SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1996
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 0-18779
PAC RIM HOLDING CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 95-4105740
- - --------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
6200 CANOGA AVENUE, WOODLAND HILLS, CALIFORNIA 91367
-------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(818) 226-6200
----------------------------------------------------
(Registrant's telephone number, including area code)
- - --------------------------------------------------------------------------------
(Former name, former address, former fiscal year, if changed since last report)
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
----- -----
The number of shares of Registrant's Common Stock, $.01 par value, outstanding
as of May 13, 1996, was 9,528,200.
PAC RIM HOLDING CORPORATION
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
------------------------------
Page No.
--------
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 1996 (Unaudited)
and December 31, 1995 3
Consolidated Statements of Operations
Three months ended March 31, 1996
and 1995 (Unaudited) 4
Consolidated Statements of Cash Flows
Three months ended March 31, 1996
and 1995 (Unaudited) 5
Notes to Unaudited Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Part II. OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
MARCH 31, DECEMBER 31,
1996 1995
(UNAUDITED)
----------- ------------
ASSETS
Investments:
Bonds, available-for-sale, at fair value (amortized cost
$118,960 and $119,314) $119,429 $121,771
Short-term investments (at cost, which approximates
fair value) 2,550 7,260
-------- --------
Total Investments 121,979 129,031
Cash 752 773
Reinsurance recoverable 4,364 4,068
Premiums receivable, less allowance for doubtful
accounts of $1,082 and $1,221 12,807 11,616
Earned but unbilled premiums 5,309 4,880
Investment income receivable 1,933 2,207
Deferred policy acquisition costs 1,294 974
Property and equipment, less accumulated depreciation
and amortization of $4,058 and $3,803 3,091 2,434
Unamortized debenture issuance costs 1,367 1,468
Income taxes recoverable 979 1,456
Deferred income taxes 9,277 8,348
Prepaid reinsurance premiums 214 227
Other assets 1,623 1,569
-------- --------
Total Assets $164,989 $169,051
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses $ 93,028 $ 96,525
Debentures payable, less unamortized discount
of $1,313 and $1,393 18,687 18,607
Unearned premiums 6,069 5,715
Reserve for policyholder dividends 421 381
Accrued expenses and accounts payable 4,482 3,668
-------- --------
Total Liabilities 122,687 124,896
Commitments and contingencies
Stockholders' Equity:
Preferred Stock:
$.01 par value--shares authorized 500,000;
none issued and outstanding
Common Stock
$.01 par value--shares authorized 35,000,000
issued and outstanding 9,528,200 95 95
Additional paid-in capital 29,624 29,624
Warrants 1,800 1,800
Unrealized gain on available-for-sale securities, net 310 1,622
Retained earnings 10,473 11,014
-------- --------
Total Stockholders' Equity 42,302 44,155
-------- --------
Total Liabilities and Stockholders' Equity $164,989 $169,051
======== ========
See notes to unaudited consolidated financial statements.
3
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED MARCH 31,
-----------------------------
1996 1995
-------------- ------------
REVENUES:
Net premiums earned $18,885 $18,242
Net investment income 1,813 2,093
Realized capital gains 88 4
------- -------
Total revenue 20,786 20,339
COSTS AND EXPENSES:
Losses and allocated loss adjustment expenses 14,675 9,649
Amortization of policy acquisition costs-net 3,517 5,499
Administrative, general, and other 2,771 2,849
Policyholder dividends 40 199
Interest expense 581 573
------- -------
Total costs and expenses 21,584 18,769
Income (loss) before income taxes (798) 1,570
Income tax expense (benefit) (257) 548
------- -------
Net income (loss) $ (541) $ 1,022
======= =======
Earnings (loss) per common and common equivalent shares:
Primary $(0.06) $0.10
======= =======
Assuming full dilution $(0.06) $0.08
======= =======
See notes to unaudited consolidated financial statements.
4
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
------------------------------
1996 1995
-------------- -------------
OPERATING ACTIVITIES
Net Income (loss) $ (541) $ 1,022
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 421 315
Provision for losses on accounts receivable (139) 97
Provision (benefit) for deferred income taxes (252) 825
Realized capital gains (88) (4)
Changes in:
Reserve for losses and loss adjustment expenses (3,497) (7,834)
Unearned premiums 354 (2,054)
Reserve for policyholders' dividends 40 (188)
Premiums receivable (1,481) 2,707
Reinsurance receivable (296) (121)
Prepaid reinsurance premiums 13 65
Deferred policy acquisition costs (320) 660
Income taxes recoverable 476 (277)
Accrued expenses and accounts payable 814 (1,787)
Investment income receivable 274 553
Other assets (54) 679
-------- -------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (4,276) (5,342)
INVESTING ACTIVITIES
Purchase of investments - bonds (23,943) (1,008)
Sales of investments - bonds 24,400 1,004
Net additions to property and equipment (912) (127)
-------- -------
NET CASH PROVIDED (USED) IN INVESTMENT ACTIVITIES (455) (131)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,731) (5,473)
Cash and cash equivalents at beginning of period 8,033 9,841
-------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,302 $ 4,368
======== =======
Supplemental Disclosure:
Interest paid $ 800 $ 800
======== =======
See notes to unaudited consolidated financial statements.
5
PAC RIM HOLDING
CORPORATION AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Pac Rim Holding
Corporation ("Pac Rim Holding") and its subsidiary, The Pacific Rim Assurance
Company ("Pacific Rim Assurance"), and its subsidiary, Regional Benefits
Insurance Services, Inc., (collectively referred to herein as "the Company")
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the Instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three months ended
March 31, 1996 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1996. For further information, refer
to the consolidated financial statements for the year ended December 31, 1995,
and notes thereto, included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
NOTE 2 -- EARNINGS PER SHARE
Earnings per common and common equivalent shares are based on the weighted
average number of common shares outstanding during each period, plus common
stock equivalent shares arising from the effects of stock options, warrants, and
convertible debentures. (See Note 4.)
The number of shares used in the three months ended March 31, 1996 and 1995 in
the computation of primary earnings per share was 9,528,000 and 12,380,000,
respectively. The number of shares used in the three months ended March 31,
1996 and 1995 for fully diluted earnings per share was 9,528,000 and 19,652,000,
respectively.
NOTE 3 -- REINSURANCE
Under the Company's specific excess of loss reinsurance treaty, the reinsurers
assume the liability on that portion of workers' compensation claims between
$350,000 and $80,000,000 per occurrence.
The Company accounts for reinsurance transactions in accordance with the
Financial Accounting Standards Board ("FASB") Statement 113, "Accounting and
Reporting for Reinsurance Short-Duration and Long-Duration Contracts", which
established the conditions required for a contract with a reinsurer to be
accounted for as reinsurance and prescribes accounting and reporting standards
for those contracts.
6
NOTE 3 -- REINSURANCE -- Continued
The components of net premiums written are summarized as follows (amounts in
thousands):
THREE MONTHS ENDED MARCH 31,
----------------------------
1996 1995
------- -------
Direct $19,918 $17,081
Assumed 294 6
Ceded (961) (834)
------- -------
Net premiums written $19,251 $16,253
======= =======
The components of net premiums earned are summarized as following (amounts in
thousands):
THREE MONTHS ENDED MARCH 31,
----------------------------
1996 1995
------- -------
Direct $19,596 $19,136
Assumed 264 5
Ceded (975) (899)
------- -------
Net premiums earned $18,885 $18,242
======= =======
The components of net losses and loss adjustment expenses are summarized as
follows (amounts in thousands):
THREE MONTHS ENDED MARCH 31,
----------------------------
1996 1995
------- -------
Direct $14,899 $ 9,891
Assumed 160 8
Ceded (384) (250)
------- -------
Net losses and loss
adjustment expense $14,675 $ 9,649
======= =======
NOTE 4--LONG TERM DEBT
The Company has $20,000,000 in outstanding principal on its August 16, 1994
issue of Series A Convertible Debentures, with detachable warrants to purchase
3,800,000 shares of the Company's common stock, which are primarily owned by
PRAC, Ltd., a Nevada limited partnership (which is controlled by Mr. Richard
Pickup), and other individuals and entities. Mr. Pickup presently controls
approximately 26% of the outstanding shares of the Company through various
investment entities, which together are the Company's largest stockholder.
7
NOTE 4--LONG TERM DEBT -- Continued
The Debentures carry an 8% annual rate of interest, payable semiannually, and
are due on August 16, 1999. The Debentures are convertible at the holder's
option, into shares of common stock at a conversion price of $2.75 per share.
The Debentures are subject to automatic conversion if, after three years from
issuance, the price of the Common Stock exceeds 150% of the conversion price for
a period of 20 out of 30 consecutive trading days.
The Debenture Agreement also provided for the issuance to the Investor of
detachable warrants (the "Warrants") to acquire 1,500,000 shares of the
Company's Common Stock at an exercise price of $2.50 per share (the "Series 1
Warrants"), 1,500,000 shares at an exercise price of $3.00 per share (the
"Series 2 Warrants"), and 800,000 shares at an exercise price of $3.50 per share
(the "Series 3 Warrants"). The Warrants expire on August 16, 1999, and the
exercise price of the Warrants is subject to downward adjustment in the event of
adverse development in the Company's December 31, 1993 loss and allocated loss
adjustment expense reserves related to the 1992 and 1993 accident years,
measured as of June 30, 1996. Under the terms of the Agreement, the maximum
adverse development that would impact the exercise price of the Warrants is
$20,000,000. In the event that the adverse development of reserves for those
periods exceeds $20,000,000, the exercise price of the Series 1 Warrants would
be reduced to $0.01, and the exercise price of the Series 2 Warrants would be
reduced to $1.39 per share.
The Debentures are carried on the balance sheet net of unamortized discount of
$1,313,000 at March 31, 1996. The effective average interest rate of this debt
after consideration of debt issuance costs and discount was 13.3%.
Pacific Rim Assurance has an unsecured line of credit for $3,000,000 at Imperial
Bank of California. Borrowing under the line of credit bears interest at a rate
of 1% in excess of prime rate. No borrowing has occurred under the line of
credit.
NOTE 5 -- NEW ACCOUNTING STANDARDS
In October 1995, FASB issued Statement 123, "Accounting For Stock-Based
Compensation" which established a fair value based method of accounting for
stock-based compensation plans. This statement is effective for financial
statements with fiscal years beginning after December 15, 1995. The Company
elected to continue accounting for stock-based compensation based on Accounting
Principles Board Opinion 25; and thus, the Company adopts only the disclosure
provision of FASB Statement 123. The Company does not expect the implementation
of this pronouncement to have a material effect on the Company's financial
position or results of operations, as the Company does not anticipate having any
stock based compensation.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1996 COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 1995.
Net premiums earned increased 3.5%, to $18,885,000, for the three months ended
March 31, 1996, from $18,242,000, for the three months ended March 31, 1995.
This increase was primarily the result of increased premium rates by the Company
in California, effective January 1, 1996, as well as continued expansion by the
Company into additional geographic areas during the first quarter of 1996, which
had begun in 1995. In May 1995, Pacific Rim Assurance received a Certificate of
Authority to write workers' compensation insurance in the State of Arizona, and
commenced operations in June 1995. The Company's net premiums earned in Arizona
were $1,043,000 for the first quarter of 1996. During August 1995, Pacific Rim
Assurance received a Certificate of Authority to write workers' compensation
insurance in the State of Texas, and commenced operations in October, 1995. The
Company's net premiums earned in Texas were $231,000 for the first quarter of
1996. In March 1996, Pacific Rim Assurance received a Certificate of Authority
to write workers' compensation insurance in the State of Georgia. The Company
also is considering the filing of applications in certain other states. The
Company believes that geographic expansion will enable it to increase its
premium revenues and operate regionally in more, and potentially less volatile,
markets. However, there can be no assurance that such expansion will ultimately
increase revenues or prove to be profitable.
Net investment income decreased 13.4% to $1,813,000 for the three months ended
March 31, 1996, from $2,093,000 for the three months ended March 31, 1995. The
amount of average invested assets decreased 15.4% to $124,300,000 for the three
months ended March 31, 1996, compared to the same period in 1995. This decrease
in invested assets was the result of the Company experiencing negative cash flow
from operations during 1995 and the first quarter of 1996. As a result, the
Company sold securities, or utilized maturing securities, to meet its cash flow
needs. The average yield on average invested assets increased to 5.8% for the
three months ended March 31, 1996 from 5.7% for the comparable period in 1995.
Losses and loss adjustment expenses ("LAE") incurred increased by $5,026,000 for
the period ended March 31, 1996 compared to the same period for 1995. The loss
and LAE ratio increased to 77.7% during the three months ended March 31, 1996,
compared to 52.9% during the three months ended March 31, 1995. The loss and
LAE ratio generally increased in the California workers' compensation
environment following more than a year of lower premium rate levels. For the
first quarter of 1996 the loss and loss expense ratio was comparable to the
fourth quarter ratio of 75.6%, reflecting the continued impact of reduced
premium rates due to open rating in California since January 1, 1995.
Total underwriting expenses decreased $2,060,000, or 24.7%, for the period ended
March 31, 1996, compared to the same period in 1995. The decrease was primarily
the result of a decrease in commissions paid to agents and brokers. The average
commission ratio to agents and brokers decreased to 16.1% for the first three
months of 1996, compared to 26.0% for the first three months of 1995.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The general and administrative expense component of the Company's underwriting
expenses decreased by $78,000, or 2.7%, to $2,771,000 during the first quarter
of 1996, from $2,849,000 during the first quarter of 1995. The decrease in
general and administrative expense was primarily due to the Company's expense
management.
Policyholder dividends decreased to $40,000 for the first quarter of 1996, from
$199,000 for the first quarter of 1995. In determining the appropriate
policyholder dividend accrual level, the Company analyzes competitive factors
related to quality of service, loss prevention, claims management and cost
control, and adequacy of premium rates, as well as its own underwriting results.
The loss before taxes was $798,000 for the quarter ended March 31, 1996, as
compared to net income before taxes of $1,570,000 for the quarter ended March
31, 1995. This decrease was due primarily to an increase in loss and LAE
expense, offset by decreases in underwriting expenses, and dividends, and an
increase in premiums earned.
The net loss for the period ended March 31, 1996 was $541,000, compared to net
income of $1,022,000 for the period ended March 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Pac Rim Holding was organized in May 1987 and has been capitalized from sales of
the Company's Common Stock. Pac Rim Holding is dependent on dividends from
Pacific Rim Assurance for operating funds. Pacific Rim Assurance may pay
dividends without prior California Insurance Department approval to the extent
it has available "earned surplus". Dividends are further limited to an amount
up to the greater of net income from the preceding calendar year or 10% of
policyholders' surplus as of the end of the preceding year. Earned surplus for
Pacific Rim Assurance is its unassigned surplus, which was $2,131,000 at
December 31, 1995. Accordingly, Pacific Rim Assurance may pay dividends of
$2,131,000 to Pac Rim Holding in 1996, without such prior approval.
One of the most widely accepted factors used by regulators and rating agencies
in evaluating insurance companies is the ratio of net premiums written to
policyholders' surplus, which is an indication of the degree to which an insurer
is leveraged. While there is no statutory requirement applicable to Pacific Rim
Assurance that establishes a permissible net premiums written to policyholders'
surplus ratio, as determined in accordance with statutory accounting practices,
the National Association of Insurance Commissioners ("NAIC") uses a ratio of
three to one as an appropriate guideline in assessing a property/casualty
insurance company's financial condition. The lower the ratio, the less
leveraged is the company. At March 31, 1996, the statutory-basis policyholders
surplus of Pacific Rim Assurance was $46,141,000. Pacific Rim Assurance's ratio
of annualized net premiums written to policyholders' surplus for 1996 was 1.41
to 1, as determined on the basis of statutory accounting practices.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Insurance companies are required to maintain on deposit with the Regulatory
Agencies deposits for the benefit of policyholders, in an amount prescribed by
regulations. At March 31, 1996, the Company was in good standing with all
Departments of Insurance with respect to its deposit requirements, maintaining
securities with a total fair value of $118,810,000 on deposit with authorized
depositories in various states, in excess of total deposit requirements of
$98,942,000.
A workers' compensation insurance company must maintain sufficient liquid assets
to meet its contractual obligations to policyholders, in addition to maintaining
funds to meet ordinary operating expenses. The Company typically has several
sources of funds to meet obligations, including cash flow from operations,
interest from fixed-income securities, recoveries from reinsurance contracts, as
well as the ability to sell portions of its investment portfolio. In addition,
the Company has an unsecured line of credit for $3,000,000. No borrowings have
been made from this line of credit. The Company has an investment portfolio of
high quality, highly liquid, U.S. Treasury, other governmental agency, and
corporate obligations. The Company's cash flows provided by (used in) operating
activities for the periods ended March 31, 1996 and 1995, were $(4,276,000), and
$(5,342,000), respectively. In light of the reduced level of premiums currently
written during 1995 and the first quarter of 1996, compared to prior years, due
to state-mandated reductions in premium rates, and the repeal of the minimum
rate law, coupled with claim payments required on premiums previously written,
it is probable that the Company will experience a continued period of negative
cash flow, until the level of loss payments decreases to the level proportionate
to the level of premiums collected. The Company believes that Pacific Rim
Assurance will be able to meet its requirements for both claim payments and
expenses.
As a result of its ownership of debentures of Pac Rim Holding, PRAC, Ltd.
("PRAC"), together with certain affiliated entities, is entitled to vote the
equivalent of 56.0% of the Company's voting securities with respect to certain
matters, and will be entitled to vote the equivalent of approximately 62.3% of
the Company's voting securities as to those matters on exercise of Warrants.
These voting rights, together with PRAC's right to designate certain members of
the Board of Directors, give PRAC effective control of the Board of Directors
and over all major corporate matters and transactions. It may also have the
effect of discouraging certain types of transactions involving an actual or
potential change of control of the Company, including transactions in which the
holders of the Company's shares might otherwise receive a premium for their
shares over then current market prices. These actions will have the effect,
among other things, of limiting the ability of the Company to enter into certain
significant transactions without the support of PRAC, and allowing PRAC to cause
the Company to enter into certain transactions. These transactions may include
transactions between PRAC, or its affiliates, and the Company, as well as
transactions for the sale of the Company or the sale of control of the Company.
PRAC may have interests that diverge from or conflict with those of the Company.
Although such conflicts may arise, Directors designated by PRAC to the Board of
Directors have a fiduciary responsibility to act in the Company's best interest.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Since the first quarter of 1995, the Company has retained as consultants,
Salomon Brothers (the investment banking firm that assisted the Company in
previous capital-raising transactions) to advise of future strategic
alternatives.
EFFECTS OF INFLATION
Inflation can be expected to affect the operating performance and financial
condition of the Company in several aspects. Inflation can reduce the market
value of the investment portfolio. However, generally the intent of the Company
is to hold its investments to maturity. (See "Liquidity and Capital Resources")
Inflation adversely affects the portion of reserve for losses and LAE that
relates to hospital and medical expenses, as these expenses normally increase
during inflationary periods (and in recent years have increased at a greater
rate than prevailing inflation). The liabilities for losses and LAE, relating
to indemnity benefits for lost wages are not directly affected by inflation, as
these amounts are established by statute. To the extent that the reserve for
losses and LAE and claim payments have increased as a result of inflation,
premium rates have historically increased by operation of the rate setting
process. This process established the minimum rates in effect in California
prior to January 1, 1995. However, no assurance can be given that following the
introduction of open premium rating in California effective January 1, 1995,
premium rates will keep pace with inflation. Another result of inflation is an
expected escalation of wages paid to employees. To the extent that wages
increase, premium revenues will proportionately increase, since rates are based
on the employer's payroll. Since May 1987, the Company's inception, the Company
believes that the effect of inflation on the Company has not been material.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 1993, the FASB issued Statement 115, "Accounting for Certain Investments
in Debt and Equity Securities", which addresses the accounting and reporting for
certain investments in debt securities. Statement 115 was effective for 1994.
Statement 115 requires that investments in debt and equity securities be
classified into one of three categories: held-to-maturity, available-for-sale,
or trading. The Company currently classifies its investments in debt securities
as available-for-sale. FASB 115 requires that any unrealized holding gains and
losses be reported as a net amount in a separate component of Stockholders'
Equity. The amount of net unrealized capital gains and losses in the Company's
portfolio, net of applicable taxes, were a gain of $1,622,000 at December 31,
1995, and $310,000 at March 31, 1996.
In October 1995, FASB issued FASB No. 123, "Accounting For Stock-Based
Compensation" which established a fair value based method of accounting for
stock-based compensation plans. This statement is effective for financial
statements with fiscal years beginning after December 15, 1995. The Company
elected to continue accounting for stock-based compensation based on Accounting
Principles Board Opinion 25; and thus, the Company adopts only the disclosure
provision of FASB Statement 123. The Company does not expect the implementation
of this pronouncement to have a material effect on the Company's financial
position or results of operations.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
WORKERS' COMPENSATION SYSTEM
Workers' compensation is a statutory system under which an employer is required
to provide its employees with the costs of medical care and other specified
benefits for work-related injuries and illnesses. Most employers provide for
this liability by purchasing workers' compensation insurance. The principal
concept underlying workers' compensation insurance laws is that an employee
injured in the course of his or her employment has only the legal remedies for
that injury available under workers' compensation law and does not have any
other claims against his or her employer. Generally, insurers must pay
compensation to an insured's employees injured in the course and scope of their
employment. The obligation to pay such compensation does not depend on any
negligence or wrong on the part of the employer, and exists even for injuries
that result from the negligence or wrongs of another person, including the
employee.
The standard workers' compensation insurance policy issued by most insurance
companies, including Pacific Rim Assurance, obligates the carrier to pay all
benefits that the insured employer may become obligated to pay under applicable
workers' compensation laws. The benefits payable under workers' compensation
policies fall under the following four categories: (i) temporary or permanent
disability benefits (either in the form of short-term to life-term payments or
lump sum payments); (ii) vocational rehabilitation benefits; (iii) medical
benefits; and (iv) death benefits. The amount of benefits payable for various
types of claims is determined by regulation and varies with the severity and
nature of the injury or illness and the wage, occupation, and age of the
employee.
The amount of the premiums charged for workers' compensation insurance is
dependent on the size of an employer's payroll and the type of business, and the
application of corresponding rate schedules setting forth the appropriate rate.
In California and Texas, rates are independently filed by the Company,
reflecting either the advisory rates of the applicable rating bureau, or an
appropriate deviation therefrom. In Arizona, and Georgia, the National Council
of Compensation Insurance (NCCI) files the pure premium rates on behalf of all
insurance companies.
In addition to established premium rates, premium levels based on the insured's
payroll could be affected by inflation and/or the application of Experience
Rating Plans. Experience Rating Plans govern all policyholders whose annual
premiums are in excess of certain levels and are based on the insured's loss
experience over a three-year period commencing four years prior to, and
terminating one year prior to, the date for which the experience modification is
to be established. Application of the Experience Rating Plan generally results
in an increase or decrease to the insured's premium rate, and is therefore
intended to provide an incentive to employers to reduce work-related injuries
and illnesses.
SIGNIFICANT CHANGES IN THE CALIFORNIA WORKERS' COMPENSATION SYSTEM
Material changes have taken place in recent years, in California, the
jurisdiction in which the Company has in the past, conducted all its activities.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Prior to 1995 within California, a minimum rate law was in effect, which law was
intended to curtail indiscriminate rate cutting, which rate cutting was felt to
threaten the solvency of private workers' compensation insurers. Although an
insurer could not charge less than the minimum rates set by the California
Insurance Department ("Department"), insurers could charge more than the minimum
rates. The minimum rates for workers' compensation policies were reviewed
annually by the Workers' Compensation Insurance Rating Bureau ("WCIRB") and the
Department. In reviewing the WCIRB's proposed rates, the Department considered
the loss experience for the industry as a whole and, after adding factors for
reasonable underwriting costs and profits, approved publication of minimum
premium rate schedules for various classifications of employees. Rates could be
revised and approved by the Insurance Commissioner whenever the legislature
changed the levels of benefits payable or industry loss experience indicated the
need for a rate revision.
In July 1993, the California state legislature passed two sets of workers'
compensation law reforms, which have significantly impacted the benefits
available under the California workers' compensation system. While the
legislation was designed to reduce the claim costs and rates applicable to
California workers' compensation coverage, its ultimate impact upon the
operations and profitability of the Company is uncertain. However, the Company
did experience a reduction in the overall number of outstanding claims, and a
stable trend in the severity of claims, during years subsequent to 1993, which
in turn has led to lower premium rates overall. The more significant aspects of
the legislation are outlined below.
Initially, the legislature enacted two sets of legislation dealing with the
premium rates applicable to California workers' compensation coverage. The
first item of legislation repealed the California minimum rate law effective
January 1, 1995. As of that date, the repeal of the minimum rate law opened the
workers' compensation insurance market to direct price competition among
insurers. Thus, the official end to the minimum rate law and the start of open
price competition in the industry was January 1, 1995. Although repeal of the
minimum rating law formally became effective January 1, 1995, the Company
believed that competitive forces working in the marketplace during 1994 already
showed signs of informal price competition, through the use of higher
commissions paid to agents and brokers, which in turn were rebated in part to
policyholders. The ultimate effect of open rating on the Company's operations
and profitability cannot be stated with certainty. However, since January 1,
1995, open rating has created an intense level of price competition and a
continuous overall erosion of premium rate levels.
The second item of rate-related legislation required a 7% decrease in the
minimum premium rates charged with respect to California workers' compensation
coverage. The 7% minimum premium rate decrease was effective July 16, 1993,
for all policies inforce at that date. Effective January 1, 1994, the minimum
premium rate was decreased another 12.7%, to be phased-in upon the insured's
policy renewal date during 1994. Effective October 1, 1994, the minimum premium
rate was decreased another 16% for all policies inforce at that date. The
reduced minimum rates were to remain in effect until a policy renewed in 1995,
at which time the open price competition resulting from the repeal of the
minimum rate law took effect.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Along with that legislation affecting workers' compensation rates, the
California legislature further enacted legislation designed to reform the
benefits available and combat fraud within the California workers' compensation
system. In particular, the legislation provided for increased benefit payments
applicable to totally disabled and seriously injured workers, while at the same
time cutting benefits for certain over-utilized treatments and psychiatric
injury claims. The more significant provisions of the benefits reform
legislation are outlined below.
The reform legislation increased the weekly benefits payable for temporary total
disability from $336 per week to $490 per week and is being phased in over a
three-year period that began July 1, 1994. In addition, benefit payments to
seriously injured workers have increased. Each of these benefit level increases
will result in increased California claims costs to the Company. While it
cannot be stated with certainty, proponents of the legislation have urged that
such increased costs will be more than offset by the following benefit reduction
reforms:
The legislation tightened restrictions on the number of permissible
evaluations utilized to resolve medical issues associated with a
claim.
Under previous law, claims for psychiatric injury, including
stress, were compensable if 10% or more of their cause was
attributable to employment-related factors. The legislation raised
this standard to require that employment be the "predominant" cause
of the psychiatric injury. The legislation further limited post
termination (including terminations and layoffs) psychiatric injury
claims to those in which the employee can establish that the injury
at issue arose prior to termination.
The legislation limited vocational rehabilitation benefits to a
total of $16,000 per claim, a decrease from $25,000 previously. Of
the $16,000 limit, no more than $4,500 can be claimed for counseling
services.
The legislation allows certain employers to direct the treatment of
work-related injuries under a system of managed care for a period of
up to 365 days. The availability of the managed care option is
dependent on the type of group health coverage provided by the
employer.
The legislation prohibits insurers, doctors, and rehabilitation
counselors from referring claimants to facilities in which such
persons or entities maintain a financial interest.
The legislation adopted certain anti-fraud provisions, which make
any efforts to bribe adjusters a felony, and provides for restitution
of benefits paid on fraudulent claims.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The ultimate effect of the workers' compensation reform legislation, repeal of
the minimum rate law, and premium rate decrease on the Company's operations and
profitability cannot be stated with certainty.
REGULATION
The NAIC has finalized a formula to calculate Risk Based Capital ("RBC") of
property and casualty insurance companies. The purpose of the RBC Model is to
help the NAIC monitor the capital adequacy of property and casualty insurance
companies. The RBC model for property and casualty insurance companies measures
three major areas of risk facing property and casualty insurers: underwriting,
credit, and investment. Companies having less statutory surplus than the RBC
model calculates are required to adequately address these three risk factors and
will be subject to varying degrees of regulatory intervention, depending on the
level of capital inadequacy. The NAIC adopted an RBC model for property and
casualty insurance companies in 1993 for inclusion in the 1994 Annual Statement.
The results of the RBC model for 1994 and 1995, showed that Pacific Rim
Assurance had adequate capital and required no form of regulatory monitoring or
intervention.
Although the federal government does not directly regulate the business of
insurance, federal initiatives often affect the insurance business in a variety
of ways. State regulation remains the dominant form of regulation; however, the
federal government has shown increasing concern over the adequacy of state
regulation. In view of the savings and loan industry crisis and several
significant insurer insolvencies, several Congressional inquiries are
considering the adequacy of existing state regulations related to the financial
health of insurance companies. Congressional committees are also reviewing the
McCarran-Ferguson Act of 1945, which currently provides a limited exemption from
federal antitrust laws for the "business of insurance". The exemption allows
limited cooperative activities by rating organizations and other joint industry
efforts. These include the development of standardized policy forms and
endorsements, statistical plans, the collection and compilation of premium,
loss, and expense data; and the development of advisory rates or loss costs.
The proposal would limit the insurance industry's limited exemption from federal
antitrust laws and was introduced in the belief that it would foster competitive
pricing among insurers. The proposal would curtail the activities of rating
organizations and thus could require the expansion of individual insurer
internal resources. With the possible loss of statistically valid data and/or
increased costs, market niches could become even more focused. California is
reviewing its statutory exemptions for the "business of insurance" from its
antitrust laws.
16
PAC RIM HOLDING CORPORATION
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
11 Computation of Per Share Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed during the quarter ended March
31, 1996.
17
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.
Pac Rim Holding Corporation
May 13, 1996 By: /s/ Stanley Braun
----------------------------
Stanley Braun
President and
Chief Executive Officer
May 13, 1996 By: /s/ Paul W. Craig
----------------------------
Paul W. Craig
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
May 13, 1996 By: /s/ Gerald Whelply
----------------------------
Gerald Whelply
Controller
(Chief Accounting Officer)
18