Zenith National Insurance (ZNT) 10-Q 2002 Q1 Quarterly report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2002

Commission File Number 1-9627

ZENITH NATIONAL INSURANCE CORP.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	95-2702776 (I.R.S. Employer Identification No.)
21255 Califa Street, Woodland Hills, California (Address of principal executive offices)	91367-5021 (Zip Code)

(818) 713-1000
(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 ý    No o

        At May 8, 2002, there were 18,646,000 shares of Zenith National common stock outstanding, net of 7,018,000 shares of treasury stock.

PART l
FINANCIAL INFORMATION

Item 1. Financial Statements

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

(In thousands)			March 31, 2002			December 31, 2001
			(Unaudited)
Assets:
Investments:
	Fixed maturities:
		At amortized cost (fair value $65,984 in 2002 and $29,284 in 2001)	$	66,153		$	28,593
		At fair value (cost $683,031 in 2002 and $699,967 in 2001)		674,958			698,666
	Floating rate preferred stocks, at fair value (cost $6,799 in 2002 and 2001)			6,157			6,093
	Convertible and non-redeemable preferred stocks, at fair value (cost $5,488 in 2002 and 2001)			5,938			5,795
	Common stocks, at fair value (cost $29,484 in 2002 and $29,411 in 2001)			30,619			28,394
	Short-term investments (at cost, which approximates fair value)			116,795			119,066
	Other investments			61,683			58,090
		Total investments		962,303			944,697
Cash				22,905			24,910
Accrued investment income				13,588			11,659
Premiums receivable, less allowance for doubtful accounts of $6,965 in 2002 and $7,704 in 2001				86,484			86,823
Receivable from reinsurers and state trust funds for paid and unpaid losses				259,821			263,500
Deferred policy acquisition costs				13,143			12,679
Properties and equipment, less accumulated depreciation				49,216			49,192
Deferred tax asset				36,833			34,526
Current federal income tax receivable				5,590			13,357
Goodwill (Note 5)				21,485			21,485
Other assets				83,732			77,231
		Total assets	$	1,555,100		$	1,540,059
Liabilities:
Policy liabilities and accruals:
	Unpaid loss and loss adjustment expenses		$	949,877		$	946,822
	Unearned premiums			80,224			71,313
Policyholders' dividends accrued				3,154			3,316
Reserves on loss portfolio transfers				12,638			13,397
Payable to banks				15,712			16,186
Senior notes payable, less unamortized issue costs of $8 in 2002 and $32 in 2001 (Note 6)				57,227			57,203
Other liabilities				70,475			63,542
		Total liabilities		1,189,307			1,171,779
Redeemable securities:
Company-obligated, mandatorily redeemable 8.55% Capital Securities of Zenith National Insurance Capital Trust I, holding solely 8.55% Subordinated Deferrable Interest Debentures due 2028 of Zenith National Insurance Corp., less unamortized issue cost and discount of $1,319 in 2002 and $1,331 in 2001				65,681			65,669
Commitments and contingent liabilities (Note 3)
Stockholders' equity:
Preferred stock, $1 par—shares authorized 1,000; issued and outstanding, none in 2002 and 2001
Common stock, $1 par—shares authorized 50,000; issued 25,652, outstanding 18,634 in 2002; issued 25,571, outstanding 18,553 in 2001				25,652			25,571
Additional paid-in capital				293,490			291,348
Retained earnings				117,749			119,600
Accumulated other comprehensive loss—net unrealized depreciation on investments, net of deferred tax benefit of $2,496 in 2002 and $951 in 2001				(4,637	)		(1,766	)
				432,254			434,753
Treasury stock at cost (7,018 shares in 2002 and 2001)				(132,142	)		(132,142	)
		Total stockholders' equity		300,112			302,611
		Total liabilities, redeemable securities and stockholders' equity	$	1,555,100		$	1,540,059

The accompanying notes are an integral part of this financial statement.

2

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

				Three Months Ended March 31,
(In thousands, except per share data)
				2002			2001
Revenues:
Premiums earned				$	121,274		$	104,638
Net investment income					12,662			13,380
Realized (losses) gains on investments					(828	)		137
Real estate sales					20,297			17,110
		Total revenues			153,405			135,265
Expenses:
Loss and loss adjustment expenses incurred					90,363			85,088
Policy acquisition costs					22,044			18,777
Other underwriting and operating expenses					14,952			13,016
Policyholders' dividends and participation					599			565
Real estate construction and operating costs					18,930			15,998
Interest expense					2,099			1,803
		Total expenses			148,987			135,247
	Income before federal income tax expense				4,418			18
Federal income tax expense					1,618			118
			Net income (loss)	$	2,800		$	(100	)
Net income (loss) per common share (Note 2)—
	Basic:			$	0.15		$	(0.01	)
	Diluted:				0.15			(0.01	)
Disclosure regarding comprehensive (loss) income:
Net income (loss)				$	2,800		$	(100	)
Change in unrealized depreciation on investments					(2,871	)		5,177
Comprehensive (loss) income				$	(71	)	$	5,077

The accompanying notes are an integral part of this financial statement.

3

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

			Three Months Ended March 31,
(In thousands)
			2002			2001
Cash flows from operating activities:
	Premiums collected		$	138,563		$	114,279
	Investment income received			10,087			12,151
	Proceeds from sales of real estate			20,297			17,110
	Loss and loss adjustment expenses paid			(77,787	)		(79,019	)
	Underwriting and other operating expenses paid			(50,943	)		(35,456	)
	Real estate construction costs paid			(18,272	)		(17,998	)
	Interest paid			(2,256	)		(1,931	)
	Income taxes refunded (paid)			5,497			(5	)
		Net cash provided by operating activities		25,186			9,131
Cash flows from investing activities:
	Purchases of investments:
		Investment securities available-for-sale		(78,210	)		(161,604	)
		Fixed maturities held-to-maturity		(39,650	)
		Other investments		(2,889	)		(291	)
	Proceeds from maturities and redemptions of investments:
		Fixed maturities held-to-maturity		2,045			751
		Investment securities available-for-sale		15,066			12,043
	Proceeds from sales of investments:
		Investment securities available-for-sale		78,915			131,167
		Other investments		156			3,008
	Net change in short-term investments			2,432			1,112
	Capital expenditures and other, net			(2,053	)		(914	)
		Net cash used in investing activities		(24,188	)		(14,728	)
Cash flows from financing activities:
	Cash advanced from bank construction loans			16,150			14,324
	Cash repaid on bank construction loans			(16,624	)		(13,932	)
	Cash dividends paid to common stockholders			(4,641	)		(4,368	)
	Proceeds from exercise of stock options			2,112			1,258
		Net cash used in financing activities		(3,003	)		(2,718	)
	Net decrease in cash			(2,005	)		(8,315	)
	Cash at beginning of period			24,910			16,026
		Cash at end of period	$	22,905		$	7,711
Reconciliation of net income (loss) to net cash flows from operating activities:
Net income (loss)			$	2,800		$	(100	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
	Net depreciation, amortization and accretion			936			1,326
	Realized losses (gains) on investments			828			(137	)
	Decrease (increase) in:
		Premiums receivable		339			(5,038	)
		Receivable from reinsurers and state trust funds on paid and unpaid losses		3,343			10,108
		Federal income tax		7,115			113
		Real estate construction in progress and land held for development		972			(930	)
	Increase (decrease) in:
		Unpaid loss and loss adjustment expenses		3,055			(5,525	)
		Unearned premiums		8,911			11,298
		Policyholders' dividends accrued		(162	)		427
		Other		(2,951	)		(2,411	)
		Net cash provided by operating activities	$	25,186		$	9,131

The accompanying notes are an integral part of this financial statement.

4

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 1. Basis of Presentation

        The accompanying unaudited, consolidated financial statements of Zenith National Insurance Corp. ("Zenith National") and subsidiaries (collectively, "Zenith") have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the financial position and results of operations of Zenith for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. For further information, refer to the financial statements and notes thereto included in the Zenith National Insurance Corp. Annual Report on Form 10-K for the year ended December 31, 2001. Zenith has elected to round to the nearest thousand dollars, except for per share data, in reporting amounts in this statement.

Note 2. Earnings and Dividends Per Share

        The following table sets forth the computation of basic and diluted net income (loss) per share:

			Three Months Ended March 31,
(In thousands, except per share data)
			2002		2001
(A)	Net income (loss)		$	2,800	$	(100	)
(B)	Weighted average outstanding shares during the period			18,598		17,485
	Additional common shares issuable under employee stock option plans using the treasury stock method			249		181
(C)	Weighted average number of common shares outstanding assuming exercise of stock options			18,847		17,666
	Net income (loss) per common share
(A)/(B)		Basic (1)	$	0.15	$	(0.01	)
(A)/(C)		Diluted (1)	$	0.15	$	(0.01	)
	Dividends per common share			0.25		0.25

(1) Additional common shares issuable under employee stock option plans using the treasury stock method are antidilutive for the first quarter of 2001 because there is a loss from continuing operations for the first quarter of 2001.

Note 3. Contingent Liabilities

RISCORP Litigation

        On April 1, 1998, pursuant to an Asset Purchase Agreement dated June 17, 1997 (as amended from time to time, the "Asset Purchase Agreement") between Zenith Insurance Company ("Zenith Insurance") and RISCORP Inc. and certain of its subsidiaries (collectively, "RISCORP"), Zenith Insurance acquired substantially all of the assets and certain liabilities of RISCORP related to

5

RISCORP's workers' compensation business (the "RISCORP Acquisition"). The total purchase price for such acquired assets and liabilities was determined by a three-step process in which RISCORP and its external accounting and actuarial consultants and Zenith Insurance and its external accounting and actuarial consultants made and presented their estimates of the GAAP values of the assets and liabilities acquired by Zenith Insurance to an independent third-party, acting as a Neutral Auditor and Neutral Actuary. Such estimates varied considerably, particularly with respect to the value of premiums receivable and the liability for unpaid losses and loss adjustment expenses. On March 19, 1999, the Neutral Auditor and Neutral Actuary issued its report determining the disputes between the parties. That report indicated that the value of the assets transferred to Zenith Insurance exceeded the value of the liabilities assumed by Zenith Insurance by $92.3 million.

        Zenith Insurance and RISCORP entered into a settlement agreement dated July 7, 1999 (the "Settlement Agreement") providing for the resolution of certain claims arising out of the RISCORP Acquisition. Pursuant to the Settlement Agreement, Zenith Insurance and RISCORP agreed, among other things, that RISCORP may request that the Neutral Auditor and Neutral Actuary (a) review an alleged error concerning the proper treatment of certain reinsurance treaties in its determinations with respect to the purchase price for the RISCORP Acquisition, without waiving whatever rights RISCORP may have to litigation of such issue, (b) determine whether the issue was properly in dispute before the Neutral Auditor and Neutral Actuary and (c) if so, determine the merits of the issue and whether a correction is appropriate. Zenith Insurance and RISCORP also agreed that Zenith Insurance would receive $6.0 million from an escrow account established pursuant to the Asset Purchase Agreement, and RISCORP would receive the balance of the escrow account. In a submission made to the Neutral Auditor and Neutral Actuary, RISCORP claimed that the purchase price for the RISCORP Acquisition should be adjusted by either $5.9 million or $23.4 million as a result of alleged errors in the original determination of the Neutral Auditor and Neutral Actuary with respect to the purchase price. On October 7, 1999, the Neutral Auditor and Neutral Actuary informed Zenith Insurance and RISCORP that it would not consider the issue raised by RISCORP because the issue had not previously been raised as a dispute pursuant to the procedures set forth in the engagement letter. On January 13, 2000, RISCORP filed a complaint against Zenith Insurance and the Neutral Auditor and Neutral Actuary in the Superior Court of Fulton County in the State of Georgia. On October 9, 2000, RISCORP filed a First Amended Complaint in the Superior Court of Fulton County. RISCORP's First Amended Complaint alleges causes of action for breach of contract against the Neutral Auditor and Neutral Actuary and, in conjunction, seeks a declaration that would have the effect of requiring Zenith to pay either $18.1 million (and related charges) or $5.9 million. RISCORP also has asserted causes of action for professional negligence solely against the Neutral Auditor and Neutral Actuary in which it seeks damages of either $18.1 million (and related charges) or $5.9 million. On May 1, 2001, the Superior Court granted in their entirety motions for judgment on the pleadings filed by Zenith Insurance and the Neutral Auditor and Neutral Actuary. The Georgia Court of Appeals rejected RISCORP's petition for expedited review of the Superior Court's decision pending a determination of counterclaims filed by Zenith Insurance and the Neutral Auditor and Neutral Actuary before the Superior Court. Zenith is unable to predict the outcome of this litigation.

Contingencies Surrounding Reinsurance Receivable from Reliance Insurance Company

        On October 3, 2001, the Commonwealth Court of Pennsylvania issued an Order of Liquidation for Reliance Insurance Company ("Reliance") in response to a petition from the Pennsylvania Department of Insurance. At March 31, 2002 and December 31, 2001, Reliance owed Zenith Insurance $6.0 million of reinsurance recoverable on paid and unpaid losses in connection with reinsurance arrangements assumed by Zenith Insurance in its 1996 acquisition of the Associated General Commerce Self-Insurers' Trust Fund. At March 31, 2002 and December 31, 2001, Zenith Insurance recorded a $3.0 million provision for impairment of the reinsurance recoverable from Reliance. Zenith Insurance cannot currently predict the ultimate outcome of this matter; but it is possible that if the Pennsylvania Department of Insurance increases its estimates of Reliance's unpaid liabilities or uncollectible

6

reinsurance recoverables without considering any additional investment income, Zenith Insurance may not recover any of its reinsurance recoverable from Reliance.

Contingencies Surrounding State Guarantee Fund Assessments

        State Guarantee Funds ("Guarantee Funds") exist to ensure that policyholders (holders of direct insurance polices but not of reinsurance policies) receive payment of their claims if insurance companies become insolvent. The Guarantee Funds are funded primarily by statutorily prescribed assessments they bill to other insurance companies doing business in their states. Various mechanisms exist in these states for assessed insurance companies to recover these assessments. Upon the insolvency of an insurance company, the Guarantee Funds become primarily liable for the payment of its policyholder liabilities. The declaration of an insolvency establishes the presumption that assessments by the Guarantee Funds are probable. Zenith writes workers' compensation insurance in many states where unpaid workers' compensation liabilities are the responsibility of the Guarantee Funds and has received and expects to continue to receive Guarantee Fund assessments, some of which may be based on certain of the premiums it has already earned at March 31, 2002. At March 31, 2002, Zenith recorded an estimate of $1.7 million (net of expected recoveries of $3.6 million recoverable before the end of 2003) for its expected liability at March 31, 2002 for Guarantee Fund assessments. This estimate is based on currently available information and could change based on additional information or reinterpretation of existing information concerning the actions of the Guarantee Funds. Zenith expects that it will continue to accrue and receive Guarantee Fund assessments; and the ultimate impact of such assessments will depend upon the amount and timing of the assessments and of any recoveries to which Zenith is entitled.

Contingencies Surrounding Recoverability of Special Disability Trust Fund Receivable

        In Florida, the Special Disability Trust Fund (the "Fund") assesses workers' compensation insurers to pay for what are commonly referred to as "Second Injuries." Historic assessments have been inadequate to completely fund obligations of the Fund. In late 1997, the Florida statute was amended so that the Fund will not be liable for, and will not reimburse employers or carriers for, Second Injuries occurring on or after January 1, 1998. Zenith Insurance has recorded its receivable from the Fund for Second Injuries based on specific claims and historical experience prior to January 1, 1998. At March 31, 2002 and December 31, 2001, the receivable from the Fund was $16.7 million and $18.1 million, respectively, related to the pre-January 1, 1998 claims.

Other Litigation

        Other than the RISCORP litigation described above, Zenith National and its subsidiaries are defendants in various other litigation. In the opinion of management, after consultation with legal counsel, such litigation is either without merit or the ultimate liability, if any, is not expected to have a material adverse effect on the consolidated financial condition or results of operations of Zenith.

7

Note 4. Segment Information

        Segment information is set forth below:

(Dollars in thousands)		Workers' Compensation			Reinsurance			Real Estate		Investments			Parent			Total
For the Three Months Ended March 31, 2002
Revenues:
Premiums earned		$	107,298		$	13,976										$	121,274
Net investment income										$	12,662						12,662
Realized losses on investments											(828	)					(828	)
Real estate sales								$	20,297								20,297
	Total revenues		107,298			13,976			20,297		11,834						153,405
Interest expense													$	(2,099	)		(2,099	)
(Loss) income before tax			(7,334	)		1,902			1,367		11,834			(3,351	)		4,418
Federal income tax (benefit) expense			(2,189	)		568			478		3,933			(1,172	)		1,618
	Net (loss) income	$	(5,145	)	$	1,334		$	889	$	7,901		$	(2,179	)	$	2,800
Combined ratios			106.8	%		86.4	%										104.5	%
As of March 31, 2002
Total assets		$	438,705		$	53,175		$	59,824	$	998,796		$	4,600		$	1,555,100

For the Three Months Ended March 31, 2001
Revenues:
Premiums earned		$	92,619		$	12,019									$	104,638
Net investment income										$	13,380					13,380
Realized gains on investments											137					137
Real estate sales								$	17,110							17,110
	Total revenues		92,619			12,019			17,110		13,517					135,265
Interest expense												$	(1,803	)		(1,803	)
(Loss) income before tax			(12,584	)		772			1,112		13,517		(2,799	)		18
Federal income tax (benefit) expense			(4,145	)		254			389		4,600		(980	)		118
	Net (loss) income	$	(8,439	)	$	518		$	723	$	8,917	$	(1,819	)	$	(100	)
Combined ratios			113.6	%		93.6	%									111.3	%
As of March 31, 2001
Total assets		$	489,514		$	33,037		$	61,088	$	895,540	$	1,127		$	1,480,306

Note 5. Goodwill—Adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142

        Effective January 1, 2002, Zenith adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which addresses the accounting for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized and other intangible assets are amortized over their useful lives (which may exceed forty years). The new standard also requires that goodwill and intangible assets with indefinite lives be tested for impairment at least annually and sets forth criteria for recognition and measurement of impairment.

        As of January 1, 2002, Zenith had recognized goodwill from previous acquisitions. Other than goodwill, Zenith had no intangible assets at January 1, 2002. Prior to January 1, 2002, goodwill

8

attributable to assets acquired since 1970 was being amortized over 25 years using the straight line method. As of January 1, 2002, Zenith ceased the amortization of such goodwill. Goodwill was $21.5 million at March 31, 2002 and December 31, 2001. Zenith evaluated this goodwill for impairment at January 1, 2002 in accordance with SFAS No. 142 and determined that such goodwill was not impaired.

        The following table presents Zenith's pro-forma net income (loss) and per share amounts excluding goodwill amortization expense in the three months ended March 31, 2001:

		Three Months Ended March 31,
(In thousands, except per share data)
		2002		2001
Net income (loss):
Net income (loss) as reported		$	2,800	$	(100	)
Goodwill amortization					231
	Pro-forma net income	$	2,800	$	131
Basic earnings per common share:
Net income (loss) as reported		$	0.15	$	(0.01	)
Goodwill amortization					0.02
	Pro-forma net income	$	0.15	$	0.01
Diluted earnings per common share:
Net income (loss) as reported		$	0.15	$	(0.01	)
Goodwill amortization					0.02
	Pro-forma net income	$	0.15	$	0.01

Note 6. Subsequent Events

        On May 1, 2002, Zenith National used $59.8 million of its available short-term investments to pay the principal and accrued interest on its 9% Senior Notes due May 1, 2002. As a result of the redemption, interest expense in future periods will be reduced, offset in part by a reduction of investment income on the funds used.

9

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

        The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. Forward-looking statements include those related to the plans and objectives of management for future operations, future economic performance, or projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure, or other financial items. Statements containing words such asexpect, anticipate, believe, or similar words that are used in Management's Discussion and Analysis of Financial Condition and Results of Operations, in other parts of this report or in other written or oral information conveyed by or on behalf of Zenith National Insurance Corp. ("Zenith National") and subsidiaries (collectively, "Zenith") are intended to identify forward-looking statements. Zenith undertakes no obligation to update such forward-looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include but are not limited to the following: (1) heightened competition, particularly intense price competition; (2) adverse state and federal legislation and regulation; (3) changes in interest rates causing fluctuations of investment income and fair values of investments; (4) changes in the frequency and severity of claims and catastrophes; (5) adequacy of loss reserves; (6) changing environment for controlling medical, legal and rehabilitation costs, as well as fraud and abuse; (7) the terrorist attacks of September 11, 2001, any future terrorist attacks and their aftermath; and (8) other risks detailed herein and from time to time in Zenith's other reports and filings with the Securities and Exchange Commission.

Overview

        The comparative components of net income (loss) after tax are set forth in the following table:

		Three Months Ended March 31,
(In thousands)
		2002			2001
Net investment income		$	8,439		$	8,828
Realized (losses) gains on investments			(538	)		89
Subtotal			7,901			8,917
Property-casualty underwriting results:
	Loss excluding catastrophes		(3,811	)		(6,946	)
	Catastrophe losses					(975	)
Property-casualty underwriting loss			(3,811	)		(7,921	)
Income from Real Estate Operations			889			723
Interest expense			(1,365	)		(1,172	)
Parent expenses			(814	)		(647	)
Net income (loss)		$	2,800		$	(100	)

        Results of operations improved in the first quarter of 2002 compared to the first quarter of 2001 principally as a result of reduced underwriting losses in the property-casualty operations (the "P&C Operations").

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        The comparative results of the P&C Operations before tax and combined ratios are set forth in the table below

				Three Months Ended March 31,
(Dollars in thousands)
				2002			2001
Premiums earned:
	Workers' Compensation:
		California		$	55,662		$	45,226
	Outside California				51,636			47,393
		Total Workers' Compensation			107,298			92,619
	Reinsurance				13,976			12,019
			Total	$	121,274		$	104,638
Underwriting (loss) income before tax:
	Workers' Compensation			$	(7,334	)	$	(12,584	)
	Reinsurance				1,902			772
			Total	$	(5,432	)	$	(11,812	)
Combined loss and expense ratios:
	Workers' Compensation:
Loss and loss adjustment expenses					75.1	%		81.8	%
Underwriting expenses					31.7	%		31.8	%
Combined ratio					106.8	%		113.6	%
	Reinsurance:
		Loss and loss adjustment expenses			70.0	%		77.3	%
		Underwriting expenses			16.4	%		16.3	%
			Combined ratio		86.4	%		93.6	%
Total:
	Loss and loss adjustment expenses				74.5	%		81.3	%
	Underwriting expenses				30.0	%		30.0	%
		Combined ratio			104.5	%		111.3	%

Workers' Compensation

        Workers' Compensation premiums earned increased in the first quarter of 2002 compared to the first quarter of 2001, continuing the trend of Zenith's increased Workers' Compensation revenues that began in January of 2000. Prior to 2000, Zenith's Workers' Compensation premium revenues declined consistently for several years in the face of unfavorable industry conditions. Beginning in 2000, competitive conditions began to improve, particularly in California, and Zenith began increasing its Workers' Compensation premium revenues, through increases in policies and rates. Zenith increased its Workers' Compensation premium rates in California as follows: effective January 1, 2001 by about 8%; effective August 1, 2001 by about 5%; and in the first quarter of 2002 by about 26%, including 5% for terrorism. Rate increases in most of the other states in which it does business were implemented at January 1, 2001 and 2002. In Florida, rates are set by the Department of Insurance, and were unchanged in 2001 and in the first quarter of 2002.

        Zenith's California Workers' Compensation premiums in-force increased from $146.7 million at December 31, 2000 to $178.5 million at March 31, 2001 and from $210.4 million at December 31, 2001 to $233.4 million at March 31, 2002. Outside of California, where competition and pricing are

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improving only in certain states, Zenith's in-force premiums increased from $162.4 million at December 31, 2000 to $186.1 million at March 31, 2001 and from $209.7 million at December 31, 2001 to $215.8 million at March 31, 2002. Net premiums earned in the first quarter of 2002 are net of $3.5 million of earned premiums ceded in connection with a new 10% quota share reinsurance arrangement which was effective January 1, 2002 for policies written on or after January 1, 2002.

        Underwriting losses in the Workers' Compensation operation decreased in the first quarter of 2002 compared to the first quarter of 2001. The estimated average cost of claims, or severity, increased in the first quarter of 2002 compared to the corresponding period in 2001, which was offset by a decrease in the frequency of claims and by the impact of higher premium rates, resulting in a lower estimated loss ratio for the first quarter of 2002 compared to the corresponding period in 2001.

        Zenith expects that the future operating profitability of its Workers' Compensation operation will be dependent upon the following: 1) general levels of competition; 2) industry pricing; 3) legislative and regulatory actions; 4) the frequency and severity of terrorist acts, if any, similar to the World Trade Center attack of September 11, 2001; and 5) management's ability to estimate the impact of any continuing adverse claim severity trends, including increases in the cost of healthcare, on the adequacy of loss reserves and premium rates. Claim frequency trends continue to decline, but the reasons therefor are not clear and management is unable to predict whether these trends will continue. Effective January 1, 2002, losses arising from acts of terrorism in the United States were excluded from the coverage provided by many of the reinsurance companies from which Zenith purchases its workers' compensation reinsurance. Zenith is unable to predict when its Workers' Compensation operations will return to underwriting profitability, although it anticipates continuing improvement in the combined ratio and profitability in the short-run as earned premiums reflect recent rate increases. Also, operating results should benefit from investing favorable cash flow from Workers' Compensation underwriting operations.

Reinsurance

        Effective January 1, 2002, losses arising from acts of terrorism were excluded from the coverage provided in Zenith's assumed reinsurance contracts.

        Underwriting income or loss and the combined ratio of the Reinsurance operation fluctuates significantly depending upon the incidence or absence of large catastrophe losses. There do not appear to have been any major catastrophes that occurred in the first quarter of 2002. Results for the three months ended March 31, 2001 were adversely impacted by catastrophe losses before tax of $1.5 million. Catastrophe losses impacting the results in the first quarter of 2001 were attributable to additional estimates of the impact of events that occurred in 1999, in particular the storms at the end of December 1999 in France.

        Estimating catastrophe losses in the Reinsurance business is highly dependent upon the nature and timing of the event and Zenith's ability to obtain timely and accurate information with which to estimate its liability to pay losses. Estimates of the impact of catastrophes on the Reinsurance operation are based on the information that is currently available and such estimates could change based on new information that becomes available or based upon reinterpretation of existing information.

Real Estate

        The Real Estate operations recognized total revenues for the three months ended March 31, 2002 and 2001 of $20.3 million and $17.1 million, respectively, and pre-tax income was $1.4 million and $1.1 million, respectively. There were 104 home sales at an average price of $195,000 for the three months ended March 31, 2002 compared to 90 home sales at an average price of $187,000 for the corresponding period in 2001. Changes in interest rates and other factors could affect future home sales, but Zenith believes the land it has acquired is strategically located and will have long-term value.

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Investments

        The change in the carrying value of Zenith's consolidated investment portfolio in 2002 was as follows:

(In thousands)
Carrying value at the beginning of the year		$	944,697
	Purchases at cost		120,749
	Maturities and redemptions		(17,111	)
	Proceeds from sales of investments		(79,071	)
	Net realized losses		(828	)
	Change in unrealized gains and losses, net		(4,416	)
	Net decrease in short-term investments		(2,432	)
	Net accretion of bonds and preferred stocks and other changes		715
Carrying value at March 31, 2002		$	962,303

        Zenith's investment portfolio increased in the three months ended March 31, 2002 principally as a result of favorable cash flow from operations. At March 31, 2002 and December 31, 2001, the portfolio emphasized high quality, taxable bonds and short-term investments, supplemented by smaller portfolios of redeemable and other preferred and common stocks. Bonds with an investment grade rating represented 94% and 95% of the consolidated carrying values of bonds at March 31, 2002 and December 31, 2001, respectively. The average life of the consolidated portfolio was 5.9 years and 5.6 years at March 31, 2002 and December 31, 2001, respectively.

        Zenith has identified certain securities, amounting to 92% and 97% of the investments in debt securities at March 31, 2002 and December 31, 2001, respectively, as "available-for-sale." Stockholders' equity decreased by $4.4 million after deferred tax from December 31, 2001 to March 31, 2002 as a result of changes in the fair values of such investments. Stockholders' equity will fluctuate with changes in the fair values of "available-for-sale" securities. The total fair value of fixed maturity investments, including short-term investments, was $857.7 million and $847.0 million at March 31, 2002 and December 31, 2001, respectively. The unrealized (loss) gain on held-to-maturity and available-for-sale fixed maturity investments were as follows:

	Held-to-Maturity			Available-for-Sale
(In thousands)
	Before Tax			Before Tax			After Tax
March 31, 2002	$	(169	)	$	(8,073	)	$	(5,247	)
December 31, 2001		691			(1,301	)		(846	)

        The yields on invested assets, which vary with the general level of interest rates, the average life of invested assets and the amount of funds available for investment, were as follows:

		Three Months Ended March 31,
		2002		2001
Investment yield:
	Before tax	5.3	%	6.2	%
	After tax	3.5	%	4.1	%

        When, in the opinion of management, a decline in the fair value of an investment is considered to be "other than temporary," such investment is written down to its fair value. The determination of "other than temporary" includes, in addition to other relevant factors, a presumption that if the market

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value is below cost by a significant amount for a period of time, a write down is necessary. There were $1.1 million of such write downs in the first quarter of 2002 and $0.7 million in the corresponding period of 2001.

Liquidity and Capital Resources

        The P&C Operations generally create liquidity because insurance premiums are collected prior to disbursements for claims and other policy benefits. Collected premiums may be invested, principally in fixed maturity securities, prior to their use in such disbursements, and investment income provides additional cash receipts. Claim payments may take place many years after the collection of premiums. In periods in which disbursements for claims and benefits, current acquisition costs and current operating and other expenses exceed operating cash receipts, cash flow is negative. Such negative cash flow is offset by cash flow from investments, principally from short-term investments and maturities of longer-term investments. The exact timing of the payment of claims and benefits cannot be predicted with certainty. The P&C Operations maintain portfolios of invested assets with varying maturities and a substantial amount of short-term investments to provide adequate cash for the payment of claims. At March 31, 2002 and December 31, 2001, cash and short-term investments in the P&C Operations amounted to $62.0 million and $63.5 million, respectively. The current trend of favorable cash flow from operations is attributable to the trend of increasing Workers' Compensation premiums.

        Zenith National requires cash to pay any dividends declared to its stockholders, make interest and principal payments on its outstanding debt obligations and fund its operating expenses. Such cash requirements are generally funded by dividends received from Zenith Insurance Company ("Zenith Insurance") and financing or refinancing activities by Zenith National. Investment income from its investment portfolio also provides a current source of cash to Zenith National. Cash, short-term investments and other available assets in Zenith National were $126.2 million and $131.0 million at March 31, 2002 and December 31, 2001, respectively. On May 1, 2002, Zenith National used $59.8 million of its available short-term investments to pay the principal and accrued interest on its 9% Senior Notes due May 1, 2002. As a result of the redemption, interest expense in future periods will be reduced, offset in part by a reduction of investment income on the funds used.

        At March 31, 2002, Zenith National had two revolving, unsecured lines of credit in an aggregate amount of $70.0 million, all of which was available at March 31, 2002. Under the agreement covering one of these lines of credit, certain financial ratios are required to be maintained by Zenith National and by its subsidiaries. At March 31, 2002 Zenith met all of such financial ratios and does not expect these requirements to impact the availability of funds under the line of credit, if required.

        From time to time, Zenith may make repurchases of its outstanding common shares or outstanding debt. At March 31, 2002, Zenith National was authorized to repurchase up to 929,000 shares of its common stock at prevailing market prices pursuant to a share purchase program authorized by its Board of Directors. These purchases are discretionary and can be adequately funded from Zenith National's existing sources of liquidity.

        Effective January 1, 2002, Zenith Insurance and Odyssey Re Holdings Corp. ("Odyssey Re"), an affiliate of Fairfax Financial Holdings Limited ("Fairfax"), entered into a 10% quota share ceded reinsurance agreement with respect to all new and renewal workers' compensation business written by Zenith Insurance in the three years commencing January 1, 2002. Quota share reinsurance allows the ceding company to increase the amount of business it writes while sharing the premiums and associated risks with the assuming company. The effect is similar to increasing the capital of the ceding company. Zenith expects that the quota share arrangement with Odyssey Re will favorably assist in the capitalization of the P&C Operations over the next three years. Fairfax owns approximately 42% of the outstanding common stock of Zenith National.

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        The Real Estate operations maintain a $50.0 million secured revolving credit facility from a bank ("Bank Line"), which it uses primarily for funding infrastructure development and home construction. No more than $20.0 million of the Bank Line may be outstanding for infrastructure development; there is no similar limitation on the use of the line for home construction. The bank's prior approval is required for any funding before draws may be taken. In addition to monthly interest payments, the maintenance of specified loan to value ratios, and principal curtailments under certain circumstances, the Bank Line requires the Real Estate operations to not exceed a prescribed leverage ratio and to maintain minimum interest coverage and minimum adjusted working capital. At March 31, 2002, the Real Estate operations were in compliance with all such requirements. Loans under the Bank Line bear interest at the prime rate plus 0.5%, resulting in interest on outstanding Bank Line loans at March 31, 2002 of 5.3%.

        Funding for project infrastructure development precedes the funding of home construction in that project. A prescribed portion of the first construction draw for each home must be used to repay the infrastructure development funding. Repayment of funding for infrastructure development is due the earlier of two years from the date the funding was approved or upon the termination date of the Bank Line. Repayment of all construction draws for each home must be made the earlier of one year from the initial construction draw for that home or upon the termination date of the Bank Line. The Bank Line is for a renewable twelve month term but upon termination will be extended for twenty four months, during which time period the Real Estate operations may only draw funds previously approved, as well as, subject to certain limitations, request funding for constructing pre-sold homes. At March 31, 2002 and December 31, 2001, $15.7 million and $16.2 million, respectively, was outstanding under the Bank Line. Zenith National also finances the land acquisitions of its Real Estate operations through inter-company loans. At March 31, 2002 and December 31, 2001, Zenith National had $27.3 million and $28.6 million, respectively, of principal and accrued interest outstanding under such loans.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

        The table below provides information about Zenith's financial instruments as of March 31, 2002 for which fair values are subject to changes in interest rates. For fixed maturity investments, the table presents fair value of investments held and weighted average interest rates on such investments by expected maturity dates. Such investments include redeemable preferred stock, corporate bonds, municipal bonds, government bonds and mortgage backed securities. For Zenith's debt obligations, the table presents principal cash flows by expected maturity dates (including interest).

			Expected Maturity Date
(Dollars in thousands)
			2002			2003			2004			2005			2006			Thereafter			Total
Investments:
	Held-to-maturity and Available-for-sale securities:
		Fixed rate	$	33,217		$	112,180		$	25,366		$	36,539		$	103,112		$	430,528		$	740,942
	Weighted average interest rate			2.7	%		4.1	%		5.8	%		6.1	%		7.0	%		7.2	%		6.4	%
	Short-term investments		$	116,795																	$	116,795
Debt and interest obligations of Zenith:
	Payable to banks		$	14,195		$	376		$	1,358											$	15,929
	Senior notes payable			59,811																		59,811
	Redeemable securities			2,865			5,729			5,729		$	5,729		$	5,729		$	193,038			218,819

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PART II, OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

3.1

Certificate of Incorporation of Zenith National Insurance Corp., dated May 28, 1971. (Incorporated by reference to Exhibit 3.1 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.2

Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated September 12, 1977. (Incorporated by reference to Exhibit 3.2 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.3

Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated May 31, 1979. (Incorporated by reference to Exhibit 3.3 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.4

Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated September 6, 1983. (Incorporated by reference to Exhibit 3.4 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.5

Certificate of Designation of Zenith National Insurance Corp., dated September 10, 1985. (Incorporated by reference to Exhibit 3.5 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.6

Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated November 22, 1985. (Incorporated by reference to Exhibit 3.6 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.7

Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated May 19, 1987. (Incorporated by reference to Exhibit 3.7 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.8

Certificate of Change of Address of Registered Office and of Registered Agent of Zenith National Insurance Corp., dated October 10, 1989. (Incorporated by reference to Exhibit 3.8 to Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)

3.9

By-laws of Zenith National Insurance Corp., as currently in effect. (Incorporated by reference to Exhibit 3.3 to Zenith National Insurance Corp.'s Annual Report on Form 10-K for the year ended December 31, 1999.)

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Statement re computation of per share earnings. (Note 2 to Consolidated Financial Statements (Unaudited) included in Item 1 of Part I of this Quarterly Report on Form 10-Q is incorporated herein by reference.)

(b)

Reports on Form 8-K

        Zenith filed no Current Reports on Form 8-K during the quarter ended March 31, 2002.

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Signatures

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 9, 2002.

ZENITH NATIONAL INSURANCE CORP.
By:	/s/  STANLEY R. ZAX      Stanley R. Zax Chairman of the Board and President (Principal Executive Officer)
By:	/s/  WILLIAM J. OWEN      William J. Owen Senior Vice President & Chief Financial Officer (Principal Financial and Accounting Officer)

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QuickLinks

FORM 10-Q
PART l FINANCIAL INFORMATION
Item 1. Financial Statements
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
PART II, OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signatures