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 June 30, 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 August 13, 1996, was 9,528,200.
1
PAC RIM HOLDING CORPORATION
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
------------------------------
Page No.
--------
Item 1. Financial Statements:
Consolidated Balance Sheets
June 30, 1996 (Unaudited)
and December 31, 1995 3
Consolidated Statements of Operations
Three months ended June 30, 1996 and
1995 (Unaudited) and six months ended
June 30, 1996 and 1995 (Unaudited) 4
Consolidated Statements of Cash Flows
Six months ended June 30, 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 18
Signatures 19
2
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share and Per Share Data)
JUNE 30, DECEMBER 31,
1996 1995
(UNAUDITED)
----------- -------------
ASSETS
Investments:
Bonds, available-for-sale, at fair value (amortized cost
$112,687 and $119,314) $112,277 $121,771
Short-term investments (at cost, which approximates
fair value) 4,777 7,260
-------- --------
Total Investments 117,054 129,031
Cash 1,493 773
Reinsurance recoverable 4,275 4,068
Premiums receivable, less allowance for doubtful
accounts of $1,094 and $1,221 13,650 11,616
Earned but unbilled premiums 5,981 4,880
Investment income receivable 1,967 2,207
Deferred policy acquisition costs 1,241 974
Property and equipment, less accumulated depreciation
and amortization of $4,353 and $3,803 3,817 2,434
Unamortized debenture issuance costs 1,265 1,468
Income taxes recoverable 979 1,456
Deferred income taxes 9,503 8,348
Prepaid reinsurance premiums 184 227
Other assets 2,080 1,569
-------- --------
Total Assets $163,489 $169,051
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses $ 90,709 $ 96,525
Debentures payable, less unamortized discount
of $1,231 and $1,393 18,769 18,607
Unearned premiums 5,586 5,715
Reserve for policyholder dividends 233 381
Obligation under capital lease 1,065 --
Accrued expenses and accounts payable 5,304 3,668
-------- --------
Total Liabilities 121,666 124,896
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 (loss) on available-for-sale securities, net (270) 1,622
Retained earnings 10,574 11,014
-------- --------
Total Stockholders' Equity 41,823 44,155
-------- --------
Total Liabilities and Stockholders' Equity $163,489 $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 June 30, Six Months Ended June 30,
---------------------------- --------------------------
1996 1995 1996 1995
------------- ------------ ------------ -----------
REVENUES:
Net premiums earned $22,374 $20,914 $41,259 $39,156
Net investment income 1,793 2,090 3,606 4,183
Realized capital gains 0 35 88 39
A&H commission income 2 0 2 0
------- ------- ------- -------
Total revenue 24,169 23,039 44,955 43,378
COSTS AND EXPENSES:
Losses and loss adjustment expenses 16,457 13,224 31,132 22,873
Amortization of policy acquisition costs-net 3,944 5,715 7,461 11,214
Administrative, general, and other 3,192 2,813 5,963 5,662
Policyholder dividends (181) 220 (141) 419
Interest expense 584 576 1,165 1,149
------- ------- ------- -------
Total costs and expenses 23,996 22,548 45,580 41,317
Income (loss) before income taxes 173 491 (625) 2,061
Income tax expense (benefit) 72 169 (185) 717
------- ------- ------- -------
Net income (loss) $ 101 $ 322 $ (440) $ 1,344
======= ======= ======= =======
Earnings (loss) per common and common equivalent shares:
Primary $ 0.01 $ 0.03 $ (0.05) $ 0.14
======= ======= ======= =======
Assuming full dilution $ 0.01 $ 0.03 $ (0.05) $ 0.12
======= ======= ======= =======
See notes to unaudited consolidated financial statements.
4
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
(Amounts in Thousands)
Six Months Ended June 30,
---------------------------
1996 1995
------------ ------------
OPERATING ACTIVITIES
Net Income (loss) $ (440) $ 1,344
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 903 673
Provision for losses on accounts receivable (127) 118
Provision (benefit) for deferred income taxes (180) 1,425
Realized capital gains (88) (39)
Changes in:
Reserve for losses and loss adjustment expenses (5,816) (12,627)
Unearned premiums (129) (3,323)
Reserve for policyholders' dividends (148) (70)
Premiums receivable (3,008) 1,172
Reinsurance recoverable (207) (876)
Prepaid reinsurance premiums 43 66
Deferred policy acquisition costs (267) 944
Income taxes recoverable 477 (708)
Accrued expenses and accounts payable 1,636 (1,407)
Investment income receivable 240 612
Other assets (511) 88
------- -------
NET CASH USED BY OPERATING ACTIVITIES (7,622) (12,608)
INVESTING ACTIVITIES
Purchase of investments - bonds (23,943) (36,138)
Sales of investments - bonds 26,145 44,017
Maturity and call of investments - bonds 4,525 0
Net additions to property and equipment (868) (352)
------- -------
NET CASH PROVIDED IN INVESTMENT ACTIVITIES 5,859 7,527
DECREASE IN CASH AND CASH EQUIVALENTS (1,763) (5,081)
Cash and cash equivalents at beginning of period 8,033 9,841
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 6,270 $ 4,760
======= =======
Supplemental Disclosures:
Interest paid $ 800 $ 800
======= =======
The Company entered into a capital lease to acquire certain
computer operating system hardware and software; the lease
obligation at June 30, 1996, is $1,065,000.
See notes to unaudited consolidated financial statements.
5
PAC RIM HOLDING CORPORATION AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 six months ended
June 30, 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.
Certain amounts in the accompanying financial statements have been reclassified
to conform with current period presentation.
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 June 30, 1996 and 1995 in
the computation of primary earnings per share was 9,528,000. The number of
shares used in the six months ended June 30, 1996 and 1995 in the computation of
primary earnings per share was 9,528,000 and 12,360,000, respectively. The
number of shares used in the three months ended June 30, 1996 and 1995 in the
computation of fully diluted earnings per share was 9,528,000. The number of
shares used in the six months ended June 30, 1996 and 1995 in the computation of
fully diluted earnings per share was 9,528,000 and 19,632,000, respectively.
NOTE 3 -- REINSURANCE
Under the Company's specific excess of loss reinsurance treaties, 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
---- ---- ---- ----
Direct $22,533 $20,709 $42,451 $37,790
Assumed 496 -- 790 6
Ceded (1,106) (1,062) (2,067) (1,896)
------- ------- ------- -------
Net premiums written $21,923 $19,647 $41,174 $35,900
======= ======= ======= =======
The components of net premiums earned are summarized as following (amounts in
thousands):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
---- ---- ---- ----
Direct $22,976 $21,975 $42,572 $41,111
Assumed 534 2 798 7
Ceded (1,136) (1,063) (2,111) (1,962)
------- ------- ------- -------
Net premiums earned $22,374 $20,914 $41,259 $39,156
======= ======= ======= =======
The components of net losses and loss adjustment expenses are summarized as
follows (amounts in thousands):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
---- ---- ---- ----
Direct $17,060 $13,976 $31,959 $23,867
Assumed 232 49 392 57
Ceded (835) (801) (1,219) (1,051)
------- ------- ------- -------
Net losses and loss
adjustment expenses $16,457 $13,224 $31,132 $22,873
======= ======= ======= =======
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.
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
7
NOTE 4--LONG TERM DEBT -- Continued
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, which date has been extended to June 30, 1997 by
agreement of the parties. 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
$1,231,000 at June 30, 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 six months ended June 30, 1996 compared to the six months ended June 30,
1995.
Net premiums earned increased 5.4%, to $41,259,000 for the six months ended June
30, 1996, from $39,156,000 for the six months ended June 30, 1995. This increase
was primarily the result of increased premium rates by the Company in California
throughout the first half of 1996, as well as continued expansion by the Company
into additional geographic areas during the first half 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. 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. In March 1996, Pacific Rim
Assurance received a Certificate of Authority to write workers' compensation
insurance in the State of Georgia, and commenced operations in April 1996.
Premiums earned outside of California equaled approximately $3,769,000 or 9.1%
of the Company's total premiums earned during the first half of 1996. 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 13.8%, to $3,606,000 for the six months ended
June 30, 1996, from $4,183,000 for the six months ended June 30, 1995. The
amount of average invested assets decreased 14.9% to $122,000,000 for the six
months ended June 30, 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 half 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 was 5.9% for the six months ended
June 30, 1996 and for the comparable period in 1995.
Losses and loss adjustment expenses ("LAE") incurred increased by $8,259,000 for
the six months ended June 30, 1996, compared to the same period for 1995. The
loss and LAE ratio increased to 75.5% during the six months ended June 30, 1996,
compared to 58.4% during the six months ended June 30, 1995. The loss and LAE
ratio generally increased in the California workers' compensation environment
since July 1, 1995, following more than a year of lower premium rate levels. For
the second quarter of 1996, the loss and loss expense ratio was lower than the
first quarter 1996 ratio of 77.7%, reflecting the positive impact of premiums
earned during the second quarter of 1996 from business written throughout the
first half of 1996 at higher premium rates.
Total underwriting expenses decreased $3,452,000, or 20.5%, for the six months
ended June 30, 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 15.0% for the
first six months of 1996, compared to 25.0% for the first six 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 increased by $301,000, or 5.3%, to $5,963,000 during the first half of
1996, from $5,662,000 during the first half of 1995. The increase in general and
administrative expense was primarily due to the Company's recent expansion into
other geographical areas and the related increased premium levels. The ratio of
general and administrative expenses to net premiums earned was 14.5% for both
the first half of 1996 and the first half of 1995.
Policyholder dividends for the six months ended June 30, 1996 were a net credit
of ($141,000), compared to a net charge of $419,000 for the six months ended
June 30, 1995. The net credit reflects the elimination of $200,000 of dividend
reserves for which no further future liability is expected. That amount was
transferred to loss and LAE reserves as of June 30, 1996. The remaining reserve
for policyholder dividends of $233,000 as of June 30, 1996 represents current
expectations of future policyholder dividend payments on participating policies
inforce. In determining the appropriate policyholder dividend reserve 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 $625,000 for the six months ended June 30, 1996,
compared to net income before taxes of $2,061,000 for the six months ended June
30, 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 six months ended June 30, 1996 was $440,000, compared to
net income of $1,344,000 for the six months ended June 30, 1995.
For the three months ended June 30, 1996 compared to the three months ended June
30, 1995.
Net premiums earned increased 7.0%, to $22,374,000, for the three months ended
June 30, 1996, from $20,914,000, for the three months ended June 30, 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 second 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. 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. In
March 1996, Pacific Rim Assurance received a Certificate of Authority to write
workers' compensation insurance in the State of Georgia, and commenced
operations in April 1996. Premiums earned outside of California equaled
approximately $2,243,000 or 10% of the total Company premiums earned during the
second quarter of 1996. 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.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Net investment income decreased 14.2% to $1,793,000 for the three months ended
June 30, 1996, from $2,090,000 for the three months ended June 30, 1995. The
amount of average invested assets decreased 15.0% to $119,500,000 for the three
months ended June 30, 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 six months 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 was 6.0% for the three
months ended June 30, 1996 and for the comparable period in 1995.
Losses and LAE incurred increased by $3,233,000 for the three months ended June
30, 1996, compared to the same period for 1995. The loss and LAE ratio
increased to 73.6% during the three months ended June 30, 1996, compared to
63.2% during the three months ended June 30, 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 second quarter
of 1996, the loss and loss adjustment expense ratio was lower than the first
quarter 1996 ratio of 77.7%, reflecting the positive impact of premiums earned
during the second quarter of 1996 from business written throughout the first
half of 1996 at higher premium rates.
Total underwriting expenses decreased $1,392,000, or 16.3%, for the three months
ended June 30, 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 14.6% for the
three months ended June 30, 1996, compared to 23.0% for the three months ended
June 30, 1995.
The general and administrative expense component of the Company's underwriting
expenses increased by $379,000, or 13.5%, to $3,192,000 during the second
quarter of 1996, from $2,813,000 during the second quarter of 1995. The
increase in general and administrative expense was primarily due to the
Company's recent expansion into other geographical areas and the related
increased premium levels. The ratio of general and administrative expenses to
net premiums earned was 14.3% for the second quarter of 1996 compared to 13.5%
for the second quarter of 1995.
Policyholder dividends for the three months ended June 30, 1996 were a net
credit of ($181,000) compared to a net charge of $220,000 for the three months
ended June 30, 1995. The net credit reflects the elimination of $200,000 of
dividend reserves for which no further future liability is expected. That amount
was transferred to loss and LAE reserves as of June 30, 1996. The remaining
reserve for policyholder dividends of $233,000 as of June 30, 1996 represents
current expectations of future policyholder dividend payments on participating
policies inforce. In determining the appropriate policyholder dividend reserve
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.
Net income before taxes was $173,000 for the three months ended June 30, 1996,
as compared to net income before taxes of $491,000 for the three months ended
June 30, 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.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
The net income for the three months ended June 30, 1996 was $101,000, compared
to net income of $322,000 for the three months ended June 30, 1995.
Certain statements in Management's Discussion and Analysis that are not
historical facts are forward looking statements. These forward looking
statements involve risks and uncertainties that could render them materially
different, including, but not limited to, the effect of economic conditions,
premium rate adequacy as a result of pricing factors related to competition or
regulation, actual versus estimated claims experience, the effect of the
Company's accounting policies, the effect of regulatory and legal developments,
and other risks detailed in the Company's filings with regulatory agencies.
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 June 30, 1996, the statutory-basis policyholders surplus of
Pacific Rim Assurance was $46,711,000. Pacific Rim Assurance's ratio of
annualized net premiums written to policyholders' surplus for 1996 was 1.76 to
1, as determined on the basis of statutory accounting practices.
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 June 30, 1996, the Company was in good standing with all
Departments of Insurance with respect to its deposit requirements, maintaining
investments with a total fair value of $112,827,000 on deposit with authorized
depositories in various states, in excess of total deposit requirements of
$99,137,000.
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 from a bank. No
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
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 used in
operating activities for the six months ended June 30, 1996 and 1995, were
$(7,622,000), and $(12,608,000), respectively. In light of the reduced level of
premiums written during 1995 and the first half 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 the relatively higher
levels of premium volume 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.
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
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
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 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.
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.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
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.
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
an overall erosion of premium rate levels.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
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. 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.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
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.
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.
17
PAC RIM HOLDING CORPORATION
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
10.115 Quota Share reinsurance agreement between TIG Insurance Company
and the Pacific Rim Assurance Company, a subsidiary of Pac Rim
Holding Corporation, dated April 1, 1996.
10.116 Producer agreement between Regional Benefits Insurance Services, a
subsidiary of Pac Rim Holding Corporation, and Hull & Co., Inc.,
dated May 15, 1996.
10.117 Producer agreement between Regional Benefits Insurance Services, a
subsidiary of Pac Rim Holding Corporation, and Gulf Atlantic
Management Group, Inc., dated May 15, 1996.
10.118 Office lease between Gulf Atlantic Investment Group, Inc. and
Regional Benefits Insurance Services, Inc., a subsidiary of Pac
Rim Holding Corporation, dated May 20, 1996.
11 Computation of Per Share Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
The Company filed a Current Report on Form 8-K, dated May 20, 1996
reporting on Item 5, Other Events, in connection with the resignation
of Mr. Robert M. Anderson as Chairman of the Board of Directors.
18
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
August 13, 1996 By: /s/Stanley Braun
-------------------------
Stanley Braun
President and
Chief Executive Officer
August 13, 1996 By: /s/Paul W. Craig
-------------------------
Paul W. Craig
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
August 13, 1996 By: /s/Jonathan T. Wallace
------------------------
Jonathan T. Wallace
Controller
(Chief Accounting Officer)
19
INDEX TO EXHIBITS
Exhibit Sequentially
Number Description Numbered Page
- ------ ----------- -------------
10.115 Quota Share reinsurance agreement between
TIG Insurance Company and the Pacific Rim
Assurance Company, a subsidiary of Pac Rim
Holding Corporation, dated April 1, 1996.
10.116 Producer agreement between Regional
Benefits Insurance Services, a subsidiary
of Pac Rim Holding Corporation, and Hull &
Co., Inc., dated May 15, 1996.
10.117 Producer agreement between Regional
Benefits Insurance Services, a subsidiary
of Pac Rim Holding Corporation, and Gulf
Atlantic Management Group, Inc., dated
May 15, 1996.
10.118 Office lease between Gulf Atlantic
Investment Group, Inc. and Regional
Benefits Insurance Services, Inc., a
subsidiary of Pac Rim Holding Corporation,
dated May 20, 1996.
11 Computation of Per Share Earnings
27 Financial Data Schedule