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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 March 31, 1999
[ ] 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 May 10, 1999, there were 11,548,271 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 -
March 31, 1999 and December 31, 1998................................................. 3
Consolidated Statements of Income -
Three Months Ended March 31, 1999 and 1998 .......................................... 4
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1999 and 1998 .......................................... 5
Notes to Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................ 7-10
PART II - OTHER INFORMATION
Item 5. Other Information.............................................................. 10
Item 6. Exhibits and Reports on Form 8-K............................................... 10
SIGNATURES.............................................................................. 11
Exhibit 10.1 - Retirement Agreement, dated May 7, 1999, between Executive Risk
Inc. and Robert H. Kullas............................................................... --
Exhibit 10.2 - Other Agreement, dated May 7, 1999, between Executive Risk Inc.
and Robert V. Deutsch................................................................... --
Exhibit 15.1 - Independent Accountants' Acknowledgment Letter........................... --
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 or 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 March 31, 1999, and the related consolidated
statements of income and cash flows for the three month periods ended March 31,
1999 and 1998. 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 is 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, 1998, 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 6, 1999, we expressed an
unqualified opinion on those consolidated financial statements.
/S/ ERNST & YOUNG LLP
Stamford, Connecticut
April 30, 1999
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
(In thousands, except share data) 1999 1998
----------- -----------
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost: 1999 - $1,075,330 and 1998 - $1,102,744) $ 1,101,175 $ 1,136,375
Equity securities available for sale, at fair value
(cost: 1999 - $52,435 and 1998 - $50,103) 82,375 79,187
Cash and short-term investments, at cost which approximates market 65,631 34,312
----------- -----------
TOTAL CASH AND INVESTED ASSETS 1,249,181 1,249,874
Premiums receivable 41,401 44,256
Reinsurance recoverables 337,224 302,062
Accrued investment income 16,302 16,479
Deferred acquisition costs 46,536 38,252
Prepaid reinsurance premiums 135,907 150,266
Deferred income taxes 22,733 22,336
Other assets 48,047 42,514
----------- -----------
TOTAL ASSETS $ 1,897,331 $ 1,866,039
=========== ===========
LIABILITIES
Loss and loss adjustment expenses $ 901,312 $ 866,285
Unearned premiums 379,874 369,532
Senior notes payable 75,000 75,000
Ceded balances payable 35,895 54,969
Accrued expenses and other liabilities 40,480 44,330
----------- -----------
TOTAL LIABILITIES 1,432,561 1,410,116
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
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STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value; authorized 4,000,000 shares;
issued - 1999 and 1998 - 0 shares -- --
Common Stock, $.01 par value; authorized 52,500,000 shares;
issued - 1999 - 12,597,891 shares and 1998 - 12,229,622 shares 126 122
Additional paid-in capital 182,268 178,740
Accumulated other comprehensive income 35,318 40,959
Retained earnings 154,614 143,658
Cost of shares in treasury, at cost: 1999 and 1998 - 1,114,294 shares (32,556) (32,556)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 339,770 330,923
----------- -----------
TOTAL LIABILITIES, PREFERRED SECURITIES OF EXECUTIVE RISK
CAPITAL TRUST AND STOCKHOLDERS' EQUITY $ 1,897,331 $ 1,866,039
=========== ===========
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 March 31,
(In thousands, except per share data) 1999 1998
--------- ---------
REVENUES
Gross premiums written $ 135,545 $ 100,084
Premiums ceded (47,837) (39,742)
--------- ---------
Net premiums written 87,708 60,342
Change in unearned premiums (24,793) (557)
--------- ---------
Net premiums earned 62,915 59,785
Net investment income 16,234 15,139
Net realized capital gains 2,182 1,775
Other income 260 83
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TOTAL REVENUES 81,591 76,782
EXPENSES
Loss and loss adjustment expenses 40,895 40,116
Policy acquisition costs 11,225 10,617
General and administrative expenses 9,247 7,371
Non-recurring merger expenses 2,644 --
Interest expense 1,388 1,376
Minority Interest in Executive Risk Capital 2,711 2,682
Trust --------- ---------
TOTAL EXPENSES 68,110 62,162
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INCOME BEFORE INCOME TAXES 13,481 14,620
Income tax expense
Current 269 1,964
Deferred 2,029 1,177
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2,298 3,141
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NET INCOME $ 11,183 $ 11,479
========= =========
Comprehensive Income $ 5,542 $ 14,327
Earnings per common share $ 1.00 $ 1.06
Weighted average shares outstanding 11,217 10,862
Earnings per common share -
assuming dilution $ 0.95 $ 0.98
Weighted average shares outstanding -
assuming dilution 11,719 11,726
Dividends declared per common share $ 0.02 $ 0.02
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)
Three Months Ended March 31,
(In thousands) 1999 1998
--------- ---------
OPERATING ACTIVITIES
Net income $ 11,183 $ 11,479
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation 1,299 990
Deferred income taxes 2,029 1,177
Amortization of bond premium 907 613
Net realized gains on investments (2,182) (1,775)
Stock based compensation plans 963 593
Other (4,914) 1,264
Change in:
Premiums receivable, net of ceded balances payable (16,219) (4,648)
Accrued investment income 177 (1,017)
Deferred acquisition costs (8,284) (2,371)
Loss and loss adjustment expenses, net of reinsurance recoverables (135) 25,659
Unearned premiums, net of prepaid reinsurance premiums 24,701 554
Accrued expenses and other liabilities 2,059 (15,579)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 11,584 16,939
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 88,041 151,274
Proceeds from sales of equity securities available for sale 2,344 2,482
Proceeds from maturities of investment securities 6,967 17,134
Purchase of fixed maturities available for sale (73,555) (201,204)
Purchase of equity securities available for sale (2,148) (5,717)
Net capital expenditures (3,439) (3,610)
--------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 18,210 (39,641)
FINANCING ACTIVITIES
Proceeds from exercise of options 1,752 589
Placement fees and other -- (183)
Dividends paid on common stock (227) (218)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,525 188
--------- ---------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 31,319 (22,514)
--------- ---------
Cash and short-term investments at beginning of period 34,312 88,505
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 65,631 $ 65,991
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(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 except as described in Note 2) 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 on Form 10-K for the fiscal year ended
December 31, 1998.
NOTE 2 - ACQUISITION AND NON-RECURRING CHARGES
On February 8, 1999, the Company announced that it had entered into an Agreement
and Plan of Merger, dated as of February 6, 1999 (the "Merger Agreement"), among
the Company, The Chubb Corporation ("Chubb") and Excalibur Acquisition, Inc. The
Merger Agreement calls for the merger of the Company with Excalibur Acquisition,
Inc., a Chubb subsidiary, with the effect that following the proposed merger the
Company would be a wholly-owned subsidiary of Chubb. The completion of the
merger is subject to customary closing conditions, including a vote of the
Company's stockholders and to approval by insurance regulators in the States of
Connecticut and Delaware, and may be subject to additional state regulatory
approvals. Approval of the Connecticut Insurance Department has been received
and the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of
1976 has expired. The Company filed a Current Report with the SEC on Form 8-K,
dated February 9, 1999, in which further information concerning the proposed
merger with Chubb is contained. Approval of the proposed merger by the Company's
stockholders will be solicited only by means of a proxy statement to be mailed
to all stockholders.
In the first quarter of 1999, the Company incurred non-recurring charges of $2.6
million related to the Company's pending acquisition by Chubb. These
non-recurring charges consist of $1.8 million related to investment banker fees
and $0.8 million for legal and other costs. These charges were recorded on the
consolidated income statement as non-recurring merger expenses.
The Company is contingently liable for approximately an additional $6.0 million
of investment banker and legal fees payable upon the successful completion of
the acquisition by Chubb.
NOTE 3 - REINSURANCE
In the first quarter of 1999, the Company restructured certain of its
reinsurance treaties. The restructured reinsurance program generally makes
greater use of excess of loss reinsurance, rather than quota share reinsurance,
to reduce exposures to severity losses. The reinsurance restructuring resulted
in the non-renewal of several in-force reinsurance treaties commensurate with
the effective date of the new reinsurance treaties. The restructuring of the
reinsurance treaties did not have a material effect on the Company's financial
position or results of operations.
NOTE 4 - NEW ACCOUNTING PRONOUNCEMENTS
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.
Implementation of SFAS 133 is not expected to have a material impact on the
Company's financial position or results of operations.
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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 quarter ended March 31,
1999 with the corresponding period for 1998. 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 companies, Executive Risk Indemnity
Inc., Executive Risk Specialty Insurance Company, Executive Risk N.V., Quadrant
Indemnity Company and Executive Risk (Bermuda) Ltd. In addition, the Company's
results include Executive Risk Capital Trust (the "Trust"), a Delaware statutory
business trust, and Sullivan Kelly Inc. ("Sullivan Kelly"), an underwriting
management 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 underwriting functions to ERMA and dissolve Sullivan Kelly. Results
for the quarter ended March 31, 1999 include $0.1 million of net after-tax
income related to the run-off of Sullivan Kelly.
RESULTS OF OPERATIONS
The Company's net income for the first quarter of 1999 was $11.2 million, or
$0.95 per diluted share, as compared to $11.5 million, or $0.98 per diluted
share, earned in the first quarter of 1998. The Company's operating earnings,
calculated as net income before realized capital gains and non-recurring
expenses related to the Company's proposed merger transaction with The Chubb
Corporation ("Chubb"), both net of tax, were $11.4 million, or $0.98 per diluted
share, for the quarter ended March 31, 1999 and $10.3 million, or $0.88 per
diluted share, for the quarter ended March 31, 1998.
Gross premiums written increased by $35.4 million, or 35%, to $135.5 million in
the first quarter of 1999 from $100.1 million in the first quarter of 1998. The
increase was principally due to growth in sales in miscellaneous errors and
omissions insurance ("E&O"), employment practices liability insurance, and
private commercial directors and officers liability insurance ("D&O"), partially
offset by a decrease in public company D&O. The level of D&O gross premiums
written for public companies 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.
Ceded premiums increased $8.1 million, or 20%, to $47.8 million in the first
quarter of 1999 from $39.7 million in the first quarter of 1998. The rise in
ceded premiums was due principally to increased cessions on E&O and certain D&O
products as a result of higher writings, partially offset by the lower cession
rates of certain reinsurance treaties restructured in the first quarter of 1999,
which included the benefits of a reinsurance portfolio transfer (see Note 3).
As a result of the foregoing, net premiums written increased $27.4 million, or
45%, to $87.7 million for the quarter ended March 31, 1999 from $60.3 million
for the quarter ended March 31, 1998. For the same periods, net premiums earned
increased $3.1 million, or 5%, to $62.9 million from $59.8 million. The increase
in net premiums earned lagged that of net premiums written due to the
incremental cost related to additional reinsurance protection purchased for D&O,
partially offset by lower cession rates for certain E&O treaties, both related
to the reinsurance restructuring in the first quarter of 1999.
Net investment income increased by $1.1 million, or 7%, to $16.2 million for the
quarter ended March 31, 1999 from $15.1 million for the quarter ended March 31,
1998. This increase resulted principally from growth in invested assets,
measured on an amortized cost basis, from $1,064.9 million at March 31, 1998 to
$1,193.4 million at March 31, 1999, partially offset by a decrease in nominal
yields. The nominal portfolio yield of the fixed maturity portfolio at March 31,
1999 was 5.79%, compared to 6.04% at March 31, 1998. The tax equivalent yields
on the fixed maturity portfolio were 7.41% and 7.52% for these periods,
respectively.
The Company's net realized capital gains were $2.2 million in the first quarter
of 1999 as compared to $1.8 million in the first quarter of 1998. In the first
quarter of 1999, net capital gains were realized principally from certain equity
limited partnership investments, equity mutual fund distributions and the sale
of fixed maturity investments.
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Loss and loss adjustment expenses ("LAE") increased by $0.8 million, or 2%, from
$40.1 million in the first quarter of 1998 to $40.9 million in the comparable
period of 1999. The Company's loss ratio was 65.0% in the first quarter of 1999
as compared to 67.1% in the first quarter of 1998. 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 primarily for the 1992 and 1993 report years by an aggregate of
$4.9 million, or $0.27 per diluted share, in the first quarter of 1999. In the
first quarter of 1998, the Company reduced its unpaid loss and LAE reserves for
prior report years by an aggregate of $3.0 million, or $0.16 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 $0.6 million, or 6%, to $11.2 million for
the quarter ended March 31, 1999 from $10.6 million for the quarter ended March
31, 1998. The Company's ratio of policy acquisition costs to net premiums earned
was 17.8% in both quarters.
General and administrative ("G&A") expenses increased $1.8 million, or 25%, to
$9.2 million in the first quarter of 1999 from $7.4 million in the first quarter
of 1998, due largely to increased compensation, benefit and related overhead
costs associated with staffing increases to support future growth in premium
volume. The ratio of G&A costs to premiums earned increased from 12.3% in the
first quarter of 1998 to 14.7% in the first quarter of 1999.
First quarter 1999 expenses also include $2.6 million in non-recurring
investment banker, legal and other expenses related to the Company's pending
merger transaction with Chubb.
The GAAP combined ratio, excluding the non-recurring charges, increased slightly
to 97.5% in the first quarter of 1999 from 97.2% in the first quarter of 1998.
The increase of 0.3 percentage points was attributable to the increase in the
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 $1.4 million for the first quarter of 1999 and 1998 was
attributable principally to the Company's outstanding senior notes payable.
Minority interest in the Trust of $2.7 million for the first quarter of 1999 and
1998 is attributable to distributions payable on the securities of the Trust.
Income tax expense decreased $0.8 million, or 27%, from $3.1 million in the
first quarter of 1998 to $2.3 million in the first quarter of 1999. The
Company's effective tax rate decreased from 21.5% to 17.0% for the same periods,
principally due to an increase in tax-exempt investment income. Tax exempt
securities comprised 58% of the Company's fixed income portfolio as of March 31,
1999 as compared to 51% as of March 31, 1998.
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 $11.6 million for the quarter ended
March 31, 1999 and $16.9 million for the quarter ended March 31, 1998. The
decrease in operating cash flows resulted from higher direct paid losses and the
outflow of ceded premiums during the quarter associated with the restructuring
of certain reinsurance treaties. Rising loss payments are expected of a maturing
professional liability underwriter. In addition, the Company is writing more
high frequency, low severity lines of business in which losses are generally
paid in shorter durations than in the Company's traditional lines of business.
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,
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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 March
31, 1999 and December 31, 1998 was 5.2 years, as compared to an expected loss
reserve duration of 5.0 to 5.5 years. The Company's short-term investment pool
was $65.6 million (5.3% of the total investment portfolio) at March 31, 1999 and
$34.3 million (2.7%) at December 31, 1998. The short-term investment pool
increased in order to fund reinsurance premiums and expected near-term operating
cash outflow needs.
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 March 31, 1999 and December 31, 1998 was 105% of amortized
cost. At March 31, 1999 and December 31, 1998, stockholders' equity was
increased by $16.8 million and $21.9 million, respectively, to record the
Company's fixed maturity investment portfolio at fair value. At March 31, 1999,
the Company owned no derivative instruments, except for $136.3 million (fair
value) invested in mortgage and asset backed securities.
On February 12, 1999, the Company declared its first quarter dividend on the
Company's Common Stock of $.02 per share, which was paid on March 31, 1999 to
stockholders of record as of March 15, 1999. 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 dates, and internal systems rely on such date fields. Further, the
Company's philosophy has long 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 collections, claims handling, investment and accounting functions,
could be materially adversely affected, with negative financial consequences and
damage to the Company's reputation.
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. Later in 1998, the Company retained
an independent consultant, which advised and made recommendations as to the
adequacy of planned testing protocols and test schedules. The Company has
completed the assessment, remediation and testing phases of all mission-critical
applications. It is on-schedule to complete the remaining testing, and currently
plans to conduct a so-called "end to end" test of all information systems by
late second quarter or early third quarter 1999. 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 insurance 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 could materially affect the Company's financial results
for the period in which such failure occurred. The Company's Y2K readiness
project calls for contingency planning to identify actions to be taken should
the Company's or its business partners' readiness efforts fail. Such plans will
be formalized during the third quarter of 1999.
Operating results in the first quarter of 1999 included some expense (less than
$0.2 million) directly or indirectly 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 impact on operating expense related to Y2K during
1999, nor will the completion of Y2K efforts result in a meaningful reduction in
expense levels in 1999 or future years.
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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," premised upon the agency's analysis of the D&O
insurance industry's exposure to the Y2K issue. Such negative ratings outlook
has since been removed in light of the announced acquisition by Chubb. 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
a) RETIREMENT AGREEMENT
On May 7, 1999, Executive Risk entered into an agreement with its Chairman,
Robert H. Kullas, which provides that Mr. Kullas will resign as an officer and
director of Executive Risk and its subsidiaries as of the day after the closing
date of the merger. Under this agreement, Mr. Kullas will be entitled to
continuation of his base salary from the time of his resignation through
December 31, 1999, subject to a minimum aggregate amount of $122,000 for this
period. Mr. Kullas will not, however, be eligible to participate in the
Executive Risk Severance Pay Plan. The agreement provides that Mr. Kullas'
resignation shall be treated as a retirement for purposes of Executive Risk's
stock based and incentive compensation plans, the principal effects of which are
that Mr. Kullas will have three years, rather than three months, following
resignation in which to exercise his stock options and Mr. Kullas will be
entitled to receive incentive compensation with respect to Executive Risk's
performance during 1999 and prior years in the event that other participants in
the Executive Risk Incentive Compensation Plan receive incentive compensation
for such periods. The agreement also contains a restriction on Mr. Kullas'
ability to compete with Executive Risk, Chubb and their affiliates through
December 31, 2000 and other customary provisions.
b) OTHER AGREEMENT
On May 7, 1999, Executive Risk entered into an agreement with Robert V. Deutsch,
its Executive Vice President, Treasurer, Chief Financial Officer and Chief
Actuary, which provides that in the event Mr. Deutsch's employment with
Executive Risk should terminate following the merger, other than as a result of
his death or disability, Mr. Deutsch's termination would be treated as a
retirement for purposes of Executive Risk's stock based and incentive
compensation plans. The principal effect of this agreement is that Mr. Deutsch
would have three years, rather than three months, following termination of
employment in which to exercise his stock options (or if, as a matter of policy,
Chubb determines that other persons who are employees of Executive Risk on the
closing date of the merger shall be allowed a period of time longer than three
years after termination of employment in which to exercise stock options, Mr.
Deutsch would have the same longer period of time, measured from his termination
date, in which to exercise his stock options). In addition, under the agreement,
Mr. Deutsch would be entitled to receive incentive compensation with respect to
Executive Risk's performance during 1999 and prior years in the event that other
participants in the Executive Risk Incentive Compensation Plan receive incentive
compensation for such periods.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBIT INDEX
Exhibit No. Description
----------- -----------
10.1 Retirement Agreement, dated May 7, 1999, between
Executive Risk Inc. and Robert H. Kullas.
10.2 Other Agreement, dated May 7, 1999, between
Executive Risk Inc. and Robert V. Deutsch.
15.1 Independent Accountant's Acknowledgment Letter
27 Financial Data Schedule
b) REPORTS ON FORM 8-K
On February 9, 1999, the Registrant filed a current report on Form 8-K,
disclosing its Agreement and Plan of Merger, dated as of February 6, 1999, with
The Chubb Corporation and its wholly-owned subsidiary, Excalibur Acquisition,
Inc.
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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. Kulias Chairman and Director May 12, 1999
- --------------------
Robert H. Kullas
/s/ Robert V. Deutsch Executive Vice President, Chief Financial Officer, May 12, 1999
- --------------------- Chief Actuary, Treasurer, Assistant Secretary and
Robert V. Deutsch Director
(Principal Financial and Accounting Officer)
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