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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 September 30, 1998.
[ ] 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 November 6, 1998 there were 11,102,739 shares of Executive Risk
Inc. Common Stock, $0.01 par value, outstanding, net of treasury shares.
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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 -
September 30, 1998 and December 31, 1997................................ 3
Consolidated Statements of Income -
Nine Months Ended September 30, 1998 and 1997 .......................... 4
Consolidated Statements of Cash Flows -
Three and Nine Months Ended September 30, 1998 and 1997 ................ 5
Notes to Consolidated Financial Statements.............................. 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 8-11
PART II - OTHER INFORMATION
Item 5. Other Information................................................. 11
Item 6. Exhibits and Reports on Form 8-K.................................. 11
SIGNATURES................................................................. 12
Exhibit 15.1 - Independent Accountants' Acknowledgment Letter.............. 13
Exhibit 27 - Financial Data Schedule ...................................... --
NOTE ON FORWARD-LOOKING STATEMENTS: The Private Securities Litigation Reform Act
of 1995 provides a "safe harbor" for forward-looking statements. This Report may
include forward-looking statements, as do other publicly available Company
documents, including reports on Forms 10-K, 10-Q and 8-K filed with the
Securities and Exchange Commission and other written or oral statements made by
or on behalf of the Company, its officers and employees. When made, such
forward-looking statements reflect the then-current views of the Company or its
management with respect to future events and financial performance. There are
known and unknown risks, uncertainties and other factors that could cause actual
results to differ materially from those contemplated or indicated by such
forward-looking statements. These include, but are not limited to, risks and
uncertainties inherent in or relating to (i) general economic conditions,
including interest rate movements, inflation and cyclical industry conditions,
(ii) governmental and regulatory policies affecting professional liability, as
well as the judicial environment, (iii) the loss reserving process, (iv)
increasing competition in the market segments in which the Company operates, (v)
the conduct of international operations, including exchange rate fluctuations
and foreign regulatory changes, and (vi) the effects of Year 2000 on Company
insureds and the degree to which liability exposure is affected thereby. The
words "believe," "expect," "anticipate," "project," and similar expressions
identify forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of their
dates. Neither the Company nor its management undertakes any obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
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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 September 30, 1998, and the related consolidated
statements of income for the three-month and nine-month periods ended September
30, 1998 and 1997, and the consolidated statements of cash flows for the
nine-month periods ended September 30, 1998 and 1997. 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 reviews, 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, 1997, 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 3, 1998, we expressed an
unqualified opinion on those consolidated financial statements.
/s/ ERNST & YOUNG LLP
Stamford, Connecticut
October 22, 1998
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
(In thousands, except share data) 1998 1997
----------- -----------
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost: 1998 - $1,063,702 and 1997 - $905,050) $ 1,108,098 $ 934,981
Equity securities available for sale, at fair value
(cost: 1998 - $45,693 and 1997 - $42,787) 69,115 61,732
Cash and short-term investments, at cost which approximates market 48,093 88,505
----------- -----------
TOTAL CASH AND INVESTED ASSETS 1,225,306 1,085,218
Premiums receivable 37,659 40,033
Reinsurance recoverables 262,560 159,918
Accrued investment income 16,687 13,731
Deferred acquisition costs 38,515 34,581
Prepaid reinsurance premiums 131,667 99,847
Deferred income taxes 19,776 23,316
Other assets 50,936 29,160
----------- -----------
TOTAL ASSETS $ 1,783,106 $ 1,485,804
=========== ===========
LIABILITIES
Loss and loss adjustment expenses $ 816,305 $ 637,929
Unearned premiums 341,916 289,840
Senior notes payable 75,000 75,000
Ceded balances payable 47,260 37,165
Accrued expenses and other liabilities 56,363 44,687
----------- -----------
TOTAL LIABILITIES 1,336,844 1,084,621
PREFERRED SECURITIES OF EXECUTIVE RISK CAPITAL TRUST
Company obligated mandatorily redeemable preferred securities of subsidiary,
Executive Risk Capital Trust, holding solely $125,000,000 aggregate
principal amount of 8.675% Series B Junior Subordinated Deferrable Interest
Debentures of the Company due February 1, 2027 and $3,866,000 aggregate
principal amount of 8.675% Series A Junior Subordinated Deferrable Interest
Debentures of the Company due February 1, 2027 125,000 125,000
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value; authorized 4,000,000 shares;
issued - 1998 and 1997 - 0 shares -- --
Common Stock, $.01 par value; authorized 52,500,000 shares;
issued - 1998 - 12,217,033 shares and 1997 - 11,953,358 shares 122 120
Additional paid-in capital 177,027 176,234
Accumulated other comprehensive income 44,880 31,288
Retained earnings 131,789 101,101
Cost of shares in treasury, at cost: 1998 - 1,114,294 and 1997 - 1,114,421 shares (32,556) (32,560)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 321,262 276,183
----------- -----------
TOTAL LIABILITIES, PREFERRED SECURITIES OF EXECUTIVE RISK
CAPITAL TRUST AND STOCKHOLDERS' EQUITY $ 1,783,106 $ 1,485,804
=========== ===========
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 Nine Months Ended
September 30, September 30,
(In thousands, except per share data) 1998 1997 1998 1997
--------- --------- --------- ---------
REVENUES
Gross premiums written $ 137,806 $ 113,692 $ 367,909 $ 308,480
Premiums ceded (65,147) (44,606) (159,668) (117,416)
--------- --------- --------- ---------
Net premiums written 72,659 69,086 208,241 191,064
Change in unearned premiums (8,824) (14,299) (20,245) (39,842)
--------- --------- --------- ---------
NET PREMIUMS EARNED 63,835 54,787 187,996 151,222
Net investment income 15,767 11,682 45,717 33,042
Net realized capital gains 2,193 587 4,838 1,928
Other income 83 35 248 150
--------- --------- --------- ---------
TOTAL REVENUES 81,878 67,091 238,799 186,342
EXPENSES
Loss and loss adjustment expenses 41,998 36,433 124,731 101,543
Policy acquisition costs 14,525 9,085 37,484 24,527
General and administrative expenses 11,870 8,249 26,774 20,334
Interest expense 1,304 27 4,036 1,446
Minority interest in Executive Risk Capital Trust 2,586 2,772 7,903 7,109
--------- --------- --------- ---------
TOTAL EXPENSES 72,283 56,566 200,928 154,959
--------- --------- --------- ---------
INCOME BEFORE TAXES 9,595 10,525 37,871 31,383
Income tax expense (benefit)
Current 3,460 3,751 9,615 10,505
Deferred (2,370) (2,141) (3,089) (5,019)
--------- --------- --------- ---------
1,090 1,610 6,526 5,486
--------- --------- --------- ---------
NET INCOME $ 8,505 $ 8,915 $ 31,345 $ 25,897
========= ========= ========= =========
Earnings per common share $ 0.77 $ 0.91 $ 2.86 $ 2.72
Weighted average shares outstanding 11,023 9,793 10,946 9,513
Earnings per common share -
assuming dilution $ 0.73 $ 0.84 $ 2.68 $ 2.50
Weighted average shares outstanding -
assuming dilution 11,638 10,637 11,696 10,377
Dividends declared per common share $ 0.02 $ 0.02 $ 0.06 $ 0.06
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)
Nine Months Ended September 30,
(In thousands) 1998 1997
--------- ---------
OPERATING ACTIVITIES
Net income $ 31,345 $ 25,897
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation 5,084 1,816
Deferred income taxes (3,089) (5,019)
Amortization of bond premium 2,318 1,259
Net realized gains on investments (4,838) (1,928)
Stock based compensation plans (1,595) 4,380
Amortization of loan arrangement fees 910
Other (3,266) (99)
Change in:
Premiums receivable, net of ceded balances payable 12,469 (4,914)
Accrued investment income (2,956) (1,808)
Deferred acquisition costs (3,934) (9,689)
Loss and loss adjustment expenses, net of reinsurance recoverables 75,734 73,449
Unearned premiums, net of prepaid reinsurance premiums 20,256 39,827
Accrued expenses and other liabilities (5,739) (5,046)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 121,789 119,035
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 421,430 206,782
Proceeds from sales of equity securities available for sale 4,240 1,434
Proceeds from maturities of investment securities 55,019 31,678
Purchase of fixed maturities available for sale (624,182) (392,234)
Purchase of equity securities available for sale (7,089) (10,102)
Net capital expenditures (11,635) (4,763)
Acquisition of the assets of Sullivan, Kelly & Associates, Inc. (2,204)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (162,217) (169,409)
FINANCING ACTIVITIES
Proceeds from exercise of options 857 3,192
Repayment of note payable to bank (70,000)
Proceeds from issuance of Common Stock 68,080
Proceeds from Capital Securities offering 125,000
Placement fees and other (183) (1,476)
Dividends paid on Common Stock (658) (591)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 16 124,205
--------- ---------
NET (DECREASE) INCREASE IN CASH AND SHORT-TERM INVESTMENTS (40,412) 73,831
--------- ---------
Cash and short-term investments at beginning of period 88,505 24,706
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 48,093 $ 98,537
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(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 Stockholders incorporated by reference in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1997.
Certain prior year amounts have been reclassified to conform with the 1998
presentation.
NOTE 2 - NON-RECURRING CHARGES
In the third quarter of fiscal 1998, the Company initiated a plan to close the
Sullivan Kelly, Inc. ("Sullivan Kelly") brokerage operation and the Paris,
France office of Executive Risk, N.V. ("ERNV"). In connection with these
closings, $5.3 million of non-recurring charges were recorded. These
non-recurring charges consisted of $3.7 million related to impairments of good
will and other intangible assets, $1.2 million for lease termination costs and
$0.4 million of employee separation and other costs. These charges were recorded
on the consolidated income statement as $1.9 million of policy acquisition costs
and $3.4 million of general and administrative costs. Operating losses
associated with Sullivan Kelly totaled $0.5 million and $0.9 million, for the
three and nine month periods ended September 30, 1998, respectively. Operating
losses associated with the Paris, France office of ERNV were not material.
NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. SFAS 130 requires unrealized gains
or losses on the Company's available for sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately in
stockholders' equity, to be included in other comprehensive income. Prior year
financial statements have been reclassified to conform to the requirements of
SFAS 130.
During the third quarter of 1998 and 1997, total comprehensive income amounted
to $44.9 million and $35.8 million, respectively.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS, CONTINUED
The components of comprehensive income, net of related tax, for the nine-month
periods ended September 30, 1998 and 1997, respectively, are as follows:
1998 1997
-------- --------
Net income $ 31,345 $ 25,897
-------- --------
Unrealized gains on securities 12,311 10,254
Foreign currency translation adjustments 1,281 (392)
-------- --------
Comprehensive income $ 44,937 $ 35,759
======== ========
The components of accumulated other comprehensive income, net of related tax, at
September 30, 1998 and December 31, 1997 are as follows:
1998 1997
-------- --------
Unrealized gains on securities $ 44,080 $ 31,769
Foreign currency translation adjustments 800 (481)
-------- --------
Accumulated comprehensive income $ 44,880 $ 31,288
======== ========
In March 1998, the American Institute of Certified Public Accountants and the
Accounting Standards Executive Committee issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 requires the capitalization of certain
costs incurred after the date of adoption in connection with developing or
obtaining software for internal use. SOP 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998, and is not
expected to have a material impact on the Company.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those derivatives at fair value. The accounting
for the changes in the fair value of the derivatives depends on the intended use
of the derivative and the resulting designation as prescribed by the provisions
of SFAS 133. SFAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999, with earlier application permitted. The Company
is currently reviewing the provisions of SFAS 133 and its anticipated financial
statement impact to the Company.
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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 nine months ended
September 30, 1998 with the corresponding period for 1997. 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 direct and indirect insurance company subsidiaries,
Executive Risk Indemnity Inc. ("ERII"), Executive Risk Specialty Insurance
Company ("ERSIC"), Executive Risk N.V. ("ERNV"), Quadrant Indemnity Company
("Quadrant") and Executive Risk (Bermuda) Ltd. In addition, the Company's
results include Executive Risk Capital Trust, a Delaware statutory business
trust (the "Trust"), and Sullivan Kelly Inc. ("Sullivan Kelly"), an underwriting
management company which is a subsidiary of Executive Re. In the third quarter
of 1998, the Company initiated a plan to close the Sullivan Kelly brokerage
operation, transfer the remaining Sullivan Kelly underwriting functions to ERMA
and dissolve Sullivan Kelly. The Company also initiated during the third quarter
of 1998 a plan to close the Paris, France office of ERNV, which closing became
effective in October 1998. Also, 1997 results include a 50% interest in UAP
Executive Partners ("UPEX"), a French underwriting agency which was a joint
venture between the Company and Union des Assurances de Paris - Incendie
Accidents ("UAP"). The joint venture agreement between the Company and UAP was
terminated on December 31, 1997.
RESULTS OF OPERATIONS
The Company's net income for the third quarter of 1998 was $8.5 million, or
$0.73 per diluted share, as compared to $8.9 million, or $0.84 per diluted
share, earned in the third quarter of 1997. For the nine months ended September
30, 1998 and 1997, net income was $31.3 million and $25.9 million, respectively.
Diluted earnings per share were $2.68 and $2.50 for the corresponding periods.
For the three months ended September 30, 1998, the Company's operating earnings
are calculated as net income before non-recurring expenses associated with
Sullivan Kelly and the closing of the Paris office of ERNV and realized capital
gains or losses, net of tax, and were $10.8 million, or $0.93 per diluted share.
The Company's operating earnings for the three months ended September 30, 1997
are calculated as net income before nonrecurring expenses and operating losses
associated with the acquisition of Sullivan Kelly Inc. and realized capital
gains or losses, net of tax, and were $8.9 million, or $0.83 per diluted share.
For the nine months ended September 30, 1998, operating earnings were $32.0
million, or $2.73 per diluted share, as compared to $25.0 million, or $2.41 per
diluted share, for the first nine months of 1997.
Gross premiums written increased by $24.1 million, or 21%, to $137.8 million in
the third quarter of 1998 from $113.7 million in the third quarter of 1997. The
increase was principally due to growth in sales of miscellaneous errors and
omissions insurance ("E&O") partially offset by a decrease in domestic and
international directors and officers liability insurance ("D&O") and
professional firms E&O. The level of D&O gross premiums written has been
adversely affected both by continued strong competition in the D&O market and by
declinations of D&O applicants that appear to the Company to present greater
than acceptable exposure to the Year 2000 issue. (See "The Year 2000 (Y2K)")
These factors are likely to continue to affect the level of D&O writings for the
foreseeable future. For the first nine months of 1998, gross premiums written
were $367.9 million compared to $308.5 million in the first nine months of 1997.
Ceded premiums increased $20.5 million, or 46%, to $65.1 million in the third
quarter of 1998 from $44.6 million in the third quarter of 1997. For the first
nine months of 1998, ceded premiums totaled $159.7, representing a 36% increase
over 1997. The rise in ceded premiums was due principally to increased cessions
on certain recently introduced E&O and D&O products and as a result of higher
writings.
As a result of the foregoing, net premiums written increased $3.6 million, or
5%, to $72.7 million for the quarter ended September 30, 1998 from $69.1 million
for the quarter ended September 30, 1997. For the first nine months of 1998, net
premiums written totaled $208.2 million, as compared to $191.1 million for the
nine months ended September 30, 1997. Net premiums earned for the third quarter
increased to $63.8 million in 1998 from $54.8 million in 1997. Net premiums
earned during the first nine months of 1998 increased to $188.0 million in 1998
from $151.2 million during the first nine months of 1997.
Net investment income increased by $4.1 million, or 35%, to $15.8 million for
the quarter ended September 30, 1998 from $11.7 million for the quarter ended
September 30, 1997. For the first nine months of 1998 and 1997, net investment
income was $45.7 million and $33.0 million, respectively. These increases
resulted principally from growth in invested assets, measured on an amortized
cost basis, from
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$912.0 million at September 30, 1997 to $1,157.5 million at September 30, 1998,
partially offset by a decrease in nominal yields. The nominal portfolio yield of
the fixed maturity portfolio at September 30, 1998 was 5.89%, compared to 6.16%
at September 30, 1997. The tax equivalent yields on the fixed maturity portfolio
were 7.40% and 7.76% at these dates, respectively.
The Company's net realized capital gains were $2.2 million in the third quarter
of 1998 as compared to $0.6 million in the third quarter of 1997. For the nine
months ended September 30, 1998, net realized capital gains totaled $4.8 million
as compared to $1.9 million for the first nine months of 1997. In 1998, net
capital gains were realized principally from the sale of fixed maturity
investments, equity mutual fund distributions and certain equity limited
partnership investments.
Loss and loss adjustment expenses ("LAE") increased by $5.6 million, or 15%,
from $36.4 million in the third quarter of 1997 to $42.0 million in the
comparable period of 1998 due to higher premiums earned offset by an improvement
in the overall loss ratio. For the nine months ended September 30, 1998 and
1997, loss and LAE were $124.7 million and $101.5 million, respectively. The
Company's loss ratio was 65.8% in the third quarter of 1998 and 66.3% for the
first nine months of 1998 as compared to 66.5% in the third quarter of 1997 and
67.1% for the first nine months of 1997. 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 $4.7 million, or $0.40 per diluted share, for
the third quarter of 1998 and $11.5 million, or $0.64 per diluted share, in the
first nine months of 1998. In the first nine months of 1997, the Company reduced
its unpaid loss and LAE reserves for prior report years by $7.4 million, or
$0.46 per diluted share. 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 $5.4 million, or 60%, to $14.5 million for
the quarter ended September 30, 1998 from $9.1 million for the quarter ended
September 30, 1997. For the first nine months of 1998 and 1997, policy
acquisition costs totaled $37.5 million and $24.5 million, respectively. The
increase in the policy acquisition costs was attributable to both higher
commission amounts paid to brokers and increased compensation and related
expenses incurred in hiring additional underwriting staff to support the growth
in the Company's business. In addition, $1.9 million of non-recurring expenses
were incurred in the third quarter of 1998 in connection with the dissolution of
Sullivan Kelly and the closing of ERNV's Paris, France office. The ratio of
policy acquisition costs to premiums earned increased to 19.9% for the first
nine months of 1998 as compared to 16.2% for the first nine months of 1997.
Excluding the non-recurring expenses associated with Sullivan Kelly and the ERNV
Paris office, the ratio of policy acquisition costs to premiums earned was 18.9%
for the nine months ended September 30, 1998.
General and administrative ("G&A") expenses increased $3.5 million, or 44%, to
$11.9 million in the third quarter of 1998 from $8.2 million in the third
quarter of 1997. For the nine months ended September 30, 1998 and 1997, G&A
expenses totaled $26.8 million and $20.3 million, respectively. The increase in
G&A costs is due primarily to increased compensation, benefit and related
overhead costs associated with the growth in premium volume. In addition, $3.9
million of non-recurring expenses were incurred in the third quarter of 1998 in
connection with the dissolution of Sullivan Kelly and the closing of the Paris
office of ERNV. The ratio of G&A costs to premiums earned increased from 13.5%
for the first nine months of 1997 to 14.3% for the first nine months of 1998.
Excluding the non-recurring expenses associated with Sullivan Kelly and ERNV,
the ratio of G&A costs to premiums earned was 12.2% for the nine months ended
September 30, 1998.
The GAAP combined ratio increased to 107.1% in the third quarter of 1998 from
98.1% in the third quarter of 1997. For the first nine months of 1998, the GAAP
combined ratio was 100.5%, as compared to 96.8% for the first nine months of
1997. The increase for the three and nine month periods ended September 30, 1998
was attributable to increases in the policy acquisition cost ratio and G&A
ratio, partially offset by a decrease in the loss ratio as discussed above. A
combined ratio below 100% 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 of $4.0 million for the first nine months of 1998 was
attributable principally to the Company's outstanding senior notes payable,
while interest expense of $1.4 million for the first nine months of 1997 was
attributable principally to outstanding balances under the Company's bank credit
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agreement. On December 12, 1997, the Company sold $75 million aggregate amount
of 7.125% senior notes payable.
In January 1997, the Company formed the Trust, the common securities of which
are wholly owned by the Company. On February 5, 1997, the Trust sold
$125,000,000 principal amount of 8.675% Series A Capital Securities, which were
later entirely exchanged for a like amount of 8.657% Series B Capital
Securities, due February 1, 2027. Minority interest in the Trust, as shown on
the Company's income statement, is attributable to distributions payable on the
securities of the Trust.
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, investment income and proceeds from
sales and redemptions of investments. Funds are used primarily to pay claims and
operating expenses, to purchase investments, to pay interest and principal under
the terms of the Company's indebtedness for borrowed money and to pay dividends
to Common Stockholders.
Cash flows from operating activities were $121.8 million for the nine months
ended September 30, 1998 and $119.0 million for the nine months ended September
30, 1997. The increase in operating cash flows resulted from an increase in net
premiums and investment income received partially offset by higher losses and
G&A expenses paid. 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 September 30,
1998 and December 31, 1997 was 4.9 and 4.6 years, respectively, as compared to
an expected loss reserve duration of 5.0 to 5.5 years. The Company's short-term
investment pool was $48.1 million (3.9% of the total investment portfolio) at
September 30, 1998 and $88.5 million (8.2%) at December 31, 1997. The decrease
in the short-term investment pool was due principally to the fact that
approximately $40 million of the senior note proceeds, which had been held in
short-term investments at year-end 1997, were used to capitalize ERNV in
February 1998.
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. The market value
of the portfolio at September 30, 1998 was 104% of amortized cost versus 103% of
amortized cost at December 31, 1997. At September 30, 1998 and December 31,
1997, stockholders' equity was increased by $28.9 million and $19.5 million,
respectively, to record the Company's fixed maturity investment portfolio at
fair value. At September 30, 1998, the Company owned no derivative instruments.
On August 7, 1998, the Company declared its third quarter dividend on the
Company's Common Stock of $.02 per share, which was paid on September 30, 1998
to stockholders of record as of September 15, 1998. Such dividends totaled $0.2
million.
THE YEAR 2000 (Y2K)
The Y2K problem is a worldwide issue facing virtually every organization that
employs technology to achieve its goals, including the Company. The Y2K problem
stems from the use of a two-digit code representing the year in computer-based
systems, which could cause some computers to fail or malfunction after December
31, 1999. The Company's insurance policies contain date sensitive data, such as
expiration
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dates, and internal systems rely on such date fields. The Company's philosophy
has emphasized the use of technology, so it may be more heavily reliant upon
computer systems than some other similarly situated insurance companies. If the
Company's principal computer systems were not made Y2K compliant, its business
operations, including policy issuance, premium billing and collection, claims
handling, investment and accounting functions, could be materially adversely
affected.
INTERNAL: Management has taken steps to address Y2K as it affects the Company's
own business systems. In addition to assigning senior Information Services staff
resources exclusively to this project, the Company has formed a Y2K Project
Office, which includes the Chairman of the Board of Directors as well as
representatives from all principal operations areas. Early in 1998, the Project
Office began monitoring the Company's Y2K compliance project, a five-phase
program incorporating assessment, remediation, testing, business partner
compliance and corporate acceptance. As of the date of this quarterly report,
the Company has completed the assessment and remediation phases and has retained
an independent consultant to advise and make recommendations as to the adequacy
of planned testing protocols and test schedules. The Company believes that it is
on-schedule to complete the testing of both internally-developed applications
and purchased software by year-end 1998. Additionally, third-party business
partners that have material vendor or customer relationships with the Company
have been identified and each is being contacted to determine its Y2K readiness.
In particular, there are several brokerage firms that produce a significant
share of the Company's insurance business. An inability on the part of any such
firm to process insurance applications due to a failure of their computer
systems would materially impair the Company's financial results for the period
in which such failure occurred. The Company's Y2K readiness project calls for
contingency plans which identify actions to be taken should the Company's or its
business partners' readiness efforts fail. Such plans will be formalized during
the first half of 1999. The final phase of the Y2K, management review and
acceptance of testing results and planning, is currently scheduled to be
conducted in the first quarter of 1999.
Operating expenses in the first nine months of 1998 and 1997 include immaterial
amounts (less than $1.0 million in the aggregate) related to Y2K readiness.
Based on the progress of the Company's Y2K project to date, it is not currently
anticipated that there will be a material increase in operating expenses related
to Y2K during the remainder of 1998 or during 1999, nor will the completion of
Y2K efforts result in a meaningful reduction in future expense levels.
EXTERNAL: Because a significant portion of the Company's business is insuring
executives of business organizations that rely on computer technology, business
interruptions and other problems related to mismanagement of the Y2K issue could
also affect the Company's claims experience in future years. In July 1998, a
national rating agency revised its outlook on the rating of the Company's senior
debt from "stable" to "negative" (which could affect future borrowing costs),
premised upon the agency's analysis of the D&O insurance industry's exposure to
the Y2K issue. The Company acknowledges that Y2K entails a significant risk to
the entities it insures. Y2K litigation is likely to cause some negative
development in the Company's loss experience. Due to the general uncertainty
inherent in the Y2K problem, however, the Company is unable to determine at this
time whether such losses will have a material impact on the Company's results of
operations or financial condition. The Company believes that its Y2K-specific
underwriting techniques, together with conservative reinsurance practices and
loss reserving, should mitigate the impact of the Y2K problem.
PART II - OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
On December 30, 1993, the Board of Directors of Executive Risk Inc. (the
"Company") approved and adopted a rights agreement (the "Original Rights
Agreement"), dated as of such date, by and between the Company and Mellon Bank,
N.A. (the "Rights Agent") and, as contemplated by the Original Rights
Agreement, such Board of Directors authorized and declared a dividend of one
right (a "Right") for each share of Common Stock, par value $.01 (the "Common
Stock"), and for each share of Class B Common Stock, par value $.01 (the "Class
B Common Stock"), of the Company outstanding on January 1, 1994 (the "Record
Date"), each Right representing the right to purchase one share of Common Stock
of the Company, upon the terms and subject to the conditions set forth in the
Original Rights Agreement, and further authorized and directed the issuance of
one Right with respect to each share of Common Stock and Class B Common Stock
that shall become outstanding between the Record Date and the earliest of the
Distribution Date, the Redemption Date and the Expiration Date. A complete copy
of the Original Rights Agreement has been filed as an exhibit to Registration
Statement No. 33-70820, as filed under the Securities Act of 1933, as amended,
and is incorporated herein by reference.
The Original Rights Agreement provided for, among other things, its
amendment or supplement from time to time by the Company.
On November 6, 1998, the Board of Directors of the Company determined to
amend and restate the Original Rights Agreement. A complete copy of the Amended
and Restated Rights Agreement is attached as Exhibit 4.1 to the Company's Form
8A/A, filed November 12, 1998, which is incorporated herein by reference and
referred to as "Exhibit 4.1".
The following is a summary of certain material revisions to the Original
Rights Agreement:
Acquiring Person. The Amended and Restated Rights Agreement revises the
definition of an "Acquiring Person" to include any person who or which
beneficially owns 15% or more of the outstanding shares of Common Stock.
Distribution Date. The Amended and Restated Rights Agreement revises the
definition of the "Distribution Date" to mean the earlier to occur of (i) a
public announcement that a person or group of affiliated or associated persons
beneficially owns 15% or more of the outstanding Common Stock of the Company or
(ii) such date as may be determined by action of the Board of Directors of the
Company following the commencement of, or announcement of an intention to
make, a tender offer or exchange offer the consummation of which would result
in a person or group beneficially owning 15% or more of the outstanding Common
Stock.
Exchange Feature. The Amended and Restated Rights Agreement includes an
exchange feature that permits the Board of Directors of the Company to
exchange, at its option at any time after a person has become an "Acquiring
Person" and before such person or group acquires 50% or more of the outstanding
Common Stock, all or part of the outstanding and exercisable Rights (other than
Rights owned by such person or group), in whole or in part, at an exchange
ratio of one share of Common Stock (or, in certain circumstances, other similar
securities of the Company) per Right (subject to adjustment).
Continuing Director Provision. The Original Rights Agreement also has been
revised to eliminate the requirement that only "continuing directors" (as such
term is defined in the Original Rights Agreement) may redeem the Rights issued
pursuant to the Original Rights Agreement.
Capitalization. On May 27, 1997, the Company adopted an Amended and
Restated Certificate of Incorporation, which eliminated the authorization of
Class B Common Stock, formerly issued only to The Aetna Casualty and Surety
Company. The Original Rights Agreement also has been amended to remove
references to Class B Common Stock.
The foregoing discussion does not purport to be complete and is qualified
in its entirety by reference to Exhibit 4.1.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBIT INDEX
Exhibit No. Description
----------- -----------
4.1 Amended and Restated Rights Agreement, dated
as of November 12, 1998, by and between Executive Risk
Inc. and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent. The Rights Agreement includes the form of
Rights Certificate as Exhibit A and the Summary of
Rights to Purchase Common Stock as Exhibit B,
incorporated by reference to Exhibit 4.1 of Form 8A/A
filed November 12, 1998.
15.1 Independent Accountant's Acknowledgment Letter
27 Financial Data Schedule
b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the quarter ended September 30,
1998.
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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 Chairman and Director November 12, 1998
Robert H. Kullas
/s/ Robert V. Deutsch Executive Vice President, November 12, 1998
Robert V. Deutsch Chief Financial Officer,
Chief Actuary, Treasurer,
Assistant Secretary and
Director (Principal Financial
and Accounting Officer)
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