------ Income from continuing operations..................................................... 26,238 47,624 Income from discontinued operations................................................... -- 10,857 ------------ ------------ Net income.......................................................................... $ 26,238 $ 58,481 ------------ ------------ ------------ ------------ Basic earnings per share Continuing operations............................................................... $ 0.22 $ 0.38 Discontinued operations............................................................. -- 0.09 ------------ ------------ Net................................................................................. $ 0.22 $ 0.47 ------------ ------------ ------------ ------------ Diluted earnings per share Continuing operations $ 0.22 $ 0.38 Discontinued operations -- 0.09 ------------ ------------ Net................................................................................. $ 0.22 $ 0.47 ------------ ------------ ------------ ------------ Weighted average common and common stock equivalent shares outstanding: Basic............................................................................... 121,614 125,297 Diluted............................................................................. 121,907 125,706
See Notes To Condensed Consolidated Financial Statements 4 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS) (UNAUDITED)
FIRST QUARTER ENDED MARCH 31, -------------------------- 1998 1997 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income.......................................................................... $ 26,238 $ 58,481 Adjustments to reconcile net income to net cash used for operating activities: Amortization and depreciation..................................................... 30,841 24,684 Other changes in net assets of discontinued operations............................ (30,324) (8,123) Other............................................................................. 939 203 Change in assets and liabilities Premium receivable and unearned subscriber premiums............................... (130,726) (127,750) Other assets...................................................................... 29,957 (32,363) Amounts receivable/payable under government contracts............................. 20,488 (22,905) Reserves for claims and other settlements......................................... (49,991) (9,454) Accounts payable and accrued liabilities.......................................... (85,520) 10,021 ------------ ------------ Net cash used for operating activities................................................ (188,098) (107,206) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Sale or maturity of securities available for sale................................... 118,609 116,510 Purchases of securities available for sale.......................................... (165,660) (146,458) Maturity of securities held to maturity............................................. 1,500 1,550 Purchases of securities held to maturity............................................ (1,052) (2,264) Purchases of property and equipment................................................. (26,450) (18,630) Investment in other companies....................................................... -- (12,566) Other............................................................................... -- (904) ------------ ------------ Net cash used for investing activities................................................ (73,053) (62,762) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options and employee stock purchases................ 1,385 5,599 Proceeds from issuance of notes payable and other financing arrangements............ 45,000 74,766 Repayment of debt and other non-current liabilities................................. (654) (706) ------------ ------------ Net cash provided by financing activities............................................. 45,731 79,659 ------------ ------------ Net decrease in cash and cash equivalents............................................. (215,420) (90,309) Cash and cash equivalents, beginning of period........................................ 559,360 487,938 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD.............................................. $ 343,940 $ 397,629 ------------ ------------ ------------ ------------
See Notes to Condensed Consolidated Financial Statements 5 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1--MERGER The current operations of Foundation Health Systems, Inc. (the "Company") are a result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the FHS Combination, FH Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the FHS Combination, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held, resulting in the issuance of approximately 76.7 million shares of the Company's Class A Common Stock to FHC stockholders. The FHS Combination was accounted for as a pooling of interests for accounting and financial reporting purposes. The pooling of interests method of accounting is intended to present, as a single interest, two or more common stockholder interests which were previously independent and assumes that the combining companies have been merged from inception. Consequently, the Company's condensed consolidated financial statements have been prepared and/or restated as though HSI and FHC always had been combined. NOTE 2--BASIS OF PRESENTATION In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments necessary for a fair presentation of the consolidated financial position of the Company and the consolidated results of its operations and its cash flows for the interim periods presented. All adjustments presented in these condensed consolidated financial statements are of a normal recurring nature. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. For further information please refer to the consolidated financial statements and notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. Results of operations for the interim periods are not necessarily indicative of results to be expected for the full year. NOTE 3--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS Net restructuring costs of $149.4 million were recorded during the year ended December 31, 1997 related to the FHS combination and the restructuring of the Company's Eastern Division health plans. As of March 31, 1998, $40.9 million of the net restructuring charge is expected to require future outlays of cash and $68.4 million has been paid. In addition, $70.4 million of merger costs, $118.6 million of other costs and $57.5 million of premium deficiency costs of Gem Insurance Company were recorded during 1997. NOTE 4--DISCONTINUED OPERATIONS The Company revised its strategy of maintaining a presence in the workers' compensation insurance business and thereby adopted a plan to discontinue this segment of its business through divestiture of its 6 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 4--DISCONTINUED OPERATIONS (CONTINUED) workers' compensation insurance subsidiaries. As a result, the Company is reporting its workers' compensation insurance segment as discontinued operations for each period presented in the condensed consolidated financial statements. Consistent with the foregoing, on May 5, 1998 the Company entered into a definitive agreement to sell its workers' compensation insurance operations to Superior National Insurance Group, Inc. The transaction is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. The following sets forth the summarized balance sheet and results of operations for the workers' compensation insurance companies to be sold as of March 31, 1998 and December 31, 1997, and for the first quarters ended March 31, 1998 and 1997 (in thousands):
MARCH 31, DECEMBER 31, 1998 1997 ------------ ------------ Total assets..................................................... $ 1,246,253 $1,260,335 Total liabilities................................................ 992,057 1,000,815 ------------ ------------ Net assets....................................................... 254,196 259,520 Amounts to reconcile to net assets from discontinued operations: Elimination of net notes payable to Parent and other net receivables from Parent and subsidiaries..................... 139,804 107,193 Loss on disposition............................................ (94,819) (99,000) ------------ ------------ Net assets from discontinued operations.......................... $ 299,181 $ 267,713 ------------ ------------ ------------ ------------
FIRST QUARTER ENDED MARCH 31, ---------------------- 1998 1997 ---------- ---------- Total revenues........................................................ $ 149,979 $ 132,225 Total expenses........................................................ 159,555 118,949 ---------- ---------- Income (loss) before income taxes..................................... (9,576) 13,276 Provision (benefit) for income taxes.................................. (5,395) 2,419 ---------- ---------- Net income (loss) from discontinued operations........................ (4,181) 10,857 Loss after measurement date anticipated in loss on disposition........ 4,181 -- ---------- ---------- Net income (loss) from discontinued operations........................ $ -- $ 10,857 ---------- ---------- ---------- ----------
The loss on disposition of $99 million recorded at December 31, 1997 included the anticipated results of operations through the disposal date and therefore the net loss of $4.2 million is not reflected on the Company's condensed consolidated statement of operations for the quarter ended March 31, 1998. NOTE 5--COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income." This standard requires that an enterprise report, by major components and as a single total, the change in 7 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 5--COMPREHENSIVE INCOME (CONTINUED) its net assets during the period from non-owner sources which is defined as net income plus direct adjustments to stockholders' equity such as unrealized investment adjustments and pension liability adjustments. The Company's comprehensive income for the first quarter ended March 31 pursuant to such standard is as follows (in thousands):
1998 1997 --------- ---------- Net Income............................................................. $ 26,238 $ 58,481 Other comprehensive income, net of tax: Unrealized gains (losses) on securities not included in net income... 3,805 (15,737) --------- ---------- Comprehensive Income................................................... $ 30,043 $ 42,744 --------- ---------- --------- ----------
NOTE 6--EARNINGS PER SHARE Basic earnings per share excludes dilution and reflects income divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (stock options) outstanding during the periods presented; no adjustment to income is required. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method. NOTE 7--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS During 1997, the Financial Accounting Standards Board issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information", which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas, and major customers; and SFAS No. 132 "Employers Disclosures About Pensions and Other Postretirement Benefits", which revises and standardizes pension and other benefit plan disclosures. Adoption of these statements will not impact the Company's consolidated financial position, results of operations or cash flows. These statements are effective for fiscal years beginning after December 15, 1997. Accordingly, the Company plans to adopt these statements during the fourth quarter of 1998. NOTE 8--PRIOR PERIOD RECLASSIFICATION Certain prior period amounts have been reclassified to conform with the current period presentation. 8 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foundation Health Systems, Inc. (the "Company") is an integrated managed care organization which administers the delivery of managed health care services. Through its subsidiaries, the Company offers group, individual, Medicaid and Medicare health maintenance organization ("HMO") and preferred provider organization ("PPO") plans; government sponsored managed care plans; and managed care products related to bill review, administration and cost-containment, behavioral health, dental, vision and pharmaceutical products and services. CONSOLIDATED OPERATING RESULTS REVENUES AND HEALTH CARE COSTS The Company's revenues grew by $405.4 million or 22.9% for the quarter ended March 31, 1998 as compared to the same period in 1997. Growth in revenues for the quarter was due primarily to the acquisitions that occured in 1997, including Physicians Health Services Inc. ("PHS"), FOHP, Inc. ("FOHP"), PACC HMO, Inc. and PACC Health Plans, Inc. (collectively, "PACC") and the Advantage Health plans ("Advantage Health"), as well as growth in the Company's existing businesses. In particular, increase in premium rates in vitrually all markets and growth in Medicaid enrollment in California contributed to the increase in revenue. Specialty Services Division revenue increased by $13.1 million or 16.8% for the quarter ended March 31, 1998 as compared to the same period in 1997 primarily due to increased revenue from the Company's behavioral health plans, and bill review, cost containment and administrative services business. This increase was partially offset by lower Government Contract Division revenue which declined $32.4 million or 13.2% for the quarter ended March 31, 1998 as compared to the same period in 1997, a result of contract risk share provisions that reduce revenues when health care costs decline. Investment and other income was $26.2 million for the quarter ended March 31, 1998, unchanged from the same period in 1997. The Health Plan medical care ratio ("MCR") (medical costs as a percentage of revenue) for the quarter ended March 31, 1998 was 85.9% compared to 83.2% for the quarter ended March 31, 1997. The increase in the MCR was primarily due to higher pharmacy and Medicare benefit costs. This was partially offset by reduced costs as a percent of revenue in the Government Contract Division and Specialty Services Division. SELLING, GENERAL, AND ADMINISTRATIVE COSTS The Company's selling, general and administrative ("SG&A") expenses increased by $43.9 million or 20.5% for the quarter ended March 31, 1998 as compared to the same period in 1997. The increase in SG&A expenses is primarily due to additional SG&A expenses associated with the acquisitions that occurred in 1997. The administrative expense ratio (SG&A as a percentage of health plan and government contracts revenue) decreased slightly to 12.6% for the quarter ended March 31, 1998 from 12.9% for the same period in 1997. AMORTIZATION AND DEPRECIATION Amortization and depreciation expense increased by $6.2 million for the quarter ended March 31, 1998 as compared to the same period in 1997. This was primarily due to higher levels of intangible and fixed assets, a result of the acquisitions of companies that occurred in 1997. INTEREST EXPENSE Interest expense increased by $6.9 million for the quarter ended March 31, 1998 as compared to the same period during the prior year. The increase in interest expense was due to higher debt levels 9 associated with the Company's revolving lines of credit. The additional borrowings were made for general corporate purposes as well as the purchase of PHS, FOHP, PACC and Advantage Health during 1997. INCOME TAX PROVISION The tax provision rate on income from continuing operations for the quarter ended March 31, 1998 of 39.4% declined slightly from the tax provision rate of 39.5% on income from continuing operations for the quarter ended March 31, 1997. The tax provision rate differs from the statutory federal rate of 35% due to state income taxes and tax-exempt income, offset by non deductable goodwill amortization. LINE OF BUSINESS REPORTING The Company currently operates in the managed health care segment. The managed health care segment's continuing operations are in three primary lines of business (i) health plan operations; (ii) government contracts; and (iii) specialty services. Discontinued operations include the worker's compensation insurance segment. CONTINUING OPERATIONS HEALTH PLANS Revenues generated by the Company's Health Plan operations increased $424.7 million or 29.9% for the quarter ended March 31, 1998 compared to the same period in 1997 due to the acquisitions that occurred in 1997 including PHS, FOHP, PACC and Advantage Health which contributed approximately $218.8 million, $90.7 million, $35.6 million and $13.0 million, respectively, in revenue during the first quarter of 1998. In addition, increases in commercial premium rates and Medicaid enrollment growth in the California Division, commercial growth in several states in the Company's Western Division, including Washington and Colorado, and strong enrollment growth in Florida of 15% contributed to the increase in Health Plan revenue. The MCR for the Company's Health Plan operations increased to 85.9% for the quarter ended March 31, 1998 as compared to 83.2% in the same period in 1997. Higher Medicare benefit costs in a number of markets and pharmacy costs in virtually all areas of the country accounted for the rise in the MCR. In addition, reductions in reserve redundancy for shared risk and excess reinsurance that occurred in the California Division during the first quarter of 1997 resulted in a lower MCR during that period. GOVERNMENT CONTRACTS Government Contract Division revenue decreased by $32.4 million or 13.2% for the quarter ended March 31, 1998, compared to the same period in 1997. The decline in revenue was primarily due to the risk sharing provision of CHAMPUS contracts that reduce revenues when health care costs decline. Government health care costs as a percentage of government contract revenue decreased to 76.4% in the first quarter of 1998 from 77.6% in the first quarter of 1997. This was primarily a result of improved health care delivery results on the California/Hawaii CHAMPUS contract. SPECIALTY SERVICES Revenues generated by the Company's Specialty Services Division for the first quarter of 1998 increased by $13.1 million or 16.8 % as compared to the same period in 1997 primarily due to growth in service fees by the Company's bill review cost containment and administrative services businesses, and continued growth in its managed health network businesses. Specialty Services Division costs decreased as a percentage of specialty services revenue to 80.3% for the first quarter of 1998 as compared to 83.6% in 1997. The reduction in the MCR was due to reduced 10 administrative expenses as a percent of revenue in the bill review, cost containment and administrative service business, partially offset by slightly higher costs due to a change in product mix in the managed health network businesses. DISCONTINUED OPERATIONS WORKERS' COMPENSATION INSURANCE BUSINESS The Company revised its strategy of maintaining a presence in the workers' compensation insurance business and thereby adopted a plan to discontinue this segment of its business through divestiture of its workers' compensation insurance subsidiaries. As a result, the Company is reporting its workers' compensation insurance segment as discontinued operations. Consistent with the foregoing, on May 5, 1998 the Company entered into a definitive agreement to sell its workers' compensation insurance operations to Superior National Insurance Group, Inc. The transaction is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. REVENUE Total workers' compensation revenue in the first quarter of 1998 increased by $17.8 million to $150.0 million compared to the same quarter in 1997. Net earned premium of $139.6 million in the first quarter of 1998 was $18.2 million or 15% greater than the first quarter of 1997. The increase in premium is due primarily to the effect of quota share and aggregate excess of loss reinsurance in 1997. Ceded premium under the Aggregate Excess of Loss Treaty was $15 million and ceded premium under the Quota Share Treaty was $8.0 million in the first quarter of 1997. The decrease in ceded premium was offset by a $11.7 million decline in written premiums, primarily as a result of reduced premium in the California market, as the market continued to experience severe price competition. COSTS Workers' compensation costs of $159.5 million, including general and administrative costs, increased $40.6 million in the first quarter of 1998 compared to the same quarter in 1997. The increase is due primarily to increased workers' compensation loss costs as a result of the elimination of the Aggregate Excess of Loss Treaty effective January 1, 1998. In the first quarter of 1997, $18.5 million of losses were ceded under this treaty. In addition, $10.1 million of losses and commissions were ceded under the Quota Share Treaty in the first quarter of 1997. Neither of these treaties were in effect during the first quarter of 1998. Workers' compensation loss and loss adjustment expense costs are $5.1 million greater than in the first quarter of 1997 and other underwriting costs increased approximately $2 million in the first quarter of 1998 compared to the first quarter of 1997 due to the impact of the Quota Share Reinsurance Treaty in the first quarter of 1997. NET INCOME The loss on dispositon of $99.0 million recorded at December 31, 1997 included the anticipated results of operations through the disposal date and therefore, the net loss of $4.2 million is not reflected on the Company's condensed consolidated statement of operations for the quarter ended March 31, 1998. This compares to net income of $10.8 million in the first quarter of 1997. The following table presents financial information reflecting the Company's continuing operations for its primary lines of business: 11 FOUNDATION HEALTH SYSTEMS, INC. LINE OF BUSINESS FINANCIAL INFORMATION (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
FIRST QUARTER ENDED FIRST QUARTER ENDED MARCH 31, 1998 MARCH 31, 1997 ------------------------------------------- ------------------------------ PERCENT PERCENT PERCENT AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL PERCENT REVENUE (DECREASE) PERCENT REVENUE ------------ ----------- ---------------- ------------ ---------------- Revenues Health plan premiums.................... $ 1,844,484 84.8% 29.9% $ 1,419,745 80.3% Government contracts.................... 213,627 9.8 (13.2) 246,034 13.9 Specialty services...................... 91,113 4.2 16.8 78,030 4.4 Investment and other income............. 26,150 1.2 (0.2) 26,210 1.4 ------------ ----- ------------ ----- 2,175,374 100.0 22.9 1,770,019 100.0 ------------ ----- ------------ ----- Expenses Health plan services.................... 1,584,503 72.8 34.2 1,181,008 66.7 Government health care services......... 163,291 7.5 (14.5) 190,912 10.8 Specialty services...................... 73,208 3.4 12.2 65,259 3.7 Selling, general and administrative (SG&A)................................ 258,408 11.9 20.5 214,535 12.1 Amortization and depreciation........... 30,841 1.4 24.9 24,684 1.4 Interest................................ 21,861 1.0 46.3 14,938 0.8 ------------ ----- ------------ ----- 2,132,112 98.0 26.1 1,691,336 95.5 ------------ ----- ------------ ----- Income from continuing operations before income taxes............................ 43,262 2.0 (45.0) 78,683 4.5 Income tax provision...................... 17,024 0.8 (45.2) 31,059 1.8 ------------ ----- ------------ ----- Income from continuing operations......... $ 26,238 1.2% (44.9)% $ 47,624 2.7% ------------ ----- ------------ ----- ------------ ----- ------------ ----- Basic earnings per share.................. $ 0.22 $ 0.38 Diluted earnings per share................ 0.22 0.38 Weighted average common and common stock equivalent shares outstanding: Basic................................. 121,614 125,297 Diluted............................... 121,907 125,706 Operating ratios: Health plan medical care ratio........ 85.9% 83.2% Government contracts medical care ratio............................... 76.4 77.6 Specialty services medical care ratio............................... 80.3 83.6 SG&A as a percent of health plan and government contracts revenues....... 12.6 12.9
12 FOUNDATION HEALTH SYSTEMS, INC. LINE OF BUSINESS FINANCIAL INFORMATION (AMOUNTS IN THOUSANDS) (UNAUDITED)
FIRST QUARTER ENDED MARCH 31, 1998 FIRST QUARTER -------------------------------- ENDED PERCENT MARCH 31, 1997 INCREASE ----------------- ENROLLMENT (DECREASE) ENROLLMENT ------------- ----------------- ----------------- Health Plan Commercial........................................................ 3,523 32.0% 2,669 Medicare risk..................................................... 310 25.5 247 Medicaid.......................................................... 492 65.1 298 ----- ----- ----- 4,325 34.6 3,214 Government.......................................................... CHAMPUS PPO and indemnity......................................... 882 (7.6) 955 CHAMPUS HMO....................................................... 720 25.4 574 ----- ----- ----- 1,602 4.8 1,529 ASO................................................................. 185 (17.4) 224 ----- ----- ----- Combined.......................................................... 6,112 23.1 4,967 ----- ----- ----- ----- ----- -----
LIQUIDITY AND CAPITAL RESOURCES Certain of the Company's subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Certain subsidiaries must maintain ratios of current assets to current liabilities of 1:1 pursuant to certain government contracts. The Company believes it is in compliance with these contractual and regulatory requirements in all material respects. The Company believes that cash from operations, existing working capital, lines of credit, and funds from planned divestitures of business are adequate to fund existing obligations, introduce new products and services, and continue to develop health care-related businesses. The Company regularly evaluates cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. The Company may elect to raise additional funds for these purposes, either through additional debt or equity, the sale of investment securities or otherwise, as appropriate. Government health care receivables and payables are best estimates of payments that are ultimately collectible or payable. Since these amounts are subject to government audit and negotiation, amounts ultimately collected may vary from current estimates. For the quarter ended March 31, 1998, cash used for operating activities was $188.1 million compared to $107.2 million in the same quarter of 1997. This decrease in the first quarter of 1998 was due primarily to the timing of receipt of payments under federal Medicare contracts, a reduction of claims inventory in the government contracts business, payments for merger, restructuring and other costs associated with the FHS Combination, and restructuring charges associated with the integration of businesses in New York, New Jersey and Connecticut. Net cash used by investing activities was $73.1 million during the first quarter of 1998 as compared to $62.8 million during the same period in 1997. The increase is due to a higher net redemption of securities available for sale and higher capital spending. Net cash generated from financing 13 activities was $45.7 million in 1998 as compared to $79.7 million during the same period in 1997. The net change during the first quarter of 1998 was due primarily to additional draws under the revolving line of credit of $45 million which were used to finance capital contributions to FOHP and PHS and to settle an intercompany tax balance with the discontinued workers' compensation operations in advance of receiving a tax refund. The Company has a $1.5 billion credit facility (the "Credit Facility") with Bank of America as Administrative Agent for the Lenders thereto, which was amended by an Amendment dated April 6, 1998 with the Lenders (the "Amendment"). All previous revolving credit facilities were terminated and rolled into the Credit Facility on July 8, 1997. At the election of the Company, and subject to customary covenants, loans are initiated on a bid or committed basis and carry interest at offshore or domestic rates, at the applicable LIBOR Rate plus margin or the bank reference rate. Actual rates on borrowings under the Credit Facility vary, based on competitive bids and the Company's unsecured credit rating at the time of the borrowing. Under the Amendment, the Company's public issuer rating becomes the exclusive means of setting the facility fee and borrowing rates under the Credit Facility. In addition, certain covenants including financial covenants were amended. The Credit Facility is available for five years, until July 2002, but it may be extended under certain circumstances for two additional years. As of May 11, 1998 $1.38 billion was outstanding under the Credit Facility. The Company's subsidiaries must comply with certain minimum capital requirements under applicable state laws and regulations. The long-term portion of principal and interest payments under the California Wellness Foundation Notes issued by the Company in connection with the Health Net conversion is subordinated to Health Net meeting tangible equity requirements under applicable California statutes and regulations. As of March 31, 1998, the Company's subsidiaries were in compliance with minimum capital requirements. IMPACT OF INFLATION AND OTHER ELEMENTS The managed health care industry is labor intensive and its profit margin is low; hence, it is especially sensitive to inflation. Increases in medical expenses or contracted medical rates without corresponding increases in premiums could have a material adverse effect on the Company. Various federal and state legislative initiatives regarding the health care industry have been proposed during recent legislative sessions, and health care reform and similar issues continue to be in the forefront of social and political discussion. If health care reform or similar legislation is enacted, such legislation could impact the Company. Management cannot at this time predict whether any such initiative will be enacted and, if enacted, the impact on the financial condition or results of operations of the Company. The Company's ability to expand its business is dependent, in part, on competitive premium pricing and its ability to secure cost-effective contracts with providers. Achieving these objectives is becoming increasingly difficult due to the competitive environment. In addition, the Company's profitability is dependent, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, integration of acquired companies, regulatory changes, utilization, new technologies, hospital costs, major epidemics and numerous other external influences may affect the Company's operating results. Accordingly, past financial performance is not necessarily a reliable indicator of future performance, and investors should not use historical records to anticipate results or future period trends. The Company's HMO and insurance subsidiaries are required to maintain reserves to cover their estimated ultimate liability for expenses with respect to reported and unreported claims incurred. These reserves are estimates of future payments based on various assumptions. Establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience, which in the past has resulted and in the future could result in loss reserves being too high or too low. The accuracy of these estimates may be 14 affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors. Future loss development or governmental regulators could require reserves for prior periods to be increased, which would adversely impact earnings in future periods. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for claims and loss reserves. Reference is also made to the disclosures contained under the heading "Cautionary Statements" included in the Company's various filings with the Securities and Exchange Commission and the documents incorporated by reference therein, which could cause the Company's actual results to differ from those projected in forward looking statements of the Company made on behalf of the Company. In addition, certain of these factors may have affected the Company's past results and may affect future results. YEAR 2000 The Company recognizes that the arrival of the Year 2000 requires computer systems to be able to recognize the date change from 1999 to 2000 and, like other companies, is assessing and modifying its computer applications and business processes to provide for their continued functionality. The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, prepare invoices or engage in normal business activities. The Year 2000 effort for the Company has the highest priority of technology projects. The project has dedicated resources with multiple teams to address unique systems environment. Uniform project management techniques are in place with overall oversight responsibility residing with the Company's Chief Technology Officer. Emphasis has been placed on business unit involvement and the use of internal staff enhanced by external specialists. Selected systems will be retired with the business functions being converted to Year 2000 compliant systems. A number of the Company's systems include packaged software from large vendors that the Company is closely monitoring to ensure that these systems are Year 2000 compliant. The Company believes that vendors will make timely updates available to ensure that all remaining purchased software is Year 2000 compliant. The remaining systems' compliance with Year 2000 will be addressed by internal technical staff. The Company has initiated formal communications with others with whom it does significant business to determine their Year 2000 issues. There can be no assurances that the systems of other companies on which the Company's systems rely will be timely converted, or that the failure to convert by another company would not have a material adverse effect on the Company. The Company does not anticipate that the related overall costs to resolve these potential Year 2000 problems will be material to any single year. The total current cost estimate for the Year 2000 project is between $13 and $17 million. These costs are expensed as incurred. However, notwithstanding the foregoing, the costs of the project and the timetable in which the Company plans to complete the Year 2000 compliance requirements are based on estimates derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. There can therefore be no assurance that these estimates will be achieved and actual results could differ materially from these estimates. At this time it is unclear as to the extent of existing insurance coverage, if any, the Company may have to cover potential year 2000 liabilities. The Company is currently analyzing the obtainment of such coverage. 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CONTINUING OPERATIONS The Company is exposed to interest rate and market risk primarily due to its investing and borrowing activities. Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and in equity prices. Interest rate risk is a consequence of maintaining fixed income investments. The Company is exposed to interest rate risks arising from changes in the level or volatility of interest rates, prepayment speeds and/or the shape and slope of the yield curve. In addition, the Company is exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer's credit rating or credit perception may affect the value of financial instruments. The Company has several bond portfolios to fund reserves. The Company attempts to manage the interest rate risks related to its investment portfolios by actively managing the asset/liability duration of its investment portfolios. The overall goal of the investment portfolios is to support the ongoing operations of the Company's business units. The Company's philosophy is to actively manage assets to maximize total return over a multiple-year time horizon, subject to appropriate levels of risk. Each business unit will have additional requirements with respect to liquidity, current income and contribution to surplus. The Company manages these risks by setting risk tolerances, targeting asset-class allocations, diversifying among assets and asset characteristics, and using performance measurement and reporting. The Company uses a value-at-risk model to assess the market risk of its investments. The estimation of potential losses that could arise from changes in market conditions is typically accomplished through the use of statistical models which seek to predict risk of loss based on historical price and volatility patterns. The Company's measured value at risk for its investments from continuing operations, using a 95% confidence level, was approximately $3.9 million at March 31, 1998. The Company's calculated value-at-risk exposure represents an estimate of reasonably possible net losses that could be recognized on its investment portfolios assuming hypothetical movements in future market rates and are not necessarily indicative of actual results which may occur. It does not represent the maximum possible loss nor any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in the Company's investment portfolios during the year. The Company, however, believes that any loss incurred would be offset by the effects of interest rate movements on the respective liabilities, since these liabilities are affected by many of the same factors that affect asset performance; that is, economic activity, inflation and interest rates, as well as regional and industry factors. In addition, the Company has some interest rate market risk due to its borrowings. Notes payable, capital leases and other financing arrangements totaled $1.35 billion at March 31, 1998 and the related average interest rate was 6.08% (which interest rate is subject to change pursuant to the terms of the Credit Facility). See a description of the Credit Facility under "Liquidity and Capital Resources." The table below presents the expected cash flows of market risk sensitive instruments at March 31, 1998. These cash flows include both expected principal and interest payments consistent with the terms of the outstanding debt as of March 31, 1998 (dollars in thousands).
1998 1999 2000 2001 2002 BEYOND TOTAL --------- --------- ---------- --------- ------------ --------- ------------ Long-term Borrowings Fixed Rate................. $ 4,329 $ 4,329 $ 24,288 $ 2,540 $ 2,715 $ 10,859 $ 49,060 Floating Rate.............. 78,600 78,600 78,600 78,600 1,388,600 0 1,703,000 --------- --------- ---------- --------- ------------ --------- ------------ Total........................ $ 82,929 $ 82,929 $ 102,888 $ 81,140 $ 1,391,315 $ 10,859 $ 1,752,060 --------- --------- ---------- --------- ------------ --------- ------------ --------- --------- ---------- --------- ------------ --------- ------------
16 DISCONTINUED OPERATIONS The Company plans to sell its risk-assuming workers' compensation insurance businesses which represent a separate segment of business. Therefore the results of these businesses have been reported as discontinued operations. The Company's measured value-at-risk of its investments from discontinued operations at a 95 percent confidence level, at March 31, 1998 was approximately $9.4 million. The discontinued operations businesses do not have any significant interest rate risk due to debt. 17 PART II. OTHER INFORMATION INTRODUCTION As referenced in Part I above, the current operations of Foundation Health Systems, Inc. (the "Company") are a result of the April 1, 1997 merger transaction (the "Merger" or the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Merger, FH Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with and into FHC and FHC survived as a wholly owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the Merger, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held. In connection with the Merger, the Company amended its Certificate of Incorporation to change the name of the Company as referenced above and to increase the number of authorized shares of the Company's Common Stock to 380,000,000 shares consisting of 350,000,000 shares of Class A Common Stock and 30,000,000 shares of Class B Common Stock. In connection with the Merger, the Company also, among other things, amended the Company's By-Laws to effect certain changes to the governance provisions of the Company following the Merger, including provisions related to the structure of the Company's Board of Directors and the committees of the Company's Board of Directors. Except in certain circumstances, during a transition period following the consummation of the Merger and up to, but not including, the election of directors at the Company's May 2000 Annual Meeting of Stockholders, the Company's Board of Directors is to consist of 11 members to be designated as set forth in the Company's Certificate of Incorporation and By-Laws. Pursuant to such designations the Company's Board of Directors is currently comprised of the following ten members (there currently exists one vacancy on the Board of Directors which vacancy is in the process of being filled): J. Thomas Bouchard, George Deukmejian, Thomas T. Farley, Patrick Foley, Earl B. Fowler, Roger F. Greaves, Richard W. Hanselman, Malik M. Hasan, M.D., Richard J. Stegemeier and Raymond S. Troubh. ITEM 1. LEGAL PROCEEDINGS MEDAPHIS CORPORATION On November 7, 1996 the Company's predecessor, HSI, filed a lawsuit against Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V. MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414, Superior Court of California, County of Los Angeles. The lawsuit arises out of the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July 1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS, representing over sixteen percent of the total outstanding equity of HDS, voted its shares in favor of the acquisition of HDS by Medaphis. HSI received as the result of the acquisition 976,771 shares of Medaphis Common Stock in exchange for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has been substituted for HSI as plaintiff in the suit. In its complaint, the Company alleges that Medaphis was actually a poorly run company with sagging earnings in its core business, and had artificially maintained its stock prices through a series of acquisitions and accounting maneuvers which provided the illusion of growth while hiding the reality of its weakening financial and business condition. The Company alleges that Medaphis, Brown and other insiders deceived the Company by presenting materially false financial statements and by failing to disclose that Medaphis would shortly reveal a "write off" of up to $40 million in reorganization costs and would lower its earnings estimate for the following year, thereby more than halving the value of the Medaphis shares received by the Company. The Company alleges that these false and misleading statements were contained in oral communications with the Company, as well as in the registration statement and the prospectus provided by 18 Medaphis to all HDS shareholders in connection with the HDS acquisition. Further, despite knowing of the Company's discussions to form a strategic alliance of its own with HDS, Medaphis and the individual defendants wrongfully interfered with that prospective business relationship by proposing to acquire HDS using Medaphis stock whose market price was artificially inflated by false and misleading statements. The Company alleges that the defendants' actions constitute violations of both federal and state securities laws, as well as fraud and other torts under state law. The Company is seeking either rescission of the transaction or damages in excess of $38 million. The defendants have denied the allegations in the complaint, and the Company is vigorously pursuing its claims against Medaphis. Recently the Company moved to disqualify the law firm representing certain of the individual defendants. The trial court granted the Company's motion, and the law firm and its clients have appealed such decision. In addition, the trial court granted a stay of the case until June 4, 1998 in order to permit the law firm to appeal. The Company intends to press for an expedited appeal. Prior to the stay the case was in the early stages of discovery. No trial date has yet been set. MONACELLI VS. GEM INSURANCE COMPANY On December 29, 1994, a lawsuit entitled MARIO AND CHRISTIAN MONACELLI V. GEM INSURANCE COMPANY, ET AL (Case No. CV94-20715) was initiated in Maricopa County (Arizona) Superior Court against Gem Insurance Company, a subsidiary of the Company ("Gem"), for bad faith and misrepresentation. Plaintiffs subsequently asserted claims in the same action against their insurance agent, Mark Davis, for negligence and misrepresentation. The Plaintiffs' claims arose from the rescission of their health insurance policy based on their alleged failure to disclose an X-ray, taken one year before the Plaintiffs filled out their insurance application, which revealed an undiagnosed mass on Mr. Monacelli's lung. Plaintiffs incurred approximately $70,000 in medical expenses in connection therewith. Prior to trial, the agent recanted certain portions of his deposition testimony and admitted that the Plaintiffs had told him that Mr. Monacelli had undergone certain tests which were not revealed on the application. Based on this new information, Gem paid the Plaintiffs' medical expenses with interest. The case went to trial in April of 1997 against Gem and the agent. A jury verdict was ultimately rendered awarding the Plaintiffs $1 million in compensatory damages and assessing fault 97% to Gem and 3% to the agent, Mark Davis. In addition, the jury awarded $15 million in punitive damages against Gem. Thereafter, the plaintiffs filed a motion seeking to recover an additional $4 million in attorneys' fees, and Gem filed post-trial motions for judgment notwithstanding the verdict, for a new trial and for remittitur of the jury verdict. Gem's motion for judgment notwithstanding the verdict was denied. The court granted Gem's motion for remittitur and remitted the jury verdict to an award of $1 million in compensatory damages and $2 million in punitive damages. The court further ordered that if the plaintiffs did not accept the remittitur order, Gem's motion for new trial would be granted. The plaintiffs accepted the court's remittitur. The court also awarded plantiffs approximately $233,000 in attorneys' fees and interest. Notwithstanding the plaintiffs' acceptance of the court's remittitur, Gem plans to appeal the verdict. In addition, on July 15, 1997 Gem filed a complaint against Mr. Davis and his spouse in Maricopa County (Arizona) Superior Court (Case No. CV97-13053) asserting a claim for indemnity against Mr. Davis with respect to the Monacelli case. MISCELLANEOUS PROCEEDINGS The Company and certain of its subsidiaries are also parties to various legal proceedings, many of which involve claims for coverage encountered in the ordinary course of its business. Based in part on advice from litigation counsel to the Company and upon information presently available, management of the Company is of the opinion that the final outcome of all such proceedings should not have a material adverse effect upon the Company's results of operations or financial condition. 19 ITEM 2. CHANGES IN SECURITIES REVOLVING CREDIT FACILITY On July 8, 1997 the Company entered into a Credit Agreement with the banks identified therein (the "Banks") and Bank of America National Trust and Savings Association ("Bank of America"), in its capacity as the Administrative Agent, pursuant to which the Company obtained an unsecured five-year $1.5 billion revolving credit facility maturing on July 7, 2002. The Credit Agreement replaced (i) the Company's prior Amended and Restated Credit Agreement, dated as of April 26, 1996, with Bank of America, as agent, providing for a $700 million unsecured revolving credit facility and (ii) FHC's prior (A) Revolving Credit Agreement, dated as of December 5, 1994, with Citicorp USA, Inc., as agent, providing for a $300 million unsecured revolving credit facility and (B) Revolving Credit Agreement, dated as of December 17, 1996, with Citibank, N.A., as administrative agent, providing for a $200 million unsecured revolving credit facility. The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and events of default. Specifically, Section 7.11 of the Credit Agreement provides that the Company and its subsidiaries may, so long as no event of default exists: (i) declare and distribute stock as a dividend; (ii) purchase, redeem or acquire its stock, options and warrants with the proceeds of concurrent public offerings; and (iii) declare and pay dividends or purchase, redeem or otherwise acquire its capital stock, warrants, options or similar rights with cash subject to certain specified limitations. Under the Credit Agreement, as amended pursuant to a Letter Agreement dated March 27, 1998 (the "Credit Facility Letter Agreement") and the First Amendment and Waiver to Credit Agreement dated as of April 6, 1998 (the "Amendment and Waiver") with the Banks, the Company is: (i) obligated to maintain certain covenants keyed to the Company's financial condition and performance (including a Total Leverage Ratio and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to customary covenants, including (A) disposition of assets only in the ordinary course and generally at fair value and (B) restrictions on acquisitions, mergers, consolidations, loans, leases, joint ventures, contingent obligations and certain transactions with affiliates; (iv) permitted to sell the Company's workers' compensation insurance business, provided that the net proceeds shall be applied towards repayment of the outstanding Loans under the Credit Agreement; and (v) permitted to incur additional indebtedness in an aggregate amount not to exceed $1,000,000,000 upon certain terms and conditions, including mandatory prepayment of the outstanding Loans with a certain portion of the proceeds from the issuance of such indebtedness, resulting in a permanent reduction of the aggregate amount of commitments under the Credit Agreement by the amount so prepaid. The Credit Facility Letter Agreement and the Amendment and Waiver also provided for an increase in the interest and facility fees under the Credit Agreement. SHAREHOLDER RIGHTS PLAN On May 20, 1996, the Board of Directors of the Company declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). The Board of Directors of the Company also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the Distribution Date (as defined below), the redemption of the Rights and the expiration of the Rights and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights Certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (the "Rights Agreement"), the Rights will separate from the Common Stock in the event any person acquires 15% or more of the outstanding Class A Common Stock, the Board of Directors of the Company declares a holder of 10% or more to the outstanding Class A Common Stock 20 to be an "Adverse Person," or any person commences a tender offer for 15% of the Class A Common Stock (each event causing a "Distribution Date"). Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a price of $170.00 per one-thousandth share. However, in the event any person acquires 15% or more of the outstanding Class A Common Stock, or the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject to certain exceptions contained in the Rights Agreement) will instead become exercisable for Class A Common Stock having a market value at such time equal to $340.00. The Rights are redeemable under certain circumstances at $.01 per Right and will expire, unless earlier redeemed, on July 31, 2006. A copy of the Rights Agreement has been filed with the Securities and Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718). In connection with its execution of the Merger Agreement for the FHS Combination, the Company entered into Amendment No. 1 (the "Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and related transactions from triggering the Rights. In addition, the Rights Amendment modifies certain terms of the Rights Agreement applicable to the determination of certain "Adverse Persons," which modifications become effective upon consummation of the transactions provided for under the Merger Agreement. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the security holders of the Company, either through the solicitation of proxies or otherwise, during the quarter ended March 31, 1998. ITEM 5. OTHER INFORMATION CAUTIONARY STATEMENTS In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company has previously filed with its Annual Report on Form 10-K for the year ended December 31, 1997 certain cautionary statements identifying important risk factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements of the Company made by or on behalf of the Company. The Company wishes to caution readers that these factors, among others, could cause the Company's actual financial or enrollment results to differ materially from those expressed in any projected, estimated or forward-looking statements relating to the Company. The factors should be considered in conjunction with any discussion of operations or results by the Company or its representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors, or other communications by the Company. In making these statements, the Company was not and is not undertaking to address or update each factor in future filings or communications regarding the Company's business or results, and is not undertaking to address how any of these factors may have caused changes to discussions or information contained in previous filings or communications. In addition, certain of these matters may have affected the Company's past results and may affect future results. 21 RECENT DEVELOPMENTS THE CALIFORNIA WELLNESS FOUNDATION Pursuant to the Amended Foundation Shareholder Agreement, dated as of January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company, the CWF and certain stockholders (the "HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the Company) ("HNMH") named therein, the CWF is subject to various volume and manner of sale restrictions specified in the CWF Shareholder Agreement which limit the number of shares that the CWF may dispose of prior to December 31, 1998. The CWF and the Company are also party to a Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration Rights Agreement") pursuant to which the CWF has the right to demand registration for sale in underwritten public offerings of up to 8,026,298 shares of Class B Common Stock. Under the relevant provisions of California law, when a corporation converts from nonprofit to for-profit corporate status, the equivalent of the fair market value of the nonprofit corporation must be contributed to a successor charity that has a charitable purpose consistent with the purposes of the nonprofit entity. The CWF was formed to be the charitable recipient of the conversion settlement when Health Net (a subsidiary of the Company) effected a conversion from nonprofit to for-profit status, which occurred in February 1992 (the "Conversion"). In connection with the Conversion, Health Net issued to the CWF promissory notes in the original principal amount of $225 million (the "CWF Notes") and shares of Class B Common Stock (which immediately prior to the business combination involving HNMH and QualMed, Inc. were split to become 25,684,152 shares of Class B Common Stock then held by the CWF). While such shares are held by the CWF, they are entitled to the same economic benefit as Class A Common Stock, but are non-voting in nature. If the CWF sells or transfers such shares to an unrelated third party, they automatically convert to Class A Common Stock. The CWF currently holds 10,297,642 shares of Class B Common Stock and, as of March 31, 1998, approximately $18.6 million in principal of the CWF Notes remained outstanding. On February 25, 1998, the CWF notified the Company of its intention to sell up to 8,026,000 shares of Class B Common Stock pursuant to the CWF Registration Rights Agreement in an underwritten public offering. Pursuant to the terms of the CWF Registration Rights Agreement, the Company upon receipt of a notification under such agreement must prepare and file a registration statement with respect to such shares with the Securities and Exchange Commission as expeditiously as possible but in no event later than 90 days following receipt of the notice, subject to certain exceptions. The Company is responding to the CWF notification in accordance with the terms of the CWF Registration Rights Agreement. Any shares of Class B Common Stock sold by the CWF to third parties will automatically convert on a one-for-one basis into shares of Class A Common Stock. SALE OF WORKERS' COMPENSATION BUSINESSES The Company revised its strategy of maintaining a presence in the workers' compensation insurance business as a result of various adverse developments arising in 1997 in the workers' compensation insurance business, primarily related to the workers' compensation claims environment in California. As discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, such adverse developments resulted in the need for the Company to strengthen its workers' compensation reserves at the end of 1997. These developments also led the Company to adopt a plan to discontinue this segment of its business, through divestiture of its workers' compensation risk-assuming insurance subsidiaries. In this connection, on May 5, 1998 the Company entered into a definitive agreement (the "Workers' Compensation Sale Agreement") to sell its risk-assuming workers' compensation insurance operations (the "Workers' Compensation Operations") to Superior National Insurance Group, Inc. of Calabasas, Calif. ("Superior National"). The transaction, subject to customary closing conditions including regulatory 22 approvals and a favorable vote from Superior National's shareholders, is expected to close in the third quarter of 1998 and is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. As required under the terms of the Workers' Compensation Sale Agreement, the Company has obtained a commitment from a third party reinsurance company to purchase reinsurance that will cover up to $150 million of adverse loss development in the Workers' Compensation Operations for losses incurred through December 31, 1997. At Superior National's option, the Company is obligated to increase reinsurance coverage by $25 million in exchange for additional purchase price consideration. A copy of the Workers' Compensation Sale Agreement is filed as Exhibit 10.65 to this Quarterly Report on Form 10-Q. In addition to the sale of the Workers' Compensation Operations, the Company and Superior National have agreed to a contract under which the Company's administrative services businesses that currently provide certain services to the Workers' Compensation Operations would continue to provide such services and additional services to Superior National for a period of five years after closing. The Company estimates that, based on past results and the expected contribution from Superior National's operations, this five-year service agreement will create additional total revenue in the range of $40 to $50 million for the Company's administrative service subsidiaries over such five-year term. OTHER POTENTIAL DIVESTITURES The Company is presently reviewing a possible plan to exit its HMO operations in the states of Texas, Louisiana and Oklahoma due to inadequate returns on invested capital. The Company is presently reviewing an exit strategy for such states' businesses (including potential sale transactions). In December 1997 the Company also entered into a sale agreement to divest its non-operational HMO license in Alabama to an unaffiliated third party. The Company has decided to review the possibility of divesting its direct ownership of two Southern California hospitals, a 128-bed hospital located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed hospital located in Gardena, California, the Memorial Hospital of Gardena. Direct ownership of these two hospitals is not consistent with the Company's business philosophy to manage health care through contracts with independent providers of medical services. The Company is presently responding to inquiries of parties which have expressed an interest in purchasing these hospitals. The Company is also analyzing the strategic fit of its Denticare managed dental operations with the ongoing operations and operating strategy of the Company and, in this connection, whether a sale of such operations could be completed consistent with the Company's interests. As described in its Annual Report on Form 10-K for the year ended December 31, 1997, the Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested. 23 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as part of this Quarterly Report on Form 10-Q or are incorporated herein by reference: 2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH Acquisition Corp. and Foundation Health Corporation (filed as Exhibit 2.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein). 3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 4.3 Form of Indenture of Foundation Health Corporation ("FHC") (filed as an exhibit to FHC's Registration Statement on Form S-3 (File No. 33-68684), which is incorporated by reference herein). 4.4 Form of Senior Notes of FHC (filed as an exhibit to FHC's Registration Statement on Form S-3 (File No. 33-68684), which is incorporated by reference herein). 10.1 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc., HN Management Holdings, Inc. and Malik M. Hasan, M.D. (filed as Exhibit 10.18 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.2 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc., HN Management Holdings, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.20 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.3 Severance Payment Agreement, dated as of April 25, 1994, among the Company, Health Net and James J. Wilk (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein).
24 10.4 Severance Payment Agreement dated March 31, 1997 between the Company and Health Net and James J. Wilk (filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.5 Severance Payment Agreement, dated as of April 25, 1994, among the Company, QualMed, Inc. and B. Curtis Westen (filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.6 Letter Agreement dated April 23, 1997 between B. Curtis Westen and the Company (filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.7 Amendment No. 1 to Employment Agreement dated as of April 25, 1994, by and among the Company, QualMed, Inc. and Malik Hasan, M.D. (filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.8 Amended and Restated Employment Agreement, dated March 10, 1997, by and between the Company and Malik M. Hasan, M.D. (Filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.9 Amendment No. 1 to Employment Agreement dated as of April 27, 1994, by and among the Company, QualMed, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.10 Office Lease, dated as of January 1, 1992, by and between Warner Properties III and Health Net (filed as Exhibit 10.23 to the Company's Registration Statements on Forms S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.11 The Company's Second Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10.30 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). 10.12 The Company's Second Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.31 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). 10.13 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.14 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). 10.15 Deferred Compensation Agreement dated as of March 3, 1995, by and among Malik M. Hasan, M.D., the Company and the Compensation and Stock Option Committee of the Board of Directors of the Company (filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.16 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan, M.D., dated as of March 3, 1995, by and between the Company and Norwest Bank Colorado N.A. (filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein).
25 10.17 Registration Rights Agreement dated as of March 2, 1995 between the Company and The California Wellness Foundation (filed as Exhibit No. 28.2 to the Company's Current Report on Form 8-K dated March 2, 1995, which is incorporated by reference herein). 10.18 The Company's 1995 Stock Appreciation Right Plan (filed as Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, which is incorporated by reference herein). 10.19 Amended and Restated Credit Agreement dated as of April 26, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated May 3, 1996, which is incorporated by reference herein). 10.20 Amendment No. 1 to Credit Agreement dated as of May 10, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.32 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, which is incorporated by reference herein). 10.21 Amendment No. 2 to Credit Agreement dated as of May 28, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein). 10.22 Amendment No. 3 to Credit Agreement dated as of January 31, 1997 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.23 Credit Agreement dated July 8, 1997 among the Company, the banks identified therein and Bank of America National Trust and Savings Association in its capacity as Administrative Agent (providing for an unsecured $1.5 billion revolving credit facility) (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.24 Guarantee Agreement dated July 8, 1997 between the Company and First Security Bank, National Association (filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein). 10.25 Employment Letter Agreement dated May 28, 1996 between Michael D. Pugh and QualMed, Inc. (filed as Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein). 10.26 Employment Letter Agreement dated June 4, 1996 between Arthur M. Southam and the Company and Health Net (filed as Exhibit 10.36 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein). 10.27 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and the Company (filed as Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference herein).
26 10.28 Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718) which is incorporated by reference herein). 10.29 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.30 Amended and Restated Employment Agreement, dated December 16, 1996, by and among the Company, Foundation Health Corporation and Kirk A. Benson (filed as Exhibit 10.2 to the Company's Registration Statement on Form S-4 (File No. 333-19273), which is incorporated by reference herein). 10.31 Consulting Agreement, dated as of May 1, 1997, between the Company, FHC and Allen J. Marabito, (filed as Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.32 1990 Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.33 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.6 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.34 1989 Stock Plan of Business Insurance Corporation (as Amended and Restated Effective September 22, 1992) (filed as Exhibit 4.7 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.35 Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit 4.8 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.36 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.37 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation (as amended and restated September 7, 1995) (filed as Exhibit 4.10 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.38 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1994 filed with the Commission on September 24, 1994, which is incorporated by reference herein). 10.39 Foundation Health Systems, Inc. 1997 Stock Option Plan (filed as Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.40 Foundation Health Systems, Inc. Third Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.41 Foundation Health Systems, Inc. Employee Stock Purchase Plan (filed as Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein).
27 10.42 Foundation Health Systems, Inc. Performance-Based Annual Bonus Plan (filed as Exhibit 10.48 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.43 Participation Agreement dated as of May 25, 1995 among Foundation Health Medical Services, as Construction Agent and Lessee, FHC, as Guarantor, First Security Bank of Utah, N.A., as Owner Trustee, Sumitomo Bank Leasing and Finance, Inc., The Bank of Nova Scotia and NationsBank of Texas, N.A., as Holders and NationsBank of Texas, N.A., as Administrative Agent for the Lenders; and Guaranty Agreement dated as of May 25, 1995 by FHC for the benefit of First Security Bank of Utah, N.A. (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.44 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.45 FHC's Supplemental Executive Retirement Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.46 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.47 Agreement and Plan Reorganization dated January 9, 1996 by and between FHC and Managed Health Network, Inc. (filed as Annex 1 of Proxy Statement/Prospectus contained in FHC's Registration Statement on Form S-4 (File No. 333-00517), which is incorporated by reference herein). 10.48 Stock and Note Purchase Agreement by and between FHC, Jonathan H., Schoff, M.D., FPA Medical Management, Inc., FPA Medical Management of California, Inc. and FPA Independent Practice Association dated as of June 28, 1996 (filed as Exhibit 10.109 to FHC's Annual Report on Form 10-K for the year ended June 30, 1996, which is incorporated by reference herein). 10.49 $300 Million Revolving Credit Agreement (the "FHC Credit Agreement") dated as of December 5, 1994, among FHC, as Borrower, Citicorp USA, Inc., as Administrative Agent, Wells Fargo Bank, N.A. and NationsBank of Texas, N.A., as Co-Agents and Citicorp Securities, Inc., as Arranger, and the Other Banks and Financial Institutions Party thereto (filed as an Exhibit to FHC's quarterly report on Form 10-Q for the quarter ended December 31, 1994 filed with the Commission on February 14, 1994, which is incorporated by reference herein). 10.50 First Amendment Agreement (to the FHC Credit Agreement) dated as of August 9, 1995 among FHC, as Borrower, the Lenders parties to the FHC Credit Agreement, Citicorp USA, Inc., as Administrative Agent, Wells Fargo Bank, N.A. and NationsBank of Texas, N.A., as Co-Agents, and Citicorp Securities, Inc., as Arranger (filed as Exhibit 10.52 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.51 Second Amendment Agreement (to the FHC Credit Agreement), dated as of June 28, 1996 among FHC, the Lenders and Citicorp USA, Inc. (filed as Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein).
28 10.52 Third Amendment Agreement and Waiver (to the FHC Credit Agreement) dated December 13, 1996 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.53 Fourth Amendment Agreement and Waiver (to the FHC Credit Agreement) dated January 28, 1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.55 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.54 Fifth Amendment Agreement (to the FHC Credit Agreement) dated April 1, 1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.56 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.55 $200 million Revolving Credit Agreement (the "FHC Revolving Credit Agreement") dated as of December 17, 1996 among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.57 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.56 First Amendment Agreement and Waiver (to the FHC Revolving Credit Agreement) dated as of January 28, 1997 among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.58 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.57 Second Amendment Agreement and Waiver (to the FHC Revolving Credit Agreement) among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.59 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.58 Lease Agreement between HAS-First Associates and FHC dated August 1, 1998 and form of amendment thereto (filed as an exhibit to FHC's Registration Statement on Form S-1 (File No. 33-34963), which is incorporated by reference herein). 10.59 Agreement and Plan of Reorganization dated as of June 27, 1994 by and among FHC, CareFlorida Health Systems, Inc., and the other parties signatory thereto (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on June 28, 1994, which is incorporated by reference herein). 10.60 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and Intergroup Healthcare Corporation (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on August 9, 1994, which is incorporated by reference herein). 10.61 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and Thomas-Davis Medical Centers, P.C. (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on August 9, 1994, which is incorporated by reference herein). 10.62 Amended Letter Agreement between the Company and Jay M. Gellert dated as of August 22, 1997 (filed as Exhibit 10.69 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein).
29 10.63 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the Company and the Majority Banks (as defined therein) (filed as Exhibit 10.70 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). *10.64 First Amendment and Waiver to Credit Agreement, dated as of April 6, 1998, among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein), a copy of which is filed herewith. *10.65 Purchase Agreement by and between Foundation Health Corporation and Superior National Insurance Group, Inc., dated as of May 5, 1998, a copy of which is filed herewith. 10.66 Employment Letter Agreement between the Company and Dale Terrell dated December 31, 1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.67 Employment Letter Agreement between the Company and Steven P. Erwin dated March 11, 1998 (filed as Exhibit 10.72 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.68 Employment Agreement, dated as of December 31, 1997, between the Company and Maurice Costa (filed as Exhibit 10.73 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.69 Employment Agreement, dated as of December 31, 1997, between the Company and Robert L. Natt (filed as Exhibit 10.74 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.70 Employment Letter Agreement, dated October 10, 1997, between the Company and Alex Labak (filed as Exhibit 10.75 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.71 Employment Letter, dated June 9, 1995, between Philip Katz, Ph.D. and Health Net (filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which is incorporated by reference herein). *11.1 Statement relative to computation of per share earnings of the Company (included in the notes to the Financial Statements contained in this Quarterly Report on Form 10-Q). 21.1 Subsidiaries of the Company (filed as Exhibit 21.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). *27.1 Financial Data Schedule, a copy of which has been filed with the EDGAR version of this filing.
- ------------------------ * A copy of the Exhibit is filed herewith. (b) Reports on Form 8-K No Current Reports on Form 8-K were filed by the Company during the quarterly period ended March 31, 1998. 30 SIGNATURES Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FOUNDATION HEALTH SYSTEMS, INC. (REGISTRANT) Date: May 14, 1998 By: /s/ JAY M. GELLERT ----------------------------------------- Jay M. Gellert PRESIDENT AND CHIEF OPERATING OFFICER Date: May 14, 1998 By: /s/ STEVEN P. ERWIN ----------------------------------------- Steven P. Erwin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
31 EX-10.64 2 EXHIBIT 10.64 EXHIBIT 10.64 FIRST AMENDMENT AND WAIVER TO CREDIT AGREEMENT THIS FIRST AMENDMENT AND WAIVER TO CREDIT AGREEMENT is made and dated as of April 6, 1998 (the "FIRST AMENDMENT") among FOUNDATION HEALTH SYSTEMS, INC. (the "COMPANY"), the Banks party to the Credit Agreement referred to below, and BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as Administrative Agent (the "AGENT"), and amends that certain Credit Agreement dated as of July 8, 1997 (as amended or modified from time to time, the "CREDIT AGREEMENT"). RECITALS WHEREAS, the Company has requested the Agent and the Banks to amend certain provisions of the Credit Agreement, and the Agent and the Banks are willing to do so, on the terms and conditions specified herein; NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereby agree as follows: 1. TERMS. All terms used herein shall have the same meanings as in the Credit Agreement unless otherwise defined herein. 2. AMENDMENT. The Credit Agreement is hereby amended as follows: 2.1 AMENDMENTS TO SECTION 1.01. (a) There shall be added to Section 1.01 of the Credit Agreement, in appropriate alphabetical sequence, the following new definitions reading as follows: "RESTRICTED INDEBTEDNESS" means all Indebtedness of the Company or its Subsidiaries, other than Specified Indebtedness, incurred after December 31, 1997 and pursuant to Section 7.05(e). "SPECIFIED INDEBTEDNESS" means up to an aggregate of $200,000,000 of (a) Indebtedness of the Company or any Subsidiary, other than any Indebtedness for borrowed money or Commercial Paper Debt and (b) Indebtedness of the Company or a Subsidiary assumed or issued in connection with Permitted Acquisition, in either case, incurred after December 31, 1997 and pursuant to Section 7.05(e). "WORKERS COMPENSATION DISPOSITION" means the sale or other disposition by the Company after December 31, 1997 of its discontinued workers compensation businesses. -1- (b) The definition of the term "Adjusted EBITDA" in Section 1.01 of the Credit Agreement is hereby amended by adding the following clause immediately prior to the end thereof: "minus (iii) the aggregate losses, reserves and charges for the Company's workers' compensation business after December 31, 1997 to the extent that the aggregate amount thereof exceeds the $25,000,000 reserve set forth in the definition of the term "Specified Charges." (c) The definition of the term "Applicable Level" in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "APPLICABLE LEVEL" means one of the levels set forth below determined by the Senior Unsecured Debt Rating as follows: "LEVEL 1" means any period during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) A- by S&P and/or (ii) A3 by Moody's. "LEVEL 2" means any period (other than a Level 1 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BBB+ by S&P and/or (ii) Baal by Moody's. "LEVEL 3" means any period (other than a Level 1 Period or Level 2 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BBB by S&P and/or (ii) Baa2 by Moody's. "LEVEL 4" means any period (other than a Level 1 Period, Level 2 Period or Level 3 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BBB- by S&P and/or (ii) Baa3 by Moody's. "LEVEL 5" means any period (other than a Level 1 Period, Level 2 Period, Level 3 Period or Level 4 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BB+ by S&P and/or (ii) Ba1 by Moody's. "LEVEL 6" means any period (other than a Level 1 Period, Level 2 Period, Level 3 Period, Level 4 Period or Level 5 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BB by S&P and/or (ii) Ba2 by Moody's. -2- "LEVEL 7" means any period (other than a Level 1 Period, Level 2 Period, Level 3 Period, Level 4 Period, Level 5 Period or Level 6 Period) during which the Senior Unsecured Debt Rating is better than or equal to at least one of the following ratings: (i) BB- by S&P and/or (ii) Ba3 by Moody's. "LEVEL 8" means any period other than a Level 1 Period, Level 2 Period, Level 3 Period, Level 4 Period, Level 5 Period, Level 6 Period or Level 7 Period. For purposes of the foregoing, (a) if the Senior Unsecured Debt Ratings fall within different Levels, the Applicable Level shall be based upon the higher (numerically lower) of the available Levels unless (i) such Levels are more than one Level apart, in which case, except as provided in clause (ii) below, the Applicable Level shall be one Level higher than the lower Level or (ii) one of such Levels is Level 7 or Level 8, in which case the Applicable Level shall be based upon the lower (numerically higher) of the Levels; (b) if only one Senior Unsecured Debt Rating exists, the Applicable Level shall be based upon the Level in which such rating falls; and (c) if no Senior Unsecured Debt Rating shall be available, the Applicable Level shall be Level 8. (d) The definition of the term "Applicable Margin" in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "APPLICABLE MARGIN" means, in the case of Facility Fees, Base Rate Committed Loans or Offshore Rate Committed Loans, a rate per annum determined by reference to the Applicable Level as follows:
APPLICABLE APPLICABLE BASE RATE APPLICABLE OFFSHORE FACILITY LEVEL MARGIN RATE MARGIN FEE ----- -------------------- ------------------- -------- Level 1 0.000% 0.200% 0.100% Level 2 0.000% 0.225% 0.125% Level 3 0.000% 0.250% 0.150% Level 4 0.000% 0.325% 0.175% Level 5 0.000% 0.550% 0.200% Level 6 0.000% 0.775% 0.225% Level 7 0.250% 1.250% 0.250% Level 8 0.700% 1.700% 0.300%
The Applicable Margin shall be effective on the earlier of the date on which such rating change is publicly announced or on the date written confirmation of a change in the Senior Unsecured Debt Rating is sent to the Company by S&P or Moody's. -3- (e) The definition of the term "Fixed Charges" in Section 1.01 of the Credit Agreement is hereby amended by adding the following clause immediately prior to the end thereof: ", each of the foregoing shall exclude all effects of the Company's workers compensation business, including, for the quarters ending on or before December 31, 1997, the amounts set forth on Part 2 of Schedule 1.01." (f) The first clause in the definition of the term "Net Cash Flow" in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "(before the Specified Charges, extraordinary gains and losses and all one-time acquisition related costs and expenses incurred by the Company in connection with a Permitted Acquisition and excluding all effects of the Company's workers compensation business, including, for the quarters ending on or before December 31, 1997, the amounts set forth on Part 2 of Schedule 1.01)"; and the following clause shall be added immediately prior to the end of such definition: "and minus (iv) the aggregate losses, reserves and charges for the Company's workers' compensation business after December 31, 1997 to the extent that the aggregate amount thereof exceeds the $25,000,000 reserve set forth in the definition of the term "Specified Charges." (g) The definition of the term "Specified Charges" in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "SPECIFIED CHARGES" means those items, and only those items, set forth on Part 1 of Schedule 1.01 hereof. (h) There shall be added to the Credit Agreement a new Schedule 1.01 reading in its entirety as set forth on Schedule 1.01 hereto. 2.2 AMENDMENTS TO SECTION 2.09. Section 2.09 of the Credit Agreement is hereby amended and restated to read in its entirety as follows: 2.09 MANDATORY REDUCTION OF COMMITMENTS AND REPAYMENT OF LOANS. (a) Subject to Section 3.04, the Company shall ratably prepay Committed Loans with all net cash proceeds (less costs of sale) from the Workers Compensation Disposition. The Company shall give the Administrative Agent not less than one Business Day's notice of such prepayment, and such notice of prepayment shall specify the date and amount of such prepayment and the Type(s) of Committed Loans to be prepaid. The Administrative Agent will promptly notify each Bank of its receipt of -4- any such notice, and of such Bank's Pro Rata Share of such prepayment. If such notice is given by the Company, the Company shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein, together with, in the case of Offshore Rate Committed Loans only, accrued interest to each such date on the amount prepaid and any amounts required pursuant to Section 3.04. (b) Subject to Section 3.04, the Company shall ratably prepay Committed Loans by an amount equal to the first $250,000,000 of net cash proceeds from any Restricted Indebtedness and 50% of any such net cash proceeds in excess of $250,000,000. The Company shall give the Administrative Agent not less than one Business Day's notice of such prepayment, and such notice of prepayment shall specify the date and amount of such prepayment and the Type(s) of Committed Loans to be prepaid. The Administrative Agent will promptly notify each Bank of its receipt of any such notice, and of such Bank's Pro Rata Share of such prepayment. If such notice is given by the Company, the Company shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein, together with, in the case of Offshore Rate Committed Loans only, accrued interest to each such date on the amount prepaid and any amounts required pursuant to Section 3.04. On the date such prepayment is required to be made, the aggregate Commitments shall automatically and permanently be reduced by an amount equal to the first $250,000,000 of net cash proceeds from any Restricted Indebtedness and 50% of such net cash proceeds in excess of $250,000,000 from any Restricted Indebtedness. (c) The Company shall repay to the Banks on the Revolving Termination Date the aggregate principal amount of Committed Loans outstanding on such date. (d) The Company shall repay each Bid Loan on the last day of the relevant Interest Period. 2.3 AMENDMENT TO SECTION 7.02. Section 7.02 of the Credit Agreement is hereby amended by replacing the period at the end thereof with "; and" and by adding the following clause immediately thereafter: "(e) the Workers Compensation Disposition; PROVIDED that all net cash proceeds therefrom (less costs of sale) shall promptly thereafter (and in no event later than 30 days after the closing thereof) be applied by the Company to prepay the Committed Loans pursuant to Section 2.09(a)." 2.4 AMENDMENT TO SECTION 7.05. Section 7.05 of the Credit Agreement is hereby amended and restated as follows: "7.05 LIMITATION ON INDEBTEDNESS. The Company shall not, and shall not suffer or permit any Subsidiary to, create, incur, assume, suffer to exist, or -5- otherwise become or remain directly or indirectly liable with respect to, any Indebtedness, except: (a) Indebtedness incurred pursuant to this Agreement; (b) Indebtedness consisting of Contingent Obligations permitted pursuant to Section 7.08; (c) Indebtedness existing on December 31, 1997 and set forth in SCHEDULE 7.05 and any renewals, extensions, replacements and refundings of such Indebtedness; (d) Indebtedness secured by Liens permitted by Sections 7.01(h) and (i) in an aggregate amount outstanding not to exceed $150,000,000; (e) other Indebtedness incurred after December 31, 1997 in an aggregate amount not to exceed $1,000,000,000, so long as (i) (A) such Indebtedness (other than Specified Indebtedness) is not senior in right of payment to the Obligations, contains no covenants, events of default or other material provisions that are more restrictive than those contained in this Agreement, and has principal payment dates commencing after July 8, 2002 and (B) the net cash proceeds of such Indebtedness (other than Specified Indebtedness) shall be applied by the Company to prepay the Committed Loans and reduce the Commitments pursuant to Section 2.09(b) and (ii) not more than $150,000,000 of all Indebtedness permitted under this subsection (e) may be Indebtedness of Subsidiaries; and (f) Commercial Paper Debt." 2.5 AMENDMENT TO SECTION 7.11. Section 7.11 of the Credit Agreement is hereby amended by adding the following sentence immediately prior to the end thereof: "The Company will not, and will not permit any of its Subsidiaries to, make any payment or prepayment of any Restricted Indebtedness on any day other than the stated scheduled date for such payment set forth in such Restricted Indebtedness or redeem, purchase or defease any Restricted Indebtedness prior to its stated maturity." 2.6 AMENDMENT TO SECTION 7.12. (a) Clause (a) of Section 7.12 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "(a) the Total Leverage Ratio, as of any date set forth below, to exceed the ratio set forth below opposite such date: -6-
Date Maximum Total Leverage Ratio ---- ---------------------------- December 31, 1997 3.50 to 1.00 March 31, 1998 4.00 to 1.00 June 30, 1998 3.75 to 1.00 September 30, 1998 3.50 to 1.00 December 31, 1998 3.25 to 1.00 Thereafter 3.00 to 1.00;"
(b) Clause (b) of Section 7.12 of the Credit Agreement is hereby amended and restated to read in its entirety as follows: "(b) the Fixed Charges Coverage Ratio, as of any date set forth below, to be less than the ratio set forth below opposite such date:
Date Minimum Fixed Charges Coverage Ratio ---- ------------------------------------ December 31, 1997 2.50 to 1.00 March 31, 1998 2.25 to 1.00 June 30, 1998 1.50 to 1.00 September 30, 1998 1.50 to 1.00 December 31, 1998 1.75 to 1.00 Thereafter 2.00 to 1.00;"
(c) Clause (c) of Section 7.12 of the Credit Agreement is hereby amended by inserting the phrase "(without giving effect to any losses)" after the date "June 30, 1997" in the third line thereof. 3. WAIVER. By their execution hereof, the Banks hereby confirm that the waivers set forth in that certain waiver letter dated March 5, 1998 to the Company have become permanent. 4. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to the Agent and the Banks that, on and as of the date hereof, and after giving effect to this First Amendment; 4.1 AUTHORIZATION. The execution, delivery and performance by the Company of this First Amendment has been duly authorized by all necessary corporate action, and this First Amendment has been duly executed and delivered by the Company. 4.2 BINDING OBLIGATION. This First Amendment constitutes the legal, valid and binding obligations of the Company, enforceable against it in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, or similar laws -7- affecting the enforcement of creditors' rights generally or by equitable principles relating to enforceability. 4.3 NO LEGAL OBSTACLE TO AMENDMENT. The execution, delivery and performance of this First Amendment will not (a) contravene the Organization Documents of the Company; (b) constitute a breach or default under any contractual restriction or violate or contravene any law or governmental regulation or court decree or order binding on or affecting the Company which individually or in the aggregate does or could reasonably be expected to have a Material Adverse Effect; or (c) result in, or require the creation or imposition of, any Lien on any of the Company's properties. No approval or authorization of any governmental authority is required to permit the execution, delivery or performance by the Company of this First Amendment, or the transactions contemplated hereby. 4.4 INCORPORATION OF CERTAIN REPRESENTATIONS. After giving effect to the terms of this First Amendment, the representations and warranties of the Company set forth in Article V of the Credit Agreement are true and correct in all respects on and as of the date hereof as though made on and as of the date hereof, except as to such representations made as of an earlier specified date. 4.5 DEFAULT. Taking into account the effectiveness of the waiver letter referenced in Section 3 hereof, no Default or Event of Default under the Credit Agreement has occurred and is continuing. 5. CONDITIONS, EFFECTIVENESS. The effectiveness of this First Amendment shall be subject to the compliance by the Company with its agreements herein contained, and to the delivery of the following to Agent in form and substance satisfactory to Agent: 5.1 AUTHORIZED SIGNATORIES. A certificate, signed by the Secretary or an Assistant Secretary of the Company and dated the date of this First Amendment, as to the incumbency of the person or persons authorized to execute and deliver this First Amendment and any instrument or agreement required hereunder on behalf of the Company. 5.2 AUTHORIZING RESOLUTIONS. A certificate, signed by the Secretary or an Assistant Secretary of the Company and dated the date of this First Amendment, as to the resolutions of the Company's board of directors authorizing the transactions contemplated by this First Amendment. 5.3 AMENDMENT FEE. Payment to the Agent, (i) for the PRO RATA benefit of each Bank executing this First Amendment on or before 2:00 p.m., Pacific time, on April 6, 1998, of an amendment fee in an amount equal to .075% of the aggregate amount of the Commitments held by the Banks that have executed this First Amendment and (ii) for the PRO RATA benefit of each Bank that delivered a written commitment to execute this First Amendment by 4:00 p.m., Pacific time, on or before March 27, 1998, an additional fee in an amount equal to .075% of the -8- aggregate amount of the Commitments held by the Banks that delivered such written commitments. 5.4 OTHER EVIDENCE. Such other evidence with respect to the Company or any other person as the Agent or any Bank may reasonably request to establish the consummation of the transactions contemplated hereby, the taking of all corporate action in connection with this First Amendment and the Credit Agreement and the compliance with the conditions set forth herein. 6. MISCELLANEOUS. 6.1 EFFECTIVENESS OF THE CREDIT AGREEMENT AND THE NOTES. Except as hereby expressly amended, the Credit Agreement and the Notes shall each remain in full force and effect, and are hereby ratified and confirmed in all respects on and as of the date hereof. 6.2 WAIVERS. This First Amendment is limited solely to the matters expressly set forth herein and is specific in time and in intent and does not constitute, nor should it be construed as, a waiver or amendment of any other term or condition, right, power or privilege under the Credit Agreement or under any agreement, contract, indenture, document or instrument mentioned therein; nor does it preclude or prejudice any rights of the Agent or the Banks thereunder, or any exercise thereof or the exercise of any other right, power or privilege, nor shall it require the Majority Banks to agree to an amendment, waiver or consent for a similar transaction or on a future occasion, nor shall any future waiver of any right, power, privilege or default hereunder, or under any agreement, contract, indenture, document or instrument mentioned in the Credit Agreement, constitute a waiver of any other right, power, privilege or default of the same or of any other term or provision. 6.3 COUNTERPARTS. This First Amendment may be executed in any number of counterparts, and all of such counterparts taken together shall be deemed to constitute one and the same instrument. This First Amendment shall not become effective until the Company, the Agent and the Majority Banks shall have signed a copy hereof and the same shall have been delivered to the Agent. 6.4 GOVERNING LAW. This First Amendment shall be governed by and construed in accordance with the laws of the State of California. -9- IN WITNESS WHEREOF, the parties hereto have caused this First Amendment to be duly executed and delivered as of the date first written above. FOUNDATION HEALTH SYSTEMS, INC. [/s/ SIGNATURE] BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as Administrative Agent [/s/ SIGNATURE] [NOTE: Signature blocks for other Banks and Schedules are not included with this copy] -10- EX-10.65 3 EXHIBIT 10.65 Exhibit 10.65 PURCHASE AGREEMENT PURCHASE AGREEMENT, dated as of May 5, 1998 (this "AGREEMENT"), by and between Foundation Health Corporation, a Delaware corporation ("SELLER"), and Superior National Insurance Group, Inc., a Delaware corporation ("PURCHASER"). WHEREAS, Seller is the owner of all of the outstanding shares (the "SHARES") of capital stock of Business Insurance Group, Inc., a Delaware insurance holding company (the "COMPANY"), whose principal assets are all of the capital stock of each of California Compensation Insurance Company, a California stock insurance company ("CALCOMP"), Business Insurance Company, a Delaware stock insurance company ("BIC"), Combined Benefits Insurance Company, a California stock insurance company ("CBIC") and Commercial Compensation Insurance Company, a New York stock insurance company ("CCIC", and together with CalComp, BIC and CBIC, taken as a whole, the "INSURANCE SUBSIDIARIES", and together with the Company, the "SELLER SUBSIDIARIES"); WHEREAS, the Seller Subsidiaries have the right to acquire the reinsurance policy described on Exhibit A (the "REINSURANCE AGREEMENT") and a condition to the obligations of the Purchaser to consummate the transactions contemplated hereby is that the Seller Subsidiaries shall have entered into the Reinsurance Agreement; WHEREAS, Purchaser desires to purchase from Seller, and Seller desires to sell to Purchaser, all of the Shares of the Company, and by that means, the ownership of the Seller Subsidiaries, subject to the terms and conditions of this Agreement; WHEREAS, Seller intends, prior to the Closing (as hereinafter defined), to cause the Company to dividend or otherwise distribute all of the capital stock of each of Foundation Health Medical Resource Management, d/b/a Reviewco ("REVIEWCO"), Foundation Integrated Risk Management Solutions, Incorporated, d/b/a FIRM Solutions ("FIRMS") and Axis Integrated Resources, Inc. ("AXIS"), each a wholly owned subsidiary of the Company (collectively, the "EXCLUDED ASSETS") to one or more other Affiliates of Seller; WHEREAS, contemporaneous with the Closing (i) Purchaser, the Company and Reviewco will enter into a long-term service agreement consistent with the terms of Exhibit B-1 (e.g., medical bill review, PPO utilization and certain managed care services), (ii) Purchaser, the Company and FIRMS will enter into a long-term service agreement consistent with the terms of Exhibit B-2 (e.g., claim negotiation and review services), (iii) Purchaser, the Company and Axis will enter into a long-term service agreement consistent with the terms of Exhibit B-3 (e.g., recruitment of employees and placement of temporary workers services) and (iv) Purchaser, the Company and Foundation Health Systems, Inc. ("FHS"), will enter into a term sheet setting forth the terms of a transitional service agreement in the form of Exhibit B-4 (e.g., transitional corporate administrative services) (collectively, the "SERVICE AGREEMENTS"); WHEREAS, Seller holds certain promissory notes, dated May 30, 1996 and August 9, 1996 issued by the Company in the current combined principal amount of $121,250,000 plus all accrued and unpaid interest thereon (the "INTERCOMPANY NOTE"), which will be satisfied in connection with the sale of the Shares; WHEREAS, certain stockholders of Purchaser, including certain of the executive officers and directors of the Purchaser and Insurance Partners, L.P., Insurance Partners Offshore (Bermuda), L.P. and certain of their affiliates have entered into Voting Agreements, dated the date hereof in the forms of Exhibit C-1-C-2 (the "VOTING AGREEMENTS"), whereby such stockholders have agreed under the terms thereof to vote all of their shares of common stock of Purchaser in favor of all matters that require stockholder approval in order to consummate the transactions contemplated hereby; and WHEREAS, Purchaser and Seller desire to treat the sale of the Shares as a sale of the Seller Subsidiaries' assets for purposes of Federal income taxation and to make an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended (the "CODE") with respect to the Company and each of the Insurance Subsidiaries. NOW, THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements set forth herein, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties, intending to be legally bound hereby, agree as follows: 2 ARTICLE I PURCHASE AND SALE SECTION 1.1 PURCHASE AND SALE. Upon the terms and subject to the conditions set forth in this Agreement, at the Closing, Seller shall sell, assign, transfer and deliver to Purchaser, and Purchaser shall purchase from Seller, the Shares, free and clear of all options, pledges, security interests, liens or other encumbrances or restrictions on voting or transfer ("ENCUMBRANCES"), other than restrictions imposed by Federal or state securities laws. SECTION 1.2 PURCHASE PRICE. On the Closing Date (as hereinafter defined) and subject to the terms and conditions set forth in this Agreement, Seller shall deliver a certificate or certificates representing the Shares duly endorsed in blank or accompanied by stock powers duly executed in blank and, in consideration of the sale, assignment, transfer and delivery of the Shares, Purchaser shall pay to Seller an amount equal to $280,000,000 less the cost of the Reinsurance Agreement (the "PURCHASE PRICE") by wire transfer of immediately available funds to an account or accounts designated by Seller. The Intercompany Note will be settled prior to Closing. Interest accrued prior to Closing on the Intercompany Note may continue to be paid to Seller consistent with past practices. All accrued but unpaid interest on the Intercompany Note as of the Closing Date will be settled pursuant to Section 4.9. SECTION 1.3 CLOSING. (a) The sale and purchase of the Shares contemplated by this Agreement shall take place at a closing (the "CLOSING") to be held at the offices of Riordan & McKinzie in Los Angeles at 8:00 a.m. local time on a date as soon as practical following the satisfaction or waiver of all conditions to the obligations of the parties set forth in Article VI, but in no event later than September 15, 1998 (or October 15, 1998, in the event Purchaser has commenced its common stock rights offering contemplated by the Financing Agreements), or at such other place or at such other time or on such other date as Seller and Purchaser mutually agree on in writing (the day on which the Closing takes place being the "CLOSING DATE"). (b) At the Closing, Seller shall deliver or cause to be delivered to Purchaser (i) stock certificates evidencing the Shares duly endorsed in blank or accompanied by stock powers duly executed in blank, (ii) duly executed Service 3 Agreements, (iii) a duly executed Reinsurance Agreement and (iv) all other previously undelivered certificates and other documents required to be delivered by Seller to Purchaser at or prior to the Closing Date in connection with the transactions contemplated hereby. (c) At the Closing, Purchaser shall deliver to Seller (i) the Purchase Price by wire transfer in immediately available funds to an account or accounts designated by Seller, (ii) duly executed Service Agreements and (iii) all other previously undelivered certificates and other documents required to be delivered by Purchaser to Seller at or prior to the Closing Date in connection with the transactions contemplated hereby. ARTICLE II REPRESENTATIONS AND WARRANTIES OF SELLER Seller represents and warrants to Purchaser as follows: SECTION 2.1 ORGANIZATION. Seller and each Seller Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization and has all requisite power and authority to own, lease and operate its properties and to carry on its business as it is now being conducted. Seller and each Seller Subsidiary is duly qualified or licensed to do business as a foreign corporation or other entity and is in good standing in each jurisdiction in which the nature of the business conducted by it makes such qualification or licensing necessary. Seller has made available to Purchaser a complete and correct copy of each of the articles or certificate of incorporation, bylaws, certificate of formation, operating agreement or similar organizational documents of Seller and each Seller Subsidiary, as currently in effect. As used in this Agreement, "SELLER MATERIAL ADVERSE EFFECT" means any material adverse change in, or material adverse effect on, the business, financial condition or operations of the Seller Subsidiaries, taken as a whole; PROVIDED, HOWEVER, that, the effects of changes that are generally applicable to (i) changes resulting from market fluctuations in the value of the Seller Subsidiaries' investment portfolio and (ii) the commutation of the Agreement of Reinsurance No. 8382 and the Agreement of Reinsurance No. 8429, each between the Seller Subsidiaries and General Reinsurance Corporation, if completed prior to Closing, shall be excluded from the determination of Seller Material Adverse Effect; and PROVIDED, FURTHER, that any adverse effect on the Seller Subsidiaries resulting from 4 the execution of this Agreement and the announcement of this Agreement and the transactions contemplated hereby shall also be excluded from the determination of Seller Material Adverse Effect. SECTION 2.2 CAPITALIZATION. Section 2.2 of the written statement delivered by Seller to Purchaser at or prior to the execution of this Agreement (the "DISCLOSURE SCHEDULE") sets forth the authorized, issued and outstanding capital stock of each Seller Subsidiary. All the outstanding shares of capital stock of the Seller Subsidiaries are duly authorized, validly issued, fully paid, nonassessable and free of preemptive rights. There are no existing (i) options, warrants, calls, subscriptions or other rights, convertible securities, agreements or commitments of any character obligating Seller or any Seller Subsidiary to issue, transfer or sell any shares of capital stock or other equity interest in any Seller Subsidiary or securities convertible into or exchangeable for such shares or equity interests, (ii) contractual or other obligations of any Seller Subsidiary to repurchase, redeem or otherwise acquire any capital stock of Seller or any Seller Subsidiary or (iii) voting trusts or similar agreements or understandings to which Seller or any Seller Subsidiary is a party with respect to the voting of the capital stock of any Seller Subsidiary. SECTION 2.3 OWNERSHIP OF STOCK. The Shares are owned by Seller free and clear of all Encumbrances, other than restrictions imposed by Federal and state securities laws. All of the issued and outstanding shares of the stock of each of the Insurance Subsidiaries is owned by the Company free and clear of all Encumbrances other than restrictions imposed by Federal and state securities laws. Upon the consummation of the transactions contemplated hereby, Purchaser will acquire title to the Shares, free and clear of all Encumbrances, other than restrictions imposed by Federal and state securities laws. SECTION 2.4 AUTHORIZATION; VALIDITY OF AGREEMENT. Seller and each Seller Subsidiary, as appropriate, has the power and authority to execute and deliver this Agreement and all the agreements and documents contemplated hereby, to carry out its obligations hereunder and thereunder, and to consummate the transactions contemplated hereby and thereby. The execution, delivery and performance by Seller and each Seller Subsidiary, as appropriate, of this Agreement, and all the agreements and documents contemplated hereby and thereby, and the consummation by it of the transactions contemplated hereby and thereby, have been duly authorized by all necessary corporate action, and no other corporate action on the part of Seller or such Seller Subsidiary is necessary to authorize the execution and delivery by Seller and such Seller Subsidiary as, appropriate, of this Agreement and all the 5 agreements and documents contemplated hereby and thereby and the consummation by it of the transactions contemplated hereby and thereby. This Agreement and each of the agreements and documents contemplated hereby has been duly executed and delivered by Seller and the Seller Subsidiaries, as appropriate, and (assuming due and valid authorization, execution and delivery hereof by Purchaser) is a valid and binding obligation of Seller and the Seller Subsidiaries, as appropriate, enforceable against Seller and the Seller Subsidiaries, as appropriate, in accordance with its terms, except that (i) such enforcement may be subject to applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect affecting creditors' rights generally and (ii) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding therefor may be brought. SECTION 2.5 CONSENTS AND APPROVALS; NO VIOLATIONS. Except as disclosed in Section 2.5 of the Disclosure Schedule and except for (a) filings pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR ACT"), (b) approvals or consents of any court, legislative, executive or regulatory authority or agency (a "GOVERNMENTAL ENTITY") under insurance holding company laws of the states in which the Seller Subsidiaries are domiciled or as may be otherwise required by law, (c) applicable requirements under corporation or "blue sky" laws of various states and (d) matters specifically described in this Agreement, neither the execution, delivery or performance of this Agreement or any agreement or document contemplated hereby by Seller or any Seller Subsidiary, as the case may be, nor the consummation by Seller or any Seller Subsidiary, as the case may be, of the transactions contemplated hereby or thereby will (i) violate any provision of the articles or certificate of incorporation, bylaws or other organizational documents of Seller or any Seller Subsidiary, (ii) result in a violation or breach of, or constitute (with or without due notice or lapse of time or both) a default (or give rise to any right of termination, cancellation or acceleration) under, or result in the creation of any lien, security interest, charge or encumbrances upon any of the properties or assets of Seller or any Seller Subsidiary under (or result in being declared void, voidable or without further binding effect) any of the terms, conditions or provisions of any note, bond, mortgage, indenture, lease, license, contract, agreement or other instrument, commitment or obligation to which Seller or any Seller Subsidiary is a party or by which any of them or any of their properties or assets may be bound, (iii) violate any order, writ, judgment, injunction, decree, law, statute, rule or regulation applicable to Seller, any Seller Subsidiary or any of their properties or assets, (iv) require on the part of Seller or any Seller Subsidiary any filing or registration with, notification to, or authorization, consent or approval of, any Governmental Entity or (v) result in a termination, 6 loss or adverse modification of any license, permit, certificate or franchise granted to, or otherwise held by, Seller or any Seller Subsidiary; except in the case of clauses (ii) through (v) for such violations, breaches, defaults or other events specified therein, which, or filings, registrations, notifications, authorizations, consents or approvals the failure of which to obtain, would (A) not have a Seller Material Adverse Effect and would not materially adversely affect the ability of Seller to consummate the transactions contemplated by this Agreement or (B) become applicable as a result of the business or activities in which Purchaser is or proposes to be engaged or as a result of any acts or omissions by, or the status of any facts pertaining to, Purchaser. SECTION 2.6 FINANCIAL STATEMENTS. (a) Seller has delivered to Purchaser the unaudited consolidated balance sheets of the Seller Subsidiaries as of December 31, 1997, and the related unaudited consolidated statements of income for each of the two years in the period ended December 31, 1997 (collectively, the "FINANCIAL STATEMENTS"). Except as set forth in Section 2.6 of the Disclosure Schedule, (i) the Financial Statements have been derived from the books and records of the Seller Subsidiaries and (ii) (A) the unaudited consolidated balance sheets included in the Financial Statements present fairly in all material respects, the financial position of the Seller Subsidiaries as of the respective dates thereof, and (B) the other related unaudited statements of income present fairly, in all material respects, the results of their operations for the periods therein specified, in each case prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP"), except for the absence of footnote disclosures, Statements of Cash Flows and Statements of Changes in Stockholders' Equity, all of which are required under GAAP. (b) Seller has delivered to Purchaser copies of audited statutory financial statements for each Insurance Subsidiary as of the year ended December 31, 1997, prepared in conformity with accounting practices prescribed or permitted by the respective state of domicile for each Insurance Subsidiary (collectively, the "STAT FINANCIAL STATEMENTS"). Each of the balance sheets included in the STAT Financial Statements fairly presents in all material respects the financial position of the applicable Seller Subsidiary as of December 31, 1997 and each statement of operations included in the STAT Financial Statements fairly presents in all material respects the results of operations of the applicable Insurance Subsidiary for the period therein set forth, in each case in accordance with statutory accounting practices prescribed or permitted by the respective state of domicile. 7 (c) Notwithstanding any other provision of this Agreement (including Sections 2.6 and 2.7), Seller makes no representation or warranty with respect to (i) the items set forth in Section 2.6 of the Disclosure Schedule (the "LISTED ITEMS") or (ii) the reserves of the Seller Subsidiaries for losses or loss adjustment expenses (including, without limitation, whether such reserves or liabilities are adequate or sufficient). Purchaser acknowledges that nothing in this Agreement (including Sections 2.6 and 2.7) is intended to, or shall be construed to, provide a guaranty of the adequacy of (i) the Listed Items or (ii) the loss and loss adjustment expense reserves of Seller as shown in the Financial Statements or the STAT Financial Statements. SECTION 2.7 NO UNDISCLOSED LIABILITIES. Except as disclosed in Section 2.7 of the Disclosure Schedule and as set forth in Section 2.6(c) above and except (a) for liabilities and obligations incurred in the ordinary course of business, consistent with past practices, after December 31, 1997, (b) for liabilities and obligations disclosed in the Financial Statements or the STAT Financial Statements and (c) for liabilities and obligations incurred in connection with the transactions contemplated hereby or otherwise as contemplated by this Agreement, since December 31, 1997, the Seller Subsidiaries have not incurred any liabilities or obligations that would constitute a Seller Material Adverse Effect. SECTION 2.8 ABSENCE OF CERTAIN CHANGES. Except as (a) disclosed in Sections 2.6 or 2.8 of the Disclosure Schedule or (b) contemplated by this Agreement, since December 31, 1997, the Seller Subsidiaries have not (i) suffered any change constituting a Seller Material Adverse Effect, (ii) amended their articles or certificate of incorporation, bylaws or other organizational documents, (iii) materially changed their accounting principles, practices or methods, except as required by GAAP or applicable law, (iv) suffered any event or change or taken any action that would have violated Section 4.1(b) through (m) below if it had occurred or been taken after the date hereof and (iv) the Company has not (x) split, combined or reclassified the Shares or (y) declared or set aside or paid any dividend or other distribution with respect to the Shares other than regular cash dividends which have been declared consistent with past practice and set forth in Section 2.8 of the Disclosure Schedule (excluding dividends or distributions payments made to Seller Subsidiaries). 8 SECTION 2.9 EMPLOYEE BENEFIT PLANS; ERISA. (a) Section 2.9(a) of the Disclosure Schedule sets forth a list of all material employee benefit plans, programs and agreements, (including but not limited to plans described in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and all multiemployer plans (as defined in Section 4001(a)(3) of ERISA maintained or contributed to by the Seller Subsidiaries, or by any trade or business, whether or not incorporated (an "ERISA AFFILIATE"), which together with the Seller Subsidiaries, would be deemed a "single employer" within the meaning of Section 414 of the Code for the benefit of employees, former employees and directors of, and consultants of, and consultants to, the Seller Subsidiaries ("BENEFIT PLANS"). (b) With respect to each Benefit Plan, Seller has made available to Purchaser complete copies of the plan documents (including all amendments thereto) and, where applicable, the most recent summary plan description, all other material employee communications and the most recent Internal Revenue Service determination letter relating to such Benefit Plan. (c) Each Benefit Plan has been operated and administered in all material respects in accordance with its terms and applicable law, including, without limitation, ERISA and the Code, except where the failure to so administer such plan would not reasonably be expected to have a Seller Material Adverse Effect. (d) Except as disclosed in Section 2.9(d) of the Disclosure Schedule, no Benefit Plan provides medical or death benefits with respect to current or former employees of the Seller Subsidiaries beyond their termination of employment other than (i) to the extent required by applicable law, (ii) death benefits under any "pension plan" (as defined in Section 3(2) of ERISA) or (iii) benefits the full cost of which is borne by the current or former employee (or his beneficiary). (e) Except as set forth in Section 2.9(e) of the Disclosure Schedule, all costs of administering and contributions required to be made to each Benefit Plan under the terms of that Benefit Plan, ERISA, the Code or any other applicable law have been timely made. (f) No Benefit Plan is subject to Code Section 412. 9 (g) The Internal Revenue Service has issued a favorable determination letter with respect to each Benefit Plan that is intended to qualify under Section 401(a) of the Code and to the knowledge of Seller, no event has occurred (either before or after the date of the letter) that would disqualify the plan. (h) Except as set forth in Section 2.9(h) of the Disclosure Schedule, to the knowledge of Seller, there are no investigations, proceedings, or lawsuits, either currently in progress or expected to be instituted in the future, relating to any Benefit Plan, by any administrative agency, whether local, state, or federal. (i) There are no pending or, to the knowledge of Seller, threatened lawsuits or other claims (other than routine claims for benefits under the plan and qualified domestic relations orders) against or involving (i) any Benefit Plan or (ii) any Fiduciary of such plan (within the meaning of Section 3(21)(A) of ERISA) brought on behalf of any participant, beneficiary, or Fiduciary thereunder relating to any Benefit Plan. (j) None of the Seller Subsidiaries have any intention or legally binding commitment to create any additional Benefit Plan, or to modify or change any existing Benefit Plan so as to increase benefits to participants or the cost of maintaining the plan. (k) Except as disclosed in Section 2.9(k) of the Disclosure Schedule, none of the Benefit Plans or employment contracts with any of the Seller Subsidiaries provide any benefits that become payable solely as a result of the consummation of this transaction. SECTION 2.10 LITIGATION. Except as disclosed in Section 2.10 of the Disclosure Schedule, there is no action, suit, proceeding or, to the knowledge of Seller or any Seller Subsidiary, investigation pending or, to the knowledge of Seller or any Seller Subsidiary, action, suit, proceeding or investigation threatened, involving the Seller Subsidiaries or any of their assets or their officers or directors as such, or challenging the validity or propriety of the transactions contemplated by this Agreement by or before any Governmental Entity or by any third party that is reasonably likely to have a Seller Material Adverse Effect. Except as disclosed in Section 2.10 of the Disclosure Schedule, no material orders, decrees, awards, sanctions or judgments exist against Seller or the Seller Subsidiaries, any of their assets or their officers or directors as such, other than those applicable to the industry as a whole in the jurisdiction where issued. 10 SECTION 2.11 NO DEFAULT; COMPLIANCE WITH APPLICABLE LAWS. (a) Except as disclosed in Section 2.11(a) of the Disclosure Schedule, none of the Seller Subsidiaries is in default or violation of any term, condition or provision of (i) its articles or certificates of incorporation, bylaws or similar organizational documents, (ii) any of the Material Agreements (as hereinafter defined) or (iii) any statute, law, rule, regulation, judgment, decree, order, arbitration award, or licenses, permits, consents, approvals and authorizations of any Governmental Entity ("PERMITS") applicable to any Seller Subsidiary including, without limitation, laws, rules and regulations relating to the environment, occupational health and safety, employee benefits, wages, workplace safety, equal employment opportunity and any unlawful discrimination, excluding from the foregoing clauses (ii) and (iii), defaults or violations which would not have a Seller Material Adverse Effect or which become applicable as a result of the business or activities in which Purchaser is or proposes to be engaged or as a result of any acts or omissions by, or the status of any facts pertaining to, Purchaser. Except as set forth on Disclosure Schedule 2.11(a) hereto, neither Seller nor any Seller Subsidiary has received any written notice since January 1, 1996 from any Governmental Entity alleging any violation described in clause (iii) or directing Seller or any Seller Subsidiary to take any remedial action with respect to such law, ordinance or regulation which in each case would have a Seller Material Adverse Effect. (b) Each Insurance Subsidiary has been duly authorized by the relevant state insurance regulatory authorities to issue the insurance contracts that it is currently writing in the respective states in which it conducts its business, with such authority listed state by state for each Insurance Subsidiary in Section 2.11(b) of the Disclosure Schedule. Each Insurance Subsidiary has all other material Permits necessary to conduct its business in the manner and in the areas in which it is presently being conducted by such Insurance Subsidiary, and all such material Permits are valid and in full force and effect. SECTION 2.12 TAXES. Except as disclosed in Section 2.12 of the Disclosure Schedule: (a) the Seller Subsidiaries have (i) timely filed or caused to be filed all Tax Returns (as hereinafter defined) required to be filed by them other than those Tax Returns the failure of which to file would not have a Seller Material Adverse Effect, and all such returns were true, correct and complete in all material respects 11 when filed and (ii) paid or accrued (in accordance with GAAP) all material Taxes (as hereinafter defined) shown to be due on such Tax Returns other than such Taxes that are being contested in good faith by the Seller Subsidiaries; (b) neither Seller nor the Seller Subsidiaries have received written notice of any ongoing or pending nor to the knowledge of Seller or the Seller Subsidiaries, there are no threatened federal, state, local or foreign audits or examinations of any Tax Return of the Seller Subsidiaries except a federal income tax examination which is currently in process for the tax year ended June 30, 1996; (c) there are no outstanding written requests, agreements, consents or waivers to extend the statutory period of limitations applicable to the assessment of any material Taxes or deficiencies against the Seller Subsidiaries other than the six-month statute extension which results from filing of federal tax returns by the extended due date; (d) none of the Seller Subsidiaries is a party to an agreement providing for the allocation or sharing of Taxes, except with its common parent, FHS, which agreement will be terminated effective as of December 31, 1997; and (e) there are no material statutory liens for Taxes upon the assets of any Seller Subsidiary which are not provided for in the Financial Statements, except liens for Taxes not yet due and payable and liens for Taxes that are being contested in good faith. (f) No assessment, audit or other proceeding by any taxing authority is proposed, pending, or, to the knowledge of the Seller or the Seller Subsidiaries, threatened with respect to any Taxes or Tax returns of any of the Seller Subsidiaries. (g) No consent to the application of Section 341(f)(2) of the Code has been made or filed by or with respect to any of the Seller Subsidiaries or any of their assets and properties. (h) The Seller Subsidiaries have not taken any action that would require an adjustment pursuant to Section 481 of the Code by reason of a change in accounting method or otherwise. 12 (i) There have not been, nor will there be from the date hereof through and including the Closing Date, any payments, or any agreements to make payments, which are contingent upon, or related to, the transactions contemplated hereunder and which would be "excess parachute payments" under Section 280G of the Code. (j) The Seller Subsidiaries have not executed or entered into any closing agreement pursuant to Section 7121 of the Code, or any predecessor provisions thereof or any similar provision of state or other law with respect to any period for which the statute of limitations has not expired. "TAXES" shall mean any and all taxes, charges, fees, levies or other assessments, including, without limitation, income, gross receipts, excise, real or personal property, sales, withholding, social security, occupation, use, service, service use, value added, license, net worth, payroll, franchise, transfer and recording taxes, fees and charges, imposed by the United States Internal Revenue Service or any taxing authority (whether domestic or foreign including, without limitation, any state, local or foreign government or any subdivision or taxing agency thereof (including a United States possession)), whether computed on a separate, consolidated, unitary, combined or any other basis; and such term shall include any interest, penalties or additional amounts attributable to, or imposed upon, or with respect to, any such taxes, charges, fees, levies or other assessments. "TAX RETURN" shall mean any report, return, document, declaration or other information or filing required to be supplied to any taxing authority or jurisdiction (foreign or domestic) with respect to Taxes. SECTION 2.13 PROPERTY. Except as set forth in Section 2.13 of the Disclosure Schedule, each Seller Subsidiary has sufficient leaseholds or rights to real property to conduct its respective businesses as currently conducted in all material respects. Section 2.13 of the Disclosure Schedule lists all facility leases and agreements or rights to use facilities to which any of the Seller Subsidiaries is a party in any capacity. No notice of default has been given to Seller or any Seller Subsidiary, there is no existing default, and no conditions that, with notice or lapse of time, would constitute a default by any party to any such agreements. SECTION 2.14 INTELLECTUAL PROPERTY. Section 2.14 of the Disclosure Schedule lists all material trademarks, copyrights and patents owned or used by the Seller Subsidiaries in the conduct of their business, and states all royalties or license fees the Seller Subsidiaries pay for material proprietary rights used in any of their businesses. Except as disclosed in Section 2.14 of the Disclosure Schedule, there are 13 no pending or, to the knowledge of Seller or the Seller Subsidiaries, threatened claims of which Seller or the Seller Subsidiaries have been given written notice, by any person and neither Seller nor any Seller Subsidiary has asserted a claim against any person with respect to any patents, patent rights, trademarks, trademark rights, service marks, service mark rights, trade names, trade name rights, copyrights, logos, assumed names and applications therefor and any know-how, technology, trade secrets or other proprietary information owned or used by the Seller Subsidiaries in their respective operations as currently conducted (collectively, the "SELLER INTELLECTUAL PROPERTY"). The Seller Subsidiaries have such ownership of or such rights by license, lease or other agreement to Seller Intellectual Property as are necessary to permit them to conduct their respective operations as currently conducted, except where the failure to have such rights would not have a Seller Material Adverse Effect. Except as set forth in Section 2.14 of the Disclosure Schedule, to the knowledge of the Seller and the Seller Subsidiaries, the Seller Subsidiaries have taken all appropriate actions and made all appropriate applications and filings pursuant to applicable laws to perfect or protect their interest in the Seller Intellectual Property. SECTION 2.15 CONTRACTS. Seller has delivered or listed in Section 2.15 of the Disclosure Schedule and made available to Purchaser copies of all written Material Agreements (as hereinafter defined). Except as set forth in Section 2.15 of the Disclosure Schedule, each Material Agreement is in full force and effect and, to the knowledge of Seller and the Seller Subsidiaries, is valid and enforceable by the applicable Seller Subsidiary in accordance with its terms. Except as set forth in Section 2.15 of the Disclosure Schedule, none of Seller Subsidiaries is in default in the observance or the performance of any term or obligation to be performed by it under any Material Agreement; to the knowledge of Seller there does not exist any event that, with the giving of notice or the lapse of time or both, would constitute a breach of or a default under any Material Agreement; and to the knowledge of Seller, there have been no intentional waivers or releases of any rights or remedies of any Seller Subsidiaries under any Material Agreement except for such breaches, defaults or waivers the effect of which, individually or in the aggregate, would not have a Seller Material Adverse Effect. To the knowledge of Seller and the Seller Subsidiaries, no other person is in default in the observance or the performance of any term or obligation to be performed by it under any Material Agreement. As used in this Agreement, "MATERIAL AGREEMENT(S)" shall mean each agreement, arrangement, instrument, bond, commitment, franchise, indemnity, indenture, lease, license or understanding to which any Seller Subsidiary is a party or to which any Seller Subsidiary or any of its respective properties is subject that (i) obligates any Seller Subsidiary to pay an amount in excess of $150,000 in any twelve-month period 14 beginning after December 31, 1997, (ii) provides for the extension of credit, (iii) provides for a guaranty by any Seller Subsidiary of obligations of others in excess of $150,000, (iv) constitutes an employment agreement or personal service contract not terminable on less than sixty (60) days' notice without penalty, (v) expressly limits, in any material respect, the ability of any Seller Subsidiary to engage in any line of business, compete with any person or expand the nature or geographic scope of its business, (vi) creates a joint venture, (vii) since January 1, 1996, involved the acquisition or disposition of a portion of the business or assets of any Seller Subsidiary that provided for an aggregate purchase price in excess of $5,000,000 (other than the sale of obsolete equipment or materials, in each case, in the ordinary course of business) (the "DISPOSED BUSINESSES"), (viii) producer agreements that the Insurance Subsidiaries have entered into with the ten largest producers overall for the Insurance Subsidiaries taken as a whole and (ix) all excess of loss, quota share and aggregate stop reinsurance agreements and reinsurance assumed or fronting arrangements. Notwithstanding the foregoing, the term "MATERIAL AGREEMENT(S)" does not include insurance contracts (including runoff contracts, reinsurance (other than as provided in clause (ix) above), retrocession agreements, surety agreements and financial guaranties, structured annuities for settlement of claims, agreements entered into with parties identified on Schedule M of the STAT Financial Statements, incentive commission agreements and agent and broker agreements (other than as provided in clause (viii) above)) entered into by the Seller Subsidiaries in the ordinary course of the insurance business except as specifically described above. SECTION 2.16 LABOR MATTERS. Except as set forth in Section 2.16 of the Disclosure Schedule, (a) neither Seller nor any Seller Subsidiary is a party to, or bound by, any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization, (b) there is no unfair labor practice or labor arbitration proceeding pending or, to the knowledge of Seller, threatened against Seller or the Seller Subsidiaries, except for any such proceeding which would not have, individually or in the aggregate, a Seller Material Adverse Effect and (c) the Seller Subsidiaries are in material compliance with all applicable regulations respecting employment practices, terms and conditions of employment, wages and hours, equal employment opportunity, and the payment of social security and similar taxes. Set forth in Section 2.16 of the Disclosure Schedule is a list of all (i) employment contracts, (ii) severance policies, (iii) compensation and bonus plans applicable to employees of the Seller Subsidiaries and (iv) historic bonus and compensation practices applicable to employees of the Seller Subsidiaries. Except as set forth in Section 2.16 of the Disclosure Schedule, there is no material controversy pending or, to the knowledge of Seller or the Seller Subsidiaries threatened between 15 the Seller Subsidiaries and any of their employees, and to the knowledge of Seller or the Sellers Subsidiaries there are not facts that could reasonably result in any such material controversy. The Seller Subsidiaries are not liable for any claims for past due wages, bonuses or compensation or any penalties for failure to pay such past due wages, bonuses or compensation. SECTION 2.17 BROKERS OR FINDERS. Except for the fees payable to Salomon Smith Barney and Shattuck Hammond Partners, Inc., which will be paid by Seller, Seller represents, as to itself and the Seller Subsidiaries, that no agent, broker, investment banker, financial advisor or other firm or person is or will be entitled to any brokers' or finder's fee or any other commission or similar fee in connection with any of the transactions contemplated by this Agreement. SECTION 2.18 TRANSACTIONS WITH RELATED PARTIES. Except as set forth in Section 2.18 of the Disclosure Schedule or with respect to inconsequential matters, no Affiliate of the Seller Subsidiaries has any contract for services, borrowed or loaned money or other property with, or made any material contractual or other claims on or against, any Seller Subsidiary or has any interest in any property used by any Seller Subsidiary. Seller has made available to Purchaser copies of all Forms B required to be filed by the Seller Subsidiaries with insurance regulatory authorities in calender year 1997. SECTION 2.19 ENVIRONMENTAL MATTERS. (a) DEFINITIONS. The following terms, when used in this Section 2.19, shall have the following meanings: (i) "SELLER SUBSIDIARIES" for purposes of this Section 2.19 includes (A) Seller, (B) the Seller Subsidiaries, (C) all affiliates of the Seller Subsidiaries, and (D) all partnerships, joint ventures and other entities or organizations in which any Seller Subsidiary was at any time after January 1, 1993, or is a partner, joint venturer, member or participant. (ii) "RELEASE" means and includes any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment of any Hazardous Substance, and otherwise as defined in any Environmental Law. 16 (iii) "HAZARDOUS SUBSTANCE" means any pollutants, contaminants and any toxic, hazardous, infectious, carcinogenic, corrosive, ignitable or flammable chemical, chemical compound, material or waste, whether solid, liquid or gas, including asbestos, urea formaldehyde, PCB's, radon gas, crude oil or any fraction thereof, all forms of natural gas, petroleum products or by-products or derivatives, radioactive substance and any other substance, material or waste that is subject to regulation, control or remediation under any Environmental Law as hazardous or toxic. (iv) "ENVIRONMENTAL LAWS" mean all laws, rules, regulations, ordinances, orders or decrees as now in effect which regulate or relate to the protection or clean-up of the environment, the use, treatment, storage, transportation, generation, manufacture, processing distribution, handling or release or threatened release of Hazardous Substances, the preservation or protection of waterways, groundwater, drinking water, air, wildlife, plants or other natural resources, or the health of persons, including protection of the health of employees. Environmental Laws include, without limitation, the Federal Water Pollution Control Act, Resource Conservation & Recovery Act, Clean Water Act, Safe Drinking Water Act, Atomic Energy Act, Occupational Safety and Health Act, Toxic Substances Control Act, Clean Air Act, Comprehensive Environmental Response, Compensation and Liability Act, Hazardous Materials Transportation Act and all analogous or related federal, state or local statutes, laws, rules and regulations. (v) "ENVIRONMENTAL CONDITIONS" mean the release into the environment of any Hazardous Substance as a result of which any Seller Subsidiary has or may become liable to any person or entity or by reason of which any of the assets of any Seller Subsidiary may suffer or be subjected to any encumbrance or lien. (b) ENVIRONMENTAL REPRESENTATIONS. Except as set forth in Section 2.19(b) of the Disclosure Schedule and except for claims which individually or in the aggregate are not reasonably likely to have a Seller Material Adverse Effect, each Seller Subsidiary is in compliance in all material respects, with all Environmental Laws. (c) NOTICE OF VIOLATION. Neither Seller nor any Seller Subsidiary has received any written notice of alleged, actual or potential responsibility for, or any written inquiry or written notice of investigation regarding (i) any Release or threat- 17 ened Release by any Seller Subsidiary or any Hazardous Substance at any location, or (ii) an alleged violation of or non-compliance by any Seller Subsidiary with the conditions of any permit required under any Environmental Law or the provisions of any Environmental Law. Neither Seller nor any Seller Subsidiary has received any written notice of any other claim, demand or action by any person or entity alleging any actual or threatened injury or damage to any person, entity, property, natural resource or the environment arising from or relating to any Release or threatened Release by any Seller Subsidiary of any Hazardous Substances. (d) ENVIRONMENTAL CONDITIONS. There are no present or past Environmental Conditions in any way relating to any Seller Subsidiary, the business or the assets of any Seller Subsidiary, except for any Environmental Conditions which individually or in the aggregate are not reasonably likely to have a Seller Material Adverse Effect. SECTION 2.20 YEAR 2000 COMPLIANCE. To the knowledge of Seller and the Seller Subsidiaries, no Seller Subsidiary owns or uses any application programs, databases, software or hardware (including distributed systems and imbedded chips), the performance of which will be adversely affected by dates after the commencement of the year 2000 ("YEAR 2000 MATTERS") except to the extent such adverse effects would not have a Seller Material Adverse Effect. Set forth in Section 2.20 of the Disclosure Schedule is a description of the Seller Subsidiaries' compliance program with respect to Year 2000 Matters and a statement as to their progress in meeting such program's compliance schedule and goals as of the date hereof. SECTION 2.21 INSURANCE. Section 2.21 of the Disclosure Schedule sets forth the insurance carriers and areas of coverage with respect to the insurance policies of the Seller Subsidiaries. SECTION 2.22 BANK ACCOUNTS. Section 2.22 of the Disclosure Schedule sets forth a list of the Seller Subsidiaries' bank accounts, safe deposit boxes, and related powers of attorney, and identifies all persons authorized to draw thereon or have access thereto. 18 ARTICLE III REPRESENTATIONS AND WARRANTIES OF PURCHASER Purchaser represents and warrants to Seller as follows: SECTION 3.1 ORGANIZATION. Purchaser is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as is now being conducted, except where the failure to be so organized, existing and in good standing or to have such power and authority would not have a Purchaser Material Adverse Effect (as hereinafter defined). Purchaser is duly qualified or licensed to do business and is in good standing in each jurisdiction in which the property owned, leased or operated by it or the nature of the business conducted by it makes such qualification or licensing necessary, except where the failure to be so duly qualified or licensed and in good standing would not have a Purchaser Material Adverse Effect. As used in this Agreement, "PURCHASER MATERIAL ADVERSE EFFECT" means any material adverse change in, or material adverse effect on, the business, financial condition or operations of Purchaser and its Subsidiaries, taken as a whole; PROVIDED, HOWEVER, that any adverse effect on Purchaser and its Subsidiaries resulting from the execution of this Agreement and the announcement of this Agreement and the transactions contemplated hereby shall also be excluded from the determination of Purchaser Material Adverse Effect. SECTION 3.2 AUTHORIZATION; VALIDITY OF AGREEMENT; NECESSARY ACTION. Subject to the approval of its stockholders, Purchaser has the corporate power and authority to execute and deliver this Agreement and all the agreements and documents contemplated hereby, and to consummate the transactions contemplated hereby. The execution, delivery and performance by Purchaser of this Agreement and all the agreements and documents contemplated hereby, and the consummation of the transactions contemplated hereby, have been duly authorized by all necessary corporate proceedings, subject to stockholder approval by a majority of all stockholders entitled to vote, and no other corporate action on the part of Purchaser is necessary to authorize the execution and delivery by Purchaser of this Agreement and all the agreements and documents contemplated hereby, and the consummation by it of the transactions contemplated hereby. Stockholders holding or otherwise controlling the right to vote not less than 41.8% of the outstanding voting shares of the Purchaser have executed and delivered Voting Agreements to the Seller. This Agreement and 19 all the agreements and documents contemplated hereby, have been duly executed and delivered by Purchaser and by certain of its stockholders as appropriate (and assuming due and valid authorization, execution and delivery hereof by Seller) is a valid and binding obligation of Purchaser and such stockholders, as appropriate, enforceable against them in accordance with its terms, except that (i) such enforcement may be subject to applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws, now or hereafter in effect, affecting creditors' rights generally and (ii) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding therefor may be brought. SECTION 3.3 CONSENTS AND APPROVALS; NO VIOLATIONS. Except as set forth in Section 3.3 of the written statement delivered by Purchaser to Seller at or prior to the execution of the Agreement (the "PURCHASER DISCLOSURE SCHEDULE") and except for (a) filings pursuant to the HSR Act, (b) approvals or consents of Governmental Entities under insurance holding company laws of the states in which the Seller Subsidiaries are domiciled, (c) filings required pursuant to the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, (d) approval by Purchasers' stockholders and (e) matters specifically described in this Agreement, neither the execution, delivery or performance of this Agreement by Purchaser nor the consummation by Purchaser of the transactions contemplated hereby will (i) violate any provision of the certificate of incorporation, bylaws or other organizational documents of Purchaser, (ii) result in a violation or breach of, or constitute (with or without due notice or lapse of time or both) a default (or give rise to any right of termination, cancellation or acceleration) under, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, lease, license, contract, agreement or other instrument or obligation to which Purchaser or any of its Subsidiaries is a party or by which any of them or any of their properties or assets may be bound, (iii) violate any order, writ, judgment, injunction, decree, law, statute, rule or regulation applicable to Purchaser, any of its Subsidiaries or any of their properties or assets or (iv) require on the part of Purchaser any filing or registration with, notification to, or authorization, consent or approval of, any Governmental Entity except in the case of clauses (ii), (iii) or (iv) for such violations, breaches or defaults which, or filings, registrations, notifications, authorizations, consents or approvals the failure of which to obtain would not have a Purchaser Material Adverse Effect and would not materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. 20 SECTION 3.4 ACQUISITION FOR INVESTMENT. Purchaser is acquiring the Shares solely for its own account and not with a view to any distribution or other disposition of such Shares, and the Shares will not be transferred except in a transaction registered or exempt from registration under the Securities Act of 1933, as amended. SECTION 3.5 FINANCING. Purchaser has (i) entered into a valid, binding and enforceable stock purchase agreement and backup letter agreement with the Zurich Centre Investments Ltd. (collectively, the "IP STOCK PURCHASE AGREEMENT") with Insurance Partners, L.P. ("IP"), Insurance Partners Offshore (Bermuda), L.P. ("IPB") and Capital Z Partners, Ltd. ("CAPITAL Z"), and (ii) received a written "highly confident letter" from Donaldson, Lufkin & Jenrette (together, the "FINANCING AGREEMENTS") for financing the consummation of the transactions contemplated hereby. IP, IPB and Capital Z have sufficient unencumbered funds unconditionally committed to fulfill their respective obligations under the IP Stock Purchase Agreement. The proceeds for such financing set forth in the Financing Agreements, together with Purchaser's cash on hand as of the date hereof and as of the Closing Date, will be sufficient to enable Purchaser to pay the full amount of the Purchase Price at the Closing. True and complete copies of each of the Financing Agreements have been provided to Seller by Purchaser. SECTION 3.6 INVESTIGATION BY PURCHASER. In entering into this Agreement, Purchaser: (a) acknowledges that, except for the specific representations and warranties of Seller contained in Article II, none of Seller, any Seller Subsidiary, or any of their respective directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives, makes or shall be deemed to have made any representation or warranty, either express or implied, as to the accuracy or completeness of any of the information (including, without limitation, any reserve estimates, projections, forecasts or other forward-looking information) provided or otherwise made available to Purchaser or any of its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives (including, without limitation, in any management presentations, information or offering memorandum, the actuarial report entitled "An Actuarial Analysis of the Loss and Loss Adjustment Expense Reserves of Business Insurance Group as of December 31, 1997," prepared by Milliman & Robertson, Inc. (the "M&R REPORT"), supplemental information or other materials or information with respect to any of the above); and 21 (b) agrees, to the fullest extent permitted by law, that Seller and its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives shall not have any liability or responsibility whatsoever to Purchaser or any of its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives on any basis in respect of the specific representations and warranties of Seller set forth in Article II, except as and only to the extent expressly set forth herein with respect to such representations and warranties and subject to the limitations and restrictions contained herein. SECTION 3.7 CAPITAL ADEQUACY; SOLVENCY. Purchaser represents that immediately after the sale of the Shares and the other transactions contemplated herein, Purchaser (and any successor corporation) will have a positive net worth (calculated in accordance with GAAP) and will not be insolvent (as defined under the federal Bankruptcy Code (the "BANKRUPTCY CODE") and in equity) and that the sale of the Shares and other transactions contemplated hereby and any borrowing by Purchaser in connection with such transactions will not have the effect of hindering, delaying or defrauding any creditors of Purchaser (or any successor corporation). Purchaser further represents that (A) upon consummation of the sale of the Shares and within the meaning of Section 548 of the Bankruptcy Code, the Seller Subsidiaries (and any successor corporations) will (i) have adequate capitalization, (ii) not have an unreasonably small capital with respect to the business or transactions engaged in or to be engaged in and (iii) not have incurred debts that would be beyond the ability of Purchaser (or any successor corporation) to pay as such debts mature and (B) the Purchase Price is a reasonably equivalent value in exchange for the Shares. ARTICLE IV COVENANTS SECTION 4.1 INTERIM OPERATIONS OF SELLER. Promptly upon the execution of this Agreement, Seller agrees that Purchaser may place certain senior executives, including Arnold Senter (the "INTERIM CONSULTING TEAM"), in interim consulting positions at the Company and the Insurance Subsidiaries pursuant to consulting arrangements which are reasonably acceptable to the parties and consistent with the terms of this Agreement. The Seller agrees to cause the Company and the Insurance Subsidiaries to take, or not take, such actions as the Interim Consulting Team may reasonably direct with respect to (i) the strategy and execution of the Seller Subsidiaries' underwriting, reinsurance, claims handling and other operational 22 functions, and (ii) the restructuring of certain asset positions, both in the Seller Subsidiaries' investment portfolios and otherwise, each subject to Seller's approval, which will not be unreasonably withheld. The Interim Consulting Team will coordinate all of its activities under this Agreement through Jay M. Gellert, B. Curtis Westen and Maurice A. Costa or their designees. Notwithstanding any other provision of the Agreement, neither the Seller, nor any of the Seller Subsidiaries, shall be obligated to commute any insurance or reinsurance policy or otherwise take any action that may be reasonably expected to cause any Governmental Entity to require Seller or any of its Affiliates to make a capital contribution to the Seller Subsidiaries. Absent the written approval of one of the Interim Consulting Team, Seller covenants and agrees that, except (i) as contemplated by this Agreement (including the distribution of the Excluded Assets) or (ii) as disclosed in Section 4.1 of the Disclosure Schedule after the date hereof and prior to the Closing Date: (a) the business of the Seller Subsidiaries shall be conducted only in the ordinary and usual course of business and shall not include any actions inconsistent with the transactions contemplated hereby or by the agreements contemplated hereunder; (b) none of the Seller Subsidiaries will amend its articles or certificate of incorporation, bylaws or similar organizational documents; (c) the Company will not (i) split, combine or reclassify the Shares, (ii) declare, set aside or pay any dividend or other distribution payable in cash, stock or property with respect to the Shares, PROVIDED, that the Company may dividend or otherwise distribute or take any other necessary action to allow Seller to retain the Excluded Assets, (iii) issue or sell any additional shares of, or securities convertible into or exchangeable for, or options, warrants, calls, commitments or rights of any kind to acquire, the Shares or any capital stock of the Company, or (iv) redeem, purchase or otherwise acquire directly or indirectly any of its capital stock; (d) none of the Seller Subsidiaries shall (i) adopt any new employee benefit plan (including any stock option, stock benefit or stock purchase plan) or amend any existing employee benefit plan in any material respect, except for changes which are less favorable to participants in such plans or as may be required by applicable law or (ii) increase any compensation or enter into or amend any employment, severance, termination or similar agreement with any of its present or future officers or directors, except for promotions in the ordinary course of business consistent with past practices, normal merit increases of five percent (5%) or less per 23 annum in the ordinary and usual course of business and the payment of cash bonuses to employees pursuant to and consistent with existing plans or programs, with respect to which any necessary accruals have been made; (e) none of the Seller Subsidiaries shall, except as may be required or contemplated by this Agreement or in the ordinary and usual course of business, consistent with prior practice, acquire, sell, lease or dispose of any assets which, individually or in the aggregate, are material to the financial position or results of operations of the affected Seller Subsidiary; (f) none of the Seller Subsidiaries shall (i) incur or assume any long-term or short-term debt or issue any debt securities except for borrowings under existing lines of credit in the ordinary course of business consistent with past practice, (ii) assume, guarantee, endorse or otherwise become liable or responsible (whether directly, indirectly, contingently or otherwise) for the material obligations of any other person except in the ordinary and usual course of business consistent with past practice in an amount not material to the affected Seller Subsidiary, (iii) make any loans, advances or capital contributions to, or investments in, any other person other than in the ordinary and usual course of business consistent with past practice, (iv) pledge or otherwise encumber the Shares or any shares of any Insurance Subsidiary or (v) mortgage or pledge any of its material assets, tangible or intangible, or create or suffer to exist any material Encumbrance of any kind with respect to any such asset; (g) none of the Seller Subsidiaries shall (i) acquire (by merger, consolidation or acquisition of stock or assets) any corporation, partnership or other business organization or division thereof or any equity interest therein (other than purchases of marketable securities in the ordinary course of business), (ii) other than capital expenditures provided for in the 1998 capital expenditures budgets of the Seller Subsidiaries, which budgets have been delivered or made available to Purchaser, authorize any new capital expenditure or expenditures which, individually, is in excess of $150,000 or, in the aggregate, are in excess of $500,000 or (iii) enter into or amend any contract, agreement, commitment or arrangement providing for the taking of any action which would be prohibited hereunder; (h) none of the Seller Subsidiaries shall adopt a plan of complete or partial liquidation or resolutions providing for or authorizing such liquidation or a dissolution, merger, consolidation, restructuring, recapitalization or other reorganization; 24 (i) none of the Seller Subsidiaries shall materially change any of the accounting methods or practices used by it unless required by GAAP, statutory accounting practices or applicable law; (j) none of the Seller Subsidiaries shall settle or compromise any claim (including arbitration) or litigation, which after insurance reimbursement involves an amount in excess of $500,000 or otherwise is material to the Seller Subsidiaries taken as a whole, without the prior written consent of Purchaser, which consent will not be unreasonably withheld; (k) none of the Seller Subsidiaries shall make any payment, loan or advance of any amount to or in respect of, or engage in the sale, transfer or lease of any of its property or assets to, or enter into any contract with, any Affiliate, except (i) in accordance with the terms of the agreements set forth in Section 2.18 of the Disclosure Schedule, and (ii) in connection with Seller's retention of the Excluded Assets and the owned real property, as contemplated by this Agreement; (l) none of the Seller Subsidiaries shall amend the terms of the (i) Material Agreements, as disclosed in Section 2.15 of the Disclosure Schedule and (ii) contracts, agreements or arrangements with any related party, as disclosed in Section 2.18 of the Disclosure Schedule, to cause any change in the cost, services being provided, or term of any such agreements, other than as specifically contemplated by this Agreement; (m) none of the Seller Subsidiaries shall cancel any indebtedness or intentionally waive, release, grant or transfer any rights of substantial value to the affected Seller Subsidiary, except in the ordinary course of business and consistent with past practice, or forgive or waive any rights in connection with any loans to its officers, directors or other related individuals; and (n) neither Seller nor any Seller Subsidiary will authorize or enter into an agreement to do any of the foregoing. SECTION 4.2 ACCESS TO INFORMATION. Seller shall cause each Seller Subsidiary to afford Purchaser's officers, employees, accountants, counsel and other authorized representatives full and complete access during normal business hours throughout the period prior to the Closing Date or the date of termination of this Agreement, to its and its offices, properties, contracts, commitments, books and records (including but not limited to Tax Returns related solely to the Seller Subsid- 25 iaries) and any report, schedule or other document filed or received by it during such period pursuant to the requirements of Federal or state securities laws and to use all reasonable efforts to cause its representatives to furnish promptly to Purchaser such additional financial and operating data and other information as to its businesses and properties as Purchaser or its duly authorized representatives may from time to time reasonably request and to make reasonably available the officers and employees of each Seller Subsidiary to answer fully and promptly reasonable questions put to them; PROVIDED, HOWEVER, that nothing herein shall require Seller or the Seller Subsidiaries to disclose any information to Purchaser if such disclosure would violate applicable laws or regulations of any Governmental Entity. Unless otherwise required by law and until the Closing Date, Purchaser will hold any such information which is nonpublic in confidence in accordance with the provisions of the Confidentiality Agreement between Seller and Purchaser, dated as of January 6, 1998 (the "CONFIDENTIALITY AGREEMENT"). SECTION 4.3 TAX MATTERS. (a) SECTION 338(h)(10) ELECTION; ALLOCATION OF "ADJUSTED GROSSED-UP BASIS." Seller and Purchaser agree to elect under section 338(h)(10) of the Code to treat the sale of the Shares as a sale by the Company of all of its assets and a sale by the Insurance Subsidiaries of all their assets (the "SECTION 338(h)(10) ELECTION") and shall make any such available election under any substantially similar state or local law, if requested by Seller. As reasonably requested by Seller, Purchaser shall take such actions as Seller deems necessary to effect the Section 338(h)(10) Election (including, without limitation, the timely filing of Internal Revenue Service Form 8023 (Corporate Qualified Stock Purchase Elections). (b) ALLOCATION. On or before the date that is 30 days after the Closing Date, Purchaser shall provide to Seller a proposed allocation of the Purchase Price for the deemed sale of assets resulting from the making of the Section 338(h)(10) Election, setting forth the estimated fair market values of the assets of each of the Company and the Insurance Subsidiaries. On or before the date that is 60 days after the Closing Date, Seller and Purchaser shall agree upon a final allocation of such purchase price (the "FINAL ALLOCATION"). Seller and Purchaser shall cooperate in developing the Final Allocation, PROVIDED, HOWEVER, that Purchaser's allocation shall be presumed to be an allocation based upon the fair market values of the Seller Subsidiaries and that Seller shall have the burden of proof to demonstrate that such allocation is not an appropriate allocation. 26 (c) FORMS. On or before the date that is ten days before the Closing Date, Seller shall provide to Purchaser drafts of all forms, together with all drafts of required attachments thereto, other than allocation of the Purchase Price, required for making the Section 338(h)(10) Election and any such available election under any substantially similar state or local law if requested by Seller (the "ELECTION FORMS"). On the Closing Date, Seller shall deliver to Purchaser the Election Forms, properly executed by Seller or any proper Affiliate of Seller. Seller and Purchaser shall cooperate in drafting and making final the Election Forms, and any dispute with respect thereto shall be resolved pursuant to Section 4.3(n). Seller shall be responsible for filing the Election Forms with the proper taxing authorities, PROVIDED that Purchaser shall be responsible for filing any Election Form that must be filed with its Tax Returns. (d) MODIFICATION; REVOCATION. Purchaser and Seller each agrees that it shall not, and shall not permit any of its respective Affiliates to, take any action to modify the Election Forms following the execution thereof, or to modify or revoke the Section 338(h)(10) Election, or any such available election under any substantially similar state or local law if requested by Seller, following the filing of the Election Forms, without the written consent of Purchaser or Seller, as the case may be. (e) CONSISTENT TREATMENT. Purchaser and Seller shall, and shall cause their respective Affiliates to, file all Tax Returns in a manner consistent with the information contained in the Election Forms as filed and the Final Allocation, unless otherwise required because of a change in applicable tax law. (f) EXPENSES RESULTING FROM SECTION 338(h)(10) ELECTIONS. Purchaser and its Affiliates (including the Company and the Insurance Subsidiaries following the Closing), on the one hand, and Seller and its Affiliates, on the other hand, shall bear their respective administrative, legal and similar expenses resulting from the making of the Section 338(h)(10) Election and any such available elections under any substantially similar state or local law if requested by Seller. (g) TAX SHARING AGREEMENT. The tax sharing agreement between, among others, each of the Seller Subsidiaries and its common parent, FHS, referenced in Section 2.12(d) shall be terminated effective as of April 30, 1998. After the Closing Date none of the Seller Subsidiaries, Seller, or any Affiliate of Seller shall have any further rights or liabilities thereunder, except to the extent stated on the balance sheet of the Seller Subsidiaries as of April 30, 1998 (using the Seller Subsidiaries' actual financial statements at and as of March 31, 1998, together with projected 27 April 30, 1998 results as provided by Salomon Smith Barney to the Purchaser), with all amounts then due being paid as soon as such amounts are determined but in no event later the Closing Date. This Agreement shall be the sole Tax sharing agreement relating to any Seller Subsidiary for all Pre-Closing Tax Periods. (h) ACTIONS OUT OF THE ORDINARY COURSE. If Purchaser causes or permits the Seller Subsidiaries or any Affiliate of Purchaser to take any action on the Closing Date other than actions contemplated by this Agreement or actions in the ordinary course of business, including but not limited to the distribution of any dividend or the effectuation of any redemption, Purchaser shall indemnify Seller for any resulting tax liability from such action. (i) TAX INDEMNITY. (i) Notwithstanding any other provisions of this Agreement, from and after the Closing Date, Seller shall be liable to, and shall indemnify and hold harmless, Purchaser and the Seller Subsidiaries against the following Taxes, but only for Taxes in excess of the sum of Taxes paid prior to December 31, 1997, Taxes accrued as current Taxes payable or reserves on the December 31, 1997 financial balance sheet, and Taxes accrued or paid after December 31, 1997 in the ordinary course of business, in accordance with past practice, with respect to business operations for the period of January 1, 1998 through the Closing Date: (A) Taxes imposed on the Seller Subsidiaries with respect to taxable years or periods ending on or before the Closing Date; (B) with respect to taxable years or periods beginning before the Closing Date and ending after the Closing Date, Taxes imposed on the Seller Subsidiaries which are allocable, pursuant to such clause (ii) hereof, to the portion of such taxable year or period ending on the Closing Date (an "INTERIM PERIOD") (Interim Periods and any taxable years or periods that end on or prior to the Closing Date being referred to collectively hereinafter as "PRE-CLOSING PERIODS"); (C) Taxes imposed on any member of any affiliated group with which the Seller and the Seller Subsidiaries or any Seller Subsidiary files or has filed a Tax Return on a consolidated, combined or unitary basis for a taxable year or period beginning before the Closing Date; (D) Taxes required to be paid or reimbursed by the Seller under subsection (i)(iii) hereof (to the extent such Taxes have not been paid by Seller); (E) Taxes or additional Taxes imposed on the Purchaser or the Seller Subsidiaries as a result of a breach of the representations and warranties set forth in Section 2.12 of this Agreement or of the covenants contained in this subsection (i) without duplication; or (F) Taxes or other payments required to be made after the date hereof by the Seller Subsidiaries to any party under any Tax sharing, indemnity or allocation agreement (whether or not written). 28 (ii) In order to apportion appropriately any Taxes relating to any taxable year or period that includes an Interim Period, the parties hereto shall, to the extent permitted under applicable law, elect with the relevant Tax authority to treat, for all purposes, the Closing Date as the last day of the taxable year or period of the Seller Subsidiaries, and such Interim Period shall be treated as a short taxable year and a Pre-Closing Period for purposes of this subsection (i). In any case where applicable law does not permit the Seller Subsidiaries to treat the Closing Date as the last day of the taxable year or period of the Seller Subsidiaries with respect to Taxes that are payable with respect to an Interim Period, the portion of any such Tax that is allocable to the portion of the Interim Period ending on the Closing Date shall be: (x) in the case of Taxes that are either (1) based upon or related to income or receipts, or (2) imposed in connection with any sale or other transfer or assignment of property (real or personal, tangible or intangible), deemed equal to the amount which would be payable if the taxable year or period ended on the Closing Date (except that, solely for purposes of determining the marginal tax rate applicable to income or receipts during such period in a jurisdiction in which such tax rate depends upon the level of income or receipts, annualized income or receipts may be taken into account, if appropriate, for an equitable sharing of such Taxes); and (y) in the case of Taxes not described in subparagraph (x) above that are imposed on a period basis and measured by the level of any item, deemed to be the amount of such Taxes for the entire period (or, in the case of such Taxes determined on an arrears basis, the amount of such Taxes for the immediately preceding period) multiplied by a fraction the numerator of which is the number of calendar days in the Interim Period ending on the Closing Date and the denominator of which is the number of calendar days in the entire relevant period. 29 (iii) The Seller shall be liable for and shall pay all applicable sales, transfer, recording, deed, stamp and other similar taxes, including, without limitation, any real property transfer or gains taxes (if any), resulting from the consummation of the transactions contemplated by this Agreement. (j) PURCHASER AND SELLER SUBSIDIARIES INDEMNIFICATION. Except as otherwise provided in Section 4.3(i), Purchaser and the Seller Subsidiaries shall be liable for, and shall indemnify and hold Seller and any of its Affiliates harmless against, (i) any and all Taxes imposed on the Seller Subsidiaries relating or apportioned to any taxable year or portion thereof ending after the Closing Date and (ii) the loss of any tax benefit solely as a result of Purchaser's failure to take any action required under Section 4.3 necessary to effectuate the filing of the Section 338(h)(10) Election. (k) REFUNDS OR CREDITS. At the reasonable request of Seller, Purchaser shall cooperate, or cause the Seller Subsidiaries to cooperate, with Seller in obtaining any refunds or credits (including interest thereon), other than any refunds or credits on the December 31, 1997 financial statements of the Seller Subsidiaries, relating to Taxes for which Seller may be liable under Section 4.3(i); PROVIDED, HOWEVER, that Purchaser shall not be required to file such claims for refund to the extent such claims for refund would have a material adverse effect in future periods or to the extent the claims for refund relate to a carryback of an item. Purchaser shall be entitled to all other refunds and credits of Taxes; PROVIDED, HOWEVER, it will not allow the amendment of any Tax Return relating to any Taxes for a period ending on or prior to the Closing Date or the carryback of an item to a period ending prior to Closing without Seller's consent. For purposes of this Section 4.3(k), the terms "refund" and "credit" shall include a reduction in Taxes and the use of an overpayment of Taxes as an audit or other Tax offset. Receipt of a refund shall occur upon the filing of a return or an adjustment thereto using such reduction, overpayment or offset, or upon the receipt of cash. (l) MUTUAL COOPERATION. As soon as practicable, but in any event within 30 days after either Seller's or Purchaser's request, Purchaser shall, or shall cause the Seller Subsidiaries to, deliver to Seller or Seller shall deliver to Purchaser, as the case may be, such information and other data relating to the Tax Returns and Taxes of the Seller Subsidiaries and shall provide such other assistance as may reasonably be requested, to cause the completion and filing of all Tax Returns or to respond to audits by any taxing authorities with respect to any Tax Returns or taxable periods or to otherwise enable Seller, Purchaser or the Seller Subsidiaries to satisfy 30 their accounting or Tax requirements. For a period of five years from and after the Closing, Purchaser and Seller shall, and shall cause their Affiliates to, maintain and make available to the other party, on such other party's reasonable request, copies of any and all information, books and records referred to in this Section 4.3(l). After such five-year period, Purchaser or Seller may dispose of such information, books and records, PROVIDED that prior to such disposition, Purchaser or Seller shall give the other party the opportunity to take possession of such information, books and records. (m) CONTESTS. Whenever any taxing authority asserts a claim, makes an assessment or otherwise disputes the amount of Taxes for which Seller is or may be liable under this Agreement, Purchaser shall, if informed of such an assertion, inform Seller within ten business days, and Seller shall have the right to control any resulting proceedings and to determine whether and when to settle any such claim, assessment or dispute to the extent such proceedings or determinations affect the amount of Taxes for which Seller may be liable under the Agreement except the Purchaser shall have the right to consent, which consent will not be unreasonably withheld, to any settlement to the extent such proceedings or settlement materially affect the amount of Taxes imposed on the Seller Subsidiaries for periods beginning after the Pre-Closing Periods. If Purchaser fails to provide such notice and such failure shall materially prejudice Seller's ability to defend such assessment, then Seller's obligation under Section 4.3(i) shall be null and void with regard to such assessment. Whenever any taxing authority asserts a claim, makes an assessment or otherwise disputes the amount of Taxes for which Purchaser is liable under this Agreement, Purchaser shall have the right to control any resulting proceedings and to determine whether and when to settle any such claim, assessment or dispute, except that Seller shall have the right to consent, which consent shall not be unreasonably withheld, to any settlement to the extent such proceedings materially affect the amount of Taxes for which Seller is or may be liable under this Agreement. (n) RESOLUTION OF DISAGREEMENTS BETWEEN SELLER AND PURCHASER. If either Seller or Purchaser disagrees as to the amount of Taxes for which it may be liable under this Agreement or Seller and Purchaser are unable to agree as to the Final Allocation, the parties shall promptly consult each other to resolve such dispute following the receipt of written notice from either party to begin such consultation (the "CONSULTATION NOTICE"). If any such point of disagreement cannot be resolved within 60 days of the date of the Consultation Notice, or in the case of the Final Allocation, within the 60-day period required by Section 4.3(b), as appropriate, Seller and Purchaser shall within ten days after such period jointly select a nationally recognized independent public accounting or law firm which has not, except pursuant 31 to this Section 4.3(n), performed any services since January 1, 1993, for Seller or Purchaser or their respective Affiliates, to act as an arbitrator to resolve, within 60 days after its selection, all points of disagreement concerning tax matters with respect to this Agreement and presented to such accounting firm at the time of its selection. If the parties cannot agree on the selection of an accounting or law firm within such ten-day period, they shall cause their respective accounting firms to select such firm within five business days of the end of such ten-day period. Any such resolution shall be conclusive and binding on Purchaser and Seller. The fees of such independent public accountants or law firm shall be divided equally between Seller and Purchaser. Seller and Purchaser shall (and shall cause the Seller Subsidiaries to) provide to such firm full cooperation. Such firm shall be instructed to reach its conclusion regarding the dispute within 60 days of its selection. (o) SURVIVAL OF OBLIGATIONS. The obligations of the parties set forth in Section 4.3 shall be unconditional and absolute, and shall remain in effect until the expiration of the applicable statutes of limitations. SECTION 4.4 EMPLOYEE MATTERS. (a) As of the Closing Date, Purchaser shall cause the Seller Subsidiaries to continue to employ all persons who, immediately prior to the Closing Date, were employees ("COMPANY EMPLOYEES") of the Seller Subsidiaries on terms consistent with Purchaser's employment policies and benefit plans in general effect at that time. Such employment may be with Purchaser, its affiliates or with third party employee leasing companies, as determined by Purchaser and shall be on terms mutually satisfactory to each Company Employee and Purchaser. With respect to any employee benefits that are provided to Company Employees under any of Purchaser's employee benefit plans, programs, policies and arrangements, including vacation policies ("PURCHASER PLANS"), service accrued by Company Employees during employment with Seller and the Seller Subsidiaries prior to the Closing Date shall be recognized for all purposes, except to the extent necessary to prevent duplication of benefits. Nothing in this Section 4.4 shall require that the Purchaser (i) maintain any particular benefit plan or benefit in effect for any period of duration following the Closing Date, or (ii) continue to employ any individual for any period of duration following the Closing Date, except as required by any employment contract or laws. (b) Purchaser agrees to assume and honor, and cause the Seller Subsidiaries to assume and honor, without modification, all employment, severance, retention, other incentive agreements and arrangements, postretirement medical, 32 dental and life insurance arrangements and all supplemental pension plans, as amended through the date hereof (each, an "EMPLOYEE ARRANGEMENT"), for the benefit of any employees and former employees of the Company or any Company Subsidiary. The Employee Arrangements set forth in Section 4.4(b) of the Disclosure Schedule represent all the employment-related obligations of the Seller Subsidiaries that will remain in effect following the Closing Date. (c) Purchaser shall cause each Purchaser Plan to waive (i) any pre-existing condition restriction which was waived under the terms of any analogous Benefit Plan immediately prior to the Closing and (ii) waiting period limitation which would otherwise be applicable to a Company Employee on or after the Closing to the extent such Company Employee had satisfied any similar waiting period limitation under an analogous Benefit Plan prior to the Closing. Company Employees shall also be given credit for any deductible or co-payment amounts paid in respect of the Benefit Plan year in which the Closing occurs, to the extent that, following the Closing, they participate in any Purchaser Plan for which deductibles or co-payments are required. For purposes of this Agreement, "COMPANY EMPLOYEES" shall include those Company Employees who, as of immediately prior to the Closing Date, are on lay-off, disability or leave of absence, paid or unpaid. (d) Purchaser shall have no liability or obligation whatsoever in connection with options to purchase FHS common stock that were granted by FHS to any Company employee; PROVIDED, HOWEVER, that Company employees shall be eligible for Purchaser equity incentives, subject to the discretion of the compensation committee of the Board of Directors of the Purchaser. (e) As soon as practicable following the Closing Date, all Company Employees who are participants in the FHS 401(k) Associate Savings Plan, as amended and restated as of September 1, 1997, shall be given the opportunity to receive a distribution of their respective account balances and shall be given the opportunity to elect to "roll over" such account balance to the Superior National Insurance Company 401(k) Plan, as amended and restated (the "SUPERIOR 401(k) PLAN"), in both cases subject to, and in accordance with, the provisions of such Plans and applicable law. Prior to such distributions, (i) Purchaser will provide FHS with such documents and other information as FHS shall reasonably request to assure itself that the Superior 401(k) Plan and the trust established 33 pursuant thereto are qualified and tax-exempt under Sections 401(a) and 501(a) of the Code and will accept eligible rollover distributions from Company Employees and (ii) FHS shall provide Purchaser with such documents and other information as Purchaser may reasonably request to assure itself that the FHS 401(k) Associate Savings Plan and the trust established pursuant thereto are qualified and tax-exempt under Sections 401(a) and 501(a) of the Code and can make eligible rollover distributions. If as of the date hereof, the Superior 401(k) Plan will not accept eligible rollover distributions from Company Employees, Purchaser shall cause such plan to be so amended as soon as practicable following the Closing Date. SECTION 4.5 PUBLICITY. Purchaser and Seller shall, subject to their respective legal obligations (including requirements of stock exchanges and other similar regulatory bodies), consult with each other and use reasonable efforts to agree upon the text of any press release before issuing it or otherwise making public statements with respect to the transactions contemplated by this Agreement. SECTION 4.6 APPROVALS AND CONSENTS; COOPERATION; NOTIFICATION. (a) The parties shall use all reasonable efforts, and cooperate with each other, to obtain as promptly as practicable all Permits and third-party consents necessary or advisable to consummate the transactions contemplated by this Agreement, and each party shall keep the other apprised of the status of matters relating to completion of the transactions contemplated hereby. Purchaser and Seller shall have the right to review in advance, to the extent reasonably practicable, and shall consult with the other on, in each case subject to applicable laws relating to the exchange of information, all the information relating to Seller, the Seller Subsidiaries or Purchaser, as the case may be, and any of their respective Affiliates, which appears in any filing made with, or written materials submitted to, any third party or any Governmental Entity in connection with the transactions contemplated by this Agreement, PROVIDED, HOWEVER, that nothing contained herein shall be deemed to provide either party with a right to review any information provided to any Governmental Entity on a confidential basis in connection with the transactions contemplated hereby. The party responsible for any such filing shall promptly deliver to the other party evidence of the filing of all applications, filings, registrations and notifications relating thereto (except for any confidential portions thereof), and any supplement, amendment or item of additional information in connection therewith (except for any confidential portions thereof). The party responsible for a filing shall, to the extent reasonably requested, also promptly deliver to the other party a copy of each material notice, order, opinion and other item or correspondence received by such filing party from any Governmental Entity in respect of any such application (except for any confidential portions thereof). 34 (b) Seller and Purchaser shall use all reasonable efforts to file as soon as practicable all notifications, filings and other documents required to obtain all governmental authorizations, approvals, consents or waivers, including, without limitation, under the HSR Act, and to respond as promptly as practicable to any inquiries received from the Federal Trade Commission, the Antitrust Division of the Department of Justice and any other Governmental Entity for additional information or documentation and to respond as promptly as practicable to all inquiries and requests received from any State Attorney General or other Governmental Entity in connection therewith. (c) Without limiting the generality of the foregoing, within 20 business days after the date hereof, Purchaser shall, if applicable as required by law, make Form A filings with the insurance departments of the states listed in Section 2.11(b) of the Disclosure Schedule with respect to the transactions contemplated hereby. Purchaser shall promptly make any and all other filings and submissions of information with such insurance departments which are required or requested by such insurance departments to obtain the approvals required by such insurance departments to consummate the transactions contemplated hereby. Seller agrees to furnish Purchaser with such information and reasonable assistance as Purchaser may reasonably request in connection with its preparation of such Form A filings and other filings or submissions. Purchaser shall keep Seller fully apprised of its actions with respect to all such filings and submissions and shall provide Seller with copies of such Form A filings and other filings or submissions in connection with the transactions contemplated by this Agreement (except for any confidential portions thereof). (d) Purchaser and Seller shall promptly advise each other upon receiving any communication from any Governmental Entity whose consent or approval is required for consummation of the transactions contemplated by this Agreement which causes such party to believe that there is a reasonable likelihood that any requisite regulatory approval will not be obtained or that the receipt of any such approval will be materially delayed. (e) Seller shall give prompt notice to Purchaser of the occurrence of any Seller Material Adverse Effect, and Purchaser shall give prompt notice to Seller of the occurrence of any Purchaser Material Adverse Effect. Each of Seller and Purchaser shall give prompt notice to the other of the occurrence or failure to occur of an event that would, or, with the lapse of time would, cause any condition to the consummation of the transactions contemplated hereby not to be satisfied. 35 SECTION 4.7 NO SOLICITATION. Seller shall not, directly or indirectly, through any Affiliate, officer, director, employee, investment banker, attorney, representative or agent of Seller or any of the Seller Subsidiaries, solicit, initiate, or encourage any inquiries or proposals that constitute, or could reasonably be expected to lead to, an Acquisition Proposal (as hereinafter defined). Seller will immediately cease and cause to be terminated any existing activities, discussions or negotiations with any parties conducted heretofore with respect to any of the foregoing. For purposes of this Agreement, "ACQUISITION PROPOSAL" means any offer or proposal for, or any indication of interest in, a merger or other business combination involving the Seller Subsidiaries or the acquisition of any equity interest in, or a substantial portion of the assets of, the Seller Subsidiaries, other than the transactions contemplated by this Agreement. SECTION 4.8 EXCLUDED ASSETS, REAL PROPERTY. (a) Seller and the Seller Subsidiaries shall take all actions necessary to cause the Excluded Assets to be transferred (by dividend or otherwise) to one or more other Affiliates of Seller so that such other Affiliates acquire valid title to the Excluded Assets prior to the Closing. (b) Seller and the Seller Subsidiaries shall take all actions necessary to cause all right, title or interest in any real property owned by any Seller Subsidiary prior to the Closing Date, whether held for use or for investment, to be transferred (by dividend or otherwise) to one or more other Affiliates of the Seller so that such other Affiliates prior to the Closing acquire all ownership rights and title to such real property assets previously held by a Seller Subsidiary. Seller, or another Affiliate of the Seller, shall replace the book value of all the owned real estate assets so transferred with cash (or cash equivalents reasonably acceptable to Purchaser) equal in value to such book value at the date of transfer. SECTION 4.9 INTERCOMPANY ACCOUNTS. All intercompany accounts and Item 5 on Section 2.18 of the Disclosure Schedule (an administrative service agreement between the Company and FHS, effective 10/1/97), including, without limitation, the August 23, 1994 promissory note from Seller to CalComp in the principal amount of $10,000,000, as set forth in Section 4.9 of the Disclosure Schedule, between the Seller Subsidiaries, on the one hand, and Seller or its Affiliates on the other hand ("INTERCOMPANY ACCOUNTS") will be terminated at or before the Closing, and, if practicable, settled at or before the Closing, and if not, then as soon as practicable after the Closing Date and, in any event, within 60 days thereafter, 36 PROVIDED, that all principal and accrued interest under the promissory notes set forth in Section 4.9 of the Disclosure Schedule will be paid in full at the Closing. SECTION 4.10 RESERVE COVER. (a) Prior to the Closing, Seller shall cause the Seller Subsidiaries to purchase $150,000,000 of adverse development protection on loss and allocated loss adjustment expense reserves for claims occurring on or before December 31, 1997, pursuant to the Reinsurance Agreement. If Purchaser should determine while the Reinsurance Agreement is in effect to commute it, Purchaser shall pay to Seller, as soon as is practicable, one-half of (a) the then fair market value of the returned assets less (b) the sum of (i) the then net present value (using a discount rate reasonably acceptable to the parties) of the commuted reserves, plus (ii) the tax cost of the commutation. Should Seller and Purchaser not agree upon the fair market value of such assets, the net present value of such commutation reserves or the tax costs of such commutation, they shall mutually retain Ernst & Young LLP ("E&Y") to act as an independent actuary (the "INDEPENDENT ACTUARY") to determine the correct value and shall be bound by its determination. If E&Y shall decline to serve in such capacity or has a conflict with either of the parties, the parties shall agree on the appointment of the Independent Actuary within a 10 day period. If the parties cannot agree upon the selection of the Independent Actuary within a ten-day period, they shall cause their respective accounting firms to select such firm within five business days of the end of such ten-day period. Any such resolution shall be conclusive and binding on Purchaser and Seller. Seller and Purchaser shall (and shall cause the Seller Subsidiaries to) provide to such firm full cooperation. Such firm shall be instructed to reach its conclusion regarding the dispute within 60 days of its selection. The cost of the Independent Actuary's services shall be evenly borne by Seller and Purchaser and shall be paid by Purchaser out of the commutation savings proceeds, evenly reducing the proceeds available to each party, prior to paying to Seller its portion of the commutation savings. (b) Within 60 days of the date hereof (but in any event at least five days prior to the Closing Date), Purchaser may request, in writing, and, if requested, Seller agrees it shall cause the Seller Subsidiaries to increase the amount of reinsurance cover by $25,000,000, consistent with the terms of the Reinsurance Agreement, for aggregate ultimate net losses incurred by Seller Subsidiaries on or prior to June 30, 1998 for losses occurring on or prior to that portion of the 1998 accident year commencing on January 1, 1998 to and including June 30, 1998, in exchange for a 37 $5,000,000 increase in the purchase price payable at the Closing by Purchaser pursuant to Section 1.2. SECTION 4.11 AUDITED FINANCIAL STATEMENTS; QUARTERLY STATEMENTS. (a) As soon as practical after the date hereof but in no event after 45 days following the date hereof, Seller shall deliver to Purchaser audited GAAP financial statements for the Seller Subsidiaries, on a consolidated basis, for each of the years ended on December 31, 1995, December 31, 1996 and December 31, 1997, including a balance sheet as of the latter two dates, and the statements of operations, shareholders' equity and cash flows, and the related management letters for the periods ending on each of such dates (collectively the "AUDITED FINANCIAL STATEMENTS"). (b) Within 30 days after the end of each fiscal quarter after the date hereof prior to the Closing, Seller shall deliver to Purchaser quarterly GAAP financial statements (the "QUARTERLY FINANCIAL STATEMENTS") for the Seller Subsidiaries, on a consolidated basis, including a balance sheet as of the end of each quarter and statements of operations for each 1998 quarterly period then ended, in a form sufficient for filing as part of Purchaser's proxy statement. (c) Upon the reasonable request of Purchaser, Seller shall promptly provide, or cause to be provided, to Purchaser such information as may be reasonably required by Purchaser in connection with its Proxy Statement (as defined below) and all other documents required to be filed by Purchaser in order to consummate the transactions contemplated hereby. SECTION 4.12 RELATED PARTY SERVICE AGREEMENTS. Purchaser shall enter into the Service Agreements with certain related parties of Seller on terms consistent with the terms of Exhibits B-1 through B-4. SECTION 4.13 LEASE RENEWALS. Purchaser and Seller shall use all reasonable efforts in good faith to negotiate leases of three years in duration (or such shorter period of time as may be remaining on the applicable underlying lease) for all properties and facilities of the Seller Subsidiaries where the use of such property or facility by a Seller Subsidiary is not the subject of a lease, or the use by an Affiliate of a Seller Subsidiary is not the subject of a lease. The monthly rents payable on such new leases will be equal to the total monthly rental cost of the Seller's Affiliate for such facility TIMES the percentage of the space (based on square footage) to be used by 38 the Seller Subsidiary. All lease agreements in effect on the date of this Agreement shall be honored for their remaining term by both Purchaser and Seller. SECTION 4.14 FURTHER ASSURANCES. (a) Each party agrees to use all reasonable efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Agreement. (b) Purchaser will use all reasonable efforts to cause a stockholder or stockholders of Purchaser holding at least 5% of the outstanding common stock of Purchaser who have not entered into Voting Agreements on or prior to the date hereof to enter into a Voting Agreement as soon as practicable after the date hereof. SECTION 4.15 STATE INSURANCE REGULATORY APPROVAL FOR CCIC. Notwithstanding the provision of Section 6.1(c), in the event that Purchaser is unable to obtain state insurance regulatory approval to acquire CCIC within five (5) business days after the receipt of state insurance regulatory approval for all of the other Insurance Subsidiaries, Seller shall have the right to treat CCIC as an "Excluded Asset" by providing written notice (the "CCIC NOTICE") to Purchaser of its election to distribute the stock of CCIC out of the Company. Following delivery of the CCIC Notice: (i) CCIC will be deemed to be an "Excluded Asset" and will no longer be treated as an "Insurance Subsidiary" for all purposes under the Agreement; (ii) the Purchase Price will be reduced by 80% of the net book value of CCIC included in the most recent Quarterly Financial Statement delivered to Purchaser (the "CCIC VALUE"); (iii) Purchaser and Seller agree to negotiate in good faith to enter into an interim management agreement prior to Closing pursuant to which Seller will agree to continue to operate CCIC, at Purchaser's full cost and risk, consistent with the terms of Section 4.1 of this Agreement until Seller is able to secure the necessary state insurance regulatory approval to acquire all of the capital stock of CCIC; 39 (iv) Seller agrees that it will take all steps reasonably necessary to secure such state insurance regulatory approval as soon as possible after the delivery of the CCIC Notice; (v) Purchaser agrees that it will purchase the capital stock of CCIC from Seller or its Affiliates, subject only to receipt of the necessary state insurance regulatory approvals and the Closing, for a price equal to the CCIC Value plus interest on such amount from the date of Closing until the date of purchase of the capital stock of CCIC accruing at a rate of 10% per annum (the "CCIC PURCHASE"); (vi) upon consummation of the CCIC Purchase, CCIC will be deemed to be an "Insurance Subsidiary" as of the Closing Date; and (vii) notwithstanding the foregoing, Seller will be free to sell the capital stock or assets of CCIC to a third party at any time after twelve (12) months after the Closing Date after which time Purchaser will no longer have the obligation to purchase CCIC pursuant to this Section 4.15. SECTION 4.16 STOCKHOLDER APPROVAL AND FINANCING. Purchaser shall, as promptly as practicable, after the date hereof prepare and file with the Securities Exchange Commission a proxy statement (the "Proxy Statement") and take such other actions necessary in accordance with applicable law and its Certificate of Incorporation and bylaws to convene a meeting of its stockholders to consider and vote upon the approval of the transaction contemplated by the Financing Agreements in connection with the consummation of the transactions contemplated by this Agreement. The Proxy Statement shall include the recommendation of the Board of Directors of Purchaser that its stockholders vote in favor of those matters requiring their approval in order to consummate the transactions contemplated by this Agreement and the Financing Agreements. The Board of Directors of Purchaser shall take all reasonable steps to solicit and obtain such approval. The Purchaser agrees to use its best efforts to arrange and complete financing of the transactions as contemplated by the Financing Agreements, including taking all steps necessary to enforce its rights under the Financing Agreements. Purchaser further agrees that prior to the Closing it will not amend the terms of the IP Stock Purchase Agreement without the prior written consent of Seller if such amendments would adversely effect the completion of the Financing Agreements. 40 ARTICLE V INDEMNIFICATION SECTION 5.1 INDEMNIFICATION BY SELLER. Subject to the limits set forth in this Article V, Seller agrees to indemnify, defend and hold Purchaser, its officers, directors, agents and Affiliates (the "PURCHASER INDEMNIFIED PARTIES"), harmless from and in respect of any and all losses, damages, costs and reasonable expenses (including, without limitation, reasonable expenses of investigation and defense fees and disbursements of counsel and other professionals and losses in connection with any clean-up or remedial action pursuant to Environmental Laws), (collectively, "LOSSES"), that they may incur arising out of or due to any inaccuracy of any representation or the breach of any warranty, covenant, undertaking or other agreement of Seller contained in this Agreement or the Disclosure Schedule; PROVIDED, HOWEVER, that Seller shall have no liability to Purchaser under this Section 5.1 unless Purchaser Indemnified Parties shall have met the aggregate deductible requirements of Section 5.3. Notwithstanding any other provision of this Agreement, including this Section 5.1, the Seller shall have no obligation to indemnify, or otherwise have any liability to, the Purchaser Indemnified Parties for any Loss arising out of, or relating to the business or operations of the Seller Subsidiaries following the date hereof (the "EXCLUDED LOSSES"), including without limitations any Excluded Breach (as defined below) unless written notice of a Loss occurring during the first 20 business days after the date hereof is provided as contemplated by Section 7.1(e) within 35 days following the date hereof. SECTION 5.2 INDEMNIFICATION BY PURCHASER. Subject to the limits set forth in this Article V, Purchaser agrees to indemnify, defend and hold Seller, its officers, directors, agents and Affiliates, harmless from and in respect of any and all Losses that they may incur (i) arising out of or due to any inaccuracy of any representation or the breach of any warranty, covenant, undertaking or other agreement of Purchaser contained in this Agreement and (ii) arising out of any and all actions, suits, claims and administrative or other proceedings of every kind and nature instituted or pending against Seller or any of its Affiliates at any time after the Closing Date to the extent that such Losses (x) relate to or arise out of or in connection with the assets, businesses, operations, conduct, products, environmental conditions or violations of Environmental Laws and/or employees (including former employees) of the Seller Subsidiaries relating to or arising out of or in connection with occurrences after the Closing Date and (y) do not arise out of a breach of Seller's 41 representations and warranties in, or a default in the performance of any of Seller's covenants under, this Agreement; SECTION 5.3 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The several representations and warranties of the parties contained in this Agreement or in any instrument delivered pursuant to this Agreement will survive the Closing Date and will remain in full force and effect thereafter for a period of one year from the Closing Date; PROVIDED, HOWEVER, that the representations and warranties contained in Section 2.12 shall be governed by Section 4.3 and the representations and warranties contained in Section 2.19 will survive the Closing Date for a period of two years from the Closing Date; PROVIDED, FURTHER, that such representations or warranties shall survive (if at all) beyond such period with respect to any inaccuracy therein or breach thereof, notice of which shall have been duly given within such one year or two years time period, as applicable, in accordance with Section 5.4. Other than as stated in the tax indemnity in Section 4.3, anything to the contrary contained herein notwithstanding, neither party shall be entitled to recover from the other unless and until the total of all claims for indemnity or damages with respect to any inaccuracy or breach of any such representations or warranties or breach of any covenants, undertakings or other agreements, whether such claims are brought under this Article V or otherwise (other than, in each case, the Excluded Losses), exceeds $5,000,000 and then only for the amount by which such claims for indemnity or damages exceed $5,000,000; PROVIDED, HOWEVER, that no party shall be entitled to recover from the other more than $50,000,000 in the aggregate pursuant to this Article V. SECTION 5.4 NOTICE AND OPPORTUNITY TO DEFEND. If an event occurs which a party asserts is an indemnifiable event pursuant to Section 5.1 or 5.2, the party seeking indemnification shall promptly notify the other party obligated to provide indemnification (the "INDEMNIFYING PARTY"). If such event involves (i) any claim or (ii) the commencement of any action or proceeding by a third person, the party seeking indemnification will give such Indemnifying Party prompt written notice of such claim or the commencement of such action or proceeding, PROVIDED, HOWEVER, that the failure to provide prompt notice as provided herein will relieve the Indemnifying Party of its obligations hereunder only to the extent that such failure prejudices the Indemnifying Party hereunder. If any such action is brought against any party seeking indemnification and it notifies the Indemnifying Party of the commencement thereof, the Indemnifying Party shall be entitled to participate therein and, to the extent that it wishes, at its cost, risk and expense to assume the defense thereof, with counsel reasonably satisfactory to the party seeking indemnification, unless the named party to such action or proceeding includes both an Indemnifying 42 Party and a party seeking indemnification and the party seeking indemnification has been advised in writing by counsel that there may be one or more legal defenses available to such party that are different from or additional to those available to the Indemnifying Party, in which event the party seeking indemnification shall be entitled, at the Indemnifying Party's reasonable cost and expense to separate counsel of its own choosing reasonably acceptable to the Indemnifying Party. After notice from the Indemnifying Party to the party seeking indemnification of such election to so assume the defense thereof, the Indemnifying Party shall not be liable to the party seeking indemnification for any legal expenses of other counsel or any other expenses subsequently incurred by such party in connection with the defense thereof. The party seeking indemnification agrees to cooperate in all reasonable respects with the Indemnifying Party and its counsel in the defense against any such asserted liability. The party seeking indemnification shall have the right to participate at its own expense in the defense of such asserted liability. The Indemnifying Party shall be entitled to compromise or settle any claim as to which it is providing indemnification, which compromise or settlement shall be made only with the written consent of the party being indemnified, such consent not to be unreasonably withheld. If an Indemnifying Party fails to assume the defense of a claim within 30 calendar days after receipt of the notice of claim by the Indemnifying Party, the party seeking indemnification, against which such claim has been asserted, will, upon delivering notice to such effect to the Indemnifying Party, have the right to undertake, at the Indemnifying Party's reasonable cost and expense subject to the limitations set forth in this Article V, the defense, compromise or settlement of such claim on behalf of and for the account of the Indemnifying Party subject to the limitations set forth in this Article V; PROVIDED, HOWEVER, that such claim shall not be compromised or settled without the written consent of the Indemnifying Party, which consent shall not be unreasonably withheld. If the party seeking indemnity assumes the defense of the claim, it shall keep the Indemnifying Party reasonably informed of the progress of any such defense, compromise or settlement. In no event shall an Indemnifying Party be liable for any settlement effected without its consent, which will not be unreasonably withheld. SECTION 5.5 ADJUSTMENT FOR INSURANCE AND TAXES. The amount which an Indemnifying Party is required to pay to, for or on behalf of the other party (hereinafter referred to as an "INDEMNITEE") pursuant to this Article V and Section 4.3 shall be adjusted (including, without limitation, retroactively) (i) by any insurance proceeds actually recovered by or on behalf of such Indemnitee in reduction of the related indemnifiable loss (the "INDEMNIFIABLE LOSS") and (ii) to take account of any tax benefit actually realized as a result of any Indemnifiable Loss, less the cost of 43 procuring such insurance proceeds or tax benefit. Amounts required to be paid, as so reduced, are hereinafter sometimes called an "INDEMNITY PAYMENT." If an Indemnitee has received or has had paid on its behalf an Indemnity Payment for an Indemnifiable Loss and subsequently receives insurance proceeds for such Indemnifiable Loss, or realizes any tax benefit as a result of such Indemnifiable Loss, then the Indemnitee shall (i) promptly notify the Indemnifying Party of the amount and nature of such proceeds and benefits, together with the cost of procuring them, and (ii) pay to the Indemnifying Party the amount of such insurance proceeds or tax benefit (reduced by such procurement cost), or, if lesser, the amount of the Indemnity Payment. SECTION 5.6 MITIGATION OF LOSS. Each Indemnitee is obligated to use its reasonable efforts to mitigate the amount of any Loss for which it is entitled to seek indemnification hereunder, and the Indemnifying Party shall not be required to make any payment to an Indemnitee in respect of such Loss to the extent such Indemnitee failed to comply with the foregoing obligation. SECTION 5.7 SUBROGATION. Upon making any Indemnity Payment, the Indemnifying Party will, to the extent of such payment, be subrogated to all rights of the Indemnitee against any third party in respect of the Loss to which the payment relates; PROVIDED, HOWEVER, that until the Indemnitee recovers full payment of its Loss, any and all claims of the Indemnifying Party against any such third party on account of such payment are hereby made expressly subordinated and subjected in right of payment of the Indemnitee's rights against such third party. Without limiting the generality of any other provision hereof, each such Indemnitee and Indemnifying Party will duly execute upon request all instruments reasonably necessary to evidence and perfect the above described subrogation and subordination rights. SECTION 5.8 TAX INDEMNIFICATION. None of the provisions of this Article V, with the exception of Section 5.5, shall apply to the claims, obligations, liabilities, covenants and representations under Section 4.3, which shall be governed solely by the terms thereof. SECTION 5.9 SET-OFF. Neither Seller nor Purchaser shall have any right to set-off any Losses against any payments to be made by such party or parties pursuant to this Agreement or the Service Agreements, except as otherwise expressly provided herein or therein. SECTION 5.10 EXCLUSIVE REMEDY. Following the Closing, the indemnities provided for in this Article V shall be the sole and exclusive remedies of 44 the parties and their respective officers, directors, employees, Affiliates, agents, representatives, successors and assigns for any breach of or inaccuracy in any representation or warranty or any breach, nonfulfillment or default in the performance of any of the covenants or agreements contained in this Agreement (but not any such covenants or agreements to the extent they are by their terms to be performed after the Closing Date). The parties shall not be entitled to a recission of this Agreement or to any further indemnification rights or claims of any nature whatsoever in respect thereof (whether by contract, common law, statute, law, regulation or otherwise, including, without limitation, under the Racketeer Influence and Corrupt Organizations Act of 1970, as amended), all of which the parties hereby waive, PROVIDED, HOWEVER, that nothing herein is intended to waive any claims for intentional fraud. ARTICLE VI CONDITIONS SECTION 6.1 CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE CLOSING. The obligations of Seller, on the one hand, and Purchaser, on the other hand, to consummate the Closing are subject to the satisfaction (or, if permissible, waiver by the party for whose benefit such conditions exist) of the following conditions: (a) no arbitrator or Governmental Entity shall have issued any order, decree or ruling, and there shall not be any statute, rule or regulation, restraining, enjoining or prohibiting the consummation of the material transactions contemplated by this Agreement; PROVIDED that the parties shall have used all reasonable efforts to cause any such order, decree, ruling, statute, rule or regulation to be vacated or lifted; (b) any waiting period applicable to the transactions contemplated hereby under the HSR Act shall have expired or been terminated; (c) the required state insurance regulatory approvals of the consummation of the transactions contemplated hereunder (the "STATE INSURANCE REGULATORY APPROVAL"), including the approval of the California Department of Insurance pursuant to California Insurance Code Section 1215 ET SEQ., shall have been obtained, PROVIDED, that if Purchaser is unable to obtain Insurance Regulatory Approval for CCIC and Seller has exercised its right under Section 4.15 to treat CCIC 45 as an Excluded Asset, this Section 6.1(c) shall be deemed satisfied with respect to CCIC; and (d) all authorizations, approvals or consents required to permit the consummation of the transactions contemplated hereby shall have been obtained and be in full force and effect, except where the failure to have obtained any such authorizations, approvals or consents would not have a Seller Material Adverse Effect or a Purchaser Material Adverse Effect, as the case may be. SECTION 6.2 CONDITIONS TO THE OBLIGATIONS OF PURCHASER. The obligations of Purchaser to consummate the transactions contemplated hereby are subject to the satisfaction (or waiver by Purchaser) of the following further conditions: (a) the representations and warranties of Seller shall be true and accurate as of the Closing Date as if made at and as of such time (other than (i) Section 2.8 and (ii) those representations and warranties that address matters only as of a particular date or only with respect to a specific period of time which need to be true and accurate only as of such date or with respect to such period), except (x) where the failure of such representations and warranties to be so true and accurate (without giving effect to any limitation as to "materiality" or "material adverse effect" set forth therein), would not have, a Seller Material Adverse Effect or (y) where the failure of such representations to be true and accurate arises out of, or relates to, the business or operations of the Seller Subsidiaries following the date hereof (an "EXCLUDED BREACH"), unless written notice of such failure or inaccuracy occurring within the first 20 business days after the date hereof is provided as contemplated by Section 7.1(e) within 35 days following the date hereof; (b) Seller shall have performed in all material respects the obligations hereunder required to be performed by it at or prior to the Closing Date; (c) Purchaser shall have received an incumbency certificate and a certificate signed by two executive officers of Seller, dated as of the Closing Date, to the effect that the conditions set forth in Section 6.2(a) and Section 6.2(b) have been satisfied; (d) the Seller Subsidiaries shall have entered into the Reinsurance Agreement; 46 (e) all Intercompany Accounts have been terminated as of the Closing Date; (f) Seller shall have entered into the Transitional Services Agreement contemplated by Exhibit B-4 hereto; (g) Purchaser shall have received letters of resignation from each of the members of the Board of Directors of each Seller Subsidiary, which resignations shall be effective as of the Closing Date; (h) the Company shall have no subsidiaries other than the Insurance Subsidiaries; and (i) Seller shall have delivered copies to Purchaser of all certificates of good standing, certificates of qualification and certificates of authority for each Seller Subsidiary consistent with the disclosure provided in Section 2.11(b) of the Disclosure Schedules. SECTION 6.3 CONDITIONS TO THE OBLIGATIONS OF SELLER. The obligations of Seller to consummate the transactions contemplated hereby are subject to the satisfaction (or waiver by Seller) of the following conditions: (a) the representations and warranties of Purchaser shall be true and accurate as of the Closing Date as if made at and as of such time (other than those representations and warranties that address matters only as of a particular date or only with respect to a specific period of time which need to be true and accurate only as of such date or with respect to such period), except where the failure of such representations and warranties to be so true and accurate (without giving effect to any limitation as to "materiality" or "material adverse effect" set forth therein) would not have a Purchaser Material Adverse Effect; (b) Purchaser shall have performed in all material respects all of the obligations hereunder required to be performed by Purchaser, at or prior to the Closing Date; (c) Seller shall have received an incumbency certificate and a certificate signed by two executive officers of Purchaser, dated as of the Closing Date, to the effect that the conditions set forth in Section 6.3(a) and Section 6.3(b) have been satisfied; 47 (d) Purchaser shall have delivered executed copies of each of the Service Agreements; and (e) at the Closing, Purchaser shall have delivered to Seller a certificate (which certificate shall survive the Closing) to the effect that (i) Purchaser has conducted and is satisfied with the results of its business, accounting and legal due diligence review of the Shares and the business and affairs of Seller and the Seller Subsidiaries and (ii) in completing the transactions contemplated in accordance with this Agreement, Purchaser has not and is not relying on any representation or warranty of Seller or the Seller Subsidiaries which is not expressly stated in this Agreement. ARTICLE VII TERMINATION SECTION 7.1 TERMINATION. Anything herein or elsewhere to the contrary notwithstanding, this Agreement may be terminated and the transactions contemplated herein may be abandoned at any time prior to the Closing Date: (a) by the mutual consent of Seller and Purchaser; (b) by Seller or Purchaser: (i) if the Closing shall not have occurred on or prior to November 30, 1998 (or December 31, 1998 if the only condition remaining unfulfilled at November 30, 1998 is approval by any required Governmental Entity and Seller and Purchaser are continuing to seek to obtain such approval); PROVIDED, HOWEVER, that the right to terminate this Agreement under this Section 7.1(b)(i) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or prior to such date; or (ii) if any Governmental Entity shall have issued an order, decree or ruling or taken any other action (which order, decree, ruling or other action the parties hereto shall use all reasonable efforts to lift), in each case permanently restraining, enjoining or otherwise prohibiting the material 48 transactions contemplated by this Agreement, and such order, decree, ruling or other action shall have become final and non-appealable; (c) by Seller if Purchaser (x) breaches or fails in any material respect to perform or comply with any of its material covenants and agreements contained herein or (y) breaches its representations and warranties in any material respect and such breach would have a Purchaser Material Adverse Effect, in each case such that the conditions set forth in Section 6.1 or Section 6.3 would not be satisfied; PROVIDED, HOWEVER, that if any such breach is curable within a reasonable period of time by Purchaser through the exercise of Purchaser's best efforts and for so long as Purchaser shall be so using its best efforts to cure such breach, Seller may not terminate this Agreement pursuant to this Section 7.1(c); (d) by Purchaser if Seller (x) breaches or fails in any material respect to perform or comply with any of their material covenants and agreements contained herein or (y) breaches its representations and warranties in any material respect (other than Excluded Breaches) and such breach would have a Seller Material Adverse Effect, in each case such that the conditions set forth in Section 6.1 or Section 6.2 would not be satisfied; PROVIDED, HOWEVER, that if any such breach is curable within a reasonable period of time by Seller through the exercise of Seller's best efforts and for so long as Seller shall be so using its best efforts to cure such breach, Purchaser may not terminate this Agreement pursuant to this Section 7.1(d); (e) by Purchaser if, from the date of this Agreement through to the Closing Date, there shall have occurred a "Material Adverse Change," as hereinafter defined, in the financial condition, business or operations of the Seller Subsidiaries, taken as a whole. A "MATERIAL ADVERSE CHANGE", for purposes of this Section 7.1(e), means (i) during the twenty (20) business days following the date of this Agreement, any change in the business or operations of the Seller Subsidiaries that meets the definition of a Seller Material Adverse Effect and with respect to which Purchaser provides Seller, within thirty-five (35) days following the date hereof, written notice of its desire to terminate this Agreement pursuant to this Section 7.1(e) and (ii) after such twenty (20) business day period, subject to the right to provide written notice as provided by the immediately preceding clause (i), until the Closing Date, a change in the business or operations of the Seller Subsidiaries that meets the definition of a Seller Material Adverse Effect, other than a Seller Material Adverse Effect arising out of, or relating to, the business or operations of the Seller Subsidiaries after the date hereof or the matters disclosed in the Disclosure Schedules; or 49 (f) by Seller if (x) Purchaser, its board of directors or officers fails to recommend to Purchaser's stockholders, or withdraws, revokes or otherwise adversely modifies its approval or recommendation of the transactions contemplated hereby or (y) the stockholders of Purchaser fail to approve those matters requiring their approval in order to consummate the transactions contemplated hereby. SECTION 7.2 PROCEDURE AND EFFECT OF TERMINATION. In the event of the termination and abandonment of this Agreement by Seller or Purchaser pursuant to Section 7.1, written notice thereof shall forthwith be given to the other party. If the transactions contemplated by this Agreement are terminated as provided herein: (a) each party will return all documents, work papers and other material of any other party relating to the transactions contemplated hereby, whether so obtained before or after the execution hereof, to the party furnishing the same; (b) all confidential information received by either party with respect to the business of any other party or its subsidiaries or Affiliates shall be treated in accordance with the provisions of the Confidentiality Agreement, which shall survive the termination of this Agreement; and (c) neither party will have any liability under this Agreement to the other except (i) as stated in subparagraphs (a) and (b) of this Section 7.2, (ii) for any willful breach of any provision of this Agreement and (iii) as provided in the Confidentiality Agreement. SECTION 7.3 BREAKUP FEE. In the event that the conditions to closing set forth in Article VI with respect to a party have been met and there is no basis for such party to terminate this Agreement pursuant to Section 7.1, yet, upon written request, such party does not agree upon and does not meet a reasonable schedule to set the Closing Date and complete the Closing, then such party shall be deemed to have wrongfully failed to close and the other party shall be entitled to: (a) obtain injunctive relief to require the Closing to occur; OR (b) receive a $15,000,000 payment from the other party and seek additional monetary damages from the other party, if any, PROVIDED, HOWEVER, that the occurrence of the Closing shall preclude in full the availability of alternative (b). In addition, in the event Seller terminates the Agreement pursuant to Section 7.1(f), Seller shall be entitled to receive a $15,000,000 payment from Purchaser and seek additional monetary damages, if any. Any payment required above shall be paid in immediately available funds within three (3) business 50 days of the demand for such payment and shall accrue interest at LIBOR plus 2% per annum. For the purposes of this Agreement, "LIBOR" shall mean "LIBOR" as defined in FHS's senior credit facility. ARTICLE VIII MISCELLANEOUS SECTION 8.1 GOVERNING LAWS AND CONSENT TO JURISDICTION. The laws of the State of Delaware (irrespective of its choice of law principles) shall govern all issues concerning the validity of this Agreement, the construction of its terms and the interpretation and enforcement of the rights and duties of the parties. Each party irrevocably submits to the exclusive jurisdiction of the federal courts of the United States of America located in Los Angeles County, California (and federal courts having jurisdiction over appeals therefrom) in respect of the transactions contemplated by this Agreement, the other agreements and documents referred to herein and the transactions contemplated by this Agreement and such other documents and agreements. SECTION 8.2 AMENDMENT AND MODIFICATION. Subject to applicable law, this Agreement may be amended, modified and supplemented in any and all respects by written agreement of the parties at any time prior to the Closing Date with respect to any of the terms contained herein. SECTION 8.3 NOTICES. All notices, consents and other communications hereunder shall be in writing and shall be deemed to have been duly given (i) upon actual receipt or when delivered by hand or by FedEx or a similar overnight courier, (ii) five days after being deposited in any United States Post Office enclosed in a postage prepaid, registered or certified envelope addressed or (iii) when successfully transmitted by telecopier (with a confirming copy of such communication to be sent as provided in clause (i) or (ii) above), to the receiving party during regular business hours at the address or telecopier number set forth below (or at such other address or telecopier number for a party as shall be specified by like notice), PROVIDED, HOWEVER, that any notice of change of address or telecopier number shall be effective only upon receipt: 51 (a) if to Purchaser, to: Superior National Insurance Group, Inc. 26601 Agoura Road Calabasas, California 91302 Telephone No.: (818) 880-1600 Telecopy No.: (818) 880-8615 Attention: J. Chris Seaman with a copy to: Riordan & McKinzie 5473 Corsa Avenue, Suite #116 Westlake Village, California 91362 Telephone No.: (818) 706-1800 Telecopy No.: (818) 706-2956 Attention: Dana M. Warren, Esq. (b) if Seller, to: Foundation Health Systems, Inc. 225 North Main Pueblo, CO 81003 Telephone : (719) 585-8077 Telecopy No: (719) 585-8175 Attention: General Counsel with a copy to: Skadden, Arps, Slate, Meagher & Flom (Illinois) 333 West Wacker Drive Chicago, Illinois 60606 Telephone No.: (312) 407-0700 Telecopy No.: (312) 407-0411 Attention: Peter C. Krupp, Esq. SECTION 8.4 INTERPRETATION. 52 (a) The words "hereof," "herein" and "herewith" and words of similar import shall, unless otherwise stated, be construed to refer to this Agreement as a whole and not to any particular provision of this Agreement, and article, section, paragraph, exhibit and schedule references are to the articles, sections, paragraphs, exhibits and schedules of this Agreement unless otherwise specified. The words describing the singular number shall include the plural and vice versa, and words denoting any gender shall include all genders and words denoting natural persons shall include corporations and partnerships and vice versa. As used in this Agreement, the term "AFFILIATE(S)" shall have the meaning set forth in Rule l2b-2 of the Securities Exchange Act of 1934, as amended. The phrases "to the knowledge of," "to a party's best knowledge," or any similar phrase shall mean such facts and other information which as of the date of determination are actually known to any vice president or chief financial officer and any officer superior to any of the foregoing, of the referenced party. The phrase "made available" in this Agreement shall mean that the information referred to has been made available if requested by the party to whom such information is to be made available. The phrases "the date of this Agreement," "the date hereof" and terms of similar import, unless the context otherwise requires, shall be deemed to refer to May 5, 1998. As used in this Agreement, the term "business day" means a day, other than a Saturday or a Sunday, on which banking institutions in the city of Los Angeles are open. The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Agreement. (b) The Disclosure Schedule shall be construed with and as an integral part of this Agreement as if the same had been set forth verbatim herein. Any matter disclosed pursuant to the Disclosure Schedule shall be deemed to be disclosed for all purposes under this Agreement, but such disclosure shall not be deemed to be an admission or representation as to the materiality of the item so disclosed. (c) Headings are for convenience of the parties only and shall be given no substantive or interpretative effect whatsoever. (d) Notwithstanding the provisions of Section 1.2, the Purchase Price shall be increased by the amount of any capital contributions made to the Company after December 31, 1997 in order to fund any capital contributions or any other payment (a "GOVERNMENTAL PAYMENT"), in an amount not to exceed $25,000,000, 53 which are required by any Governmental Entity (as defined below) and such increase shall be payable by wire transfer of immediately available funds to an account designated by Seller; PROVIDED that an increase in the Purchase Price attributable to Governmental Payments in excess of $10,000,000 shall be paid in the form of a senior note from Purchaser (the "PURCHASER NOTE") with the principal amount thereon due three years from the Closing Date and bearing a rate of interest, payable quarterly, equal to the interest on the senior notes to be issued by Purchaser pursuant to the Financing Agreements. The Purchaser Note, if any, shall be in a form reasonably acceptable to Seller and Purchaser. SECTION 8.5 COUNTERPARTS. This Agreement may be executed in multiple counterparts, all of which shall together be considered one and the same agreement. SECTION 8.6 ENTIRE AGREEMENT; THIRD PARTY BENEFICIARIES. This Agreement (including the documents and the instruments referred to herein), the Confidentiality Agreement and the Disclosure Schedule (i) constitute the entire agreement and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof and (ii) except as provided herein, are not intended to confer upon any person other than the parties hereto any rights or remedies hereunder. SECTION 8.7 SEVERABILITY. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void, unenforceable or against its regulatory policy, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. SECTION 8.8 SERVICE OF PROCESS. Each party irrevocably consents to the service of process outside the territorial jurisdiction of the courts referred to in Section 8.1 hereof in any such action or proceeding by mailing copies thereof by registered United States mail, postage prepaid, return receipt requested, to its address as specified in or pursuant to Section 8.3 hereof. However, the foregoing shall not limit the right of a party to effect service of process on the other party by any other legally available method. SECTION 8.9 SPECIFIC PERFORMANCE. Each party acknowledges and agrees that in the event of any breach of this Agreement, each non-breaching 54 party would be irreparably and immediately harmed and could not be made whole by monetary damages. It is accordingly agreed that, subject to the terms of Section 7.3, the parties will (a) waive, in any action for specific performance, the defense of adequacy of a remedy at law and (b) be entitled, in addition to any other remedy to which they may be entitled at law or in equity, to compel specific performance of this Agreement in any action instituted in accordance with Section 8.1. SECTION 8.10 ASSIGNMENT. Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by either party (whether by operation of law or otherwise) without the prior written consent of the other party. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of and be enforceable by the parties and their respective permitted successors and assigns. SECTION 8.11 EXPENSES. Except as otherwise provided herein, all costs and expenses incurred in connection with the transactions contemplated hereby, this Agreement and the consummation of the transactions contemplated hereby shall be paid by the party incurring such costs and expenses, whether or not the transactions contemplated hereby is consummated, PROVIDED that Purchaser shall pay all fees associated with any filings made under the HSR Act in connection with the transactions contemplated by this Agreement. SECTION 8.12 WAIVERS. Except as otherwise provided in this Agreement, any failure of either party to comply with any obligation, covenant, agreement or condition herein may be waived by the party or parties entitled to the benefits thereof only by a written instrument signed by the party granting such waiver, but such waiver or failure to insist upon strict compliance with such obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure. 55 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be signed by their respective officers thereunto duly authorized as of the date first written above. FOUNDATION HEALTH CORPORATION By: /s/ SIGNATURE ------------------------------------ SUPERIOR NATIONAL INSURANCE GROUP, INC. By: /s/ SIGNATURE ------------------------------------ 56 EX-27 4 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 343,940 603,498 512,512 0 0 2,311,377 435,070 0 3,946,886 1,542,439 1,353,420 0 0 124 927,278 3,946,886 2,149,224 2,175,374 1,821,002 1,821,002 289,249 0 21,861 43,262 17,024 26,238 0 0 0 26,238 0.22 0.22 NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS NET OF ACCUMULATED DEPRECIATION INCLUDES BORROWINGS UNDER FHS REVOLVING CREDIT FACILITY MISC NOTES PAYABLE & CAPITAL LEASES
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