SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 1998 Commission file number 0-5537
Gryphon Holdings Inc.
(Exact name of registrant as specified in its charter)
Delaware 13-3287060
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
30 Wall Street, New York, New York 10005-2201
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (212) 825-1200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 30, 1998
Common stock, par value $.01 6,740,229
Gryphon Holdings Inc.
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets at
September 30, 1998 and December 31, 1997 3
Consolidated Statements of Income for the
three and nine months ended September 30,
1998 and 1997 4
Consolidated Statements of Cash Flows for
the nine months ended September 30, 1998
and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
EXHIBIT 27 Financial Data Schedule 24
PART 1-FINANCIAL INFORMATION
Gryphon Holdings Inc. and Subsidiaries
Consolidated Balance Sheet
September 30, December 31,
Assets 1998 1997
Investments: (Dollars in thousands)
Fixed maturities, available for sale,
at fair value (amortized cost: 9/30/98
- $371,714; 12/31/97 - $274,506) $385,403 $280,553
Short-term investments, at cost, which
approximates market 233 257
Equity securities, available for sale, at
fair value (cost: 9/30/98 - $882) 901 -
Total investments 386,537 280,810
Cash and cash equivalents 16,733 32,272
Accrued investment income 5,340 4,071
Premiums receivable 36,242 16,151
Reinsurance recoverable on paid losses 17,068 18,261
Reinsurance recoverable on unpaid losses 201,051 140,810
Prepaid reinsurance premiums 34,794 16,573
Deferred policy acquisition costs 12,746 11,849
Deferred income taxes 15,216 10,569
Income taxes receivable 1,030 -
Goodwill 11,368 1,409
Other assets 9,872 6,210
Total assets $747,997 $538,985
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses $448,636 $328,911
Unearned premiums 91,555 62,351
Total policy liabilities 540,191 391,262
Reinsurance balances payable 23,212 12,179
Income taxes payable - 389
Long-term debt 55,000 21,125
Other liabilities 13,918 9,521
Total liabilities 632,321 434,476
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 1,000,000
shares authorized;14,444 issued and outstanding 11,741 -
Common stock, $.01 par value; 15,000,000 shares
authorized; 8,148,050 shares issued 81 81
Additional paid-in capital 30,581 30,742
Accumulated other comprehensive income,
net of tax 8,342 3,585
Deferred compensation (234) (151)
Retained earnings 89,080 95,065
Treasury stock, at cost; shares 1998:
1,407,821; 1997: 1,461,169 (23,915) (24,813)
Total stockholders' equity 115,676 104,509
Total liabilities and stockholders' equity $747,997 $538,985
See accompanying notes to consolidated financial statements.
The interim financial statements are unaudited.
Gryphon Holdings Inc. and Subsidiaries
Consolidated Statements of Income
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
(Dollars and shares in thousand,
except per-share data)
Revenues
Gross premiums written $48,629 $37,290 $127,137 $113,688
Net premiums written 29,123 28,223 76,089 79,855
Net premiums earned 28,418 27,783 72,849 76,801
Net investment income 5,407 4,344 13,809 12,829
Realized gains on investments 648 2,601 1,945 2,630
Other income - 296 - 794
Total revenues 34,473 35,024 88,603 93,054
Expenses
Losses and loss adjustment
expenses 21,225 17,895 63,946 47,862
Underwriting, acquisition, and
insurance expenses 12,089 11,712 34,265 33,730
Interest expense 819 398 1,508 1,228
Total expenses 34,133 30,005 99,719 82,820
Income (loss) before income
taxes 340 5,019 (11,116) 10,234
Provision for income taxes
(benefit):
Current 486 872 (1,226) 2,070
Deferred (970) 450 (4,136) 129
Total income taxes (benefit) (484) 1,322 (5,362) 2,199
Net income (loss) before accretion
of preferred stock $824 $3,697 ($5,754) $8,035
Accretion of preferred stock 111 111
Net income (loss) attributable to
common stockholders 713 3,697 (5,865) 8,035
Other comprehensive income, net of tax:
Unrealized investment gains (losses),
net of reclassification
adjustments 4,879 1,284 4,872 698
Foreign currency translation
adjustments (162) 3 (237) (9)
Comprehensive income (loss) $5,430 $4,984 $(1,230) $8,724
Basic net earnings (loss)
per share $0.11 $0.55 ($0.87) $1.20
Diluted net earnings (loss)
per share $0.11 $0.55 ($0.87) $1.20
Basic comprehensive income (loss)
per share $0.81 $0.75 ($0.18) $1.31
Diluted comprehensive income (loss)
per share $0.75 $0.75 ($0.18) $1.31
Weighted average shares
outstanding 6,740 6,688 6,726 6,680
See accompanying notes to consolidated financial statements.
These statements are unaudited.
Gryphon Holdings Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine months ended September 30,
1998 1997
(Dollars in thousands)
Operating activities
Net (loss) income ($5,865) $8,035
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred income tax provision (4,136) 129
Amortization and depreciation 696 573
Amortization of bond discount, net 747 352
Realized gains on investments (1,945) (2,630)
Change in assets and liabilities, net of
effect of purchase acquisition
Increase in net policy liabilities 24,678 2,811
Increase in premiums receivable (11,129) 1,263
Decrease (increase) in deferred
acquisition costs 739 (1,231)
Change in other assets and liabilities (2,005) (4,160)
Increase (decrease) in reinsurance balances
payable 4,589 (3,940)
Decrease (increase) in accrued investment
income (267) 272
Net cash provided by operating activities 6,102 1,474
Investing activities
Sales of fixed maturities 215,046 304,542
Purchases of fixed maturities (241,373) (298,471)
Maturities or calls of fixed maturities - 1,800
Payment for the purchase acquisition,
net of cash acquired (39,924) -
Capital expenditures (562) (959)
Net cash (used in) provided by investing
activities (66,813) 6,912
Financing activities
Proceeds from long-term debt 55,000 -
Debt issue costs (686) -
Repayment of long-term debt (21,125) (2,625)
Issuance of common stock 738 342
Issuance of preferred stock 11,630 -
Deferred compensation (148) 60
Net cash used in financing activities 45,409 (2,223)
Effect of exchange rate changes on cash (237) (9)
Decrease in cash and cash equivalents (15,539) 6,154
Cash and cash equivalents at beginning
of period 32,272 23,398
Cash and cash equivalents at end
of period $16,733 $29,552
Supplemental disclosure of cash flow information
Income taxes paid $75 $530
Interest paid $1,508 $1,228
See accompanying notes to consolidated financial statements.
These statements are unaudited.
Gryphon Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Basis of Presentation
Gryphon Holdings Inc. (the "Company") operates through its main
subsidiary, Gryphon Insurance Group Inc., as a specialty property and casualty
underwriting organization. The Company's wholly owned insurance company
subsidiaries are Associated International Insurance Company ("Associated"),
Calvert Insurance Company ("Calvert") and, since July 13, 1998, The First
Reinsurance Company of Hartford ("First Re"). The accompanying consolidated
financial statements include the accounts and operations of Gryphon Holdings
Inc. and its subsidiaries.
2. Principles of Consolidation
The accompanying consolidated financial statements have been prepared on
the basis of generally accepted accounting principles, which as to the three
wholly owned insurance company subsidiaries differ from the statutory
accounting practices prescribed or permitted by regulatory authorities, and
include the accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
3. Acquisition
On July 13, 1998, the Company acquired all of the capital stock of The
First Reinsurance Company of Hartford, Oakley Underwriting Agency, Inc. and F/I
Insurance Agency, Incorporated (collectively, "First Re") from Dearborn Risk
Management, Inc. for a combination of cash and preferred stock with an
estimated value of $43.6 million, plus certain other performance-driven
contingent consideration. First Re, a Connecticut corporation with
headquarters in Chicago, is a specialty insurer of professional liability and
program risks. Through its affiliate, Oakley Underwriting Agency, First Re
provides Directors & Officers and Errors & Omissions coverages for
corporations, professional firms, not-for-profit entities, and public entities.
The total estimated purchase consideration of $43.6 million consisted of
$31.9 million of cash and $11.7 million fair value of a new issue of Gryphon
perpetual convertible preferred stock. The preferred stock, which has a face
amount of $14.4 million, is convertible into 643,672 shares of the Company's
common stock, reflecting a conversion price of $22.44 per share. No cash
dividends will be paid or owed during the first four and one-half years; a cash
dividend at a rate of 4.0% of the face amount will be paid thereafter. The
discount on the preferred shares attributable to the period in which no cash
dividends are paid is accreted over that four and one-half years. The
preferred shares, which are non-callable for three years, have no sinking
fund or mandatory redemption features. In connection with the transaction,
Gryphon entered into a $55.0 million credit facility with a group of financial
institutions, the proceeds of which were used to pay the cash portion of the
purchase price, including related expenses of the acquisition, and to repay
existing bank borrowings.
The acquisition was accounted for by the purchase method of accounting
under Opinion No. 16, "Business Combinations," of the Accounting Principles
Board of the American Institute of Certified Public Accountants. Under this
accounting method, the results of First Re are included in the Financial
Statements from the date of the acquisition and any excess of purchase price
and direct costs of acquisition over management's preliminary estimates of the
fair market value of identifiable assets acquired less liabilities assumed
have been recorded as goodwill (approximately $10.0 million) and amortized
over 40 years.
As part of the Stock Purchase Agreement the final determination of the
purchase price is subject to adjustment due to contingencies. The
contingencies include final determination and agreement as to the closing
balance sheet amounts. The allocation of the purchase price of the acquisition
is subject to revision when additional information concerning asset and
liability valuations are obtained.
In addition, the seller may earn additional consideration over the next
three years at an amount equal to a multiple of net underwriting income, net of
tax, on certain program business. Since any amounts that may become due to the
seller under this agreement are entirely contingent upon future performance, no
provision for such amounts has been included in the financial statements.
The pro forma financial data, which give effect to the acquisition of
First Re as though it had been completed January 1, 1997, for the nine months
ended September 30, 1998 and 1997 include revenues of $102.4 million and $103.0
million, net income (loss) attributable to common stockholders of $(6.8)
million and $8.1 million, basic net earnings (loss) per share of $(1.01) and
$1.21, and diluted net earnings (loss) per share of $(1.01) and $1.16,
respectively.
The results of operations in the proforma financial data reflect adjustments
to give effect to the acquisition as if it had occurred on January
1, 1997, for the amortization of goodwill, interest expense related to the debt
incurred to finance the acquisition and their tax effect. In addition, the
accretion of preferred stock has been reflected as if it had occurred from
January 1, 1997.
The pro forma financial information does not purport to represent what
Gryphon's results of operations or financial position would actually have been
had the acquisition in fact occurred on January 1, 1997 or to project the
company's results of operations or financial position for or at any future
period or date.
4. Investments
The Company's securities are classified as available for sale and reported
at fair value, with unrealized gains and losses, net of deferred income taxes,
included in stockholders' equity.
Fair values are based on quoted market prices, when available, or
estimates based on market prices for similar securities, when quotes are not
available. Short-term investments are carried at cost, which approximates
their fair value. Realized gains and losses from the sales or liquidation of
investments are determined on the basis of the specific identification method
and are included in net income. Investment income is recognized when earned.
The amortization of premium and accretion of discount for fixed maturity
securities are computed utilizing the interest method.
The major categories of net investment income are summarized as follows:
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
(Dollars in thousands)
Fixed maturities $5,365 $4,151 $13,641 $12,212
Cash, cash equivalents and
short-term investments 340 441 975 1,353
Total investment income 5,705 4,592 14,616 13,565
Less related expenses 298 248 807 736
Net investment income $5,407 $4,344 $13,809 $12,829
The gross realized gains and losses from sales of fixed maturity
securities are as follows:
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
(Dollars in thousands)
Gross realized gains $1,703 $2,711 $3,332 $3,879
Gross realized losses (1,055) (110) (1,387) (1,249)
Net realized gain on sales $648 $2,601 $1,945 $2,630
At September 30, 1998 and December 31, 1997, the amortized cost and
estimated fair values of investments in fixed maturities and equity securities,
by categories of securities, and short-term investments were as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
(Dollars in thousands)
September 30, 1998
Fixed maturities
U.S. Treasury securities
and obligations of U.S.
government corporations and
agencies $69,770 $3,334 ($17) $73,087
Debt securities issued by
foreign governments 6,399 233 - 6,632
Tax-exempt obligations of
states and political
subdivisions 148,990 6,699 (3) 155,686
Mortgage-backed securities 81,459 1,968 (131) 83,296
Corporate securities 65,096 2,091 (485) 66,702
Total fixed maturities 371,714 14,325 (636) 385,403
Equity securities
Preferred stock 882 19 - 901
Short-term investments 233 - - 233
$372,829 $14,344 ($636) $386,537
December 31, 1997
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $78,623 $667 $(22) $79,268
Debt securities issued by
foreign governments 5,857 130 (6) 5,981
Tax-exempt obligations of states
and political subdivisions 108,194 4,322 - 112,516
Mortgage-backed securities 47,488 501 (47) 47,942
Corporate securities 34,344 617 (115) 34,846
274,506 6,237 (190) 280,553
Short-term investments 257 - - 257
$274,763 $6,237 $(190) $280,810
5. Long-Term Debt
In July 1998, the Company borrowed $55.0 million from a group of
commercial lending institutions to finance the cash portion of the purchase
price, including related expenses, of its acquisition of The First Reinsurance
Company of Hartford and its affiliates and repay previously existing bank
debt. The loan matures in varying amounts through 2004 with interest payable
quarterly. The initial term loan interest rate is equivalent to either the
bank's prime rate plus 62.5 basis points or the London Interbank Offered Rate
("LIBOR") plus 162.5 basis points, at the discretion of the Company. The term
loan agreement contains certain restrictive covenants, including restrictions
on the Company's ability to declare or pay any cash dividends to its
shareholders. As of September 30, 1998, the fair value of the loan
approximated the carrying value.
Principal payments due on the term loan are as follows:
Principal Amount
Year ending December 31, (Dollars in thousands)
1998 $ 0
1999 0
2000 4,000
2001 6,000
2002 7,500
Thereafter 37,500
Total $ 55,000
The Company has entered into interest rate swap agreements with commercial
lending institutions in order to reduce the impact of interest rate
fluctuations on the Company's term loan. The interest rate swaps were
effected with respect to the first $43.5 million of scheduled principal
amortizations of the $55.0 million loan. The impact of the swap was to
create an effective fixed rate of approximately 7.65% on the $43.5 million
principal amount.
6. Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share," which the Company implemented in 1997. SFAS No. 128 establishes
standards for computing and presenting earnings per share. Primary earnings
per share have been replaced by basic earnings per share and calculated by
dividing income available to common stockholders by the weighted average
number of common shares outstanding during the period. Fully diluted
earnings per share have been replaced by diluted earnings per share and
calculated by including additional common shares that would have been
outstanding if potentially dilutive shares had been issued during the period.
Prior period earnings per share were not affected by the adoption of SFAS
No. 128.
7. Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
comprehensive Income." This statement establishes standards for the reporting
and presentation of comprehensive income and its components in a full set of
financial statements. Comprehensive income encompasses all changes in
shareholders' equity (except those arising from transactions with shareholders)
and includes net income, net unrealized capital gains or losses on available-
for-sale securities and foreign currency translation adjustments, net of
taxes. This new standard changes only the presentation of certain
information in the financial statements and does not affect the Company's
financial position or results of operations.
The summary of the Accumulated other comprehensive income, net of tax, as
reported in the Consolidated Balance Sheets are as follows:
As at September 30, As at December 31,
1998 1997
(Dollars in thousands) (Dollars in thousands)
Unrealized investment gains,
net of tax $8,925 $3,931
Foreign currency translation
adjustments, net of tax (583) (346)
Accumulated other comprehensive
income, net of tax $8,342 $3,585
The following table provides a summary of the components of net unrealized
investment gains (losses), as reported in the Consolidated Statements of
Income:
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
(Dollars in thousands)
Unrealized gains arising during
the period (net taxes of
$2,784 and $2,758 in 1998,
respectively and $567 and $187
in 1997, respectively) $5,172 $1,053 $5,122 $348
Less: reclassification
adjustments for realized
gains (losses) included in net
income (net of taxes of $158
and $134 in 1998, respectively
and $(124) and $(188) in 1997,
respectively) 293 (231) 250 (350)
Net unrealized investment gains
on securities $4,879 $1,284 $4,872 $698
8. New Accounting Standards
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information". SFAS No. 131 redefines how operating
segments are determined and requires disclosure of certain financial and
descriptive information about a company's operating segments. This statement
relates to presentation of information and will have no impact on results of
operations or financial condition. An annual presentation is required for the
year ending December 31, 1998 and interim financial information will be
required beginning in 1999 (with comparative 1998 information). The Company
is currently evaluating the segment information disclosures required by
SFAS No. 131.
In December 1997, the American Institute of Certified Public Accountants issued
Statement of Position No. 97-3 "Accounting by Insurance and Other Enterprises
for Insurance-related Assessments" ("SOP 97-3"). SOP 97-3 establishes
standards for accounting for guaranty-fund and certain other insurance related
assessments. SOP 97-3 is effective for fiscal years beginning after December
15, 1998 and requires any impact of adoption to be reported as a change in
accounting principle. The adoption of this statement is not expected to have a
material effect on the Company's results of operations or financial condition.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which requires
companies to record all derivatives on the balance sheet as either assets or
liabilities and measure those instruments at fair value. The manner in which
companies are to record gains or losses resulting from changes in the values of
those derivatives depends on the use of the derivative and whether it qualifies
for hedge accounting. This standard is effective January 1, 2000, with early
adoption permitted. The Company is currently evaluating the impact of the
adoption of this statement and the potential effect on its financial position
and results of operations.
9. Unaudited Consolidated Financial Statements
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
results of operations and financial position of the Company for the periods
ended September 30, 1998 and 1997. The unaudited consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related notes to financial statements as contained in the
Company's 1997 Annual Report on Form 10-K. The results of operations for the
period presented are not necessarily indicative of the results to be expected
for the entire year.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
General
The Company is a holding company that, through its subsidiaries,
underwrites specialty property and casualty insurance in sectors of the
insurance industry that are generally considered difficult to insure. Many of
the coverages written by the Company can be categorized as excess and surplus
lines, which generally means that the risks are nonstandard, or that the
policies in respect of the risks are written with unusual limits or at deviated
rates. The property and casualty insurance industry is highly cyclical. The
excess and surplus lines sectors of the property and casualty insurance
industry are often subject to greater cyclicality and volatility than the
industry in general. During soft markets, large standard lines insurers
often utilize excess capacity to assume risks in excess and surplus and
specialty lines. During hard markets, such insurers tend to abandon the
excess and surplus and specialty lines to the carriers that concentrate in
these sectors. Thus, capacity in these lines will fluctuate substantially,
often with fluctuations in revenues or profits, or both.
Acquisition
On July 13, 1998, the Company completed its acquisition of The First
Reinsurance Company of Hartford and its affiliates (collectively "First Re"),
which were accounted for by the purchase method of accounting; results are
included in the financial statements from the acquisition date.
Results of Operations
Third Quarter of 1998 Compared with the Third Quarter of 1997
Gross Premiums Written. Gross premiums written were $48.6 million for the
third quarter of 1998, compared with $37.3 million for the third quarter of
1997. In 1998, the acquisition of First Re contributed $9.7 million of gross
premiums written and the Company's other operating subsidiaries experienced
increases in the following lines of business: a $3.4 million increase in
Difference in Conditions ("DIC") premiums as a result of the replacement of a
companion carrier by a quota share reinsurer in 1998; and a $2.0 million
increase in Architects' & Engineers' Liability, primarily due to expanded
marketing and the issuance of new multi-year policies. Such increases were
partially offset by a $1.4 million decrease in Specialty Lines, primarily
due to the cancellation of brokerage business; a $1.3 million decrease in
Casualty premiums, primarily due to the discontinuance of a residential
real estate developers book of business in 1998; a $0.6 million decrease
in Commercial Automobile, due to non-renewal of policies because of
competitive market conditions; and a $0.4 million decrease in Other
Property, primarily in the Company's national account business.
Net Premiums. Net premiums written increased to $29.1 million for the
third quarter of 1998 from $28.2 million for the third quarter of 1997. Net
premiums written were affected in 1998 by most of the factors described above,
including the contribution of $5.0 million to net premiums from the acquisition
of First Re in 1998. In addition, Commercial Automobile and DIC net premiums
written decreased due to increased ceded premiums from quota share reinsurance
agreements entered into in 1998. The Commercial Automobile quota share treaty
reduced the net retention to $250,000 per risk from $500,000 per risk, and in
DIC a companion carrier was replaced by a quota share reinsurer.
Net premiums earned increased by 2.3% to $28.4 million for the third
quarter of 1998 from $27.8 million in the third quarter of 1997. The
acquisition of First Re contributed $4.8 million, mitigated by decreases in net
premiums earned in Commercial Automobile, Casualty lines, Other Property and
DIC, as well as increased reinsurance costs.
Net Investment Income. Net investment income was $5.4 million for the
third quarter of 1998, compared with $4.3 million for the third quarter of
1997. In 1998 net investment income was affected by $1.1 million from the
acquisition of First Re and by additional funds available for investment,
offset by lower average interest rates compared with the third quarter of 1997.
Net Realized Gains on Investments. During the third quarter of 1998, the
Company realized a net gain of $0.6 million, compared with a net gain of $2.6
million for the third quarter of 1997. Portfolio sales were effected in each
period to optimize the mix of taxable and tax-exempt investments.
Other Income. For the second quarter of 1997, the Company recorded $0.3
million of underwriting management fees for DIC business underwritten on behalf
of a companion carrier. In 1998, the companion carrier was replaced by a quota
share reinsurer.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
("LAE") were $21.2 million for the third quarter of 1998, compared with $17.9
million for the third quarter of 1997. In the third quarter of 1998, the
Company strengthened reserves by $2 million related to various lines of
business, including commercial automobile, artisan contractors, and liquor
liability in two states, almost all of which had been previously
discontinued, and for stable liability. Also, in 1998, losses and LAE
increased due to the acquisition of First Re.
Underwriting, Acquisition, and Insurance Expenses. Underwriting,
acquisition, and insurance expenses were $12.1 million for the third quarter of
1998, compared with $11.7 million for the third quarter of 1997. In 1998, the
acquisition of First Re contributed to $2.0 million of the increase, which was
partially offset by lower acquisition costs in 1998.
Interest Expense. Interest expense was $0.9 million for the third quarter
of 1998, compared with $0.4 million for the third quarter of 1997. In the
third quarter of 1998, the Company borrowed $55.0 million from a group of
commercial lending institutions to finance the cash portion of the purchase
price of First Re, including related expenses and repay previously existing
bank debt. The increase in the principal amount of debt versus the
year-earlier period was $33.0 million.
Income Taxes (benefit). A $(0.5) million income tax benefit was recorded for
the third quarter of 1998, compared with income taxes of $1.3 million for the
third quarter of 1997. In 1998, the income tax benefit resulted from an
operating loss due to reserve strengthening.
Net Income before Accretion of Preferred Stock. The Company recorded a
net income before accretion of preferred stock of $0.8 million for the third
quarter of 1998, compared with $3.7 million for the third quarter of 1997.
Accretion of Preferred Stock. The Company recorded $0.1 million in the
third quarter of 1998 for the accretion of preferred stock issued in the
acquisition of First Re.
Net Income Attributable to Common Stockholders. Net income attributable
to common stockholders in the third quarter of 1998 was $0.7 million, compared
with $3.7 million for the third quarter of 1997.
Weighted Average Shares Outstanding. Average shares outstanding were 6.7
million in 1998 and 6.7 million in 1997. The Company's basic earnings per
share are calculated by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the period.
Diluted earnings per share includes the conversion of preferred stock to
common stock with the exclusion of the preferred stock accretion from
earnings during the period.
Nine Months Ended September 30, 1998 Compared with the Nine Months Ended
September 30, 1997
Gross Premiums Written. Gross premiums written were $127.1 million for
the nine months ended September 30, 1998, compared with $113.7 million for the
nine months ended September 30, 1997. In 1998, the acquisition of First Re
contributed $9.7 million of gross premiums written and the Company's other
operating subsidiaries experienced increases in the following lines of
business: a $7.5 million increase in Difference in Conditions ("DIC")
premiums as a result of the replacement of a companion carrier by a quota
share reinsurer in 1998; a $5.3 million increase in Architects' & Engineers'
Liability, primarily due to expanded marketing and the issuance of new
multi-year policies; and a $0.7 million increase in Commercial Automobile.
Such increases were partially offset by a $5.2 million decrease in Casualty
premiums, primarily due to the discontinuance of a residential real estate
developers book of business in 1998; a $2.4 million decrease in Specialty
Lines, primarily due to the cancellation of brokerage business; and a
$2.0 million decrease in Other Property, primarily in the Company's national
account business.
Net Premiums. Net premiums written decreased to $76.1 million for the
nine months ended September 30, 1998 from $79.9 million for the nine months
ended September 30, 1997. Net premiums written were affected in 1998 by
most of the factors described above, including a $5.0 million contribution
to net premiums from the acquisition of First Re in 1998. In addition,
Commercial Automobile and DIC net premiums written decreased, due to
increased ceded premiums from quota share reinsurance agreements entered
into in 1998. The Commercial Automobile quota share treaty reduced the
net retention to $250,000 per risk from $500,000 per risk, and in DIC a
companion carrier was replaced by a quota share reinsurer.
Net premiums earned decreased by 5.1% to $72.9 million for the nine months
ended September 30, 1998 from $76.8 million for the nine months ended September
30, 1997. The acquisition of First Re contributed $4.8 million, offset by a
decrease in net premiums earned in Commercial Automobile, Casualty Lines, Other
Property and DIC, as well as increased reinsurance costs.
Net Investment Income. Net investment income was $13.8 million for the
nine months ended September 30, 1998, compared with $12.8 million for the nine
months ended September 30, 1997. In 1998, net investment income was
affected by $1.1 million from the acquisition of First Re and by additional
funds available for investment, offset by lower average interest rates
compared with the nine months ended September 30, 1997.
Net Realized Gains on Investments. During the nine months ended September
30, 1998, the Company realized a net gain of $1.9 million, compared with a net
gain of $2.6 million in 1997. Portfolio sales were effected in each period to
optimize the mix of taxable and tax-exempt investments.
Other Income. For the nine months ended September 30, 1997, the Company
recorded $0.8 million of underwriting management fees for DIC business
underwritten on behalf of a companion carrier. In 1998, the companion carrier
was replaced by a quota share reinsurer.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
("LAE") were $63.9 million for the nine months ended September 30, 1998,
compared with $47.9 million for the nine months ended September 30, 1997. In
the second quarter of 1998 and continuing in the third quarter of 1998, the
Company performed a comprehensive review of its reserves, resulting in an
addition of $10.6 million in the second quarter and $2.0 million in the third
quarter, to reserves relating primarily to previous accident years. The
reserve strengthening related to various lines of business, including
pre-1985 casualty coverages with environmental impairment and
asbestos-related exposures, nursing home liability, commercial automobile,
artisan contractors, and liquor liability in two states, almost all of which
had been previously discontinued, and to health clubs and stable liability.
In addition, First Re's third quarter losses and LAE were included in
results for the nine months ended September 30, 1998.
Underwriting, Acquisition, and Insurance Expenses. Underwriting,
acquisition, and insurance expenses were $34.3 million for the nine months
ended September 30, 1998, compared with $33.7 million for the nine months ended
September 30, 1997. In 1998, these expenses increased by $2.0 million as a
result of the acquisition of First Re and by $0.8 million from a restructuring
charge, recorded in the second quarter of 1998, relating to the elimination of
sixteen positions, as well as the related write-off of future office lease
obligations on certain space that is no longer necessary. The acquisition of
First Re and the restructuring charge was partially offset by lower acquisition
costs in 1998.
Interest Expense. Interest expense was $1.5 million for the nine months
ended September 30, 1998, compared with $1.2 million for the nine months ended
September 30, 1997. In the third quarter of 1998, the Company borrowed $55.0
million from a group of commercial lending institutions to finance the cash
portion of the purchase price of First Re, including related expenses and repay
previously existing bank debt. The increase in the principal amount of debt
versus the year-earlier period was $33.0 million.
Income Taxes (benefit). A $(5.4) million income tax benefit was recorded
for the nine months ended September 30, 1998, compared with income taxes of
$2.2 million for the nine months ended September 30, 1997. In 1998, the
income tax benefit resulted from an operating loss due to reserve
strengthening and a restructuring charge.
Net income (loss) before Accretion of Preferred Stock. The Company
recorded a net loss before accretion of preferred stock of $(5.8) million for
the nine months ended September 30, 1998, compared with the $8.0 million net
income for the nine months ended September 30, 1997.
Accretion of Preferred Stock. The Company recorded $0.1 million in the
third quarter of 1998 for the accretion of preferred stock issued in the
acquisition of First Re.
Net Income (loss) Attributable to Common Stockholders. The Company
recorded a net loss attributable to common stockholders of $(5.9) million for
the nine months ended September 30, 1998, compared with the $8.0 million net
income for the nine months ended September 30, 1997.
Weighted Average Shares Outstanding. Average shares outstanding were 6.7
million in 1998 and 6.7 million in 1997. The Company's basic earnings per
share are calculated by dividing income available to common stockholders
by the weighted average number of common shares outstanding during the
period. Diluted earnings per share includes the conversion of preferred
stock to common stock with the exclusion of the preferred stock accretion
from earnings during the period.
Liquidity and Capital Resources
The Company receives cash from premiums and, to a lesser extent,
investment income. The principal cash outflows are for the payment of claims,
reinsurance premiums, policy acquisition costs and general and administrative
expenses. Net cash provided by operations was $6.2 million for the first nine
months of 1998.
At September 30, 1998, the Company maintained cash and cash equivalents of
$16.7 million to meet current payment obligations. In addition, the Company's
investment portfolio could be substantially liquidated without any material
financial impact. Substantially all of the cash and investments of the Company
at September 30, 1998 were held by its subsidiaries.
As a holding company, the Company depends principally on dividends from
its insurance company subsidiaries to pay corporate overhead expenses,
including principal and interest on its borrowings. The Company's
subsidiaries are subject to state insurance laws that restrict their ability
to collectively pay dividends. Under the insurance code of Pennsylvania,
dividends from Calvert are limited to the greater of 10% of surplus as
regards policyholders as of the preceding year end or the net income for the
previous year, without prior approval from the Pennsylvania Department of
Insurance. Under the insurance code of California, dividends from Associated
are limited to the greater of 10% of policyholders' statutory surplus as of
the preceding year end or the Company's statutory net income for the previous
year, without prior approval from the California Department of Insurance.
Under the insurance code of Connecticut, dividends from First Re are limited
to the greater of 10% of policyholders' statutory surplus as of the preceding
year end or the Company's net income for the previous year, without prior
approval from the Connecticut Department of Insurance, however, as a result
of the acquisition dividends approval is required for a two-year period
following the acquisition date.
The National Association of Insurance Commissioners adopted a risk-based
capital system for assessing the adequacy of statutory capital and surplus for
all property and casualty insurers. Based on the guidelines and computations
made by the Company in conformity with such guidelines, Associated, Calvert and
First Re have exceeded the required levels of capital. There can be no
assurance that capital requirements applicable to the Company's business will
not increase in the future.
On July 13, 1998, the Company acquired The First Reinsurance Company of
Hartford and Oakley Underwriting Agency from Dearborn Risk Management, Inc. for
an estimated combination of cash and preferred stock valued at $43.6 million,
plus certain other performance-driven contingent consideration.
The total estimated purchase consideration of $43.6 million consisted of
$31.9 million of cash and $11.7 million fair value of a new issue of Gryphon
perpetual convertible preferred stock. The preferred stock, which has a face
amount of $14.4 million, is convertible into 643,672 shares of the Company's
common stock, reflecting a conversion price of $22.44 per share. No cash
dividends will be paid or owed during the first four and one-half years; a cash
dividend at a rate of 4.0% of the face amount will be paid thereafter. The
discount on the preferred shares, attributable to the period in which no cash
dividends are paid, is accreted over that four and one-half years. The
preferred shares, which are non-callable for three years, have no sinking fund
or mandatory redemption features. In connection with the transaction, Gryphon
entered into a $55 million credit facility with a group of financial
institutions, the proceeds of which were used to pay the cash portion of the
purchase price and to repay existing bank borrowings.
The Company regularly evaluates opportunities for the acquisitions of
books of business, of specialty insurance companies or companies in related
businesses and for business combinations or joint ventures with other specialty
insurance companies. There can be no assurance, however, that any suitable
business opportunities will arise. In the event that such opportunities do
arise, the Company may incur indebtedness for borrowed money in connection with
the consummation of any such transaction. Such indebtedness, under certain
circumstances, could adversely affect the Company's liquidity and capital
resources.
The Company has no off-balance-sheet obligations that are not disclosed in
its financial statements. The Company believes that retained earnings will be
sufficient to satisfy its long-term capital requirements to fund growth.
Year 2000 Issue
There has been significant public discussion in recent years of the "Year 2000"
issue, which relates to the potential inability of computer programs and
systems to adequately store and process data after December 31, 1999, due
to the inability of such programs and systems to identify correct dates
subsequent to December 31, 1999.
The Company has initiated a Year 2000 Compliance Review to address this
issue, which is overseen by a Year 2000 Compliance Group comprised of
representatives from both technical and non-technical departments of the
Company. In addition, the Company has sought the assistance of outside
technical and legal advisors. The Board of Directors and its Audit Committee
receive regular reports on the status of the Year 2000 Compliance Review, which
involves six phases: awareness and initial assessment; inventory of potential
problems; development of corrective plans; remediation; testing; and deployment
of corrected systems.
The Company's core financial and operational computer and software systems were
scheduled for replacement in 1998, independent of any Year 2000 remediation
efforts. At this stage, these systems are in the testing and deployment phases
of the Year 2000 Compliance Review, and management believes that these systems
will be suitable for continued use into and beyond the year 2000. If for any
reason these systems are not suitable for such use, the Year 2000 problem could
have a material adverse impact on the Company's ability to meet financial and
reporting requirements and to support its insurance operations.
The Company's Year 2000 Compliance Review includes an assessment of
"embedded chip" systems associated with its end-user computing hardware and
software (including personal computers, spreadsheets, word processing and other
personal and work group applications), its corporate facilities (such as
security systems, elevators and climate control systems) and its office
equipment (including telephones, fax machines and similar equipment). The
Company is continuing to identify potential problems associated with its
embedded chip systems and to develop corrective plans to avoid or mitigate such
potential problems. Where appropriate, the Company intends to upgrade or
replace non-compliant embedded chip systems to avoid potential Year 2000
problems. The Company anticipates that the deployment of corrected systems for
its "embedded chip" technology will be completed during the second quarter of
1999.
The Company has initiated discussions with a broad group of suppliers,
business partners, customers and other parties to determine the extent to which
the Company may be vulnerable to the failure of these parties to address and
correct their own Year 2000 problems. The Company has reviewed written
questionnaires returned by these parties, and it intends to monitor the
state of compliance of those key business affiliates that provide
significant support to the Company's insurance operations, and, where
necessary, to work with these parties to address potential problems.
However, there can be no guarantee that the systems of other companies
that support the Company's operations will be timely converted or that a
failure by these companies to correct their Year 2000 problems will not
have a material adverse effect on the Company.
The Company is reviewing with the management of First Re the integration
of First Re's computer systems and programs with those of the Company in light
of various operational considerations. At this stage, the software and computer
systems of First Re in place prior to the acquisition are in the testing and
deployment phases of the Company's Year 2000 Compliance Review, and management
believes that these systems will be suitable for use into and beyond the year
2000. It is not anticipated that the eventual integration of First Re's
systems with those of the Company will be influenced by Year 2000
considerations.
The Company's Year 2000 Compliance Review is intended to reduce significantly
the level of uncertainty associated with the Year 2000 issue. As
part of this review, the Company plans to develop contingency plans to address
and mitigate the potential impact of problems that might surface with the
approach of the millennium. In light of the current stage of the Company's
review of its core financial and operational systems and its "embedded chip"
technology, the Company is developing contingency plans that focus on the
potential interruption of support services provided to the Company by business
affiliates or public authorities due to problems these parties may experience
in connection with the Year 2000 issue. The Company intends to explore these
and other "worst case" scenarios in the coming months to anticipate and limit,
wherever possible, the potential impact of any such scenario on the Company's
insurance operations or financial condition. These plans will include
identifying alternate suppliers and vendors, conducting staff training and
developing alternative communication plans.
Several years ago, the Company initiated a program to replace by 1998 its
core computer systems and software in order to enhance its internal
capabilities, better support its business affiliates and improve its service to
policyholders. An incidental benefit of this program has been the replacement
of dated technology with new systems and software that are Year 2000
compliant. As a result, costs incurred to date by the Company in connection
with its Year 2000 Compliance Review have been less than $100,000, and the
Company anticipates that the costs associated with any remaining actions in
connection with the Year 2000 Compliance Review, such as the completion of
a Year 2000 audit by an independent consultant and the potential replacement
or upgrade of non-compliant embedded chip technology, will not be material.
The Company is currently assessing what changes may be appropriate in
insurance coverages it currently markets in light of the Year 2000 issue. In
this connection, management is considering possible modifications and/or
exclusions to policy forms that could be implemented in connection with future
insurance policies that will extend coverage beyond December 31, 1999. In the
past, judicial interpretations have expanded the coverage of insurance
policies, including those regarding pollution and other environmental
exposures, beyond the scope anticipated by insurers. This has increased
the difficulty of estimating the loss and loss adjustment expense reserves
established by insurers. The Company will continue to review its reserves
in light of evolving developments relating to the Year 2000 issue.
The dates on which the Company believes that the various components of its
Year 2000 Compliance Review will be completed are based on management's best
estimates, which, in turn, are based upon numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
compliance plans and other factors. As a result, there can be no guarantee
that the Company's schedule of completion dates will be realized or that
there will not be increased costs associated with the implementation of the
Year 2000 Compliance Review. Due to the general uncertainty inherent in the
Year 2000 problem, resulting in part from the uncertainty of the Year 2000
readiness of third-parties, the Company cannot assure its ability to timely
and cost-effectively resolve problems associated with the Year 2000 issue
that may effect its operations and business or expose it to third-party
liability.
Effects of Inflation
There was no significant impact on the Company's operations as a result of
inflation during the third quarter of 1998. However, there can be no assurance
that inflation will not have a material impact on the Company's operations in
the future.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 20, 1998, Markel Corporation ("Markel"), the beneficial owner of
11.7% of the Company's outstanding common stock, commenced an action in the
Court of Chancery of the State of Delaware in and for New Castle County (the
"Delaware Litigation"), which names the Company and its Board as defendants.
In the Delaware Litigation, Markel seeks, among other things, (i) an injunction
enjoining the Board from adopting any defensive measure which has the effect of
impeding, thwarting, frustrating or interfering with an unsolicited tender
offer (the "Offer") by Markel to purchase, for $18.00 per share, all of the
outstanding common stock of the Company; (ii) a declaration that a certain
rights agreement (the "Rights Agreement") dated as of June 5, 1995, as amended
from time to time thereafter, between the Company and State Street Bank and
Trust Company, as Rights Agent, is invalid and that the adoption of the Rights
Agreement constituted a breach of fiduciary duty and violated Delaware law; and
(iii) a declaration that the Company's failure to render Section 203 of the
Delaware General Corporation Law inapplicable to the Offer constitutes a breach
of fiduciary duty. The Company and the Board believe that they have
meritorious defenses to the Delaware Litigation and intend to defend the
action on that basis.
The proposed acquisition of the outstanding common stock of the Company by
Markel pursuant to the Offer will require the approvals of the Insurance
Commissions of California, Connecticut and Pennsylvania, which are the states
in which the insurance companies owned by the Company are domiciled. The
filing by Markel with each of these Insurance Commissions of an application
for the approval of its acquisition of control of the Company has triggered
public hearing requirements and/or statutory periods within which decisions
by these authorities must be rendered. The Company has not yet determined
the position it will take with respect to these applications.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit No. Description Page No.
27 Financial Data Schedule 24
b) The following Forms 8-K and financial statements were filed during the third
quarter of 1998:
1. Form 8-K filed July 27, 1998 reporting the completion of the acquisition
from Dearborn Risk Management, Inc. of all of the issued and outstanding
shares of capital stock of The First Reinsurance Company of Hartford,
Oakley Underwriting Agency, Inc. and F/I Insurance Agency, Incorporated
(collectively, the "Acquired Companies").
2. Form 8-K filed July 29, 1998 reporting the amendment of the Company's
Shareholder Rights Plan.
3. Form 8-K/A filed September 28, 1998 submitting the financial statements of
the Acquired Companies.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Gryphon Holdings Inc.
(Registrant)
Date: November 16, 1998 Stephen A. Crane
Stephen A. Crane
President & Chief Executive
Officer
Date: November 16, 1998 Robert P. Cuthbert
Robert P. Cuthbert
Senior Vice President &
Chief Financial Officer
(Principal Financial and
Accounting Officer)