1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended June 30, 1996.
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number 1-12800
EXECUTIVE RISK INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1388171
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
82 Hopmeadow Street
Simsbury, Connecticut 06070
(Address of principal executive offices) (Zip Code)
(860) 408-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No .
--- ---
As of August 7, 1996, there were 9,309,366 shares of Executive Risk
Inc. Common Stock, $0.01 par value, outstanding.
As of August 7, 1996, there were --0-- shares of Executive Risk Inc.
Class B Common Stock, $0.01 par value, outstanding.
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EXECUTIVE RISK INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
- ------------------------------ ----
Item 1. Financial Statements
Independent Accountants' Review Report................................................. 2
Consolidated Balance Sheets -
June 30, 1996 and December 31, 1995.................................................... 3
Consolidated Statements of Income -
Three Months and Six Months Ended June 30, 1996 and 1995............................... 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1996 and 1995................................................ 5
Notes to Consolidated Financial Statements............................................. 6-8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................. 8-12
PART II - OTHER INFORMATION
Item 4. Submission of Matters to Vote of Security Holders ................................. 13
Item 6. Exhibits and Reports on Form 8-K................................................... 13
Signatures.................................................................................. 14
Exhibit 15 - Independent Accountants' Acknowledgement Letter ............................... 15
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ITEM 1. FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Stockholders and Board of Directors
Executive Risk Inc.
We have reviewed the accompanying consolidated balance sheet of Executive Risk
Inc. and its subsidiaries as of June 30, 1996, and the related consolidated
statements of income for the three-month and six-month periods ended June 30,
1996 and 1995 and the consolidated statements of cash flows for the six-month
periods ended June 30, 1996 and 1995. These consolidated financial statements
are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
consolidated financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Executive Risk Inc. and
subsidiaries as of December 31, 1995, and the related consolidated statements of
income, stockholders' equity and cash flows for the year then ended (not
presented herein) and in our report dated February 2, 1996, we expressed an
unqualified opinion on those consolidated financial statements.
/s/ ERNST & YOUNG LLP
Stamford, Connecticut
July 7,1996
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
(In thousands, except share data) 1996 1995
---------- -----------
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost: 1996 - $484,957 and 1995 - $480,135) $ 496,504 $ 503,485
Equity securities available for sale, at fair value
(cost: 1996 - $22,338 and 1995 - $20,474) 30,249 26,123
Cash and short-term investments, at cost which approximates market 54,303 20,244
--------- ---------
TOTAL CASH AND INVESTED ASSETS $ 581,056 $ 549,852
Premiums receivable 21,698 10,652
Reinsurance recoverables 52,833 33,781
Accrued investment income 8,576 9,409
Investment in UPEX 990 990
Deferred acquisition costs 19,424 16,244
Prepaid reinsurance premiums 45,721 32,303
Deferred income taxes 24,494 18,337
Other assets 18,583 16,269
--------- ---------
TOTAL ASSETS $ 773,375 $ 687,837
========= =========
LIABILITIES
Loss and loss adjustment expenses $ 383,683 $ 324,416
Unearned premiums 156,214 116,971
Note payable to bank 70,000 25,000
Accrued expenses and other liabilities 44,950 43,725
--------- ---------
TOTAL LIABILITIES 654,847 510,112
STOCKHOLDERS' EQUITY
Common Stock, $.01 par value; authorized - 52,500,000 shares; issued - 1996 -
10,423,241 shares and 1995 - 11,626,766 shares
outstanding - 1996 - 9,307,991 shares and 1995 - 11,497,816 shares 104 116
Additional paid-in capital 87,889 87,228
Unrealized gains on investments, net of tax 12,837 19,156
Currency translation adjustments (155) 29
Retained earnings 50,437 74,315
Cost of shares in treasury, at cost: 1996 - 1,115,250 shares and
1995 - 128,950 shares (32,584) (3,119)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 118,528 177,725
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 773,375 $ 687,837
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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EXECUTIVE RISK INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
(In thousands, except per share data) 1996 1995 1996 1995
---------- ---------- ---------- ---------
REVENUES
Gross premiums written $ 90,357 $ 51,619 $ 148,039 $ 87,252
Premiums ceded (33,043) (13,578) (51,874) (23,741)
-------- -------- --------- --------
Net premiums written 57,314 38,041 96,165 63,511
Change in unearned premiums (20,889) (10,029) (25,827) (10,212)
-------- -------- --------- --------
NET PREMIUMS EARNED 36,425 28,012 70,338 53,299
Net investment income 7,450 6,406 14,825 12,690
Net realized capital (losses) gains (1,308) 1,717 (354) 1,268
Other income (losses) 195 (95) 287 7
-------- -------- --------- --------
TOTAL REVENUES 42,762 36,040 85,096 67,264
EXPENSES
Loss and loss adjustment expenses 24,607 18,881 47,501 35,939
Policy acquisition costs 6,225 5,192 12,969 10,072
General and administrative expenses 3,912 2,520 7,080 4,874
Long-term incentive compensation 173 187 593
Interest expense 1,296 500 1,874 971
-------- -------- --------- --------
TOTAL EXPENSES 36,040 27,266 69,611 52,449
-------- -------- --------- --------
INCOME BEFORE INCOME TAXES 6,722 8,774 15,485 14,815
Income tax expense (benefit)
Current 3,899 2,177 5,634 3,246
Deferred (2,737) (472) (2,934) (798)
-------- -------- --------- --------
1,162 1,705 2,700 2,448
-------- -------- --------- --------
NET INCOME $ 5,560 $ 7,069 $ 12,785 $ 12,367
======== ======== ========= ========
Earnings per common and common equivalent share $ 0.57 $ 0.59 $ 1.17 $ 1.04
Weighted average shares outstanding 9,809 11,850 10,910 11,799
Earnings per common and common equivalent share -
assuming full dilution $ 0.56 $ 0.59 $ 1.17 $ 1.04
Weighted average shares outstanding -
assuming full dilution 9,856 11,903 10,950 11,861
Dividends declared per common share $ 0.02 $ 0.02 $ 0.04 $ 0.04
NOTE: The sum of the 1996 quarters' earnings per share does not equal the
year-to-date per share amount.
The accompanying notes are an integral part of the consolidated financial
statements.
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EXECUTIVE RISK INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
(In thousands) 1996 1995
----------- -----------
OPERATING ACTIVITIES
Net income $ 12,785 $ 12,367
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation 826 413
Share of income of UPEX (60) (7)
Deferred income taxes (2,934) (798)
Amortization of bond premium 739 808
Net realized losses (gains) on investments 354 (1,268)
Other (476) (909)
Change in:
Premiums receivable (11,046) (9,040)
Accrued investment income 833 (615)
Deferred acquisition costs (3,180) (1,940)
Loss and loss adjustment expenses, net of reinsurance recoverables 40,215 12,938
Unearned premiums, net of prepaid reinsurance premiums 25,827 10,212
Accrued expenses and other liabilities (2,283) 293
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 61,600 22,454
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 114,129 80,343
Proceeds from maturities of investment securities 12,560 7,433
Purchase of investment securities (130,777) (110,205)
Net capital expenditures (1,804) (2,281)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (5,892) (24,710)
FINANCING ACTIVITIES
Placement fees and other (136)
Proceeds from exercise of options 233 5
Repayment of note payable to bank (25,000)
Note payable to bank 70,000
Loan arrangement fees (980)
Cost of repurchase of Common Stock (75,025)
Proceeds from Over-allotment option exercise 9,675
Dividends paid on Common Stock (416) (460)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (21,649) (455)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 34,059 (2,711)
--------- ---------
Cash and short-term investments at beginning of period 20,244 24,567
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 54,303 $ 21,856
========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The accompanying unaudited interim consolidated financial
statements of Executive Risk Inc. (the "Company" or "ERI") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and notes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting solely of normal
recurring accruals) considered necessary for a fair presentation of the
financial position, results of operations and cash flows for the interim periods
have been included. Operating results for any interim period are not necessarily
indicative of results that may be expected for the full year. These consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and related notes contained in the Company's Annual Report
to Shareholders incorporated by reference in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1995.
STOCK PURCHASE & SECONDARY OFFERING: On March 22, 1996, ERI entered into a Stock
Purchase Agreement ("the Agreement") with Aetna Life and Casualty Company
("AL&C") and AL&C's wholly-owned subsidiary, The Aetna Casualty and Surety
Company ("Aetna"). Prior to the closing of the Agreement, Aetna owned 4,511,300
shares of the Company's capital stock, consisting of (i) 3,286,300 shares of
Common Stock and (ii) all 1,225,000 shares of the Class B Common Stock. Together
with an option to purchase 100,000 shares of ERI Common Stock at an exercise
price of $12 per share, AC&S controlled approximately 40% of the Common and
Class B Common Stock. Pursuant to the Agreement, on March 26, 1996, the Company
purchased 1,286,300 shares of ERI Common Stock and 1,225,000 shares of ERI Class
B Common Stock from Aetna at a per share price of $29.875, or approximately $75
million in the aggregate. Upon the closing of the Agreement, 2,000,000 shares of
Common Stock, representing approximately 22% of the Company's issued and
outstanding Common Stock, remained under Aetna ownership. In connection with the
acquisition of Aetna by The Travelers Insurance Group Inc., Aetna transferred
ownership of the remaining Common Stock to AL&C.
In connection with the Agreement, the Company secured a $70 million senior
credit facility (the "Senior Credit Facility") arranged through The Chase
Manhattan Bank (National Association) ("Chase"). See "Credit Agreement."
The Agreement also contained provisions requiring that, except under certain
market and other conditions, the Company was obligated to file a registration
statement with respect to the remaining 2,000,000 shares under AL&C ownership
and AL&C was obligated to sell all of these shares in an underwritten secondary
offering. The secondary offering was completed on June 7, 1996. In conjunction
with the secondary offering, the Company granted to the underwriters an option
to purchase an additional 300,000 shares, at $34.00 per share less underwriting
discounts and commissions of $1.75 per share, to cover over-allotments. Such
over-allotment option was exercised in full, and the Company received $9.7
million in proceeds. The shares for the 300,000 over-allotment option were
issued from shares held in treasury.
On May 10, 1996, the Board of Directors approved a resolution to retire the
1,225,000 shares of Class B Common Stock in treasury acquired in the Aetna stock
repurchase as described above.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CREDIT AGREEMENT: Until March 26, 1996 (the "Closing Date"), the Company had a
credit agreement with Chase, Morgan Guaranty Trust Company of New York and The
Fleet National Bank of Connecticut to borrow up to $50 million, of which $25
million was outstanding through the Closing Date. On the Closing Date, the
Company borrowed $70 million under the terms of the Senior Credit Facility with
Chase. The proceeds of the loan were utilized as follows: $38 million to
partially finance the repurchase of common stock from Aetna, $25 million to
refinance the Company's previously existing debt, and $7 million for general
corporate purposes. In addition, the Company has secured through Chase a $25
million revolving credit facility. The Company has no current plans to draw
funds under the revolving credit facility. Interest accrues on principal
balances outstanding under the term loan and revolving credit facility at a rate
per annum equal to (a) the higher of (i) the federal funds rate plus a
stipulated percentage and (ii) Chase's prime rate or, (b) for London Interbank
Offered Rate ("LIBOR") based loans, LIBOR plus a stipulated percentage over
LIBOR based on the Company's debt-to-capital ratio and its then effective
Standard & Poor's claims-paying ability rating.
On May 31, 1996, as required under the Term Loan Agreement, the Company entered
into an interest rate protection agreement providing interest rate protection
for an aggregate notional amount equal to 50% of the principal outstanding under
the term loan. This interest rate protection agreement is structured in two
parts with 3 month LIBOR as the reference rate: a $35 million interest rate swap
from May 31, 1996 to November 30, 1997 and an interest rate cap on 50% of the
principal then outstanding with a strike rate of 7.75% from November 30, 1997 to
May 31, 2002. The interest rate swap involves the receipt of floating rate
interest payments over the life of the agreement in exchange for fixed interest
rate payments over the life of the agreement without an exchange of the $35
million principal amount. In exchange for a premium payment, the interest rate
cap involves the Company receiving the maximum of zero or 3 month LIBOR less the
strike rate on the then outstanding principal amount. The differential to be
paid or received is accrued as interest rates change and is recognized as an
adjustment to interest expense related to the debt. Under the terms of the
interest rate protection agreement, the all-in borrowing rate for the Company is
7.10%. The fair value of the interest rate protection agreement is not
recognized in the financial statements.
In connection with the Senior Credit Facility, the Company has pledged the stock
of its direct subsidiary, Executive Re ("Executive Re"), and Executive Re has
pledged the stock of its direct subsidiary, Executive Risk Indemnity Inc.
("ERII"). The terms of the credit agreements require, among other things, that
the Company maintain certain defined minimum consolidated net worth and combined
statutory surplus levels, and certain debt leverage, premiums-to-surplus and
fixed charge ratios, and place restrictions on the payment of dividends, the
incurrence of additional debt, the sale of assets, the making of acquisitions
and the incurrence of liens.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
NOTE 2 - PRO FORMA FINANCIAL DATA
The following table presents consolidated pro forma income statement data for
the three months and six months ended June 30, 1995, as adjusted to give pro
forma effect to the stock repurchase of 2,511,300 shares of the Company's
capital stock as if it had occurred on March 26, 1995 and the exercise of the
300,000 share over-allotment option in the secondary offering, at $32.25 per
share, as if it had occurred on June 7, 1995.
Three Months Ended Six Months Ended
(In thousands, except per share data) June 30, 1995 June 30, 1995
-------------------- -------------------
Total revenue $35,641 $66,841
Net income $ 6,203 $11,452
Earnings per common share -
assuming full dilution $ 0.64 $ 1.09
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis of financial condition and results of
operations compares certain financial results for the three months and six
months ended June 30, 1996 with the corresponding periods in 1995. The results
of Executive Risk Inc. (the "Company" or "ERI") include the consolidated results
of Executive Risk Management Associates ("ERMA"), Executive Re Inc. ("Executive
Re"), and Executive Re's insurance subsidiaries, Executive Risk Indemnity Inc.
("ERII"), Executive Risk Specialty Insurance Company ("ERSIC"), and Executive
Risk N.V., a Dutch insurance company incorporated in the Netherlands. In
addition, the Company's results include its 50% interest in UAP Executive
Partners ("UPEX"), a French underwriting agency which is a joint venture between
the Company and Union des Assurances de Paris -- Incendie-Accidents. This
interest is reported using the equity method of accounting.
On March 22, 1996, ERI entered into a Stock Purchase Agreement ("the Agreement")
with Aetna Life and Casualty Company ("AL&C") and AL&C's wholly-owned
subsidiary, The Aetna Casualty and Surety Company ("Aetna"). Prior to the
closing of the Agreement, Aetna owned 4,511,300 shares of the Company's capital
stock, consisting of (i) 3,286,300 shares of Common Stock and (ii) all 1,225,000
shares of the Class B Common Stock. Together with an option to purchase 100,000
shares of ERI Common Stock at an exercise price of $12 per share, AC&S
controlled approximately 40% of the Common and Class B Common Stock. Pursuant to
the Agreement, on March 26, 1996, the Company purchased 1,286,300 shares of ERI
Common Stock and 1,225,000 shares of ERI Class B Common Stock from Aetna at a
per share price of $29.875, or approximately $75 million in the aggregate. Upon
the closing of the Agreement, 2,000,000 shares of Common Stock, representing
approximately 22% of the Company's issued and outstanding Common Stock, remained
under Aetna ownership. In connection with the acquisition of Aetna by The
Travelers Insurance Group Inc., Aetna transferred ownership of the remaining
Common Stock to AL&C.
In connection with the Agreement, the Company secured a $70 million senior
credit facility (the "Senior Credit Facility") arranged through The Chase
Manhattan Bank (National Association) ("Chase"). See "Liquidity and Capital
Resources."
The Agreement also contained provisions requiring that, except under certain
market and other conditions, the Company was obligated to file a registration
statement with respect to the remaining 2,000,000 shares under AL&C ownership
and AL&C was obligated to sell all of these shares in an underwritten secondary
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offering. The secondary offering was completed on June 7, 1996. In conjunction
with the secondary offering, the Company granted to the underwriters an option
to purchase an additional 300,000 shares, at $34.00 per share less underwriting
discounts and commissions of $1.75 per share, to cover over-allotments. Such
over-allotment option was exercised in full, and the Company received $9.7
million in proceeds. The shares for the 300,000 over-allotment option were
issued from shares held in treasury.
On May 10, 1996, the Board of Directors approved a resolution to retire the
1,225,000 shares of Class B Common Stock in treasury acquired in the Aetna stock
repurchase as described above.
Results of Operations
The Company's net income for the second quarter of 1996 was $5.6 million, or
$0.56 per share on a fully diluted basis, as compared to $7.1 million, or $0.59
per share, earned in the second quarter of 1995. For the six months ended June
30, 1996 and 1995, net income was $12.8 million and $12.4 million, respectively.
Fully diluted earnings per share were $1.17 and $1.04 for the corresponding
periods. The Company's operating earnings, calculated as net income before
realized capital gains or losses, net of tax, were $6.4 million, or $0.65 per
share on a fully diluted basis, for the quarter ended June 30, 1996 and $6.0
million, or $0.50 per share on a fully diluted basis, for the quarter ended June
30, 1995. For the six months ended June 30, 1996, operating earnings were $13.0
million, or $1.19 per share on a fully diluted basis, as compared to $11.5
million, or $0.97 per share, for the first half of 1995.
Gross premiums written increased by $38.8 million, or 75%, to $90.4 million in
the second quarter of 1996 from $51.6 million in the second quarter of 1995. For
the first half of 1996, gross premiums written were $148.0 million as compared
to $87.3 million in the first half of 1995. The increase was due in part to
growth in all of the Company's key lines of business, including domestic and
international directors and officers liability insurance ("D&O"), and lawyers
professional liability and miscellaneous professional liability errors and
omissions insurance ("E&O"). Also contributing to the rise in gross premiums
written was the Company's ability to issue ERII and ERSIC D&O policies, rather
than Aetna policies, to both new and renewing insureds. Converting an insured to
ERII or ERSIC from Aetna results in the Company receiving 100% of the gross
premiums written (and ceding 12.5% to Aetna) as compared to receiving 50% when
reinsuring Aetna's risks. In the first half of 1996, $104.7 million of gross D&O
premiums written were issued on ERII and ERSIC policies as compared to $31.3
million in the first half of 1995.
Ceded premiums increased $19.4 million, or 143%, to $33.0 million in the second
quarter of 1996 from $13.6 million in the second quarter of 1995. For the first
six months of 1996, ceded premiums totaled $51.9 million, representing a 119%
increase over 1995. The rise in ceded premiums was due principally to an
increase in direct premium volume, a portion of which is ceded to reinsurers
under the Company's various D&O and E&O treaties.
As a result of the foregoing, net premiums written increased $19.3 million, or
51%, to $57.3 million for the quarter ended June 30, 1996 from $38.0 million for
the quarter ended June 30, 1995. For the six months ended June 30, 1996, net
premiums written totaled $96.2 million as compared to $63.5 million for the six
months ended June 30, 1995. Net premiums earned for the second quarter increased
from $28.0 million in 1995 to $36.4 million in 1996. Year-to-date, premiums
earned increased from $53.3 million in 1995 to $70.3 million in 1996.
Net investment income increased by $1.0 million, or 16%, to $7.4 million for the
quarter ended June 30, 1996 from $6.4 million for the quarter ended June 30,
1995. For the first half of 1996 and 1995, net investment income was $14.8
million and $12.7 million, respectively. These increases resulted principally
from growth in invested assets, measured on an amortized cost basis, from $461.6
million at June 30, 1995 to $561.6 million at June 30, 1996. The nominal
portfolio yield of the fixed maturity portfolio at June 30, 1996 was 6.29%,
compared to 6.31% at June 30, 1995. The tax equivalent yields on the fixed
maturity portfolio were 8.36% and 8.62% for these periods, respectively.
The Company's net realized capital losses were $1.3 million in the second
quarter of 1996, as compared to net realized capital gains of $1.7 million in
the second quarter of 1995. For the six months ended June 30, 1996, net realized
capital losses totaled $0.4 million as compared to net realized capital gains of
$1.3 million for the six months ended June 30, 1995. In the second quarter of
1996, fixed maturities with
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relatively low yields were sold at a loss to take advantage of expiring capital
loss carrybacks and replaced with higher yielding securities. Partially
offsetting these realized capital losses were capital gains realized from the
sale of the fixed maturity portfolios of ERI and Executive Re to provide
available cash for the repurchase of common stock from Aetna on March 22, 1996.
Loss and loss adjustment expenses ("LAE") increased by $5.7 million, or 30%,
from $18.9 million in the second quarter of 1995 to $24.6 million in the
comparable period of 1996 due to higher premiums earned. For the first six
months of 1996 and 1995, loss and LAE were $47.5 million and $35.9 million,
respectively. The Company's loss ratio was 67.6% for the second quarter of 1996
and 67.5% for the first six months of 1996 as compared to 67.4% for both the
second quarter and first six months of 1995. In connection with the Company's
normal reserving review, which includes a reevaluation of the adequacy of
reserve levels for prior years' claims, the Company reduced its unpaid loss and
LAE reserves for prior report years by $3.1 million, or $0.18 per share on a
fully diluted basis, in the first half of 1996. In the first half of 1995, the
Company reduced its unpaid loss and LAE reserves for prior report years by $2.4
million, or $0.13 per share on a fully diluted basis. There can be no assurance
that reserve adequacy reevaluations will produce similar reserve reductions and
net income increases in future quarters.
Policy acquisition costs increased by $1.0 million, or 20%, to $6.2 million for
the quarter ended June 30, 1996 from $5.2 million for the quarter ended June 30,
1995, and increased $2.9 million, or 29%, to $13.0 million for the six months
ended June 30, 1996 from $10.1 million for the six months ended June 30, 1995.
The Company's ratio of policy acquisition costs to net premiums earned decreased
slightly from 18.5% in the second quarter of 1995 to 17.1% in the second quarter
of 1996. Year-to-date, the acquisition cost ratio decreased from 18.9% in 1995
to 18.4% in 1996. The decrease in the acquisition cost ratio is attributable to
the savings achieved by paying less in override commissions to AC&S as a result
of converting insureds from AC&S policies to ERII and ERSIC policies. Under the
Amended and Restated Agency and Insurance Services Agreement among Aetna, the
Company and ERMA, ERMA paid Aetna an override commission equal to 3% of gross
written premiums with respect to Aetna D&O policies issued through ERMA through
June 30, 1996. Pursuant to this agreement, effective July 1, 1996, ERMA is no
longer required to pay an override commission to Aetna.
General and administrative ("G&A") expenses increased $1.4 million, or 55%, to
$3.9 million for the quarter ended June 30, 1996 from $2.5 million for the
quarter ended June 30, 1995. For the six months ended June 30, 1996 and 1995,
G&A expenses were $7.1 million and $4.9 million, respectively. The increase in
G&A costs is due largely to increased compensation and related costs associated
with the growth of the business. The ratio of G&A expenses to earned premium
increased to 10.1% for the six months ended June 30, 1996 from 9.2% for the six
months ended June 30, 1995.
The GAAP combined ratio for the second quarter 1996 was 95.4%, compared to 94.9%
for the comparable period in 1995. For the first half of 1996, the GAAP combined
ratio was 96.0%, as compared to 95.5% for the first half of 1995. A combined
ratio below 100% generally indicates profitable underwriting prior to the
consideration of investment income, capital gains and interest expense. A
company with a combined ratio exceeding 100% can still be profitable in that
period due to such factors as investment income and capital gains realized
during that period.
Interest expense is incurred principally on the outstanding balances under the
Company's bank credit agreement. Higher outstanding balances on the debt in 1996
resulted in an increase in interest expense to $1.3 million for the quarter
ended June 30, 1996 as compared to $0.5 million for the quarter ended June 30,
1995. Interest expense was $1.9 million for the first half of 1996 and $1.0
million for the first half of 1995. The outstanding balances were $25 million
for the quarter and six months ended June 30, 1995, $25 million from January 1,
1996 through March 26, 1996 and $70 million from March 26 through June 30, 1996.
See "Liquidity and Capital Resources."
Income tax expense decreased $0.5 million, or 32%, from $1.7 million in the
second quarter of 1995 to $1.2 million in the second quarter of 1996. The
Company's effective tax rate decreased from 19.4% to 17.3% for the same periods.
The decrease in the effective tax rate was due to an increase in tax-exempt
investment income as a percentage of pretax income. Income tax expense was $2.7
million for the first half of 1996 and $2.4 million for the first half of 1995.
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Liquidity and Capital Resources
ERI is a holding company, the principal asset of which is equity in its
subsidiaries. ERI's cash flows depend primarily on dividends and other payments
from its subsidiaries. ERI's sources of funds consist primarily of premiums
received by the insurance subsidiaries, revenues received by ERMA under
insurance agency arrangements, investment income and proceeds from sales and
redemptions of investments. Funds are used primarily to pay claims and operating
expenses, to purchase investments, and to pay interest and principal under the
Company's bank credit agreement.
Cash flows from operating activities were $61.6 million for the six months ended
June 30, 1996 and $22.5 million for the six months ended June 30, 1995. The
increase in operating cash flows resulted from the increase in net premiums
received resulting from higher net premiums written. In addition, the Company
settled fewer losses in the first half of 1996 than anticipated. These losses
could be settled in future quarters, depressing net cash flows for the remainder
of 1996. Rising loss payments are expected of a maturing professional liability
underwriter.
The Company believes that it has sufficient liquidity to meet its anticipated
insurance obligations as well as its operating and capital expenditure needs.
The Company's investment strategy emphasizes quality, liquidity and
diversification. With respect to liquidity, the Company considers liability
durations, specifically loss reserves, when determining investment maturities.
Average investment duration of the fixed maturity portfolio at June 30, 1996 and
December 31, 1995 was 4.7 and 4.6 years, respectively, as compared to an
expected loss reserve duration of 4.5 to 5.5 years. The Company's short-term
investment pool was $54.3 million (9.3% of the total investment portfolio) at
June 30, 1996 and $20.2 million (3.7%) at December 31, 1995. The increase in the
short-term investment pool was due to strong operating cash flows and $9.7
million of proceeds received from the exercise of the over-allotment option.
The Company's entire investment portfolio is classified as available for sale
under the provisions of Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," and is
reported at fair value, with the resulting unrealized gains or losses included
as a separate component of stockholders' equity until realized. Due to a rise in
interest rates, the market value of the portfolio at June 30, 1996 was 102% of
amortized cost versus 105% of amortized cost at December 31, 1995. At June 30,
1996 and December 31, 1995, stockholders' equity was increased by $7.6 million
and $15.4 million, respectively, to record the Company's fixed maturity
investment portfolio at fair value. At June 30, 1996 and December 31, 1995, the
Company owned no derivative instruments, except for certain mortgage and other
asset backed securities and an interest rate protection agreement which was used
to effectively convert a portion of its floating rate debt to a fixed rate
basis, thus reducing the impact of interest rate changes on future income.
Until March 26, 1996 (the "Closing Date"), the Company had a credit agreement
with Chase, Morgan Guaranty Trust Company of New York and The Fleet National
Bank of Connecticut to borrow up to $50 million, of which $25 million was
outstanding through the Closing Date. On the Closing Date, the Company borrowed
$70 million under the terms of the Senior Credit Facility with Chase. The
proceeds of the loan were utilized as follows: $38 million to partially finance
the repurchase of common stock from Aetna, $25 million to refinance the
Company's previously existing debt, and $7 million for general corporate
purposes. In addition, the Company has secured through Chase a $25 million
revolving credit facility. The Company has no current plans to draw funds under
the revolving credit facility. Interest accrues on principal balances
outstanding under the term loan and revolving credit facility at a rate per
annum equal to (a) the higher of (i) the federal funds rate plus a stipulated
percentage and (ii) Chase's prime rate or, (b) for London Interbank Offered Rate
("LIBOR") based loans, LIBOR plus a stipulated percentage over LIBOR based on
the Company's debt-to-capital ratio and its then effective Standard & Poor's
claims-paying ability rating.
On May 31, 1996, as required under the Term Loan Agreement, the Company entered
into an interest rate protection agreement providing interest rate protection
for an aggregate notional amount equal to 50% of the principal outstanding under
the term loan. This interest rate protection agreement is structured in two
parts with 3 month LIBOR as the reference rate: a $35 million interest rate swap
from May 31, 1996 to November 30, 1997 and an interest rate cap on 50% of the
principal then outstanding with a strike rate of 7.75% from November 30, 1997 to
May 31, 2002. The interest rate swap involves the receipt of floating rate
interest payments over the life of the agreement in exchange for fixed interest
rate payments over the
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life of the agreement without an exchange of the $35 million principal amount.
In exchange for a premium payment, the interest rate cap involves the Company
receiving the maximum of zero or 3 month LIBOR less the strike rate on the then
outstanding principal amount. The differential to be paid or received is accrued
as interest rates change and is recognized as an adjustment to interest expense
related to the debt. Under the terms of the interest rate protection agreement,
the all-in borrowing rate for the Company is 7.10%. The fair value of the
interest rate protection agreement is not recognized in the financial
statements.
In connection with the Senior Credit Facility, the Company has pledged the stock
of its direct subsidiary, Executive Re, and Executive Re has pledged the stock
of its direct subsidiary, ERII. The terms of the credit agreements require,
among other things, that the Company maintain certain defined minimum
consolidated net worth and combined statutory surplus levels, and certain debt
leverage, premiums-to- surplus and fixed charge ratios, and place restrictions
on the payment of dividends, the incurrence of additional debt, the sale of
assets, the making of acquisitions and the incurrence of liens.
On May 10, 1996, the Company declared its second quarter dividend on the
Company's Common Stock of $.02 per share, which was paid on June 28, 1996 to
stockholders of record as of June 15, 1996. Such dividends totaled $0.2 million.
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PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on Friday, May
10, 1996 at 10:00 a.m. (the "1996 Annual Meeting"). At the 1996 Annual Meeting,
the following director was elected as a Class II director to a term expiring at
the 1998 Annual Meeting: Gary G. Benanav. The following directors were elected
as Class III directors, each to a term expiring at the 1999 Annual Meeting:
Barbara Cohen, Joseph P. Kiernan, Joseph D. Sargent and Stephen J. Sills. Those
directors who continued on the Board as of the 1996 Annual Meeting are: Robert
H. Kullas, John G. Crosby, Patrick A. Gerschel, Peter A. Goldberg, Michael D.
Rice and LeRoy A. Vander Putten.
Also presented to stockholders at the 1996 Annual Meeting was a
resolution to approve the Company's Performance Share Plan, under which
1,000,000 shares of the Company's Common Stock was set aside for issuance to
senior management employees upon the Company's achievement of certain
performance measures as described in the Plan. The resolution was adopted by the
stockholders by the vote shown below.
1. Election of Directors:
Name Common Shares "For" Class B Common Shares "For" Shares Withheld
---- ------------------- --------------------------- ---------------
Gary G. Benanv 8,911,011 1,225,000 33,650
Barbara G. Cohen 8,921,611 1,225,000 23,050
Joseph P. Kiernan 8,910,811 1,225,000 33,850
Joseph D. Sargent 8,911,011 1,225,000 33,650
Stephen J. Sills 8,910,911 1,225,000 33,750
2. Approval of Performance Share Plan
6,476,554 shares IN FAVOR 1,739,591 shares AGAINST 1,365 shares ABSTAIN
3. Ratification of Ernst & Young LLP as independent accountants for 1996
8,941,911 shares IN FAVOR 1,700 shares AGAINST 1,050 shares ABSTAIN
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBIT INDEX
Exhibit No. Description Page
----------- ----------- ----
15 Independent Accountant's Acknowledgement Letter
27 Financial Data Schedule
B) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed by the Company during the quarter ended
June 30, 1996.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SIGNATURE TITLE DATE
--------- ----- ----
/S/Robert H. Kullas Vice Chairman, Chief Operating Officer and August 12, 1996
Robert H. Kullas Director
/S/ Robert V. Deutsch Executive Vice President, Chief Financial Officer, August 12, 1996
Robert V. Deutsch Chief Actuary, Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
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