[THEZENITH]
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ZENITH NATIONAL INSURANCE CORP.
A N N U A L 2 0 0 0 R E P O R T
FINANCIAL HIGHLIGHTS
Years ended December 31, 2000 1999 1998
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OPERATING RESULTS:
(Dollars in thousands, except per
share data)
Revenues(1) $459,569 $492,108 $636,779
======== ======== ========
Operating (loss) income after tax(2) (37,739) (55,228) 11,559
Realized (losses) gains after tax:
On investments (10,054) 4,993 7,541
On sale of CalFarm Insurance Company(1) 104,335
-------- -------- --------
(Loss) income before extraordinary item (47,793) 54,100 19,100
Extraordinary item -- gain on extinguishment
of debt after tax(3) 993
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Net (loss) income $(46,800) $ 54,100 $ 19,100
======== ======== ========
PER SHARE DATA:
Operating (loss) income after tax(2) $ (2.19) $ (3.22) $ 0.67
Realized (losses) gains after tax:
On investments (0.58) 0.29 0.44
On sale of CalFarm Insurance Company(1) 6.08
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(Loss) income before extraordinary item (2.77) 3.15 1.11
Extraordinary item -- gain on extinguishment
of debt after tax(3) 0.06
-------- -------- --------
Net (loss) income $ (2.71) $ 3.15 $ 1.11
======== ======== ========
Stockholders' dividends $ 1.00 $ 1.00 $ 1.00
KEY STATISTICS:
Combined ratio:
Including catastrophes(2) 130.2% 135.2% 105.3%
Excluding catastrophes(2) 123.6% 130.0% 103.1%
Stockholders' equity $309,776 $354,559 $346,952
Stockholders' equity per share(4) 17.76 20.67 20.23
Closing common stock price 29 3/8 20 5/8 23 1/8
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(1) Zenith completed the sale of CalFarm Insurance Company effective March 31,
1999 for a gain of $104.3 million after tax, or $6.08 per share.
(2) The year ended December 31, 1999 includes $50.0 million before tax
($32.5 million after tax, or $1.89 per share) of net charges associated with
an increase in the purchase price of RISCORP.
(3) In 2000, Zenith repurchased a total of $16.5 million aggregate principal
amount of the outstanding 9% Senior Notes due 2002 and $8.0 million
aggregate liquidation amount of the outstanding 8.55% Capital
Securities.
(4) Excluding the effect of Statement of Financial Accounting Standards
No. 115, stockholders' equity per share was $18.31, $21.80 and $19.86 at
December 31, 2000, 1999 and 1998, respectively.
TheZenith
1
TABLE OF CONTENTS
/ / Financial Highlights 1
/ / Letter to Stockholders 3
/ / Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations 25
/ / 5-Year Summary of Selected Financial Information 38
/ / Property-Casualty Loss Development 40
/ / Consolidated Balance Sheet 42
/ / Consolidated Statement of Operations 44
/ / Consolidated Statement of Cash Flows 45
/ / Consolidated Statement of Stockholders' Equity 46
/ / Notes to Consolidated Financial Statements 48
/ / Report of Independent Accountants 66
/ / Corporate Directory 67
Zenith National Insurance Corp. 68
Zenith Insurance Company 69
TheZenith Marketing, Underwriting and Claims Offices 70
Perma-Bilt, a Nevada Corporation 70
2
TO OUR STOCKHOLDERS
Workers' Compensation markets nationally, and specifically in California
(where we write approximately half our business), have been an industry
pricing, expense and reserving disaster for the past several years. Even though
our strategy has been significantly different from most of our competitors, we
have been impacted to some extent. However, we began experiencing positive
change in 2000 which has continued into 2001; our operating losses not
withstanding.
As a transaction-based Company, we have never believed in growth for
growth's sake, rather we have held steadfast to our customer service and profit
culture. And, throughout this difficult period, we have never wavered in our
resolve to support our four fundamental business objectives:
1. Deliver value-added Workers' Compensation services with underwriting
discipline and at adequate rates to help our policyholders protect the
safety and health of their employees, and to reduce their ultimate cost
of insurance. Consistently-favorable loss ratios, regularly
out-performing the industry, and a high rate of renewal customers are
evidence of meeting this goal.
2. Attract and train a professionally managed employee team, with an
understanding of our strategies, and the resolve and courage to execute
our plan.
3. Maintain financial strength, documented by an excellent balance sheet
and cash and securities in the holding company, and high quality ratings
from rating agencies.
TheZenith
3
THE LONG PERIOD OF INADEQUATE PRICING IS APPARENTLY COMING TO AN END; WE
HAVE EXPERIENCED AN INCREASE IN BUSINESS FOR THE FIRST TIME IN SEVEN YEARS
AT OUR ACTUARIAL PRICES.
4. Provide long-term investor value as reflected by growth in our stock
price and stockholders' equity.
A PERIOD OF CHARACTER BUILDING
The current period of adverse industry results has its roots in the Workers'
Compensation markets of the early 1990's. On the one hand, there was a degree
of positive legislative reform, some rate improvement in various states and
reserve adequacy. Plus, the industry's and employers' surprisingly effective
assault on fraud and abuse in the system saved hundreds of millions of dollars,
resulting in favorable frequency trends and underwriting results. On the other
hand, there was the advent of open rating in California in 1995, and adverse
insurer pricing trends elsewhere, resulting in plunging employer costs and
unsatisfactory insurer results. As I reported last year, it was the best of
times and the worst of times.
But, the major trend of inadequate pricing was escalating and the
foreseeable catastrophic damage to insurers was becoming evident.
Operating as if oblivious to escalating benefits and increased healthcare
and claims costs, masked, in part, by declines in claim frequency, numerous
opportunistic competitors attacked the market with selling prices below cost as
if there was no tomorrow. Market shares were built with inadequate pricing,
de-engineered policyholder services, naive reinsurance and unrealistic
reserving. It was growth for growth's sake at the expense of solvency and
financial strength, with adverse ramifications, as well, to
4
STOCKHOLDERS' EQUITY PER SHARE
[GRAPH]
carriers committed to customer service and profitability like TheZenith. As
could reasonably be anticipated, the competitors' strategies did not work, and
negative financial and regulatory consequences have become apparent.
More specifically:
- - Industry combined ratios grew to 130-135%; more than 150% in California.
- - Healthcare and claims management costs increased at a rate of 5%-6%;
double-digit in California.
- - California's "treating physician presumption," for example, was intended to
reduce the number of medical reports required to evaluate an injury.
Unintended result: we are now limited in our ability to rebut a medical
analysis that may not be accurate, leading to substantial increases in the
cost of an average claim.
- - Industry has estimated under-reserving of $18 billion; $5 billion in
California as prior-period loss development continues to escalate.
- - Unprecedented underwriting losses and diminishing balance sheets forced the
California regulators to takeover a large competitor, require the sale of
another, and restrict operations of others.
- - Competitors, fighting to survive their sins of the past, answered with
pricing and reserving increases significantly in excess of ours; especially
in the California marketplace.
TheZenith
5
AS A TRANSACTION-BASED COMPANY, WE HAVE NEVER BELIEVED IN GROWTH FOR
GROWTH'S SAKE, RATHER WE HAVE HELD STEADFAST TO OUR CUSTOMER SERVICE AND
PROFIT CULTURE.
During this period, we responded with acquisition and geographic
diversification, the sale of CalFarm at an attractive profit, recruiting an
improved management team, and substantial investment in information technology
to cost-reduce our G&A (primarily in claims management where the majority of
premium is spent). Tough-minded value propositions were applied to every
expense factor throughout our operations. We gradually reduced our employee
census, held firm to transaction-based pricing, and maintained underwriting and
reserving discipline. Of interest, we were the only company to reduce premiums
in California for six consecutive years.
To say it was a time of character building is an understatement. With tens
of thousand of applications submitted to us throughout our national network of
offices over the years, can you imagine the frustration of our people almost
always having to say "no?" No to unprofitable pricing. No to unrealistic
underwriting. No to inadequate reserving. No to dismantling our policyholder
services. In essence, "no" to a substantial percentage of our new business
development and renewal opportunities, but in a professional manner so that
agents and employers would continue to do business with us when markets
changed. As a result, we reduced premium volume and market share. Our expenses,
as expected, were disproportionate to our revenues resulting in operating
losses. But, what if we had followed the unrealistic pricing of the market? Our
operating losses would have been far more serious and our underwriting
discipline would have been damaged. As
6
STOCK PRICES
[GRAPH] [GRAPH]
a result, our loss ratios continue to be substantially better than industry
averages, and now provide a favorable starting point for future performance.
In summary, there are indications the long period of inadequate pricing is
apparently coming to an end. During 2000, and so far in 2001, TheZenith has
experienced an increase in business for the first time in seven years at our
actuarial prices. Of significance, our value-added service strategy is more in
demand at appropriate prices in several regions of the country. Although
unrealistic pricing and underwriting continues in various markets, it is to a
lesser extent than in the past.
Lastly, we hold firmly to our fundamental belief that operating with an eye
to the long term is the correct strategy. TheZenith is stronger in many ways
than at any time during this Management's 23-year tenure. Our 2000 Report will
discuss in detail the major issues impacting our current and future operations,
and our efforts to return to profitability.
SUMMARY OF FINANCIAL HIGHLIGHTS:
- - Workers' Compensation premiums earned increased 10% to $300.8 million.
- - Operating losses after tax were $37.7 million, or $2.19 per share in 2000,
compared to $55.2 million, or $3.22 per share in 1999.
- - Investment income after tax was $34.2 million, or $1.98 per share in 2000,
compared to $35.6 million, or $2.07 per share in 1999.
- - Realized losses on investments after tax were $10.1 million, or $0.58 per
share, compared to gains of $5.0 million, or $0.29 per share in 1999.
TheZenith
7
OUR RECENT RESULTS ARE UNSATISFACTORY, BUT IF WE HAD FOLLOWED THE
UNREALISTIC PRICING OF THE MARKET, OUR OPERATING LOSSES WOULD HAVE BEEN FAR
MORE SERIOUS.
Unrealized losses on fixed maturities and equity securities, recorded as a
reduction of stockholders' equity after tax, were $8.2 million, compared to
$20.0 million in 1999. Also, we have a deferred gain after tax of $3.3
million, or $0.19 per share, in connection with an installment sale of real
estate.
- - Net loss was $46.8 million, or $2.71 per share in 2000, compared to net
income of $54.1 million, or $3.15 per share for 1999.
- - The combined ratio for the property-casualty operations was 130.2% for 2000,
compared to 135.2% for 1999.
- - Stockholders' equity per share at December 31, 2000 was $17.76, compared to
$20.67 at December 31, 1999.
ANALYSIS
Net loss was $46.8 million, or $2.71 per share in 2000, compared to net
income of $54.1 million, or $3.15 per share the prior year.
The following table summarizes pre-tax underwriting performance during the
past three years.
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1998 1999 2000
UNDERWRITING RESULTS
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(Dollars in thousands)
Workers' Compensation $(42,638) $(122,543) $ (87,854)
Other Property-Casualty 4,410 (22)
Reinsurance 10,268 (7,324) (14,536)
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Underwriting loss $(27,960) $(129,889) $(102,390)
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8
INVESTMENT INCOME AFTER TAX PER SHARE
[GRAPH]
2000 results were significantly below our goals, due primarily to continuing
underwriting losses in the Workers' Compensation operations, and adverse
reserve development of 1999 reinsurance losses. The 1999 results were impacted
by the $50.0 million purchase price adjustment in connection with the RISCORP
acquisition coupled with underwriting losses in the Workers' Compensation
operations.
Our combined ratio for the Workers' Compensation operations was 129%,
composed of a 70% accident year loss ratio (compared to 71% for the current
estimate of last year), a 57% loss adjustment and underwriting expense ratio
and a 2% ratio of prior years' reserve strengthening. Since the beginning of
California's open-rating in 1995, our California loss ratio has averaged 68%,
compared to 101% for the California industry. Our 33-point advantage is better
than TheZenith's comparative results prior to open rating, and demonstrates the
discipline of our pricing and underwriting strategy during a period of
significant market turmoil.
2000 accident year Reinsurance operations were excellent, but were impacted
by adverse loss development on the large losses of prior years.
Investment income after tax decreased slightly to $34.2 million, or $1.98
per share in 2000, from $35.6 million, or $2.07 per share in 1999.
Stockholders' equity at December 31, 2000 was $309.8 million, compared to
$354.6 million at December 31, 1999.
Cash used in operating activities was $47.0 million in 2000, compared to
$51.6 million in 1999; primarily due to payment of claim liabilities.
TheZenith
9
QUARTERLY RESERVING REVIEWS AND RATE ADJUSTMENTS WILL
KEEP US FOCUSED ON CHANGING TRENDS.
We purchased 2,000 shares of Zenith common stock during 2000, leaving
authority to purchase an additional 938,000 shares. Since 1987, we have
repurchased 8,009,000 shares, or an estimated 38% of the shares then issued,
for an aggregate cost of $150.8 million, or an average of $18.82 per share.
At December 31, 2000, Zenith had long-term debt of $58.4 million, compared
to $74.7 million at December 31, 1999, with a total debt-to-equity position of
19.3%, compared to 21.1% at December 31, 1999. Also outstanding was $65.6
million of 8.55% Capital Trust Securities issued in July 1998, maturing in 28
years. We repurchased $24.5 million of debt securities in 2000. TheZenith's
parent company had $70.0 million of bank lines of credit available, and $135.7
million of investments. In order to maintain the financial strength of our
insurance subsidiaries, we contributed $25.0 million to capital in the fourth
quarter of 2000.
Zenith's subsidiaries are rated A (Excellent) by A.M. Best Company. Moody's
Investor's Service and Standard & Poor's have assigned an insurance financial
strength rating of Baa1 (Adequate) and A (Strong), respectively.
Information in the following table provides estimates of Zenith's net
incurred losses and loss adjustment expenses by accident year, evaluated in the
year they were incurred and as they were subsequently evaluated in succeeding
years. These data are of critical importance in judging the
10
LOSS RESERVE DEVELOPMENT MEASURES THE ACCURACY OF
OUR ESTIMATES.
accuracy of our reserve estimates, as well as providing a guide to the setting
of fair prices and rates. The increase in estimated incurred losses between
1997 and 1998 is mainly attributable to the business acquired from RISCORP and
the increase from 1998 to 1999 is primarily a result of the reserve increase
that was part of the RISCORP purchase price adjustment referred to in prior
reports. Our reserves are not discounted.
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ACCIDENT YEAR RESERVE DEVELOPMENT FROM OPERATIONS
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Net incurred losses and loss adjustment expenses reported at end of year
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Years in which losses were incurred 1994 1995 1996 1997 1998 1999 2000
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(Dollars in thousands)
Prior to 1994 $1,876,649 $1,865,388 $1,862,648 $1,855,543 $2,256,746 $2,256,637 $2,261,370
1994 170,999 177,819 169,222 168,016 345,006 348,121 349,071
Cumulative 2,047,648 2,043,207 2,031,870 2,023,559 2,601,752 2,604,758 2,610,441
1995 180,170 187,517 196,335 341,708 351,292 342,839
Cumulative 2,223,377 2,219,387 2,219,894 2,943,460 2,956,050 2,953,280
1996 181,844 238,635 429,335 443,443 434,315
Cumulative 2,401,231 2,458,529 3,372,795 3,399,493 3,387,595
1997 204,502 333,818 339,907 346,276
Cumulative 2,663,031 3,706,613 3,739,400 3,733,871
1998 258,000 271,317 276,768
Cumulative 3,964,613 4,010,717 4,010,639
1999 278,054 309,012
Cumulative 4,288,771 4,319,651
2000 306,082
Ratios:
1994 66.92% 69.59% 66.22% 65.75% 65.95% 66.55% 66.73%
1995 73.12% 76.10% 79.68% 73.11% 75.16% 73.35%
1996 73.36% 79.35% 80.08% 82.71% 81.01%
1997 75.04% 72.56% 73.88% 75.26%
1998 74.76% 78.62% 80.20%
1999 86.91% 96.58%
2000 88.76%
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- -This analysis displays the accident year net incurred losses and loss adjustment expenses development for accident years
1994-2000 for all property-casualty business. The total of net loss and loss adjustment expenses for all claims occurring
within each annual period is shown first at the end of that year and then annually thereafter. The total cost includes both
payments made and the estimate of future payments as of each year-end. Past development may not be an accurate indicator of
future development since trends and conditions change.
- -The data prior to 1999 has been restated to exclude the results of CalFarm, which was sold effective March 31, 1999.
TheZenith
11
ZENITH'S SUBSIDIARIES ARE RATED A (EXCELLENT) BY A.M. BEST; MOODY'S AND S&P
HAVE ASSIGNED INSURANCE FINANCIAL STRENGTH RATINGS OF Baa1 (ADEQUATE) AND A
(STRONG), RESPECTIVELY.
INVESTMENTS
Investment activities are a major part of our revenues and earnings; we
believe our portfolio is diversified to achieve a reasonable balance of risk
and a stable source of earnings. Zenith primarily invests in debt securities,
as compared to equities, and our largest holdings are U.S. Government
securities. In comparison to other insurers, we believe that our portfolio
contains a smaller percentage of equities to total assets and a larger
percentage of cash or short-term securities.
- - Consolidated investment income after tax and after interest expense was $30.6
million, or $1.77 per share in 2000, compared to $30.3 million, or $1.76 per
share in 1999. Average yields on this portfolio in 2000 were 5.9% before tax
and 3.9% after tax, respectively, compared to 5.5% and 3.7%, respectively, in
1999.
- - During 2000, we recorded net losses before tax from our investment portfolio
of $15.5 million, compared to $7.7 million of gains the prior year. The
losses were primarily a result of write downs of bonds originally acquired as
investment grade securities, most of which continue to pay interest.
- - Pre-tax income during 2000 from our real estate activities was $5.5 million,
compared to $3.6 million the prior year.
12
THEZENITH IS POSITIONED TO PROVIDE COVERAGE FOR NEW AND EXISTING CUSTOMERS,
RESPONSIBLY AND PROFITABLY, WHILE DELIVERING QUALITY, VALUE-ADDED
POLICYHOLDER SERVICES.
- - Unrealized losses in our portfolio of fixed maturity investments were $14.5
million before tax in 2000, compared to $30.1 million before tax the prior
year.
Our investment portfolio is recorded in the financial statements primarily
at market value. Average life of the bond portfolio was 5.3 years at December
31, 2000, compared to 6.2 years at December 31, 1999. Portfolio quality is high
with 94% and 95% rated investment grade at December 31, 2000 and 1999,
respectively.
The major developments in the U.S. bond markets were continued low inflation
and declining interest rates on Treasury Securities. Corporate bond spreads in
relation to Treasury Securities increased, notwithstanding most high-quality
corporate categories gained in price. Since we are capable of holding these
investments to maturity, and the average maturities are relatively short,
fluctuations in bond values do not significantly impact our operations.
Short-term investments and liquidity remained high as we searched for
intelligent investment opportunities, and avoided large losses in certain
equity markets.
TheZenith
13
SHORT-TERM INVESTMENTS AND LIQUIDITY REMAINED HIGH AS WE SEARCHED FOR
INTELLIGENT INVESTMENT OPPORTUNITIES, AND AVOIDED LARGE LOSSES IN CERTAIN
EQUITY MARKETS.
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SECURITIES PORTFOLIO
At December 31, 1999 At December 31, 2000
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Amortized Cost* Market Value Amortized Cost* Market Value
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(Dollars in thousands)
Short-term investments $ 179,748 $ 179,748 $ 158,438 $ 158,438
U.S. Government bonds 218,158 215,936 161,796 162,262
Taxable bonds:
Investment grade 411,674 389,512 392,218 385,044
Non-investment grade 40,944 36,711 42,216 35,284
Redeemable preferred stocks 13,879 12,402 13,644 12,752
Other preferred stocks* 11,099 9,825 10,532 9,090
Common stocks* 25,428 25,634 23,630 27,301
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*Equity securities at cost
In 1993, we started a home-building operation in order to participate in the
growth of the Las Vegas, Nevada housing market. During 2000, we closed and
delivered 469 homes at an average selling price of $177,000, compared to 366
homes at an average selling price of $158,000 the prior year. Sales of $84.5
million and $5.5 million of pre-tax income were recorded during 2000, compared
to sales of $58.7 million and $3.6 million of pre-tax income the previous year.
Land presently owned at a cost of $34.5 million will support the construction
of an estimated 1,300 homes over the next several years.
14
OUR VALUE-ADDED SERVICE STRATEGY IS MORE IN DEMAND AT APPROPRIATE PRICES IN
SEVERAL REGIONS OF THE COUNTRY.
Changes in interest rates or other factors could affect future home sales
(we have not seen any impact so far), but we believe the land we have acquired
is strategically located and has long-term value.
An agreement was consummated to sell our Las Vegas strip property for a gain
of $6.0 million, of which $5.1 million will be deferred until additional
payments are received. At the closing we received $7.3 million in cash and
first mortgage notes for the balance, of which $7.7 million has been adequately
guaranteed. We will own a 25% interest in the joint venture owner of the
property which will be managed by a successful developer.
WORKERS' COMPENSATION
TheZenith is a specialty insurer with primary operations in California,
Florida, Texas and 40 other states. Premiums written in 2000 were $308.1
million, an increase of 15% from the prior year. Underwriting losses were $87.9
million in 2000 and $122.5 million in 1999. At year-end 2000, there were 32,400
policies in force.
Even though our underwriting losses are significant and unacceptable, they
are not a result of either inadequate rates or a lack of underwriting
discipline. In our case, TheZenith's strategy, compared to the competition,
resulted in less revenue than needed to achieve a reasonable expense ratio.
TheZenith
15
OUR ACCIDENT YEAR LOSS RATIOS ARE SUBSTANTIALLY BELOW INDUSTRY AVERAGES AND
WILL ASSIST COMBINED RATIO IMPROVEMENT AS VOLUME INCREASES.
Our accident year loss ratios, as currently estimated, continue to be
substantially below industry averages, as follows:
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California Outside of California
ACCIDENT YEAR --------------------------------- ---------------------------------
LOSS RATIOS TheZenith Industry TheZenith Industry
- ---------------------------------------------------------------------------------------------------
1996 63% 94% 46% 63%
1997 67% 101% 49% 72%
1998 67% 110% 59% 80%
1999 76% 118% 67% 81%
2000 74% -- 66% --
One of the many reasons why our loss ratios outperform the industry is that
we rely upon our actuaries to establish adequate rates. Except in Florida,
where minimum rates are established by the Insurance Commissioner, most of our
business is written at rates we establish and adjust based upon sound actuarial
data and judgment which includes estimates of future cost trends. This strategy
penalizes volume when competitors ignore data and trends, and price for growth,
but assists us in producing low loss ratios and maintaining our discipline.
As we wrote in last year's Report, competitors (particularly in California)
began raising rates and adjusting underwriting to improve their profitability
at substantially higher prices than TheZenith. We expected these changes to
gain momentum and allow us to write more business. Our predictions were
16
REDUCING EMPLOYER LOSS RATIOS, EXPERIENCE MODIFICATIONS, AND ULTIMATELY THE
LONG-TERM COST OF THEIR INSURANCE IS OUR HALLMARK AND OUR MISSION.
correct, with our 2000 inforce California volume increasing 50%, from
$98.1 million to $146.7 million. Markets outside California were not as
favorable, however, we increased premium from $145.8 million to $162.4 million.
Along with the pricing changes, the most significant development last year
was the continued deterioration in the estimated 1999 results of the industry.
At the beginning of last year, California and U.S. indications were combined
ratios in the 150% and 125% ranges, respectively, for 1999. Today these
estimates have been increased to 156% and 135%, respectively. From a historical
point of view, these are large changes in a very short period of time and are
the worst combined ratio increases on record. As a result, continuing and
significant price increases will be required to restore the industry's
financial health, and individual companies will need to be vigilant as to
pricing, underwriting and loss reserve adequacy. Firmer pricing will also be
supported by lower interest rates.
Pricing wars, naive reinsurance capacity, and escalating claims costs of
recent years have taken their toll. Substantial increases in estimating prior-
accident-year loss reserves are commonplace. California regulators have
initiated the following actions against three large Workers' Compensation
carriers: a take-over, restrictions and reduced mandated writings, and pricing
activity intervention. Two other California competitors have ceased business,
as well as Reliance Insurance Co., a large writer in the marketplace. But,
soft-market problems may be far from over. Continuing
TheZenith
17
WE ARE WORKING ON LEGISLATIVE REFORM OF CALIFORNIA'S "TREATING PHYSICIAN
PRESUMPTION" IN ORDER TO IMPACT
CLAIM COSTS.
price increases, upward loss reserve adjustments, and financial difficulties
will persist. Add to this a major unknown: claim frequency trends. While they
were favorable during the first nine months of 2000, what if they increase
before the industry returns to financial stability?
We are not aware of any definitive data as to why claim frequency trends
have been favorable for the last several years. It is possible that the positive
economy is one of the reasons. If so, we are mindful that it is slowing and, in
California, current energy problems may impact jobs and the economy.
TheZenith is positioned to provide coverage for new and existing customers,
responsibly and profitably, while delivering quality, value-added policyholder
services. Compare January 2001 with 2000: we wrote approximately $40.0 million
of new business, compared to approximately $18.0 million the prior year, and
renewed a large percentage of existing policies at our actuarial prices. In
California, where pricing flexibility exists, we increased our sales in all
regions of the state at prices averaging 25% more than the prior year. Combined
ratio improvement will be a result of volume and price increases in concert
with continuing expense control. Profit improvement should be augmented by
increases in cash flow and investable assets. Quarterly reserving reviews and
rate adjustments (versus annual reviews as practiced by many competitors), will
keep us focused on rising healthcare and indemnity claims costs. Again, the
frequency and severity of new claims, along with reserve adequacy estimates,
will determine the timing and magnitude of our on-going performance improvement.
18
EMPLOYERS WANT TO KEEP THEIR COSTS TO A MINIMUM AND OUR SERVICES, TOGETHER
WITH SAFETY PRACTICES, ARE ESSENTIAL.
Incredibly, there are still a number of competitors significantly under-
pricing accounts, with managing general agents, reinsurers and not-for-profit
companies the major discounters. While their impact will be far less than in
recent years, one would think the "message" would have been received by now.
Unfortunately, it is easy to predict the discounters will continue to erode
their financial performance, and their ability to provide needed services to
assist employers in controlling their costs.
Reducing employer loss ratios, experience modifications, and ultimately the
long-term cost of their insurance is our hallmark and our mission. TheZenith's
value-added services, implemented in partnership with our policyholders, have
an excellent record of delivering against these objectives, and constitute the
Company's most valuable asset along with our highly-professional staff.
- - Expert Safety and Health programs assist with accident and illness
prevention, incident investigation and remediation, and safe-work practices
education for management and employees.
- - Claims and Medical/Disability Management procedures facilitate prompt injury
reporting, the use of recommended physicians (where permitted
state-by-state), nurse case management of serious claims, analysis and
negotiation of hospital and medical bills, and continuing communications and
reviews to monitor and manage recoveries, costs and reserving.
- - Special Investigation Unit and specialized Workers' Compensation Legal
personnel protect employers from fraud and abuse, negotiate settlements where
prudent, and represent policyholders throughout the litigation process as
appropriate.
TheZenith
19
WE DO NOT FORECAST FUTURE FINANCIAL RESULTS AS A MATTER OF POLICY, BUT IT
WOULD APPEAR REASONABLE TO SEE IMPROVED OPERATING RESULTS IN THE SHORT TERM.
- - Return to Work programs place recovering employees in transitional duties
with physician approval, improving employer morale and productivity, while
containing costs.
- - Premium Auditors provide proper payroll classifications to assure accuracy
and avoid unanticipated retroactive billing.
Politically, significant changes affecting our operations were minimal. In
California, a major benefit increase bill with sorely needed reforms was
understandably vetoed by the Governor for the second year in a row. Future
efforts towards reform of the system will be made this year, hopefully with the
cooperation of the Governor. We are mindful this task has been made more
difficult by the enactment of musculoskeletal regulations and ergonomic
standards by the Occupational Safety and Health Association (OSHA) in
Washington. These regulations add significant costs to employers over and above
the price of Workers' Compensation, and it is anticipated until the legality
and costs of these regulations is determined, it may be difficult for labor and
business to negotiate with the politicians for needed Workers' Compensation
changes. Obviously, employers are sensitive to the cost of any benefit package;
we too are concerned with the need for a gradual phase-in of benefits and its
equitable distribution among disability ratings in order that claim frequency
not be increased. We continue to be active in these negotiations because it is
essential to eliminate the treating physician presumption from the California
system in order to control
20
THEZENITH'S VALUE-ADDED SERVICES AND OUR PEOPLE CONSTITUTE THE COMPANY'S
MOST VALUABLE ASSETS.
escalating costs. Also, we desire changes that will speed up the dispute
resolution process and make it less costly.
Lastly, legislative consideration should be given to the role played by the
State Fund in the California marketplace. The State Fund is the largest writer,
a fierce competitor in certain risks, and during this past year, seems to be
the most growth-oriented participant. Since the spread between their rates and
the general market rates is so large, it is quite likely they are not in
compliance with statutes requiring them to be "fairly competitive." These
statutes predate open rating in California, and at the least the Legislature
should provide some objective criteria of "fairly competitive," since it is the
legislative intent that the State Fund "become neither more nor less than
self-supporting." At present the State Fund continues to report operating
losses, and if this continues or escalates, there will be an adverse impact on
the California market. Our concerns are not about competing with the State
Fund, but about the rules under which they operate and are regulated.
As a result of the large insolvency of one of the competitors, it is
expected that the California Insurance Guarantee Association will be required
to fund hundreds of millions of dollars of losses. Each of our policyholders
(all policyholders in the State) will be assessed, under current law, at 1% of
their premiums for these losses. Furthermore, we expect there will be efforts
to obtain an increase in the assessment amount. Obviously, if other companies
become insolvent there will be additional serious financial and political
problems.
TheZenith
21
REINSURANCE PREMIUM INCREASES AND MORE FAVORABLE TERMS ARE OCCURRING FROM
THE 1999 LOSSES, PARTICULARLY IN THE RETROCESSION MARKET WHERE WE ARE ACTIVE.
REINSURANCE
For the past 15 years, Zenith Insurance has been selectively underwriting
assumed treaty and facultative reinsurance. Reinsurance represents 11% of our
property-casualty volume, while Reinsurance reserves represent 15% of our total
property-casualty reserves.
During 2000, the net written premium of this operation was $39.3 million,
compared to $35.9 million in 1999. Earned premium was $37.9 million, compared
to $36.4 million in 1999. Underwriting losses of $14.5 million were recorded in
2000, resulting in a combined ratio of 138.3%, compared to an underwriting loss
of $7.3 million and a combined ratio of 120.1% the prior year. Since the
inception of this operation in 1985, the combined ratio has averaged 97.4%.
During 2000 and 1999, the majority of written premium was derived from
worldwide property catastrophe business.
Accounting for the property catastrophe reinsurance business has a different
result from our other property-casualty business. At the end of each reporting
period, income is recognized without reserves being established if no major
catastrophe has occurred. In our other businesses, reserves are mandated based
upon actual events as well as expected loss patterns. As a result, there may be
large fluctuations (positive or negative) in underwriting results for the
property catastrophe reinsurance business in the short-term, since only actual
events are considered. In 1999, the largest storm impacts were Hurricanes Floyd
and Anatol, Typhoon Bart in Japan,
22
TECHNOLOGY INVESTMENTS IMPROVE PRODUCTIVITY AND THE QUALITY OF OUR SERVICES.
and French windstorm losses on December 26, 27 and 28, 1999. It was difficult
to evaluate our losses from these events in 1999 and, therefore, additional
losses were recorded this past year. Fortunately in 2000, there do not appear
to have been significant events causing losses. Nevertheless, premium increases
and more favorable terms are occurring from the 1999 losses, particularly in
the retrocession market where we are active.
INFORMATION TECHNOLOGY
We focused on two areas this past year: first, improving the functionality
of our claims systems with technology and second, our Intranet capability.
Additionally, we are making progress toward consolidating our three separate
systems into a single national network. Work in all these areas will continue
in 2001 and beyond as we insist on improving productivity.
DIRECTORS AND OFFICERS
Significant strength was added to our Board of Directors and management team
this past year. Leon Panetta, Founder and Director of the Leon & Sylvia Panetta
Institute for Public Policy, and formerly White House Chief of Staff, joined
our Board. His wisdom and judgement, along with all of our Directors, have
already made valuable contributions.
Wes Heyward and Kari Van Gundy, formerly President and Financial Senior Vice
President, respectively, of CalFarm Insurance, have re-joined us in senior
management positions. Also, Steve Pratt was appointed as Senior Vice President,
Claims to supervise our claims operation nationwide.
TheZenith
23
WE HAVE THE FINANCIAL AND INTELLECTUAL STRENGTH TO TAKE ADVANTAGE OF THE
CURRENT MORE POSITIVE PRICING TRENDS.
CONCLUSION
We are optimistic about the opportunities available in the Workers'
Compensation market at our actuarial prices after many years of significantly
inadequate pricing and turmoil. Our intellectual and financial strengths are
excellent and we are benefiting from the patience and discipline we
demonstrated during the last several years. And, we are constantly focused on
improving the quality of the services provided to our customers and improving
our productivity, since both are essential to our continued success.
While it is not our policy to forecast future financial results, it would
appear reasonable to predict improved operating results in the short term.
We appreciate the confidence of our long-term investors and welcome our new
Shareholders as we navigate through the more favorable market conditions to
restore profitability. The support, guidance and good judgment of our
distinguished Directors provide assistance and confidence to our management
team in our efforts to enhance Shareholder value.
/s/ Stanley R. Zax
Stanley R. Zax
Chairman of the Board and President
Woodland Hills, California, March 2001
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED 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 as EXPECT, ANTICIPATE, BELIEVE, or similar
words that are used in the 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. 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;
and (7) other risks detailed herein and from time to time in Zenith's other
reports and filings with the Securities and Exchange Commission.
OVERVIEW
Zenith's long-term source of consolidated earnings is principally the income
and investment income from the operation of its property-casualty insurance
businesses ("P&C Operations") and its investment portfolio. The P&C Operations
comprise Workers' Compensation, Reinsurance and Other Property-Casualty (through
March 31, 1999). Workers' Compensation represents insurance coverage for the
statutorily prescribed benefits that employers are required to pay to their
employees injured in the course of employment. During 2000, the P&C Operations
wrote workers' compensation insurance in 43 states but the largest
concentrations, 45.7% and 28.2% of the Workers' Compensation premiums earned
during 2000, were in California and Florida, respectively. Reinsurance
principally consists of world-wide, assumed reinsurance of property losses from
catastrophes and large property risks. Results of the Reinsurance Operations can
be adversely impacted in periods that sustain large catastrophe losses. Other
Property-Casualty, which was operated by CalFarm Insurance Company ("CalFarm"),
formerly a wholly-owned subsidiary of Zenith Insurance Company ("Zenith
Insurance"), a wholly-owned subsidiary of Zenith National Insurance Corp.
("Zenith National"), represents multiple product line direct insurance other
than workers' compensation, principally in California. Effective March 31, 1999,
Zenith sold CalFarm. Results of the P&C Operations for the three years ended
December 31, 2000 are set forth in the table on page 27. The Real Estate
Operations develop land and primarily construct single-family residences in Las
Vegas, Nevada. Investment operations provide income and realized gains on
investments, primarily in debt securities. The Parent operations represent
Zenith National, a holding company which owns, directly or indirectly, all of
the capital stock of
TheZenith 25
the P&C Operations, non-insurance companies and securities.
The comparability of the results of operations between each of the three
years ended December 31, 2000, 1999 and 1998 is affected by several items.
First, on April 1, 1998, Zenith Insurance acquired substantially all of the
assets and certain liabilities of RISCORP, Inc. and certain of its subsidiaries
(collectively, "RISCORP") related to RISCORP's workers' compensation business
(the "RISCORP Acquisition"-- for a full description of the RISCORP Acquisition,
see Note 14 to the Consolidated Financial Statements on pages 58-59). Second, in
the third quarter of 1999, Zenith recorded net charges of $50.0 million before
tax ($32.5 million after tax, or $1.89 per share) associated with an increase in
the estimated net liabilities for unpaid losses and loss adjustment expenses
acquired from RISCORP (the "RISCORP Purchase Adjustment"-- for a full
description of the RISCORP Purchase Adjustment, see Note 14 to the Consolidated
Financial Statements on pages 58-59). Third, effective March 31, 1999, Zenith
sold CalFarm which had previously operated Zenith's Other Property-Casualty
Operations. The sale of CalFarm resulted in a gain of $104.3 million after tax
(see Note 13 to the Consolidated Financial Statements on pages 57-58).
The comparative components of net (loss) income after tax for the three years
ended December 31, 2000 are set forth in the following table:
- -------------------------------------------------------------------------------------------------
(Dollars in thousands)
2000 1999 1998
- -------------------------------------------------------------------------------------------------
Net investment income $ 34,243 $ 35,632 $ 35,907
Realized (losses) gains on investments (10,054) 4,993 7,541
- -------------------------------------------------------------------------------------------------
Subtotal 24,189 40,625 43,448
Property-casualty underwriting results:
Loss excluding catastrophes and RISCORP Purchase
Adjustment (53,251) (40,404) (11,230)
Catastrophe losses (14,690) (12,285) (7,475)
RISCORP Purchase Adjustment (32,500)
- -------------------------------------------------------------------------------------------------
Property-casualty underwriting loss (67,941) (85,189) (18,705)
Income from Real Estate Operations 3,552 2,372 868
Interest expense (3,666) (5,342) (3,824)
Parent expenses (3,927) (2,701) (2,687)
- -------------------------------------------------------------------------------------------------
(Loss) income before gain on sale of CalFarm and
extraordinary item (47,793) (50,235) 19,100
Gain on sale of CalFarm 104,335
Extraordinary item-gain on extinguishment of debt 993
- -------------------------------------------------------------------------------------------------
Net (loss) income $(46,800) $ 54,100 $ 19,100
- -------------------------------------------------------------------------------------------------
26
The comparative results of the P&C Operations before tax and combined ratios
for the three years ended December 31, 2000 are set forth in the table below.
1999 is presented both including and excluding the RISCORP Purchase Adjustment.
- ------------------------------------------------------------------------------------------------
(Dollars in thousands) 2000 1999(1) 1999(2) 1998
- ------------------------------------------------------------------------------------------------
Premiums earned:
Workers' Compensation:
California $ 137,497 $107,929 $ 107,929 $123,173
Outside California 163,336 164,325 170,925 155,487
- ------------------------------------------------------------------------------------------------
Total Workers' Compensation 300,833 272,254 278,854 278,660
Reinsurance 37,919 36,441 36,441 29,150
Other Property-Casualty(3) 54,108 54,108 222,045
- ------------------------------------------------------------------------------------------------
Total $ 338,752 $362,803 $ 369,403 $529,855
- ------------------------------------------------------------------------------------------------
Underwriting (loss) income before tax:
Workers' Compensation $ (87,854) $(72,543) $(122,543) $(42,638)
Reinsurance (14,536) (7,324) (7,324) 10,268
Other Property-Casualty(3) (22) (22) 4,410
- ------------------------------------------------------------------------------------------------
Total $(102,390) $(79,889) $(129,889) $(27,960)
- ------------------------------------------------------------------------------------------------
Combined loss and expense ratios:
Workers' Compensation:
Loss and loss adjustment expenses 96.4% 89.2% 102.5% 79.3%
Underwriting expenses 32.8 37.4 41.4 36.0
- ------------------------------------------------------------------------------------------------
Combined ratio 129.2% 126.6% 143.9% 115.3%
- ------------------------------------------------------------------------------------------------
Reinsurance:
Loss and loss adjustment expenses 124.0% 105.0% 105.0% 45.3%
Underwriting expenses 14.3 15.1 15.1 19.5
- ------------------------------------------------------------------------------------------------
Combined ratio 138.3% 120.1% 120.1% 64.8%
- ------------------------------------------------------------------------------------------------
Other Property-Casualty(3):
Loss and loss adjustment expenses 66.5% 66.5% 67.0%
Underwriting expenses 33.5 33.5 31.0
- ------------------------------------------------------------------------------------------------
Combined ratio 100.0% 100.0% 98.0%
- ------------------------------------------------------------------------------------------------
Total:
Loss and loss adjustment expenses 99.4% 87.4% 97.5% 72.3%
Underwriting expenses 30.8 34.6 37.7 33.0
- ------------------------------------------------------------------------------------------------
Combined ratio 130.2% 122.0% 135.2% 105.3%
- ------------------------------------------------------------------------------------------------
(1) Excluding RISCORP Purchase Adjustment
(2) Including RISCORP Purchase Adjustment
(3) CalFarm was sold effective March 31, 1999
Zenith's key operating goal for the P&C Operations is to achieve a combined
ratio of 100% or lower. The combined ratio, expressed as a percentage, is the
key measure of underwriting profitability traditionally used in the
property-casualty insurance business. It is the sum of net incurred loss and
loss adjustment expenses, underwriting expenses and policyholders' dividends,
expressed as a percentage of net premiums earned.
The profitability of the P&C Operations is principally dependent upon the
adequacy of rates charged to the insured for insurance protection; the frequency
and severity of claims and catastrophes; the ability to accurately estimate and
accrue reported and
TheZenith 27
unreported losses in the correct period; and the ability to manage claim costs
and keep operating expenses in line with premium volume. Some of the factors
that continue to impact the business and economic environment in which Zenith
operates include: intense price competition; poor operating results and reports
of substantial under estimation of reported loss reserves in the national
workers' compensation insurance industry; an uncertain political and regulatory
environment, both state and federal; the outlook for economic growth in
geographic areas where Zenith operates; the frequency and severity of claims and
catastrophes; and the changing environment for controlling medical, legal and
rehabilitation costs, as well as fraud and abuse. Fluctuations in interest rates
cause fluctuations in Zenith's investment income and the fair values of its
investments. Although management is currently unable to predict the effect of
any of the foregoing, these factors, related trends and uncertainties could have
a material effect on Zenith's future operations and financial condition.
The amount by which estimated losses, measured subsequently by reference to
payments and additional estimates, differ from those originally reported for a
period is known as "development." Development is favorable when losses
ultimately settle for less than the amount reserved or subsequent estimates
indicate a basis for reducing reserves on open claims. The following shows the
one-year loss reserve development for loss and loss adjustment expense for the
P&C Operations:
- ----------------------------------------------------------------------
Other
(Dollars in Workers' Property-
thousands) Compensation Reinsurance Casualty(1) Total
- ----------------------------------------------------------------------
One-year loss
development in:
2000 $ 8,251 $ 22,629 $ 30,880
1999 38,767 7,336 $(1,279) 44,824
1998 (75) (7,538) (3,754) (11,367)
- ----------------------------------------------------------------------
Favorable development is shown in brackets.
(1) CalFarm was sold effective March 31, 1999
Zenith continually monitors loss development trends and data to establish
adequate premium rates and loss reserves. In 2000, Zenith increased its estimate
of unpaid Workers' Compensation losses for principally the 1999 accident year by
about $8.0 million. The Workers' Compensation reserve strengthening in 1999 is
attributable to the RISCORP Purchase Adjustment. Adverse development in 2000 in
the Reinsurance Operations is attributable to additional estimates of the impact
of the events in 1999 but there do not appear to be any major catastrophic
events in 2000. Adverse development in the Reinsurance Operations in 1999 was
principally attributable to increased estimates in 1999 of the loss associated
with Hurricane Georges, the principal catastrophe in 1998.
The process of evaluating an insurance company's exposure to the cost of
environmental and asbestos damage is subject to significant uncertainties. Among
the complications are lack of historical data, long reporting delays,
uncertainty as to the number and identity of insureds with potential exposure
and unresolved legal issues regarding policy coverage. The legal issues
concerning the interpretations of various insurance policy provisions and
whether environmental and asbestos losses are, or were ever intended to be,
covered are complex. Courts have reached different and sometimes inconsistent
conclusions regarding such issues as: when the loss occurred and which policies
provide coverage, how policy limits and exclusions are applied and determined,
whether clean-up costs are covered as insured property damage and whether site
assessment costs are either indemnity payments or adjusting costs.
28
Zenith has exposure to asbestos losses in the Workers' Compensation
Operations for medical, indemnity and loss adjustment expenses associated with
covered workers' long-term exposure to asbestos or asbestos-containing
materials. Most of these claims date back to the 1970's and early 1980's and
Zenith's exposure is generally limited to a pro rata share of the workers'
compensation-related loss for the period of time coverage was provided. Zenith
also has potential exposure to environmental and asbestos losses and loss
adjustment expenses beginning in 1985 through its Reinsurance Operations but the
business reinsured by Zenith in its Reinsurance Operations contains exclusion
clauses for environmental and asbestos losses. CalFarm (through March 31, 1999)
wrote liability coverage under farmowners' and small commercial policies,
however any such liabilities associated with CalFarm were retained by CalFarm
when it was sold and Zenith retains no exposure to any such liabilities. All
claims for damages resulting from asbestos losses are identified and handled by
Zenith's most experienced claims/ legal professionals. Environmental and
asbestos losses have not been material and Zenith believes that its reserves for
environmental and asbestos losses are appropriately established based on
currently available facts, technology, laws and regulations. However, due to the
long-term nature of these claims, the inconsistencies of court decisions on
coverage, plaintiffs' expanded theories of liability, the risks inherent in
major litigation and other uncertainties, the ultimate exposure from these
claims may vary from the amounts currently reserved.
Inflation rates may impact the financial statements and operating results in
several areas. Fluctuations in inflation rates impact the market value of the
investment portfolio and yields on new investments. Inflation also impacts the
portion of the loss reserves that relates to hospital and medical expenses and
property claims and loss adjustment expenses, but not the portion of loss
reserves that relates to workers' compensation indemnity payments for lost wages
which are fixed by statute. Adjustments for inflationary impacts are implicitly
included as part of the P&C Operations' continual review of property-casualty
reserve estimates. Actuarial account of increased costs is considered in setting
adequate rates, and this is particularly important in the health care area where
hospital and medical inflation rates have exceeded general inflation rates.
Operating expenses, including payrolls, are impacted to a certain degree by the
inflation rate.
WORKERS' COMPENSATION
The following is a discussion of results of the Workers' Compensation
Operations as set forth on page 27 excluding the impact of the RISCORP Purchase
Adjustment in 1999.
In the three years ended December 31, 2000, intense competition and
inadequate premium rates adversely affected the national workers' compensation
industry. Industry data indicates a national trend of increasing claims
severity, and premium rates have not kept pace with the trend of increasing
severity. Industry organizations such as the National Council on Compensation
Insurance, Inc. and the California Workers' Compensation Insurance Rating Bureau
have reported that their analyses of the data show that the liabilities for
unpaid loss and loss adjustment expenses as estimated and reported by the
industry are significantly inadequate. The estimated accident year combined
ratio in 1999 was about 135% for the national workers' compensation industry and
about 156% for the California workers' compensation industry, including a 1999
accident year loss ratio of about 118%.
TheZenith 29
Zenith's inforce Workers' Compensation premiums decreased consistently in the
several years ended December 31, 1999 as a result of Zenith's endeavors during
that period to maintain rate adequacy in the face of intense competition in the
national workers' compensation insurance industry and, as a result, premiums
earned in the Workers' Compensation Operations decreased in 1999 compared to
1998. In the year ended December 31, 2000, competitive pricing conditions
improved somewhat in California and Zenith increased its inforce premiums in
California by about 50% at December 31, 2000 compared to December 31, 1999.
Outside of California, where competition and pricing are improving only
moderately and only in certain states, Zenith's inforce premiums increased by
about 11% at December 31, 2000 compared to December 31, 1999. As a result,
Zenith's Workers' Compensation premiums earned increased in 2000 compared to
1999. In January 2001, Zenith continued to increase its inforce premiums in
California and other selected states.
Zenith increased its premium rates in California by about 8% effective
January 1, 2000 and by about 9% effective September 1, 2000. Rates were
increased again in California by about 8% effective January 1, 2001 and Zenith
implemented other rate increases in most of the states in which it does
business. Minimum rates in Florida, which are set by the Department of
Insurance, were unchanged at January 1, 2001.
Underwriting losses in the Workers' Compensation Operations increased in 2000
compared to 1999 principally because of a higher loss ratio in 2000. The
increase in the loss ratio is due to the trend of increasing severity of claims
in Zenith's Workers' Compensation Operations offset partially by a decrease in
frequency of claims and by rate increases in California. Zenith continually
monitors loss development trends and data to establish adequate rates and loss
reserves. Zenith also increased its estimate of California losses for prior
years, principally for 1999, and about $8.0 million of reserve strengthening is
included in the loss ratio and underwriting loss in 2000. Underwriting losses in
the Workers' Compensation Operations increased in 1999 compared to 1998
principally because of a higher loss ratio in 1999 and the impact of reduced
premium volumes in 1999 relative to operating expenses.
Zenith expects that the profitability of its Workers' Compensation Operations
will be dependent upon general levels of competition, industry pricing and
management's ability to estimate the impact of claim frequency and severity
trends on the adequacy of loss reserves and premium rates. Zenith is unable to
predict when its Workers' Compensation Operations will return to underwriting
profitability, although it anticipates improvement in the short-run with
increases in volume and prices.
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 December 31, 2000
and 1999, the receivable from the Fund was $31.1 million and $37.0 million,
respectively, related to the pre-January 1, 1998 claims.
30
REINSURANCE
Results of the Reinsurance Operations may be adversely impacted in years when
large catastrophes occur. However, since its inception in 1985, the combined
ratio of the Reinsurance Operations through December 31, 2000 was 97.4%. In the
three years ended December 31, 2000, the Reinsurance Operations were adversely
impacted by catastrophe losses. Catastrophe losses were $22.6 million,
$18.9 million and $11.5 million before tax in 2000, 1999 and 1998, respectively.
Catastrophe losses in 2000 were attributable to additional estimates of the
impact of the events in 1999, but there do not appear to have been any major
catastrophes in 2000. There were frequent catastrophes of a moderate size
culminating in severe storms in Europe at the end of 1999. Catastrophe losses in
1998 were attributable principally to a single large event--Hurricane Georges.
Estimates of the impact of catastrophes on the Reinsurance Operations 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.
OTHER PROPERTY-CASUALTY
The Other Property-Casualty Operations, through CalFarm, offered automobile,
farmowners, commercial coverages, group health and homeowners coverage,
primarily in California. CalFarm was sold, effective March 31, 1999, to
Nationwide Mutual Insurance Company resulting in a gain of $104.3 million after
tax.
Underwriting results for 1999 and 1998 were impacted by intense competition
and increased expenses, primarily due to computer upgrade costs. In 1998,
CalFarm sustained catastrophe losses before tax of $5.0 million in conjunction
with California wind and storm damage. The Other Property-Casualty Operations
underwriting results in 1999 and 1998 were also adversely impacted by losses in
the group health line of business because of higher health care costs and
increased utilization.
REAL ESTATE OPERATIONS
Total revenues recognized in the Real Estate Operations in 2000, 1999 and
1998 were $84.5 million, $58.7 million and $37.7 million, respectively, and
pre-tax income was $5.5 million, $3.6 million and $1.4 million, respectively.
Revenues and operating income increased in 2000 compared to 1999 and in 1999
compared to 1998 due to an increase in the number of home sales (number of sales
were 469, 366 and 275 for the years ended December 31, 2000, 1999 and 1998,
respectively). Revenues also increased in 2000 compared to 1999 and in 1999
compared to 1998 because of an increase in the average selling price per home
(average selling price was $177,000, $158,000 and $137,000 for the years ended
December 31, 2000, 1999 and 1998, respectively). Land presently owned at a cost
of $34.5 million will support the construction of an estimated 1,300 homes over
the next several years. Changes in interest rates and other factors could affect
future home sales (we have not seen any impact so far), but Zenith believes the
land it has acquired is strategically located and will have long term value.
INVESTMENTS
At December 31, 2000 and 1999, Zenith's consolidated investment portfolio
emphasized high quality, taxable bonds and short-term investments, supplemented
by smaller portfolios of redeemable and other preferred and common stocks. Bonds
constituted 68% and 71%, and short-term investments constituted 19% and 20% of
the carrying value of Zenith's consolidated investment portfolio at
December 31, 2000 and 1999, respectively. Bonds with an investment grade rating
represented 94% and 95% of the consolidated carrying values of bonds at
December 31, 2000 and 1999, respectively. The average life of the consolidated
portfolio was 5.1 and 5.7 years at December 31, 2000 and 1999, respectively.
TheZenith 31
The change in the carrying value of Zenith's consolidated investment
portfolio in 2000 was as follows:
- ----------------------------------------------------------------------------------
(Dollars in thousands)
- ----------------------------------------------------------------------------------
Carrying value at beginning of year $901,734
Purchases at cost 168,737
Maturities and redemptions (51,281)
Proceeds from sales of investments (182,297)
Net realized losses (15,467)
Change in unrealized gains and losses, net 18,141
Net change in short-term investments (25,026)
Net accretion of bonds and preferred stocks and other
changes 38,193
- ----------------------------------------------------------------------------------
Carrying value at end of year $852,734
- ----------------------------------------------------------------------------------
Zenith's investment portfolio decreased in the year ended December 31, 2000
principally to fund the use of cash in operations and the repurchases of
outstanding debt described in the Liquidity and Capital Resources section on
page 35.
Zenith has identified certain securities, amounting to 96% of the investments
in debt securities at December 31, 2000 and 1999, as "available-for-sale."
Stockholders' equity increased by $9.6 million after deferred tax from
December 31, 1999 to December 31, 2000 and decreased by $25.7 million after
deferred tax from December 31, 1998 to December 31, 1999 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
$753.8 million and $834.3 million at December 31, 2000 and 1999, repectively.
The unrealized gain (loss) on held-to-maturity and available-for-sale fixed
maturity investments were as follows:
- ------------------------------------------------------------
Held-to-
Maturity Available-for-Sale
-------- -------------------
(Dollars in thousands) Before Before After
Tax Tax Tax
- ------------------------------------------------------------
December 31, 2000 $ 368 $(14,877) $ (9,670)
December 31, 1999 (340) (29,698) (19,304)
- ------------------------------------------------------------
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, for the three years ended December 31, 2000 were as follows:
- ---------------------------------------------------
2000 1999 1998
- ---------------------------------------------------
Investment yield:
Before tax 5.9% 5.5% 5.7%
After tax 3.9 3.7 3.8
- ---------------------------------------------------
When, in the opinion of management, a decline in market value of investments
is considered to be "other than temporary," such investment is written down to
its net realizable value. The determination of "other than temporary" includes,
in addition to other relevant factors, a presumption that if the market value is
below cost by a significant amount for a period of time, a write down is
necessary. During the years ended December 31, 2000 and 1999, there were
$22.5 million and $1.7 million, respectively, of such write downs, including
$7.3 million during the fourth quarter of 2000.
In December 2000, Zenith sold approximately 183 acres of land located in Las
Vegas, Nevada. The gain on the sale was $6.0 million, of which $5.1 million was
deferred at December 31, 2000.
32
PARENT
Parent expenses in 2000 include $1.8 million before tax of severance costs
associated with the termination provisions of an employment contract of a
company officer.
MARKET RISK OF FINANCIAL INSTRUMENTS
The fair value of the fixed maturity investment portfolio is exposed to
interest rate risk -- the risk of loss in fair value resulting from changes in
prevailing market rates of interest for similar financial instruments. However,
Zenith has the ability to hold fixed maturity investments to maturity. Zenith
relies on the experience and judgment of senior management to monitor and
mitigate the effects of market risk. Zenith does not utilize financial
instrument hedges or derivative financial instruments to manage risks, nor does
it enter into any swap, forward or options contracts, but will attempt to
mitigate its exposure through active portfolio management. The allocation among
various types of securities is adjusted from time to time based on market
conditions, credit conditions, tax policy, fluctuations in interest rates and
other factors. In addition, Zenith places the majority of its investments in
high quality, liquid securities and limits the amount of credit exposure to any
one issuer.
The table below provides information about Zenith's financial instruments as
of December 31, 2000 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 debt obligations, the table presents principal cash flows by
expected maturity dates (including interest).
- -----------------------------------------------------------------------------------------------------------------------------
Expected Maturity Date
(Dollars in thousands) ------------------------------------------------------------------------
2001 2002 2003 2004 2005 Thereafter Total
- -----------------------------------------------------------------------------------------------------------------------------
Fixed maturities:
Held-to-maturity and available-for-sale
securities:
Fixed rate $120,642 $63,715 $35,902 $35,928 $34,498 $301,687 $592,372
Weighted average interest rate 5.8% 5.9% 7.9% 7.1% 7.0% 8.5% 7.4%
Trading securities:
Fixed rate $ 2,970 $ 2,970
Weighted average interest rate 6.9% 6.9%
Short-term investments $158,438 $158,438
Debt and interest obligations:
Payable to banks and other notes payable $ 9,480 $ 7,556 $ 17,036
Senior notes payable 5,265 61,133 66,398
Redeemable securities 5,729 5,729 $ 5,729 $ 5,729 $ 5,729 $198,767 227,412
- -----------------------------------------------------------------------------------------------------------------------------
TheZenith 33
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 December 31,
2000 and 1999, cash and short-term investments in the P&C Operations amounted to
$112.6 million and $92.1 million, respectively.
In the year ended December 31, 2000, payment of income taxes for 1999,
including $56.0 million associated with the gain on sale of CalFarm, reduced
cash flow from operations. In the year ended December 31, 1999, $54.3 million of
cash was used to pay the balance of the purchase price for the RISCORP
Acquisition and net proceeds of approximately $211.0 million were received in
connection with the sale of CalFarm.
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 in the long run by dividends received from 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.
The P&C Operations are subject to insurance regulations which restrict their
ability to distribute dividends. Such dividend capabilities are set forth in
Note 17 to the Consolidated Financial Statements on page 62. Such restrictions
have not had, and under current regulations are not expected to have, a material
adverse impact on Zenith. The maximum dividend which can be paid to Zenith
National without prior approval of the California Department of Insurance in
2001 is $26.2 million. In 2000, Zenith National received $10.0 million of
dividend payments from Zenith Insurance. In 1999, Zenith National received
$130.0 million of such dividend payments, including a dividend of $100.0 million
paid from the gain on the sale of CalFarm and with the prior approval of the
California Department of Insurance. Zenith National has available cash,
short-term investments and other investments, which currently significantly
exceed its short-term cash requirements. Cash, short-term investments and other
investments in Zenith National amounted to $135.7 million and $171.7 million at
December 31, 2000 and 1999, respectively.
At December 31, 2000, Zenith National had two revolving, unsecured lines of
credit in an aggregate amount of $70.0 million, all of which was available at
December 31, 2000. Under these agreements certain restrictive covenants apply
including the maintenance of certain financial ratios.
The amount of capital in the P&C Operations is maintained relative to
standardized capital adequacy measures such as risk based capital where ratios
such as net premiums written to statutory surplus measure capital adequacy. Risk
based capital is used by regulators for regulatory financial surveillance
purposes and by rating agencies
34
to assign financial strength ratings to the P&C Operations and ratings for the
debt issued by Zenith National. From time to time, the level of capitalization
of the P&C Operations may be increased by contributions from Zenith National.
Zenith National made contributions of $25.0 million and $65.0 million in 2000
and 1998, respectively, to the capital and surplus of Zenith Insurance.
In the first quarter of 2000, Zenith's financial strength and debt ratings
were reduced by Moody's Investors Service ("Moody's") and by Standard & Poor's
("S&P"), principally over concerns about continuing operating losses in the P&C
Operations. In August 2000, S&P affirmed its ratings of Zenith, but changed its
outlook for Zenith to "negative" and Moody's also changed its outlook for Zenith
to "negative" at the same time making no changes to Zenith's ratings. Both
rating agencies cited continuing concerns about the operating performance of the
P&C Operations. In the second quarter of 2000, A. M. Best Company reduced the
rating of the P&C Operations from A+ (Superior) to A (Excellent). The actions of
such rating agencies have had no material impact on Zenith's operations. Because
of the available invested assets and available lines of credit in Zenith
National, Zenith National has the flexibility, if necessary, to contribute
capital to the P&C Operations.
From time to time, Zenith may make repurchases of its outstanding common
shares or outstanding debt. At December 31, 2000, Zenith National was authorized
to repurchase up to 938,000 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. In 2000, Zenith National paid
$22.8 million to repurchase $16.5 million aggregate principal amount of the
outstanding 9% Senior Notes due 2002 and $8.0 million aggregate liquidation
amount of the outstanding 8.55% Capital Securities of the Zenith National
Insurance Capital Trust I, a Delaware statutory business trust, all of the
voting securities of which are owned by Zenith National (the "Trust"). The
repurchases resulted in an extraordinary gain before tax of $1.5 million. Zenith
National used its available cash balances to fund these purchases.
The Real Estate Operations maintain certain bank credit facilities to provide
financing for development and construction of single-family residences for sale.
Each agreement pertains to a separate residential housing project. The
agreements provide that funding and repayment of development and construction
loans are made in tandem for each project. A development loan will always
precede a construction loan for a project and the proceeds of the construction
loan are required to first be used to pay off the respective development loan.
At December 31, 2000 and 1999, the maximum credit available was $29.7 million
and $37.1 million, respectively. At December 31, 2000 and 1999, $15.7 million
and $19.1 million, respectively, was outstanding under these facilities. Zenith
National also finances the land acquisitions of its Real Estate Operations
through inter-company loans.
Insurance companies are required to have securities on deposit for the
protection of policyholders in accordance with various states' regulations. At
December 31, 2000 and 1999, investments carried at their fair value of
$235.9 million and $205.5 million, respectively, were on deposit to comply with
such regulations.
On July 30, 1998, Zenith National issued $75.0 million of 8.55% Capital
Securities at a price of $996.24 per security through the Trust. (See Note 10 to
the Consolidated Financial Statements on pages 56-57 for a full description of
the Capital Securities).
TheZenith 35
CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting.
(Statutory accounting is a comprehensive basis of accounting for insurance
companies based on prescribed accounting practices, which include state laws,
regulations and general administrative rules, as well as a variety of
publications of the NAIC.) The Codification provides guidance for the areas
where statutory accounting has been silent and changes current statutory
accounting in some areas. The NAIC established January 1, 2001 as the effective
date of the Codification and the California and Texas Departments of Insurance
have adopted the Codification. Zenith believes that the Codification, as
currently constituted, will not have a material impact on the statutory capital
and surplus of the P&C Operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
On June 15, 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133") "Accounting
for Derivative Instruments and Hedging Activities". SFAS No. 133 is effective
for all fiscal years beginning after June 15, 2000. SFAS No. 133 requires, among
other things, that companies record all derivative instruments on the balance
sheet at fair value. Changes in the fair value of derivatives will be required
to be recorded each period in current earnings or other comprehensive income,
depending on the nature of the derivative. Zenith believes that adoption of SFAS
No. 133 will not have a material effect on its results of operations or its
financial position.
36
FINANCIAL STATEMENTS
TheZenith
37
5-YEAR SUMMARY OF SELECTED FINANCIAL INFORMATION
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Years ended December 31, Note 2000 1999
- --------------------------------------------------------------------
(Dollars and shares in thousands,
except per share data)
Revenues: 1, 2
Premiums earned $ 338,752 $ 369,403
Net investment income 51,766 53,662
Realized (losses) gains on
investments (15,467) 7,682
Real estate sales 84,518 58,670
Service fee income 2,691
- --------------------------------------------------------------------
Total revenues 459,569 492,108
- --------------------------------------------------------------------
(Loss) income after tax and before
realized (losses) gains and
extraordinary item 1, 2 (37,739) (55,228)
Per common share 3 (2.19) (3.22)
- --------------------------------------------------------------------
Components of net (loss) income:
Underwriting (loss) income:
(Loss) income excluding
catastrophes 1, 2 (53,251) (72,904)
Catastrophe losses (14,690) (12,285)
Net investment income 34,243 35,632
Realized (losses) gains on
investments (10,054) 4,993
Income from real estate
operations 3,552 2,372
Parent expenses and interest
expense (7,593) (8,043)
Gain on sale of CalFarm 2 104,335
Extraordinary item-gain on
extinguishment of debt 4 993
- --------------------------------------------------------------------
Net (loss) income (46,800) 54,100
Per common share 3 (2.71) 3.15
- --------------------------------------------------------------------
Cash dividends per share to common
stockholders 1.00 1.00
- --------------------------------------------------------------------
Weighted average common shares
outstanding 17,269 17,172
- --------------------------------------------------------------------
Financial condition: 1, 2
Total assets $1,472,190 $1,573,786
Investments 852,734 901,734
Unpaid loss and loss adjustment
expenses 877,883 880,929
Senior notes, bank debt and other
notes payable 4 74,048 94,955
Redeemable securities 4 65,618 73,397
Total stockholders' equity 309,776 354,559
Stockholders' equity per share 5 17.76 20.67
Return on average equity (14.3)% 13.9%
- --------------------------------------------------------------------
Insurance statistics (GAAP): 1, 2
Paid loss and loss adjustment
expense ratio 90.9% 96.0%
Combined ratio:
Loss and loss adjustment expense
ratio 99.4% 97.5%
Underwriting expense ratio 30.8% 37.7%
---------- ----------
Combined ratio 130.2% 135.2%
Net premiums earned-to-surplus
ratio 1.1 1.1
Loss and loss adjustment expense
reserves-to-surplus ratio (net
of reinsurance) 2.0 1.8
- --------------------------------------------------------------------
(1) On April 1, 1998, Zenith acquired substantially all of the assets and
certain liabilities of RISCORP, Inc. and subsidiaries (collectively,
"RISCORP"). In 1999, Zenith recorded $50.0 million before tax
($32.5 million after tax, or $1.89 per share) of net charges associated with
an increase in the purchase price of RISCORP (See Note 14 to the
Consolidated Financial Statements on pages 58-59).
(2) Zenith completed the sale of CalFarm Insurance Company ("CalFarm") effective
March 31, 1999 resulting in a gain of $104.3 million after tax, or $6.08 per
share, in the first quarter of 1999. (See Note 13 to the Consolidated
Financial Statements on pages 57-58.)
(3) Amounts prior to 1997 have been restated as required to comply with
Statement of Financial Accounting Standards No. 128 "Earnings per Share" and
represent diluted amounts per share and weighted average shares assuming
exercise of stock options.
38
- --------------------------------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------------
(Dollars and shares in thousands,
except per share data)
Revenues:
Premiums earned $ 529,855 $ 488,721 $ 452,856
Net investment income 53,593 52,332 51,154
Realized (losses) gains on
investments 11,602 14,008 10,807
Real estate sales 37,737 45,419 41,554
Service fee income 3,992
- --------------------------------------------------------------------------------------
Total revenues 636,779 600,480 556,371
- --------------------------------------------------------------------------------------
(Loss) income after tax and before
realized (losses) gains and
extraordinary item 11,559 19,669 30,575
Per common share 0.67 1.10 1.72
- --------------------------------------------------------------------------------------
Components of net (loss) income:
Underwriting (loss) income:
(Loss) income excluding
catastrophes (11,230) (10,217) 356
Catastrophe losses (7,475) (975)
Net investment income 35,907 34,655 34,069
Realized (losses) gains on
investments 7,541 8,431 7,025
Income from real estate
operations 868 1,079 1,251
Parent expenses and interest
expense (6,511) (4,873) (5,101)
Gain on sale of CalFarm
Extraordinary item-gain on
extinguishment of debt
- --------------------------------------------------------------------------------------
Net (loss) income 19,100 28,100 37,600
Per common share 1.11 1.57 2.12
- --------------------------------------------------------------------------------------
Cash dividends per share to common
stockholders 1.00 1.00 1.00
- --------------------------------------------------------------------------------------
Weighted average common shares
outstanding 17,158 17,886 17,752
- --------------------------------------------------------------------------------------
Financial condition:
Total assets $ 1,818,726 $ 1,252,156 $ 1,242,724
Investments 1,048,681 879,973 852,799
Unpaid loss and loss adjustment
expenses 997,647 613,266 620,078
Senior notes, bank debt and other
notes payable 93,851 88,216 88,861
Redeemable securities 73,341
Total stockholders' equity 346,952 361,866 337,503
Stockholders' equity per share 20.23 20.31 19.17
Return on average equity 5.4% 8.3% 11.4%
- --------------------------------------------------------------------------------------
Insurance statistics (GAAP):
Paid loss and loss adjustment
expense ratio 82.9% 66.9% 69.9%
Combined ratio:
Loss and loss adjustment expense
ratio 72.3% 71.2% 69.5%
Underwriting expense ratio 33.0% 32.2% 30.3%
----------- ----------- -----------
Combined ratio 105.3% 103.4% 99.8%
Net premiums earned-to-surplus
ratio 1.2 1.4 1.4
Loss and loss adjustment expense
reserves-to-surplus ratio (net of
reinsurance) 1.6 1.5 1.6
- --------------------------------------------------------------------------------------
(4) In 2000, Zenith repurchased a total of $16.5 million aggregate principal
amount of the outstanding 9% Senior Notes due 2002 and $8.0 million
aggregate liquidation amount of the outstanding 8.55% Capital Securities.
(5) Excluding the effect of Statement of Financial Accounting Standards
No. 115, stockholders' equity per share was $18.31, $21.80, $19.86, $20.03
and $19.28 at December 31, 2000, 1999, 1998, 1997 and 1996, respectively.
TheZenith
39
PROPERTY-CASUALTY LOSS DEVELOPMENT
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
The table that follows shows development of loss and loss adjustment expense
liabilities as originally estimated on a generally accepted accounting
principles basis at December 31 of each year presented. The accounting policies
used to estimate these liabilities are described in Note 1 to the Consolidated
Financial Statements on pages 49-50.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE LIABILITY DEVELOPMENT
- --------------------------------------------------------------------------------
Years ended December 31, 2000 1999 1998
- ---------------------------------------------------------------------
(Dollars in thousands)
Liability for unpaid loss and loss
adjustment expenses, net $ 634,172 $ 605,250 $ 599,357
- ---------------------------------------------------------------------
Paid, net (cumulative) as of:
One year later 235,968 244,402
Two years later 387,815
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
- ---------------------------------------------------------------------
Liability, net re-estimated as of:
One year later 636,130 645,460
Two years later 645,463
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
- ---------------------------------------------------------------------
Favorable (deficient) development $ (30,880) $ (46,106)
- ---------------------------------------------------------------------
Net Liability -- December 31, $ 634,172 $ 605,250 $ 599,357
Receivable from reinsurers and
state trust funds
on paid and unpaid losses 243,711 275,679 276,526
- ---------------------------------------------------------------------
Gross liability -- December 31, 877,883 880,929 875,883
Re-estimated liability, net of
reinsurance 636,130 645,463
Re-estimated receivable from
reinsurers and state
trust funds on paid and unpaid
losses 269,395 299,589
- ---------------------------------------------------------------------
Re-estimated liability, gross 905,525 945,052
- ---------------------------------------------------------------------
Favorable (deficient) development,
gross $ (24,596) $ (69,169)
- ---------------------------------------------------------------------
The analysis above presents the development of Zenith National Insurance
Corp. and subsidiaries' balance sheet liabilities for 1990 through 2000. The
first line in the table shows the liability for unpaid loss and loss adjustment
expense, net of reinsurance, as estimated at the end of each calendar year. The
first section shows the actual payments of loss and loss adjustment expenses
that relate to each year-end liability as they were paid during subsequent
annual periods. The second section shows revised estimates of the original
unpaid amounts, net of reinsurance, including the subsequent payments. The next
line shows the favorable or deficient developments of the original estimates for
each year, net of reinsurance. This loss reserve development table is cumulative
and, therefore, ending balances should not be added since the amount at the end
of each calendar year includes activity for both the current and prior years.
The liability at the end of each year includes an estimate of the amount yet
unpaid and still due at the subsequent re-evaluation date for all previously
estimated liabilities. For example, the liability at the end of 1997 includes an
estimate of the amount still due on the 1996 and prior liabilities. Information
for 1998 includes the results of the acquisition of substantially all assets and
certain liabilities from RISCORP, Inc. and subsidiaries (See Note 14 to the
Consolidated Financial Statements on pages 58-59). The data prior to 1999 has
been restated to exclude the results of CalFarm Insurance Company, which was
sold effective March 31, 1999 (See Note 13 to the Consolidated Financial
Statements on pages 57-58).
Since conditions and trends that have affected loss and loss adjustment expense
development in the past may not occur in the future in exactly the same manner,
if at all, future results may not be reliably predicted by extrapolation of the
data presented.
Adverse development in 2000 on the reserves established at December 31, 1999
is attributable, principally, to additional estimates of 1999 catastrophe
losses. Adverse development in 1999 on the reserves established at December 31,
1998 is attributable, principally, to an increase in the reserves acquired from
RISCORP (see Note 14 to the Consolidated Financial Statements on pages 58-59).
40
- --------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Liability for unpaid loss and loss
adjustment expenses, net $ 418,529 $ 419,451 $ 357,652 $ 365,296 $ 385,629 $ 380,388 $ 354,789 $ 330,678
- -----------------------------------------------------------------------------------------------------------------------------------
Paid, net (cumulative) as of:
One year later 137,681 149,195 127,428 116,193 119,158 124,303 124,186 108,230
Two years later 226,165 238,809 208,452 189,086 193,815 206,332 202,060 181,610
Three years later 280,615 289,673 250,865 236,623 238,268 257,922 252,011 225,615
Four years later 322,887 278,760 262,775 271,090 288,034 284,734 253,841
Five years later 299,537 280,005 287,806 312,352 304,198 273,078
Six years later 294,969 298,976 323,555 323,213 286,033
Seven years later 309,829 331,914 330,371 299,507
Eight years later 340,990 336,626 304,090
Nine years later 349,155 308,691
Ten years later 314,181
- -----------------------------------------------------------------------------------------------------------------------------------
Liability, net re-estimated as of:
One year later 402,551 423,327 358,249 359,658 371,537 381,758 369,480 335,588
Two years later 399,660 414,854 358,264 347,845 359,665 380,057 378,978 342,180
Three years later 392,001 410,924 351,831 339,076 356,475 378,383 377,713 347,537
Four years later 398,561 348,226 332,834 348,916 382,382 379,440 347,146
Five years later 345,132 330,097 342,608 376,917 380,672 346,558
Six years later 335,489 340,001 370,165 377,166 347,087
Seven years later 344,442 368,173 370,720 342,728
Eight years later 372,922 368,921 336,467
Nine years later 372,834 334,437
Ten years later 337,365
- -----------------------------------------------------------------------------------------------------------------------------------
Favorable (deficient) development $ 26,528 $ 20,890 $ 12,520 $ 29,807 $ 41,187 $ 7,466 $ (18,045) $ (6,687)
- -----------------------------------------------------------------------------------------------------------------------------------
Net Liability -- December 31, $ 418,529 $ 419,451 $ 357,652 $ 365,296 $ 385,629 $ 380,388
Receivable from reinsurers and
state trust funds
on paid and unpaid losses 74,313 82,869 40,419 37,561 38,543 26,822
- -----------------------------------------------------------------------------------------------------------
Gross liability -- December 31, 492,842 502,320 398,071 402,857 424,172 407,210
Re-estimated liability, net of
reinsurance 392,001 398,561 345,132 335,489 344,442 372,922
Re-estimated receivable from
reinsurers and state
trust funds on paid and unpaid
losses 82,082 89,783 47,398 43,006 51,698 65,984
- -----------------------------------------------------------------------------------------------------------
Re-estimated liability, gross 474,083 488,344 392,530 378,495 396,140 438,906
- -----------------------------------------------------------------------------------------------------------
Favorable (deficient) development,
gross $ 18,759 $ 13,976 $ 5,541 $ 24,362 $ 28,032 $ (31,696)
- -----------------------------------------------------------------------------------------------------------
TheZenith
41
CONSOLIDATED BALANCE SHEET
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- -----------------------------------------------------------------------------------------------
December 31, Note 2000 1999
- -----------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets:
Investments:
Fixed maturities:
At amortized cost (fair value $24,891 in 2000 and
$27,186 in 1999) $ 24,523 $ 27,526
At fair value (cost $585,351 in 2000 and $657,129 in 1999) 570,451 627,375
Floating rate preferred stocks, at fair value (cost $6,799
in 2000 and 1999) 5,699 6,420
Convertible and non-redeemable preferred stocks, at fair
value (cost $3,733 in 2000 and $4,300 in 1999) 3,391 3,405
Common stocks, at fair value (cost $23,630 in 2000 and
$25,428 in 1999) 27,301 25,634
Short-term investments (at cost, which approximates fair
value) 158,438 179,748
Other investments 62,931 31,626
- -----------------------------------------------------------------------------------------------
Total investments 2, 3 852,734 901,734
Cash 16,026 15,714
Accrued investment income 11,883 11,832
Premiums receivable, less allowance for doubtful accounts of
$7,596 in 2000 and $10,172 in 1999 76,405 74,586
Receivable from reinsurers and state trust funds for paid
and unpaid losses 6 305,341 343,671
Deferred policy acquisition costs 10,310 7,892
Properties and equipment, less accumulated depreciation 4 49,827 54,981
Deferred tax asset 5 35,123 34,601
Current federal income tax receivable 5 17,746
Intangible assets 1 22,410 23,207
Other assets 1 74,385 105,568
- -----------------------------------------------------------------------------------------------
Total assets $1,472,190 $1,573,786
- -----------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
42
- -------------------------------------------------------------------------------------------------------
December 31, Note 2000 1999
- -------------------------------------------------------------------------------------------------------
(Dollars and shares in thousands)
Liabilities:
Policy liabilities and accruals:
Unpaid loss and loss adjustment expenses 6 $ 877,883 $ 880,929
Unearned premiums 58,907 50,906
Policyholders' dividends accrued 2,773 3,375
Reserves on loss portfolio transfers 14,471 17,658
Payable to banks and other notes payable 3, 7 15,674 20,238
Senior notes payable, less unamortized issue costs of $126
in 2000 and $283 in 1999 3, 8, 11 58,374 74,717
Current federal income tax payable 5 23,793
Other liabilities 68,714 74,214
- -------------------------------------------------------------------------------------------------------
Total liabilities 1,096,796 1,145,830
- -------------------------------------------------------------------------------------------------------
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 $1,382 in
2000 and $1,603 in 1999 3, 10, 11 65,618 73,397
- -------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities 15
Stockholders' equity:
Preferred stock, $1 par -- shares authorized 1,000; issued
and outstanding, none in 2000 and 1999
Common stock, $1 par -- shares authorized 50,000; issued
25,452, outstanding 17,443 in 2000; issued 25,157,
outstanding 17,150 in 1999 25,452 25,157
Additional paid-in capital 282,120 274,897
Retained earnings 161,174 225,229
Accumulated other comprehensive loss -- net unrealized
depreciation on investments, net of deferred tax benefit
of $4,419 in 2000 and $10,768 in 1999 2 (8,206) (19,998)
- -------------------------------------------------------------------------------------------------------
460,540 505,285
Treasury stock, at cost (8,009 shares in 2000 and
8,007 shares in 1999) 16 (150,764) (150,726)
- -------------------------------------------------------------------------------------------------------
Total stockholders' equity 309,776 354,559
- -------------------------------------------------------------------------------------------------------
Total liabilities, redeemable securities and stockholders'
equity $1,472,190 $1,573,786
- -------------------------------------------------------------------------------------------------------
TheZenith
43
CONSOLIDATED STATEMENT OF OPERATIONS
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------
Years ended December 31, Note 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------
(Dollars and shares in thousands, except per share data)
Revenues:
Premiums earned 12 $338,752 $369,403 $529,855
Net investment income 2 51,766 53,662 53,593
Realized (losses) gains on investments 2 (15,467) 7,682 11,602
Real estate sales 84,518 58,670 37,737
Service fee income 2,691 3,992
- ------------------------------------------------------------------------------------------------------------------
Total revenues 459,569 492,108 636,779
- ------------------------------------------------------------------------------------------------------------------
Expenses:
Loss and loss adjustment expenses incurred 6, 12 336,962 360,172 382,890
Policy acquisition costs 62,891 65,266 96,937
Other underwriting and operating expenses 45,787 80,090 85,299
Policyholders' dividends and participation 1,544 610 516
Real estate construction and operating costs 79,054 55,020 36,374
Interest expense 7, 8, 9, 10 5,640 8,218 5,928
- ------------------------------------------------------------------------------------------------------------------
Total expenses 531,878 569,376 607,944
- ------------------------------------------------------------------------------------------------------------------
Gain on sale of CalFarm Insurance Company 13 160,335
- ------------------------------------------------------------------------------------------------------------------
(Loss) income before federal income tax (benefit)
expense and extraordinary item (72,309) 83,067 28,835
Federal income tax (benefit) expense, including expense
of $56,000 related to the sale of CalFarm Insurance
Company in 1999 5, 13 (24,516) 28,967 9,735
- ------------------------------------------------------------------------------------------------------------------
(Loss) income before extraordinary item (47,793) 54,100 19,100
Extraordinary item -- gain on extinguishment of debt,
net of federal income tax expense of $534 11 993
- ------------------------------------------------------------------------------------------------------------------
Net (loss) income $(46,800) $ 54,100 $ 19,100
- ------------------------------------------------------------------------------------------------------------------
Net (loss) income per common share:
Basic:
(Loss) income before extraordinary item 19 $ (2.78) $ 3.15 $ 1.12
Extraordinary item -- gain on extinguishment of debt,
net of federal income tax expense 11 0.06
- ------------------------------------------------------------------------------------------------------------------
Net (loss) income 19 $ (2.72) $ 3.15 $ 1.12
- ------------------------------------------------------------------------------------------------------------------
Diluted:
(Loss) income before extraordinary item 19 $ (2.77) $ 3.15 $ 1.11
Extraordinary item -- gain on extinguishment of debt,
net of federal income tax expense 11 0.06
- ------------------------------------------------------------------------------------------------------------------
Net (loss) income 19 $ (2.71) $ 3.15 $ 1.11
- ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
44
CONSOLIDATED STATEMENT OF CASH FLOWS
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------------------
Years ended December 31, Note 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Cash flows from operating activities:
Premiums and service fee income collected $ 355,538 $ 394,564 $ 580,945
Investment income received 48,802 51,170 54,970
Proceeds from sales of real estate 84,518 58,670 37,737
Loss and loss adjustment expenses paid (298,777) (321,510) (434,610)
Underwriting and other operating expenses paid (114,790) (132,505) (182,235)
Real estate construction costs paid (74,524) (66,462) (47,423)
Reinsurance premiums paid (10,138) (24,126) (41,429)
Interest paid (13,512) (13,467) (10,513)
Income taxes (paid) recovered 5 (24,155) 2,084 (4,580)
- ---------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (47,038) (51,582) (47,138)
- ---------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments:
Debt and equity securities available-for-sale (164,485) (366,567) (390,373)
Other investments (4,252) (9,332) (12,894)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 2,962 7,500 11,583
Debt and equity securities available-for-sale 48,319 95,668 96,362
Proceeds from sales of investments:
Debt and equity securities available-for-sale 173,490 233,742 302,648
Other investments 8,807 21,922 13,145
Net change in short-term investments 25,026 (41,746) 14,916
Cash payment to RISCORP 14 (54,308) (35,000)
RISCORP acquisition costs 14 (11,035)
Cash acquired in RISCORP Acquisition 14 29,309
Net proceeds from sale of CalFarm Insurance Company 13 211,068
Capital expenditures and other, net (5,789) (15,189) (11,356)
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 84,078 82,758 7,305
- ---------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repurchase of redeemable securities 11 (6,164)
Repurchase of 9% Notes 11 (16,585)
Repayment of note assumed from RISCORP 14 (15,000)
Net cash received from the sale of Zenith National
Insurance Capital Trust I 8.55% Capital Securities 10 73,320
Cash advanced from bank lines of credit 7 7,400 7,000
Cash repaid on bank lines of credit 7 (12,400) (2,000)
Cash advanced from bank construction loans 7 73,988 56,970 35,431
Cash repaid on bank construction loans 7 (77,992) (52,397) (34,918)
Cash dividends paid to common stockholders (17,183) (17,165) (17,010)
Proceeds from exercise of stock options 16 7,246 4,322 6,527
Purchase of treasury shares 16 (38) (4,190) (24,023)
- ---------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (36,728) (17,460) 29,327
- ---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 312 13,716 (10,506)
Cash at beginning of year 15,714 1,998 12,504
- ---------------------------------------------------------------------------------------------------------------
Cash at end of year $ 16,026 $ 15,714 $ 1,998
- ---------------------------------------------------------------------------------------------------------------
Reconciliation of net (loss) income to net cash flows from
operating activities:
Net (loss) income $ (46,800) $ 54,100 $ 19,100
Adjustments to reconcile net (loss) income to net cash flows
(used in) provided by operating activities:
Depreciation and amortization 5,588 8,369 9,096
Realized gain on sale of CalFarm Insurance Company 13 (160,335)
Realized losses (gains) on investments 2 15,467 (7,682) (11,602)
Gain on extinguishment of debt 11 (1,527)
Amortization of deferred gain on retroactive reinsurance
contract 14 (8,340) (11,000)
Decrease (increase) in:
Premiums receivable (1,819) 22,528 25,757
Receivable from reinsurers and state trust funds for
paid and unpaid losses 36,184 44,507 30,549
Real estate construction in progress and land held
for development (4,408) (20,041) (16,266)
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (3,046) 8,823 (97,601)
Unearned premiums 8,001 (16,095) (13,681)
Policyholders' dividends accrued (602) (1,388) (597)
Federal income tax 5 (48,136) 31,062 5,019
Other 2,400 (4,430) 3,088
- ---------------------------------------------------------------------------------------------------------------
Net cash used in operating activities $ (47,038) $ (51,582) $ (47,138)
- ---------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
TheZenith
45
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Common
shares Preferred
Three years ended December 31, 2000 Note outstanding stock $1 par
- ------------------------------------------------------------------------------------
(Dollars and shares in thousands,
except per share data)
Balance at December 31, 1997 17,819
Net income for 1998
Other comprehensive income --
net unrealized appreciation on
investments, net of deferred
tax expense of $142 2
Comprehensive income
Exercise of stock options 16 289
Tax benefit on options exercised
in 1998
Purchase of treasury shares at cost 16 (960)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly)
- ------------------------------------------------------------------------------------
Balance at December 31, 1998 17,148
Net income for 1999
Other comprehensive loss -- net
unrealized depreciation on
investments, net of deferred
tax benefit of $15,935 2
Comprehensive income
Exercise of stock options 16 187
Tax benefit on options exercised
in 1999
Purchase of treasury shares at cost 16 (185)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly)
- ------------------------------------------------------------------------------------
Balance at December 31, 1999 17,150
Net loss for 2000
Other comprehensive income --
net unrealized appreciation on
investments, net of deferred
tax expense of $6,349 2
Comprehensive loss
Exercise of stock options 16 295
Tax benefit on options exercised
in 2000
Purchase of treasury shares at cost 16 (2)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly)
- ------------------------------------------------------------------------------------
Balance at December 31, 2000 17,443
- ------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
46
- --------------------------------------------------------------------------------
Accumulated other
comprehensive
income (loss) - net
unrealized
appreciation
Common Additional Retained (depreciation) Treasury
stock $1 par paid-in capital earnings on investments stock Total
- ------------------------------------------------------------------------------------------------------------------------------
(Dollars and shares in thousands,
except per share data)
Balance at December 31, 1997 $ 24,681 $ 264,098 $ 186,268 $ 9,332 $ (122,513) $ 361,866
Net income for 1998 19,100 19,100
Other comprehensive income --
net unrealized appreciation on
investments, net of deferred
tax expense of $142 264 264
----------
Comprehensive income 19,364
Exercise of stock options 289 6,238 6,527
Tax benefit on options exercised
in 1998 343 343
Purchase of treasury shares at cost (24,023) (24,023)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly) (17,125) (17,125)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 24,970 270,679 188,243 9,596 (146,536) 346,952
Net income for 1999 54,100 54,100
Other comprehensive loss -- net
unrealized depreciation on
investments, net of deferred
tax benefit of $15,935 (29,594) (29,594)
----------
Comprehensive income 24,506
Exercise of stock options 187 4,135 4,322
Tax benefit on options exercised
in 1999 83 83
Purchase of treasury shares at cost (4,190) (4,190)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly) (17,114) (17,114)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 25,157 274,897 225,229 (19,998) (150,726) 354,559
Net loss for 2000 (46,800) (46,800)
Other comprehensive income --
net unrealized appreciation on
investments, net of deferred
tax expense of $6,349 11,792 11,792
----------
Comprehensive loss (35,008)
Exercise of stock options 295 6,951 7,246
Tax benefit on options exercised
in 2000 272 272
Purchase of treasury shares at cost (38) (38)
Cash dividends declared to common
stockholders ($1.00 per share,
paid quarterly) (17,255) (17,255)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $ 25,452 $ 282,120 $ 161,174 $ (8,206) $ (150,764) $ 309,776
- ------------------------------------------------------------------------------------------------------------------------------
TheZenith
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTE 1
SUMMARY OF ACCOUNTING POLICIES, OPERATIONS AND PRINCIPLES OF CONSOLIDATION
Zenith National Insurance Corp. ("Zenith National") is engaged through its
wholly-owned property-casualty insurance subsidiaries (the "P&C Operations") in
Workers' Compensation insurance; Reinsurance, principally of world-wide, assumed
reinsurance of property losses from catastrophes and large property risks; and
Other Property-Casualty insurance, consisting of automobile, farmowners,
commercial coverages, group health and homeowners coverage, primarily in
California, operated by CalFarm Insurance Company ("CalFarm"), which was sold
effective March 31, 1999 by Zenith Insurance Company ("Zenith Insurance"), a
wholly owned subsidiary of Zenith National. The P&C Operations sell insurance
and reinsurance through agents and brokers and not directly to consumers. The
Real Estate Operations develop land and primarily construct single-family
residences in Las Vegas, Nevada. Investment operations provide income and
realized gains on investments, primarily from debt securities. The Parent
operations represent Zenith National, a holding company which owns, directly or
indirectly, all of the capital stock of the P&C Operations, non-insurance
companies and securities.
The financial statements have been prepared in accordance with generally
accepted accounting principles ("GAAP") in the United States and include Zenith
National and its subsidiaries (collectively, "Zenith"). GAAP requires the use of
assumptions and estimates in reporting certain assets and liabilities and
related disclosures and actual results could differ from those estimates. All
significant intercompany transactions and balances have been eliminated in
consolidation.
The comparability of the results of operations between each of the three
years ended December 31, 2000, 1999, 1998 is affected by several items. First,
on April 1, 1998, Zenith Insurance acquired substantially all of the assets and
certain liabilities of RISCORP, Inc. and certain of its subsidiaries
(collectively, "RISCORP"), related to RISCORP's workers' compensation business
(the "RISCORP Acquisition"-- see Note 14). Second, in the third quarter of 1999,
Zenith recorded net charges of $50.0 million before tax ($32.5 million after tax
or $1.89 per share) associated with an increase in the estimated net liabilities
for unpaid losses and loss adjustment expenses acquired from RISCORP (the
"RISCORP Purchase Adjustment"-- see Note 14). Third, effective March 31, 1999,
Zenith sold CalFarm which had previously operated Zenith's Other
Property-Casualty Operations (see Note 13). The sale of CalFarm resulted in a
gain of $104.3 million after tax.
Investments
Zenith's investments in debt and equity securities are identified in three
categories as follows: held-to-maturity -- those securities, which by their
terms must be redeemed by the issuing company and that Zenith has the positive
intent and ability to hold to maturity, and are reported at amortized cost;
trading -- those securities that are held principally for the purpose of selling
in the near term and are reported at fair value with unrealized gains and losses
included in earnings; and available-for-sale -- those securities not classified
as either held-to-maturity or trading and are reported at fair value with
unrealized gains and losses excluded from earnings and reported as a separate
component of stockholders' equity, net of deferred tax. Other investments are
carried at cost.
48
Short-term investments include debt securities such as corporate, municipal
and treasury securities with maturities of less than one year at the time of
purchase. For these short-term investments, the amortized cost is a reasonable
estimate of fair value. Investment income is recorded when earned. Realized
capital gains and losses are calculated based on the cost of securities sold,
which is determined by the "identified cost" method.
Cash
Cash includes currency on hand and demand deposits with financial
institutions.
Recognition of Property-Casualty
Revenue and Expense
Premiums are earned on a pro rata basis over the terms of the policies.
Premiums applicable to the unexpired terms of policies in force are recorded as
unearned premiums. Included with premiums earned is an estimate for earned but
unbilled audit premiums. Workers' Compensation premiums are determined based
upon the payroll of the insured and applicable premium rates and are recorded as
written when billed. Premiums for retrospectively-rated policies are also
determined by the loss experience incurred by the policyholder.
Policy acquisition costs, consisting of commissions, premium taxes and
certain other underwriting costs, are deferred and amortized as the related
premiums are earned.
The P&C Operations make provisions for the settlement of all incurred claims,
both reported and unreported. The liabilities for unpaid loss and loss
adjustment expenses are estimates of the eventual costs of claims incurred but
not settled, less estimates of salvage and subrogation. Estimates for reported
claims are primarily determined by evaluation of individual reported claims and
amounts reported by ceding companies. Estimates for claims incurred but not
reported are based on experience with respect to the probable number and nature
of such claims. The methods for making such estimates and for establishing the
resulting liabilities are continually reviewed and updated and any adjustments
resulting therefrom are reflected in earnings currently. Estimates of losses
from environmental and asbestos-related claims are included in overall loss
reserves and to date have not been material. Due to the significant
uncertainties inherent in establishing such reserves, the ultimate exposure may
vary from the amounts currently reserved.
An estimated provision for Workers' Compensation policyholders' dividends is
accrued as the related premiums are earned. Such dividends do not become a fixed
liability unless and until declared by the respective Boards of Directors of
Zenith's insurance subsidiaries. Zenith's policyholder dividends have not been
material in the three years ended December 31, 2000 due to competitive
conditions in the workers' compensation industry.
Property insurance and reinsurance coverages expose Zenith to the risk of
significant loss in the event of major adverse natural phenomena, known in the
insurance industry as catastrophes. Catastrophes may cause significant
contemporaneous financial statement losses since catastrophe losses may not be
accrued in advance of the event.
Approximately 45.7% and 28.2% of the premiums earned in the Workers'
Compensation Operations in 2000 was in California and Florida, respectively. The
concentration of Zenith's business in these states makes the results of
operations highly dependent upon the states' economies, social and cultural
trends, legislative and regulatory changes, and catastrophic events such as
windstorms and earthquakes.
TheZenith 49
Reinsurance
In accordance with general industry practices, the P&C Operations annually
purchase, principally from large United States reinsurance companies, excess of
loss reinsurance to protect Zenith against the impact of large, irregularly
occurring losses. Such reinsurance reduces the magnitude of sudden and
unpredictable changes in net income and the capitalization of the P&C
Operations. Reinsurance makes the assuming reinsurer liable to the ceding
company to the extent of the reinsurance. It does not, however, discharge the
ceding company from its primary liability to its policyholders in the event the
reinsurer is unable to meet its obligations under such reinsurance treaty.
Zenith monitors the financial condition of its reinsurers and does not believe
that it is exposed to any material credit risk through its ceded reinsurance
arrangements. Historically, no material amounts due from reinsurers have been
written off as uncollectable. At December 31, 2000, Reliance Insurance Company
("Reliance") owed Zenith Insurance approximately $6.3 million in reinsurance
recoverables for paid and unpaid losses in connection with reinsurance
arrangements assumed by Zenith Insurance in the 1996 acquisition of the
Associated General Contractors Self-Insurance Fund. On January 29, 2001,
Reliance entered into an Order of Supervision with the Pennsylvania Insurance
Department under which its business and operations will be monitored and
reviewed by the Department. Zenith Insurance considered its receivables from
Reliance in the normal course of assessing the collectibility of reinsurance
recoverables. Zenith Insurance believes this matter will not have a material
adverse effect on its financial condition or results of operations.
Earned premiums and loss and loss adjustment expenses incurred are stated in
the Consolidated Statement of Operations after deduction of amounts ceded to
reinsurers. Balances due from reinsurers on unpaid losses, including an estimate
of such recoverables related to reserves for incurred but not reported losses,
are reported as assets and are included in receivable from reinsurers even
though amounts due on unpaid losses are not recoverable from the reinsurer until
such losses are paid. Receivable from reinsurers on unpaid losses amounted to
$264.6 million and $292.8 million at December 31, 2000 and 1999, respectively,
of which approximately $185.4 million and $216.2 million, respectively, were
reinsurance recoverables relating to reinsurance arrangements entered into by
RISCORP. Such RISCORP-related amounts are primarily recoverable from large
United States reinsurance companies. Also included in reinsurance recoverable on
unpaid losses is $50.0 million of reinsurance recoverable under reinsurance
entered into by Zenith Insurance in connection with the RISCORP Acquisition (see
Note 14). Such reinsurance recoverable is secured by a trust account and an
irrevocable letter of credit.
Real Estate Operations
Land, land development costs and construction costs, including costs of
acquisition and development, property taxes and related interest, are
capitalized. Such costs, and an estimate of the costs to complete a project, are
recognized pro rata against sales of completed units (see Note 9). Such
capitalized costs are included in other assets. The profitability of the Real
Estate Operations is dependent upon real estate values, interest rates,
construction costs, competition and management ability.
Included in other assets is land and real estate construction in progress
carried at a cost of $61.1 million and $87.9 million at December 31, 2000 and
1999, respectively.
50
Properties and Equipment
Properties and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated principally on a straight-line basis using the
following useful lives: buildings, 10 to 40 years; and furniture, fixtures and
equipment, 3 to 10 years.
Expenditures for maintenance and repairs are charged to operations as
incurred. Additions and improvements to buildings and other fixed assets are
capitalized and depreciated over the useful lives of the properties and
equipment. Upon disposition, the asset cost and related depreciation are removed
from the accounts and the resulting gain or loss is included in income.
Intangible Assets
Intangible assets include the costs in excess of tangible assets acquired,
including those related to the RISCORP Acquisition discussed in Note 14. The
amounts assigned to assets acquired since 1970 are being amortized on a
straight-line basis over 25 years. Amortization expense was $0.8 million,
$0.9 million and $1.1 million in 2000, 1999 and 1998, respectively. Accumulated
amortization was $2.7 million and $1.9 million at December 31, 2000 and 1999,
respectively. Of the intangible assets at December 31, 2000 and 1999, $20.4
million and $21.2 million, respectively, were amortizable. Management
periodically assesses the recoverability of these intangible assets based on a
review of projected, undiscounted cash flows of the operations acquired.
Codification of Statutory
Accounting Principles
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting.
(Statutory accounting is a comprehensive basis of accounting for insurance
companies based on prescribed accounting practices, which include state laws,
regulations and general administrative rules, as well as a variety of
publications of the NAIC.) The Codification provides guidance for the areas
where statutory accounting has been silent and changes current statutory
accounting in some areas. The NAIC established January 1, 2001 as the effective
date of the Codification and the California and Texas Departments of Insurance
have adopted the Codification. Zenith believes that the Codification, as
currently constituted, will not have a material impact on the statutory capital
and surplus of the P&C Operations.
Recently Issued Accounting Standards
On June 15, 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133") "Accounting
for Derivative Instruments and Hedging Activities". SFAS No. 133 is effective
for all fiscal years beginning after June 15, 2000. SFAS No. 133 requires, among
other things, that companies record all derivative instruments on the balance
sheet at fair value. Changes in the fair value of derivatives will be required
to be recorded each period in current earnings or other comprehensive income,
depending on the nature of the derivative. Zenith believes that adoption of SFAS
No. 133 will not have a material effect on its results of operations or its
financial position.
TheZenith 51
NOTE 2
INVESTMENTS
The amortized cost and fair values of investments were as follows:
- -----------------------------------------------------------------------------
Gross
unrealized
December 31, 2000 Amortized ----------------- Fair Carrying
(Dollars in thousands) cost gains (losses) value value
- -----------------------------------------------------------------------------
Held-to-maturity:
Corporate debt $ 5,320 $ 95 $ 5,415 $ 5,320
Mortgage-backed 19,203 273 19,476 19,203
- -----------------------------------------------------------------------------
Total held-to-maturity $ 24,523 $ 368 $ 24,891 $ 24,523
- -----------------------------------------------------------------------------
Available-for-sale:
U.S. government debt $128,423 $ 346 $ (63) $128,706 $128,706
State and local
government debt 14,170 (90) 14,080 14,080
Corporate debt 402,523 2,758 (16,932) 388,349 388,349
Mortgage-backed 23,598 (4) 23,594 23,594
Redeemable preferred
stocks 13,644 (892) 12,752 12,752
Equities 34,137 5,307 (3,055) 36,389 36,389
Short-term investments 158,438 158,438 158,438
- -----------------------------------------------------------------------------
Total available-
for-sale $774,933 $8,411 $(21,036) $762,308 $762,308
- -----------------------------------------------------------------------------
Trading:
Corporate debt $ 2,993 $ (23) $ 2,970 $ 2,970
Equities 25 (23) 2 2
- -----------------------------------------------------------------------------
Total trading $ 3,018 $ (46) $ 2,972 $ 2,972
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
Gross
unrealized
December 31, 1999 Amortized ----------------- Fair Carrying
(Dollars in thousands) cost gains (losses) value value
- -----------------------------------------------------------------------------
Held-to-maturity:
Corporate debt $ 5,325 $ (127) $ 5,198 $ 5,325
Mortgage-backed 22,201 (213) 21,988 22,201
- -----------------------------------------------------------------------------
Total held-to-maturity $ 27,526 $ (340) $ 27,186 $ 27,526
- -----------------------------------------------------------------------------
Available-for-sale:
U.S. government debt $163,971 $ (1,660) $162,311 $162,311
State and local
government debt 26,495 (325) 26,170 26,170
Corporate debt 444,308 $1,054 (27,266) 418,096 418,096
Mortgage-backed 5,491 (24) 5,467 5,467
Redeemable preferred
stocks 13,879 (1,477) 12,402 12,402
Equities 36,501 3,601 (4,669) 35,433 35,433
Short-term investments 179,748 179,748 179,748
- -----------------------------------------------------------------------------
Total available-
for-sale $870,393 $4,655 $(35,421) $839,627 $839,627
- -----------------------------------------------------------------------------
Trading:
Corporate debt $ 2,985 $ (56) $ 2,929 $ 2,929
Equities 26 26 26
- -----------------------------------------------------------------------------
Total trading $ 3,011 $ (56) $ 2,955 $ 2,955
- -----------------------------------------------------------------------------
Debt securities, including short-term investments, by contractual maturity
were as follows:
- -----------------------------------------------------
December 31, 2000 Amortized Fair
(Dollars in thousands) cost value
- -----------------------------------------------------
Held-to-maturity:
Due after ten years $ 24,523 $ 24,891
- -----------------------------------------------------
Total held-to-maturity $ 24,523 $ 24,891
- -----------------------------------------------------
Available-for-sale:
Due in one year or less $279,156 $279,080
Due after one year through
five years 172,226 170,043
Due after five years through
ten years 187,913 178,328
Due after ten years 101,501 98,468
- -----------------------------------------------------
Total available-for-sale $740,796 $725,919
- -----------------------------------------------------
Trading:
Due in one year or less $ 2,993 $ 2,970
- -----------------------------------------------------
Total trading $ 2,993 $ 2,970
- -----------------------------------------------------
Fluctuating interest rates will impact stockholders' equity, profitability
and maturities of certain debt and preferred securities. Expected maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Mortgage-backed securities are shown as being due at their average expected
maturity dates. Redeemable preferred stocks with sinking fund redemption periods
are shown as being due at the mid-point of the sinking fund period.
52
When, in the opinion of management, a decline in market value of an
investment is considered to be "other than temporary," such investment is
written down to its net realizable value. The determination of "other than
temporary" includes, in addition to other relevant factors, a presumption that
if the market value is below cost by a significant amount for a period of time,
a write down is necessary. Such write downs are reflected as a reduction of net
realized gains on investments. During the years ended December 31, 2000 and
1999, there were $22.5 million and $1.7 million, respectively, of such write
downs.
The gross realized gains on sales of investments classified as
available-for-sale during 2000, 1999 and 1998 were $8.7 million, $8.2 million
and $9.9 million, respectively, and the gross realized losses were
$2.4 million, $5.5 million and $3.0 million, respectively. The change in net
unrealized holding (losses) gains on trading securities, which is included in
realized gains, was $10,000, $(96,000) and $54,000 for the years ended December
31, 2000, 1999 and 1998, respectively.
At December 31, 2000 and 1999, 96% of Zenith's consolidated portfolio of
fixed maturity investments were classified as available-for-sale with the
unrealized appreciation or depreciation recorded as a separate component of
stockholders' equity. The change in fair value of fixed maturity investments
classified as available-for-sale resulted in an increase in stockholders' equity
of $9.6 million after deferred tax from December 31, 1999 to December 31, 2000,
compared to a decrease of $25.7 million from 1998 to 1999.
Realized and unrealized investment gains and losses on fixed maturity
investments and equity securities are summarized as follows:
- -----------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- -----------------------------------------------------------
Realized (losses) gains:
Fixed maturities $(19,063) $ (503) $ 4,355
Equity securities 2,733 3,059 2,568
Change in fair value over
(under) cost:
Fixed maturities 15,562 (41,549) 2,429
Equity securities 3,297 (5,984) (1,719)
- -----------------------------------------------------------
Net investment income is detailed as follows:
- ----------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- ----------------------------------------------------------
Fixed maturities:
Bonds $43,415 $45,080 $44,460
Redeemable preferred stocks 1,165 1,362 1,113
Equity securities:
Floating rate preferred
stocks 401 777 977
Convertible and non-
redeemable preferred
stocks 254 350 477
Common stocks 862 984 717
Short-term investments 9,355 8,327 8,265
Other 677 756 1,088
- ----------------------------------------------------------
Subtotal 56,129 57,636 57,097
Investment expenses (4,363) (3,974) (3,504)
- ----------------------------------------------------------
Net investment income $51,766 $53,662 $53,593
- ----------------------------------------------------------
Investments carried at their fair value of $235.9 million and $205.5 million
at December 31, 2000 and 1999, respectively, were on deposit with regulatory
authorities in compliance with insurance company regulations.
TheZenith 53
NOTE 3
FAIR VALUES OF FINANCIAL INSTRUMENTS
Financial instruments are contractual obligations that result in the delivery
of cash or an ownership interest in an entity. Disclosures regarding the fair
value of financial instruments have been derived using external market sources
or estimates using present value and other valuation techniques.
The following summarizes the carrying amounts and fair value of Zenith's
financial instruments. For financial instruments not discussed below, the
carrying amount is a reasonable estimate of the fair value.
- -----------------------------------------------------------------------
2000 1999
December 31, ------------------- -------------------
(Dollars in Carrying Fair Carrying Fair
thousands) Note amount value amount value
- -----------------------------------------------------------------------
Assets:
Investments:
Trading securities 2 $ 2,972 $ 2,972 $ 2,955 $ 2,955
Other investments 2 849,762 850,130 898,779 898,439
-------- -------- -------- --------
852,734 853,102 901,734 901,394
Liabilities:
Payable to banks and
other notes payable 7 15,674 15,674 20,238 20,238
Senior notes payable 8 58,374 58,374 74,717 76,082
Redeemable securities 10 65,618 45,518 73,397 69,055
- -----------------------------------------------------------------------
Fair values of investments are further detailed in Note 2.
The fair values for investments were supplied by the Merrill Lynch pricing
service, with the exception of 44 items whose values were obtained from other
brokers making a market in the investment, the Bloomberg financial news service
and the use of analytical pricing methods for issues for which there is no ready
market. The pricing for municipal bonds is provided by Muller Data.
NOTE 4
PROPERTIES AND EQUIPMENT
Properties and equipment consist of the following:
- -------------------------------------------------------
December 31,
(Dollars in thousands) 2000 1999
- -------------------------------------------------------
Land $ 9,650 $ 9,650
Buildings 31,751 31,103
Furniture, fixtures and equipment 46,688 45,430
- -------------------------------------------------------
Subtotal 88,089 86,183
Accumulated depreciation (38,262) (31,202)
- -------------------------------------------------------
Total $49,827 $54,981
- -------------------------------------------------------
Depreciation expense amounted to $7.8 million, $9.9 million and $8.8 million
in 2000, 1999 and 1998, respectively.
NOTE 5
FEDERAL INCOME TAX
The components of the (benefit) provision for tax on income are:
- -------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- -------------------------------------------------------
Current $(18,007) $29,488 $ 6,458
Deferred (6,509) (521) 3,277
- -------------------------------------------------------
Federal income tax
(benefit) expense $(24,516) $28,967 $ 9,735
- -------------------------------------------------------
The difference between the statutory federal income tax rate of 35% and
Zenith's effective tax rate on income, as reflected in the financial statements,
is explained as follows:
- -------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- -------------------------------------------------------
Statutory federal income
tax (benefit) expense $(25,308) $29,074 $10,092
Increase (reduction) in
tax:
Dividend received
deduction and tax-
exempt interest (596) (765) (1,062)
Other 1,388 658 705
- -------------------------------------------------------
Federal income tax
(benefit) expense $(24,516) $28,967 $ 9,735
- -------------------------------------------------------
54
Deferred tax is provided based upon temporary differences between the tax and
book basis of assets and liabilities. The components of the deferred tax assets
and liabilities were as follows:
- ---------------------------------------------------------------------------
2000 1999
Years ended December 31, Deferred Tax Deferred Tax
(Dollars in thousands) Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------
Investments $ 12,701 $10,768
Deferred policy
acquisition costs $ 3,609 $ 2,762
Intangible assets 2,199 3,133
Properties and equipment 3,742 5,658
Property-casualty loss
reserve discount 26,501 27,536
Limitation on deduction
for unearned premiums 4,583 3,782
Policyholders' dividends
accrued 971 1,181
Deferred income on
retroactive reinsurance 5,131 8,050
Other 1,686 6,900 2,508 7,671
- ---------------------------------------------------------------------------
51,573 16,450 53,825 19,224
- ---------------------------------------------------------------------------
Net deferred tax asset $ 35,123 $34,601
- ---------------------------------------------------------------------------
Zenith's net deferred tax asset is expected to be fully recoverable because
all future deductible amounts can be offset by reversing deferred tax
liabilities, recovery of federal income taxes paid within the statutory
carryback period or anticipated future taxable income, including investment
income. Property-casualty loss reserves are not discounted for book purposes,
however the Tax Reform Act of 1986 requires property and casualty loss reserves
to be discounted for tax purposes.
Zenith files a consolidated federal income tax return. The P&C Operations pay
premium taxes on gross premiums written in lieu of most state income or
franchise taxes.
NOTE 6
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The following table represents a reconciliation of changes in liabilities for
unpaid loss and loss adjustment expenses:
- ---------------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- ---------------------------------------------------------------
Beginning of year, net of
reinsurance recoverable $ 605,250 $ 708,684 $ 525,601
Acquisition of RISCORP as
of April 1, 1998 242,760
Sale of CalFarm as of
March 31, 1999 (109,150)
Incurred claims:
Current year 306,082 315,348 394,257
Prior years 30,880 44,824 (11,367)
- ---------------------------------------------------------------
Total incurred claims 336,962 360,172 382,890
- ---------------------------------------------------------------
Payments:
Current year (72,072) (83,437) (176,678)
Prior years (235,968) (271,019) (265,889)
- ---------------------------------------------------------------
Total payments (308,040) (354,456) (442,567)
- ---------------------------------------------------------------
End of year, net of
reinsurance 634,172 605,250 708,684
Receivable from reinsurers
and state trust funds
for paid and unpaid
losses 243,711 275,679 288,963
- ---------------------------------------------------------------
End of year $ 877,883 $ 880,929 $ 997,647
- ---------------------------------------------------------------
NOTE 7
PAYABLE TO BANKS
At December 31, 2000, Zenith National had two revolving, unsecured lines of
credit in an aggregate amount of $70.0 million, all of which was available at
December 31, 2000. Under these agreements, certain restrictive covenants apply
including the maintenance of certain financial ratios.
The Real Estate Operations maintain certain bank credit facilities to provide
financing for development and construction of single-family residences for sale.
At December 31, 2000, these loans bear interest at the rates of prime plus 0.75%
or prime plus 1.0% and mature between June 2001 and April
TheZenith 55
2002. Each agreement pertains to a separate residential housing project and the
maximum credit available was $29.7 million and $27.1 million at December 31,
2000 and 1999, respectively. The agreements provide that funding and repayment
of development and construction loans are made in tandem for each project. A
development loan will always precede a construction loan for a project and the
proceeds of the construction loan are required to first be used to pay off the
respective development loan. At December 31, 2000 and 1999, $15.7 million and
$19.1 million, respectively, was outstanding under these facilities.
Zenith National also finances the land acquisitions of its Real Estate
Operations through inter-company loans.
NOTE 8
SENIOR NOTES PAYABLE
Zenith National had $58.5 million and $75.0 million of the $75.0 million
issued of its 9% Senior Notes due 2002 (the "9% Notes") at December 31, 2000 and
1999, respectively (see Note 11). Interest on the 9% Notes is payable
semi-annually. The 9% Notes are general unsecured obligations of Zenith
National. Issue costs of $1.2 million are being amortized over the term of the
9% Notes. In the years ended December 31, 2000, 1999 and 1998, $5.8 million,
$6.9 million and $6.9 million, respectively, of interest and issue costs were
expended. Covenants contained in the indenture include restrictions on the
ability of Zenith National to incur secured debt and the right of holders of the
9% Notes to require Zenith National to repurchase the 9% Notes upon a decline in
the rating of the 9% Notes within ninety days after the occurrence of certain
events. Those events are: (a) a person or group becomes the beneficial owner of
more than 50% of Zenith National common stock; (b) 10% or more of Zenith
National common stock is acquired by Zenith National within any 12-month period;
or (c) the sum of the fair market value of distributions (other than regular
dividends or distributions of capital stock) and the consideration for purchases
of Zenith National common stock by Zenith National during a 12-month period is
30% or more of the fair market value of outstanding Zenith National common
stock.
NOTE 9
INTEREST INCURRED
Interest incurred on borrowings was as follows:
- ---------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- ---------------------------------------------------------
Interest capitalized for
Real Estate Operations
$ 8,364 $ 7,048 $ 4,922
Interest expense not
related to Real Estate
Operations 5,640 8,218 5,784
- ---------------------------------------------------------
Total interest incurred $14,004 $15,266 $10,706
- ---------------------------------------------------------
NOTE 10
REDEEMABLE SECURITIES
On July 30, 1998, Zenith issued $75.0 million of 8.55% Capital Securities at
a price of $996.24 per security through Zenith National Insurance Capital Trust
I, a Delaware statutory business trust (the "Trust"), all of the voting
securities of which are owned by Zenith National. Each Capital Security pays
semi-annual cumulative cash distributions at the annual rate of 8.55% of the
$1,000 liquidation amount per security.
The Trust used the proceeds from its offering to purchase $75.0 million of
Zenith National's 8.55% Subordinated Deferrable Interest Debentures due 2028
(the "Subordinated Debentures"), which constitute the principal asset of the
Trust. The semi-annual interest payments on the Subordinated Debentures may be
deferred by Zenith National for up to ten consecutive semi-annual periods. The
Subordinated Debentures
56
are redeemable at any time by Zenith National at the then present value of the
remaining scheduled payments of principal and interest. Payments on the Capital
Securities, including distributions and redemptions, follow those of the
Subordinated Debentures. Zenith National used $65.0 million from the net
proceeds to make a capital contribution to Zenith Insurance. The remaining net
proceeds were used for general corporate purposes. Zenith National fully and
unconditionally guaranteed the distributions on, and the liquidation amount
generally of, the Capital Securities to the extent the Trust has funds legally
available therefor. Zenith National's guarantee of the Capital Securities, as
well as the Subordinated Debentures, are subordinated to all other indebtedness
of Zenith National. At December 31, 2000 and 1999, $67.0 million and
$75.0 million, respectively, was outstanding (see Note 11).
The issue cost and discount on the Subordinated Debentures of $1.7 million
are being amortized over the term of the Subordinated Debentures. During the
years ended December 31, 2000, 1999 and 1998, $5.9 million, $6.5 million and
$2.7 million, respectively, of interest, issue costs and discount were expensed.
NOTE 11
EXTRAORDINARY ITEM--GAIN ON EXTINGUISHMENT OF DEBT
In 2000, Zenith National paid $22.8 million to repurchase $16.5 million
aggregate principal amount of the outstanding 9% Notes and $8.0 million
aggregate liquidation amount of the outstanding 8.55% Capital Securities. The
repurchases resulted in an extraordinary gain before tax of $1.5 million. Zenith
National used its available cash balances to fund these purchases.
NOTE 12
REINSURANCE
Reinsurance transactions reflected in the financial statements were as
follows:
- ---------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- ---------------------------------------------------------
Direct premiums earned $307,514 $345,085 $545,573
Assumed premiums earned 41,848 40,667 38,769
Ceded premiums earned (10,610) (16,349) (54,487)
- ---------------------------------------------------------
Net premiums earned $338,752 $369,403 $529,855
- ---------------------------------------------------------
Ceded loss and loss
adjustment expenses
incurred $ 8,186 $ 58,948 $ 26,456
- ---------------------------------------------------------
Zenith Insurance (in its Workers' Compensation Operations) maintains excess
of loss and catastrophe reinsurance protection, which varies based on the type
of coverage, as follows: excess of loss reinsurance per occurrence in excess of
$0.6 million and catastrophe reinsurance coverage against aggregate losses per
event up to $100.0 million.
NOTE 13
SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance completed the sale of CalFarm for
$273.0 million in cash to Nationwide Mutual Insurance Company. CalFarm wrote
Zenith's Other Property-Casualty business, principally in California. The gain
on the sale after tax was $104.3 million. After accounting for applicable taxes,
expenses and certain intercompany transactions, the net proceeds from the sale
that were available to Zenith Insurance for investment were $211.0 million,
compared to cash and investments of $226.4 million that were excluded from
Zenith's Consolidated Balance Sheet upon the sale of CalFarm.
TheZenith 57
The following table summarizes the assets and liabilities of CalFarm at
March 31, 1999:
- -----------------------------------------------
(Dollars in thousands) March 31, 1999
- -----------------------------------------------
Assets:
Investments $170,050
Cash 1,904
Receivable from Zenith
Insurance 59,256
Premiums receivable 36,517
Receivable from reinsurers
on paid and unpaid losses
and prepaid reinsurance
premiums 23,002
Deferred policy acquisition
costs 15,620
Properties and equipment 20,505
Other assets 6,874
- -----------------------------------------------
Total assets $333,728
- -----------------------------------------------
Liabilities:
Unpaid loss and loss
adjustment expenses $125,589
Unearned premiums 90,964
Other liabilities 10,617
- -----------------------------------------------
Total liabilities $227,170
- -----------------------------------------------
NOTE 14
RISCORP ACQUISITION AND THE RISCORP PURCHASE ADJUSTMENT
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 and RISCORP, Zenith Insurance completed 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. Zenith Insurance recorded the assets and
liabilities acquired from RISCORP at their estimated fair values consistent with
the values determined by the Neutral Auditor and Neutral Actuary. Zenith
Insurance indicated that any new information that might become available with
respect to certain assets and liabilities acquired from RISCORP may change the
estimates of the carrying values of such amounts and such changes, if any, would
be reflected in the results of operations for the period in which they occur.
In October of 1999, Zenith Insurance completed a review of the liabilities
for unpaid losses and loss adjustment expenses in its Southeast Operations,
which principally consists of the operations acquired from RISCORP. The review
was conducted with assistance from independent actuarial consultants. As a
result of the review, Zenith Insurance recorded, in the third quarter of 1999,
the RISCORP Purchase Adjustment, which mainly comprises an increase of
$46.0 million before tax ($29.9 million after tax) in the estimated net
liabilities for unpaid losses and loss adjustment expenses acquired from
RISCORP. The increase resulted primarily from adjustments to reserves for the
years 1994 through 1997. Certain related receivables, principally contingent
commissions receivable under reinsurance contracts assumed from RISCORP, were
reduced by $19.0 million net ($12.4 million after tax) as a result of such
increase in net liabilities. Zenith Insurance purchased reinsurance protection
relating to adverse development of the unpaid loss and loss adjustment expense
reserves acquired from RISCORP. Such reinsurance allows Zenith Insurance to
recover up to $50.0 million in excess of $182.0 million for net unpaid losses
and allocated loss adjustment expenses acquired from RISCORP. In the third
quarter of 1999, Zenith Insurance recorded an increase in the amount recoverable
to $50.0
58
million and a benefit of $9.0 million ($5.9 million after tax) associated with
such reinsurance.
The RISCORP Purchase Adjustment, net of the benefit of reinsurance protection
and the recovery of $6.0 million pursuant to the "settlement agreement" (see
"RISCORP Litigation" in Note 15), in the aggregate, reduced income by
$50.0 million ($32.5 million after tax, or $1.89 per share) in 1999.
The remaining deferred benefit associated with the reinsurance relating to
the RISCORP reserves before tax was $14.7 million and $23.0 million at
December 31, 2000 and 1999, respectively.
NOTE 15
COMMITMENTS AND CONTINGENT LIABILITIES
Zenith has office space leases, equipment leases and automobile leases
expiring through 2005. The minimum rentals on these operating leases as of
December 31, 2000 were as follows:
- ------------------------------------------------------
Equipment
(Dollars in thousands) and
Years auto fleet Offices Total
- ------------------------------------------------------
2001 $ 925 $3,317 $ 4,242
2002 620 2,232 2,852
2003 292 1,054 1,346
2004 157 603 760
2005 and thereafter 60 469 529
- ------------------------------------------------------
Total $2,054 $7,675 $ 9,729
- ------------------------------------------------------
Rental expenses for 2000, 1999 and 1998 amounted to $5.2 million,
$5.7 million and $5.8 million, respectively.
Other than the RISCORP litigation described below, 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, will not have a material
adverse effect on the consolidated financial condition or results of operations
of Zenith.
RISCORP Litigation
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
TheZenith 59
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 could 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. Zenith is unable to predict
the outcome of this litigation.
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 December 31, 2000
and 1999, the receivable from the Fund was $31.1 million and $37.0 million,
respectively, related to the pre-January 1, 1998 claims.
NOTE 16
COMMON STOCK
Under employee non-qualified stock option plans adopted by the Board of
Directors and Stockholders of Zenith National in 1978 and in 1996, options are
granted to certain officers and key employees for the purchase of Zenith
National's common stock at 100% of the market price at the date of grant. The
majority of the options outstanding at December 31, 2000 and 1999 expire five
years after the date of the grant or three months after termination of
employment and vest one-fourth per year after the first year. One grant for
1,000,000 shares is for a term of ten years and vests one-fifth per year after
the first year.
Zenith has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123 ("SFAS No. 123") "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for the
stock option plans. Had compensation cost for Zenith's stock option plans been
determined based on the fair value at the grant date for awards in 2000, 1999
and 1998 consistent with the provisions of SFAS No. 123, Zenith's net (loss)
income and per share amounts would have been reduced to the pro-forma amounts
indicated as follows:
- --------------------------------------------------------------------------------------------------------------------
2000 1999 1998
-------------------- ------------------ ------------------
Years ended December 31, As Pro- As Pro- As Pro-
(Dollars in thousands, except per share data) Reported forma Reported forma Reported forma
- --------------------------------------------------------------------------------------------------------------------
Net (loss) income $(46,800) $(48,300) $54,100 $52,600 $19,100 $17,700
Net (loss) income per common share
-- basic (2.72) (2.80) 3.15 3.06 1.12 1.04
-- diluted (2.71) (2.80) 3.15 3.06 1.11 1.03
- --------------------------------------------------------------------------------------------------------------------
The pro-forma effect on net income for 2000, 1999 and 1998 is not
representative of the pro-forma effect on net income in future years because the
presented disclosure does
60
not take into consideration pro-forma compensation expense related to grants
made prior to 1995.
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
- -----------------------------------------------------------------------------------------------------------------
2000 Grants 1999 Grants 1998 Grants
- -----------------------------------------------------------------------------------------------------------------
Risk-free interest rates 5.45% - 6.85% 5.36% - 6.30% 4.52% - 5.66%
Dividend yields 3.55% 4.34% - 5.08% 3.75%
Volatility factors 20.87% - 22.97% 20.30% - 20.56% 19.83%
Weighted average expected life (five-year term options) 4.5 yrs. 4.5 yrs. 4.5 yrs.
Weighted average fair value per share $4.44 $3.49 $4.40
- -----------------------------------------------------------------------------------------------------------------
Additional information with respect to stock options was as follows:
- ----------------------------------------------------------
Weighted
average
Number exercise
(Shares in thousands) of shares price
- ----------------------------------------------------------
Outstanding at December 31, 1997 2,630 $24.58
Granted 460 26.74
Exercised (289) 22.56
Expired or cancelled (268) 26.43
-----
Outstanding at December 31, 1998 2,533 25.00
Granted 154 21.95
Exercised (187) 23.11
Expired or cancelled (385) 26.02
-----
Outstanding at December 31, 1999 2,115 24.76
Granted 537 21.15
Exercised (295) 24.54
Expired or cancelled (209) 25.76
-----
Outstanding at December 31, 2000 2,148 24.03
- ----------------------------------------------------------
Certain information on outstanding options at December 31, 2000 was as
follows:
- ----------------------------------------------------------------
Range of Weighted Outstanding
exercise price average options weighted
(Shares in Number remaining life average exercise
thousands) outstanding in years price
- ----------------------------------------------------------------
$23.63 1,000 4.8 $23.63
19.16 - 29.47 1,148 3.1 24.39
- ----------------------------------------------------------------
Options exercisable at December 31, 2000, 1999 and 1998 were 1,205,000,
1,127,000 and 877,000, respectively. Certain information on exercisable options
at December 31, 2000 was as follows:
- --------------------------------------------------------
Exercisable
options weighted
Range of exercise prices Number average exercise
(Shares in thousands) exercisable price
- --------------------------------------------------------
$23.63 800 $23.63
19.16 - 29.47 405 24.30
- --------------------------------------------------------
From time to time, Zenith may make repurchases of its outstanding common
shares or outstanding debt. At December 31, 2000, Zenith National was authorized
to repurchase up to 938,000 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.
TheZenith 61
NOTE 17
DIVIDEND RESTRICTIONS
The California and Texas Insurance Holding Company System Regulatory Acts
limit the ability of Zenith Insurance to pay dividends to Zenith National, and
of the insurance subsidiaries of Zenith Insurance to pay dividends to Zenith
Insurance, by providing that the appropriate insurance regulatory authorities in
the states of California and Texas must approve any dividend that, together with
all other such dividends paid during the preceding twelve months, exceeds the
greater of: (a) 10% of the paying company's statutory surplus as regards
policyholders at the preceding December 31; or (b) 100% of the net income for
the preceding year. In addition, any such dividend must be paid from
policyholders' surplus attributable to accumulated earnings. During 2000, Zenith
Insurance paid $10.0 million of dividends to Zenith National. During 1999,
Zenith Insurance paid $130.0 million of dividends to Zenith National, including
a $100.0 million dividend from the proceeds of the sale of CalFarm for which it
received prior approval from the California Department of Insurance.
Stockholder's equity of the P&C Operations, in accordance with GAAP, amounted to
$315.0 million as of December 31, 2000, of which $26.2 million can be paid in
2001 to Zenith National in dividends without prior approval.
NOTE 18
STATUTORY FINANCIAL DATA
Capital stock and surplus and net (loss) income of the P&C Operations on a
statutory basis, as reported to regulatory authorities, were as follows:
- ------------------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
- ------------------------------------------------------------------
Capital stock and surplus $262,315 $297,969 $345,041
Net (loss) income (60,737) 68,507 21,959
- ------------------------------------------------------------------
The insurance business is subject to state-by-state regulation and
legislation focused on solvency, pricing, market conduct, claims practices,
underwriting, accounting, investment criteria and other areas. Such regulation
and legislation is constantly changing and compliance is essential and is an
inherent risk of the business.
NOTE 19
EARNINGS AND DIVIDENDS PER SHARE
The following table sets forth the computation of basic and diluted net
(loss) income per common share.
- ----------------------------------------------------------
Years Ended December 31,
(Dollars in thousands,
except per share data) 2000 1999 1998
- ----------------------------------------------------------
(A) Net (loss) income $(46,800) $54,100 $19,100
- ----------------------------------------------------------
(B) Weighted average
outstanding shares
during the period 17,212 17,161 17,035
Additional common shares
issuable under employee
stock option plans using
the treasury stock
method 57 11 123
- ----------------------------------------------------------
(C) Weighted average number
of common shares
outstanding assuming
exercise of stock
options 17,269 17,172 17,158
- ----------------------------------------------------------
Net (loss) income per common
share:
(A)/(B) -- basic $ (2.72) $ 3.15 $ 1.12
(A)/(C) -- diluted (2.71) 3.15 1.11
- ----------------------------------------------------------
Dividends per common share $ 1.00 $ 1.00 $ 1.00
- ----------------------------------------------------------
Options to purchase 589,000 shares and 2,053,000 shares, respectively, of
common stock at an average price of $27.64 and $24.90 per share, respectively,
were outstanding as of December 31, 2000 and 1999 but were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common shares, and, therefore,
the effect would be anti-dilutive.
62
NOTE 20
SEGMENT INFORMATION
Zenith classifies its business into the following segments: Workers'
Compensation, Reinsurance, Other Property-Casualty (through March 31, 1999, the
date of the sale of CalFarm), Real Estate, Investment and Parent. Segments are
designated based on the types of products and services provided. Workers'
Compensation represents insurance coverage for the statutorily prescribed
benefits that employers are required to pay to their employees injured in the
course of employment. Reinsurance principally consists of world-wide, assumed
reinsurance of property losses from catastrophes and large property risks. Other
Property-Casualty, which was operated by CalFarm and was sold effective
March 31, 1999, represented multiple product line direct insurance other than
workers' compensation primarily in California. The Real Estate Operations
develop land and primarily construct single-family residences in Las Vegas,
Nevada. Investment operations provide income and realized gains on investments,
primarily from debt securities. The Parent operations represent Zenith National,
a holding company which owns, directly or indirectly, all of the capital stock
of the P&C Operations, non-insurance companies and securities.
The accounting policies of the segments are the same as those described in
Note 1. Zenith evaluates insurance segment performance based on the combined
ratios and income or loss from operations before income tax, and not including
investment income or realized gains or losses.
Information as to the operations of the segments is set forth below:
- ------------------------------------------------------------------------------------------------------------------------------
Other
Workers' Property- Real
(Dollars in thousands) Compensation Reinsurance Casualty(1) Estate Investment Parent Total
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2000
- ------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 300,833 $37,919 $ 338,752
Net investment income $ 51,766 51,766
Realized losses on investments (15,467) (15,467)
Real estate sales $84,518 84,518
- ------------------------------------------------------------------------------------------------------------------------------
Total revenues $ 300,833 $37,919 $84,518 $ 36,299 $ 459,569
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense $ (5,640) $ (5,640)
- ------------------------------------------------------------------------------------------------------------------------------
(Loss) income before tax and
extraordinary item $ (87,854) $(14,536) $ 5,464 $ 36,299 $(11,682) $ (72,309)
Federal income tax (benefit)
expense (29,558) (4,891) 1,912 12,110 (4,089) (24,516)
- ------------------------------------------------------------------------------------------------------------------------------
(Loss) income before
extraordinary item (58,296) (9,645) 3,552 24,189 (7,593) (47,793)
Extraordinary item(2) 993 993
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (58,296) $(9,645) $ 3,552 $ 24,189 $ (6,600) $ (46,800)
- ------------------------------------------------------------------------------------------------------------------------------
Combined ratios 129.2% 138.3% 130.2%
- ------------------------------------------------------------------------------------------------------------------------------
Total assets $ 500,167 $30,733 $59,133 $ 880,643 $ 1,514 $1,472,190
- ------------------------------------------------------------------------------------------------------------------------------
(1) CalFarm was sold effective March 31, 1999
(2) Gain on extinguishment of debt (net of income tax)
TheZenith 63
- ------------------------------------------------------------------------------------------------------------------------------
Other
Workers' Property- Real
(Dollars in thousands) Compensation Reinsurance Casualty(1) Estate Investment Parent Total
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999
- ------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 278,854 $36,441 $ 54,108 $ 369,403
Net investment income $ 53,662 53,662
Realized gains on investments 7,682 7,682
Real estate sales $58,670 58,670
Service fee income 2,691 2,691
- ------------------------------------------------------------------------------------------------------------------------------
Total revenues $ 281,545 $36,441 $ 54,108 $58,670 $ 61,344 $ 492,108
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense $ (8,218) $ (8,218)
- ------------------------------------------------------------------------------------------------------------------------------
(Loss) income before tax $(122,543) $(7,324) $ (22) $ 3,649 $ 61,344 $(12,372) $ (77,268)
Gain on sale of CalFarm before
tax 160,335 160,335
Federal income tax (benefit)
expense (42,199) (2,494) 55,993 1,277 20,719 (4,329) 28,967
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (80,344) $(4,830) $104,320 $ 2,372 $ 40,625 $ (8,043) $ 54,100
- ------------------------------------------------------------------------------------------------------------------------------
Combined ratios 143.9% 120.1% 100.0% 135.2%
- ------------------------------------------------------------------------------------------------------------------------------
Total assets $ 520,544 $27,701 $85,731 $ 929,280 $ 10,530 $1,573,786
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 278,660 $29,150 $222,045 $ 529,855
Net investment income $ 53,593 53,593
Realized gains on investments 11,602 11,602
Real estate sales $37,737 37,737
Service fee income 3,992 3,992
- ------------------------------------------------------------------------------------------------------------------------------
Total revenues $ 282,652 $29,150 $222,045 $37,737 $ 65,195 $ 636,779
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense $ (5,928) $ (5,928)
- ------------------------------------------------------------------------------------------------------------------------------
(Loss) income before tax $ (42,638) $10,268 $ 4,410 $ 1,363 $ 65,195 $ (9,763) $ 28,835
Federal income tax (benefit)
expense (14,003) 3,322 1,426 495 21,747 (3,252) 9,735
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (28,635) $ 6,946 $ 2,984 $ 868 $ 43,448 $ (6,511) $ 19,100
- ------------------------------------------------------------------------------------------------------------------------------
Combined ratios 115.3% 64.8% 98.0% 105.3%
- ------------------------------------------------------------------------------------------------------------------------------
NOTE 21
EMPLOYEE BENEFIT AND RETIREMENT PLANS
Zenith offers a tax deferred savings plan organized under Section 401(k) of
the Internal Revenue Code for all of its subsidiaries' eligible employees.
Zenith matches up to one third of the first 6% of employee contributions on a
current basis and is not liable for any future payments under the plan. For the
years ended December 31, 2000, 1999 and 1998, Zenith contributed $0.8 million,
$1.2 million and $1.1 million, respectively.
Zenith also offers a stock purchase plan, under which all employees are able
to purchase shares of Zenith National common stock at market value. Zenith
matches 25% of all employee purchases. For the years ended December 31, 2000,
1999 and 1998, Zenith contributed $0.3 million, $0.3 million and $0.4 million,
respectively.
NOTE 22
RELATED PARTIES
Pursuant to a Stock Purchase Agreement, dated June 25, 1999 (the "Stock
Purchase Agreement"), between Fairfax Financial Holdings Limited, a Canada
corporation ("Fairfax"), and Reliance, Fairfax agreed to purchase the 6,574,000
shares of common stock of Zenith National owned by Reliance and its affiliates
for $28 per share. At December 31,
64
2000, Fairfax, through its subsidiaries, owned 6,816,000 shares of common stock
of Zenith National.
The P&C Operations conduct assumed and ceded reinsurance transactions with
subsidiaries of Fairfax. The following table summarizes the reinsurance
transactions with the subsidiaries of Fairfax:
- ----------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2000 1999
- ----------------------------------------------------------
Assumed Reinsurance:
Premiums earned $ 177
Other underwriting and operating
expenses 277
Premiums receivable 8
Unpaid loss and loss adjustment
expenses $ 118 220
Ceded Reinsurance:
Receivable from reinsurers on paid
and unpaid losses 4,480 2,407
Unearned premiums 37
- ----------------------------------------------------------
At December 31, 2000 and 1999, Zenith owned $12.8 million and $5.1 million,
respectively, at fair value of securities issued by Fairfax. In addition, at
December 31, 2000 and 1999, Zenith owned $3.0 million and $4.5 million,
respectively, at fair value of securities issued by TIG Capital Trust 1, a
subsidiary of Fairfax.
NOTE 23
QUARTERLY FINANCIAL DATA (UNAUDITED)
- --------------------------------------------------------------------
2000 Quarter Ended
-----------------------------------------
(Dollars in thousands, March June September December
except per share data) 31 30 30 31
- --------------------------------------------------------------------
Premiums earned $77,139 $ 78,306 $ 87,692 $ 95,615
Net investment income 13,561 13,000 12,861 12,344
Realized gains (losses) on
investments 3,255 (2,589) (10,913) (5,220)
Real estate sales 16,434 22,099 23,278 22,707
Extraordinary item(1) 973 20
Net loss (4,400) (19,600) (12,200) (10,600)
Net loss per common share
-- basic (0.26) (1.14) (0.71) (0.61)
-- diluted (0.26) (1.14) (0.71) (0.61)
- --------------------------------------------------------------------
(1) Gain on extinguishment of debt after tax (see Note 11)
- -------------------------------------------------------------------
1999 Quarter Ended
------------------------------------------
(Dollars in thousands, March June September December
except per share data) 31 30 30 31
- -------------------------------------------------------------------
Premiums earned $135,577 $ 75,977 $ 87,110 $ 70,739
Net investment income 13,325 12,946 14,229 13,162
Realized gains on
investments 1,534 2,531 2,322 1,295
Real estate sales 10,768 14,438 14,034 19,430
Service fee income 959 585 802 345
Gain on sale of CalFarm 160,335
Net income (loss) 104,400 (3,400) (37,300) (9,600)
Net income (loss) per
common share
-- basic 6.09 (0.20) (2.17) (0.56)
-- diluted 6.09 (0.20) (2.17) (0.56)
- -------------------------------------------------------------------
The net loss for the year ended December 31, 2000 includes catastrophe losses
of $14.7 million after tax, or $0.85 per share, of which $3.6 million, $8.5
million, $1.3 million and $1.4 million were incurred in the first, second, third
and fourth quarters, respectively. Net income for the year ended December 31,
1999 includes catastrophe losses of $12.3 million after tax, or $0.72 per share,
of which $1.3 million, $2.7 million, $3.1 million and $5.2 million were incurred
in the first, second, third and fourth quarters, respectively. During the
quarter ended December 31, 2000, there were write downs for "other than
temporary" declines in market value of investments (see Note 2) of $4.7 million
after tax.
NOTE 24
COMMON STOCK MARKET PRICES (UNAUDITED)
The following table shows the high and low common stock prices during each
quarter for the past two years.
- --------------------------------------------------------------------------------
2000 1999
--------------------------- ---------------------------
Quarter ended High Low High Low
- --------------------------------------------------------------------------------
March 31 $ 22 3/16 $ 18 3/4 $ 26 $ 20 5/16
June 30 24 15/16 20 1/2 26 11/16 22 1/4
September 30 23 7/8 20 13/16 26 21 1/8
December 31 29 3/4 20 22 13/16 19 1/4
- --------------------------------------------------------------------------------
As of March 7, 2001, there were 267 registered holders of record of Zenith
National common stock.
TheZenith 65
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Zenith National Insurance Corp.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows, and stockholders' equity
present fairly, in all material respects, the financial position of Zenith
National Insurance Corp. and subsidiaries (the "Company") at December 31, 2000
and 1999, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Los Angeles, California
February 7, 2001
66
CORPORATE DIRECTORY
TheZenith
67
CORPORATE DIRECTORY
ZENITH NATIONAL INSURANCE CORP.
Directors
Also Directors of Zenith
Insurance Company
Max M. Kampelman
Attorney, Of Counsel,
Fried, Frank, Harris,
Shriver & Jacobson
Robert J. Miller
Attorney, Senior Partner,
Jones Vargas
Leon E. Panetta
Founder and Director,
The Leon and Sylvia Panetta
Institute for Public Policy
William S. Sessions
Attorney,
Holland & Knight LLP
and Security Consultant
Harvey L. Silbert
Attorney, Of Counsel,
Christensen, Miller, Fink, Jacobs,
Glazer, Weil & Shapiro LLP
Gerald Tsai, Jr.
Management of
Private Investments
Michael Wm. Zavis
Attorney, Co-Managing Partner,
Katten, Muchin & Zavis
Stanley R. Zax
Chairman of the Board
and President
Executive Officers
Stanley R. Zax
Chairman of the
Board and President
Jack D. Miller
Executive Vice President
Robert E. Meyer
Senior Vice President
William J. Owen
Senior Vice President &
Chief Financial Officer
John J. Tickner
Senior Vice President
and Secretary
Officer
Hyman J. Lee Jr.
Vice President
Transfer Agent-
Common Stock
Mellon Investor
Services LLC
Los Angeles, CA
www.mellon-investor.com
Transfer Agent-
9% Senior Notes and
8.55% Capital Securities
Wells Fargo Corporate
Trust Services
Wells Fargo Bank Minnesota, N.A.
Minneapolis, MN
Corporate
Headquarters
21255 Califa Street
Woodland Hills, CA 91367
(818) 713-1000
www.thezenith.com
NYSE Trading Symbol
Common Stock -- ZNT
Independent
Accountants
PricewaterhouseCoopers LLP
Los Angeles, CA
The Annual Report
on Form 10-K, for the year ended December 31, 2000 and our quarterly reports may
be obtained at our website or free of charge upon written request to:
Chief Financial Officer
Zenith National
Insurance Corp.
21255 Califa Street
Woodland Hills, CA 91367
68
CORPORATE DIRECTORY
ZENITH INSURANCE COMPANY
Officers
Stanley R. Zax
Chairman of the
Board and President
Jack D. Miller
Executive Vice President,
and Chief Operating Officer
William J. Owen
Senior Vice President
Chief Financial Officer and Treasurer
John J. Tickner
Senior Vice President,
General Counsel and Secretary
Stephen J. Albers
Senior Vice President
James T. Braun
Senior Vice President
Ron R. Cordova
Senior Vice President
Dan M. Hair
Senior Vice President
John C. Hasbrouck
Senior Vice President
Robert L. Hernandez
Senior Vice President
Westley M. Heyward
Senior Vice President
Fred A. Hunt
Senior Vice President
Corey A. Ingber
Senior Vice President
Michael W. Jacobson
Senior Vice President
Edward G. Krisak
Senior Vice President
Robert E. Meyer
Senior Vice President
and Actuary
Stephen M. Pratt
Senior Vice President
William J. Saake
Senior Vice President
Keith E. Trotman
Senior Vice President
Chris L. Uselton
Senior Vice President
Kari L. Van Gundy
Senior Vice President
Glen R. Zepnick
Senior Vice President
Bryan A. Anderson
Vice President
Jeffrey J. Beaudoin
Vice President
Everett M. Brookhart
Vice President
Richard V. Caligiuri
Vice President
Suzanne M. Chapan
Vice President
Duane H. Chernow
Vice President
Douglas A. Claman
Vice President
Ronald W. Crabtree
Vice President
Mark T. Cross
Vice President
Gerald D. Curtin
Vice President
Charles J. Davis
Vice President
Bradley C. Eastwood
Vice President
Jesse R. Farese
Vice President
Eden C. Feder
Vice President
F. Stephen Fetchet
Vice President
James C. Guidos
Vice President
Diane H. Heidenreich
Vice President and Assistant General Counsel
Carolyn N. Hinson
Vice President
David G. Hoppen
Vice President
Mark M. Jansen
Vice President
Lisa A. Krouse
Vice President and General
Counsel-Southeast
Hyman J. Lee Jr.
Vice President and Assistant Secretary
Jonathan W. Lindsay
Vice President
Michael R. McFadden
Vice President
Colin S. Mitchell
Vice President
David A. O'Connor
Vice President
Michael J. Paladino
Vice President
Stephen D. Petrula
Vice President
Alan I. Steinhardt
Vice President
John A. Swift
Vice President
Jesse J. Thomas
Vice President
John H. Weber
Vice President
Norman C. Winters
Vice President
TheZenith 69
CORPORATE DIRECTORY
THEZENITH MARKETING, UNDERWRITING AND CLAIMS OFFICES
Los Angeles, CA
Corporate Headquarters
21255 Califa Street
Woodland Hills, CA 91367
818/713-1000
www.thezenith.com
San Francisco, CA
425 California Street
Suite 1010
San Francisco, CA 94104
415/646-0230
Pleasanton, CA
4309 Hacienda Drive
Suite 200
Pleasanton, CA 94588
925/460-0600
Fresno, CA
575 E. Locust Avenue
Suite 101
Fresno, CA 93720
209/432-6660
San Diego, CA
1660 N. Hotel Circle Drive
Suite 400
San Diego, CA 92108
619/299-6252
Salt Lake City, UT
3 Triad Center
345 W. North Temple
Suite 175
Salt Lake City, UT 84180
801/741-4900
Austin, TX
1101 Capital of Texas
Hwy South Bldg. J
Austin, TX 78746
512/306-1700
Dallas, TX
17304 Preston Rd.
8th floor
Dallas, TX 75252
972/701-5700
Little Rock, AR
900 S. Shackleford Rd.
Suite 300
Little Rock, AR 72211
877/200-8600
Harrisburg, PA
4400 Deer Path Way
Suite 200
Harrisburg, PA 17110
717/221-7000
Springfield, IL
2105 W. White Oaks Drive
Springfield, IL 62704
217/726-2900
Sarasota, FL
1390 Main St.
Sarasota, FL 34236
941/906-2000
Orlando, FL
3504 Lake Lynda Drive Ste 400
Orlando, FL 32817
407/206-8200
Charlotte, NC
5832 Farm Pond Lane
Suite 300
Charlotte, NC 28212
800/200-2667
Birmingham, AL
10 Iverness Center Parkway
Suite 220
Birmingham, AL 35242
800/355-0708
PERMA-BILT, A NEVADA CORPORATION
Officers
Daniel Schwartz
President
Robert M. Beville
Executive Vice President
David R. Durant
Vice President
Craig A. Hardy
Vice President
Fred W. Lessman
Vice President
Ruth E. Ochoa
Vice President
Headquarters
7150 Pollock Drive
Suite 104
Las Vegas, NV 89119
702/896-9100
www.permabilthomes.com
70