SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
Commission File Number 1-9627
ZENITH NATIONAL INSURANCE CORP.
[Exact name of registrant as specified in its charter]
Delaware 95-2702776
[State or other jurisdiction of [I.R.S. Employer
incorporation or organization] Identification No.]
21255 Califa Street, Woodland Hills, California 91367-5021
[Address of principal executive offices] [Zip Code]
(818) 713-1000
[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 [ ]
At July 31, 1999, there were 17,209,000 shares of Zenith Common Stock
outstanding, net of 7,916,000 shares of treasury stock.
1
PART L
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
- -----------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(Dollars in thousands, except per share data) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS:
Investments:
Fixed maturities:
At amortized cost (fair value $30,247 in 1999 and $36,712 in 1998) $ 29,949 $ 35,143
At fair value (cost $679,652 in 1999 and $725,397 in 1998) 667,017 735,284
Floating rate preferred stocks, at fair value (cost $14,614 in 1999 and
$16,614 in 1998) 14,973 17,324
Convertible and non-redeemable preferred stocks, at fair value (cost
$5,005 in 1999 and $7,679 in 1998) 4,278 7,350
Common stocks, at fair value (cost $34,256 in 1999 and $22,402 in 1998) 39,235 26,935
Short-term investments (at cost, which approximates fair value) 158,248 187,123
Other investments 41,765 39,522
------------- ---------------
TOTAL INVESTMENTS 955,465 1,048,681
Cash 7,551 1,998
Accrued investment income 12,703 13,646
Premiums receivable 95,335 133,631
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums 344,328 373,045
Deferred policy acquisition costs 9,087 23,941
Properties and equipment, less accumulated depreciation 56,991 79,908
Net deferred tax asset 28,432 22,611
Federal income taxes receivable 2,740
Intangible assets 22,935 25,744
Other assets 92,821 92,781
------------- ---------------
TOTAL ASSETS $ 1,625,648 $ 1,818,726
============= ===============
(continued)
2
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
- -----------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(Dollars in thousands, except per share data) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
LIABILITIES:
Policy liabilities and accruals:
Unpaid loss and loss adjustment expenses $ 840,524 $ 997,647
Unearned premiums 60,982 157,965
Policyholders' dividends accrued 4,182 4,763
Reserves on loss portfolio transfers 8,900 9,689
Payable to banks and other notes payable 16,741 19,255
Senior notes payable, less unamortized issue costs of $344
in 1999 and $404 in 1998 74,656 74,596
Federal income taxes payable 46,184
Payable to RISCORP 52,952
Other liabilities 73,519 81,566
------------- ---------------
TOTAL LIABILITIES 1,125,688 1,398,433
------------- ---------------
REDEEMABLE SECURITIES:
Company-obligated, mandatorily redeemable capital securities of Zenith National
Insurance Capital Trust I, holding solely 8.55% Subordinated Deferrable
Interest Debentures due 2028, of Zenith National Insurance Corp., less
unamortized issue cost and discount of $1,630 in 1999 and $1,659 in 1998. 73,370 73,341
------------- ---------------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par - shares authorized 1,000; issued and outstanding, none
in 1999 and 1998
Common stock, $1 par - shares authorized 50,000; issued 25,119,
outstanding 17,209 in 1999; issued 24,970, outstanding 17,148 in 1998 25,119 24,970
Additional paid-in capital 274,114 270,679
Retained earnings 280,741 188,243
Accumulated other comprehensive income - net unrealized (depreciation)
appreciation on investments, net of deferred tax (benefit) expense of
$(2,542) in 1999 and $5,167 in 1998 (4,721) 9,596
------------- ---------------
575,253 493,488
Less treasury stock at cost (7,910 shares in 1999 and 7,822 shares in 1998) (148,663) (146,536)
------------- ---------------
TOTAL STOCKHOLDERS' EQUITY 426,590 346,952
------------- ---------------
TOTAL LIABILITIES, REDEEMABLE SECURITIES AND
STOCKHOLDERS' EQUITY $ 1,625,648 $ 1,818,726
============= ===============
The accompanying notes are an integral part of this financial statement.
3
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
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Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands, except per share data) 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
CONSOLIDATED REVENUES:
Premiums earned $ 75,977 $ 137,554 $ 211,554 $ 256,338
Net investment income 12,946 13,583 26,271 25,926
Realized gains on investments 2,531 3,754 4,065 6,174
Real estate sales 14,438 8,684 25,206 20,432
Service fee income 585 1,392 1,544 1,392
----------- ------------- ------------ -------------
Total revenues 106,477 164,967 268,640 310,262
EXPENSES:
Loss and loss adjustment expenses incurred 65,983 94,581 171,473 178,509
Policy acquisition costs 13,604 26,710 40,834 48,989
Other underwriting and operating expenses 15,816 23,196 33,015 39,042
Policyholders' dividends and participation 507 (120) 942 (63)
Real estate construction and operating costs 13,628 8,544 23,389 20,038
Interest expense 2,116 515 4,136 1,508
----------- ------------- ------------ -------------
Total expenses 111,654 153,426 273,789 288,023
Gain on sale of CalFarm Insurance Company (see Note 3) 160,335
------------
(Loss) income before federal income tax expense (5,177) 11,541 155,186 22,239
Federal income tax (benefit) expense, including expense of
$56,000 related to the sale of CalFarm Insurance Company
in the six months ended June 30, 1999 (1,777) 4,241 54,186 7,839
----------- ------------- ------------ -------------
NET (LOSS) INCOME $ (3,400)$ 7,300 $ 101,000 $ 14,400
=========== ============= ============ =============
EARNINGS PER SHARE:
Net (loss) income per common share -
Basic $ (0.20)$ 0.43 $ 5.89 $ 0.85
=========== ============= ============ =============
Diluted $ (0.20)$ 0.42 $ 5.89 $ 0.84
=========== ============= ============ =============
Additional Required Disclosure:
Net (loss) income $ (3,400)$ 7,300 $ 101,000 $ 14,400
Change in unrealized appreciation/(depreciation) on investments (7,073) 403 (14,317) 802
----------- ------------- ------------ -------------
Comprehensive (Loss) Income $ (10,473)$ 7,703 $ 86,683 $ 15,202
=========== ============= ============ =============
The accompanying notes are an integral part of this financial statement.
4
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Premiums and service fee income collected $ 222,787 $ 266,717
Investment income received 27,477 23,654
Proceeds from sales of real estate 25,206 20,432
Loss and loss adjustment expenses paid (195,619) (203,893)
Underwriting and other operating expenses paid (53,249) (75,496)
Real estate construction costs paid (25,633) (29,917)
Reinsurance premiums paid (26,547) (15,824)
Dividends paid to policyholders (1,623) 413
Interest paid (9,642) (3,453)
Income taxes (paid) refunded (2,814) 644
--------------- -------------
Net cash used in operating activities (39,657) (16,723)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments:
Investment securities available-for-sale (192,565) (165,269)
Other investments (6,303) (1,403)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 5,114 5,688
Investment securities available-for-sale 68,451 42,203
Proceeds from sales of investments:
Investment securities available-for-sale 47,152 131,178
Other investments 5,515
Capital and other expenditures (6,777) (8,272)
Net change in short-term investments (21,658) 62,469
Cash paid to RISCORP (54,308) (35,000)
Cash acquired in RISCORP Acquisition 29,309
Net proceeds from sale of CalFarm 211,068
Other (786) (5,880)
--------------- -------------
Net cash provided by investing activities 54,903 55,023
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of note assumed from RISCORP (15,000)
Cash advanced from bank construction loans 24,412 20,222
Cash repaid on bank construction loans (21,926) (18,280)
Cash advanced from bank lines of credit 7,400
Cash repaid on bank lines of credit (12,400)
Cash dividends paid to common stockholders (8,564) (8,484)
Proceeds from exercise of stock options 3,512 3,777
Purchase of treasury shares (2,127) (23,301)
--------------- -------------
Net cash used in financing activities (9,693) (41,066)
--------------- -------------
Net increase (decrease) in cash 5,553 (2,766)
Cash at beginning of period 1,998 12,504
--------------- -------------
Cash at end of period $ 7,551 $ 9,738
=============== =============
(continued)
5
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
- -------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- -------------------------------------------------------------------------------------------------------
(Restated)
RECONCILIATION OF NET INCOME TO NET CASH FLOWS
FROM OPERATING ACTIVITIES:
Net Income $ 101,000 $ 14,400
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 4,292 4,637
Realized gain on sale of CalFarm Insurance Company (160,335)
Realized gains on investments (4,065) (6,174)
Decrease (increase) in:
Accrued investment income (1,052) (1,809)
Premiums receivable 1,779 (2,276)
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums 5,715 8,741
Federal income taxes 51,386 8,483
Deferred policy acquisition costs (766) (1,191)
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (31,582) (34,850)
Unearned premiums (6,019) (693)
Policyholders' dividends accrued (581) (200)
Other policyholder funds (3,732) (3,869)
Other 4,303 (1,922)
----------- -------------
Net cash used in operating activities $ (39,657) $ (16,723)
=========== =============
The accompanying notes are an integral part of this financial statement.
6
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Zenith
National Insurance Corp. ("Zenith National") and subsidiaries (collectively,
"Zenith") have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities
Exchange Act of 1934, as amended. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the financial
position and results of operations of Zenith for the periods presented have
been included. The results of operations for an interim period are not
necessarily indicative of the results for an entire year. For further
information, refer to the financial statements and footnotes included in the
Zenith Annual Report on Form 10-K for the year ended December 31, 1998.
Certain prior year balances have been reclassified to conform to the current
year presentation. Zenith has elected to round to the nearest thousand
dollars, except for share and per share data, in reporting amounts in this
statement.
The comparability of the three months and six months ended June 30, 1999 as
compared to the corresponding periods in 1998 is affected by the purchase of
substantially all of the assets and certain liabilities of the former operations
of RISCORP, Inc. and certain of its subsidiaries (collectively, "RISCORP")
effective April 1, 1998 (see Note 4), and by the sale of CalFarm Insurance
Company ("CalFarm"), a wholly-owned subsidiary of Zenith Insurance Company
("Zenith Insurance"), a wholly-owned subsidiary of Zenith National, to
Nationwide Mutual Insurance Company effective March 31, 1999 (see Note 3).
RESTATEMENT - As previously reported, the Consolidated Balance Sheet,
Consolidated Statement of Operations and Consolidated Statement of Cash Flows as
of and for the quarter ended June 30, 1998 have been restated to incorporate the
resolution of the purchase price determination for the RISCORP Acquisition (see
Note 4). The restatement impacted invested assets, accrued investment income,
receivable from reinsurers, deferred policy acquisition costs, federal income
taxes, intangible assets, unpaid losses, policyholder dividends accrued, other
liabilities, net investment income, other underwriting and operating expenses
and federal income tax expense.
7
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2. EARNINGS AND DIVIDENDS PER SHARE
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 1999 1998 1999 1998
- ---------------------------------------------------------------- -------------- ------------- -------------- -------------
(Restated) (Restated)
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
(A) Net (loss) income $(3,400) $7,300 $101,000 $ 14,400
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
(B) Weighted average outstanding
shares during the period 17,140 17,049 17,138 16,999
Additional common shares issuable
under employee stock option plans
using the treasury stock method 17 220 16 176
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
(C) Weighted average number of common
shares outstanding
assuming exercise
of stock options 17,157 17,269 17,154 17,175
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
Net (loss) income per common share -
(A)/(B) Basic $ (0.20) $ 0.43 $5.89 $ 0.85
(A)/(C) Diluted (0.20) 0.42 5.89 0.84
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
Dividends per common share 0.25 0.25 0.50 0.50
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
NOTE 3. SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance completed the sale of all of the
issued and outstanding capital stock of CalFarm for approximately $273,000,000
in cash to Nationwide Mutual Insurance Company. CalFarm wrote Zenith's Other
Property-Casualty business, principally in California, through March 31, 1999.
The gain on the sale, net of tax, was approximately $104,000,000.
Approximately $59,000,000 of cash was transferred from Zenith Insurance to
CalFarm in connection with the cessation of CalFarm's participation in the
intercompany reinsurance pooling agreement to which Zenith Insurance and its
wholly-owned property-casualty insurance subsidiaries are parties. Zenith
Insurance and its wholly-owned property-casualty subsidiaries, other than
CalFarm, will continue to participate in an intercompany reinsurance pooling
agreement.
After accounting for applicable taxes and expenses, the net proceeds from the
sale that are available to Zenith Insurance for investment are approximately
$211,000,000, compared to cash and investments of approximately $226,000,000
that are excluded from Zenith's Consolidated Balance Sheet with the sale of
CalFarm.
8
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. SALE OF CALFARM INSURANCE COMPANY (CONTINUED)
The following table summarizes the assets and liabilities of CalFarm at March
31, 1999:
- --------------------------------------------------------------------------------------------------------------
(Dollars in thousands) March 31, 1999
- --------------------------------------------------------------------------------------------------------------
Assets:
Investments $ 170,050
Cash 1,904
Receivable from Zenith Insurance Company 59,256
Premiums receivable 36,517
Receivable from reinsurers 23,002
Deferred policy acquisition costs 15,620
Properties and equipment 20,505
Other assets 6,874
- --------------------------------------------------------------------------------------------------------------
Total assets $ 333,728
- --------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid loss and loss adjustment expense $ 125,589
Unearned premium reserve 90,964
Other liabilities 10,617
- --------------------------------------------------------------------------------------------------------------
Total liabilities $ 227,170
- --------------------------------------------------------------------------------------------------------------
Pro forma total revenues for Zenith for the three months ended June 30, 1999
and 1998 (after giving effect to the sale of CalFarm as if it had been
consummated at the beginning of the respective periods) would have been
$106,477,000 and $106,399,000, respectively. Pro forma results of operations
after taxes for such periods would have been a net loss of $3,400,000 and net
income of $4,100,000, respectively. Pro forma earnings per share for such
periods would have been a net loss of $0.20 (basic and diluted) and net
income of $0.24 (basic and diluted), respectively.
Pro forma total revenues for Zenith for the six months ended June 30, 1999
and 1998 (after giving effect to the sale of CalFarm as if it had been
consummated at the beginning of the respective periods) would have been
$211,488,000 and $192,772,000, respectively. Pro forma results of operations
after taxes for such periods would have been a net loss of $5,300,000 and net
income of $9,100,000, respectively. Pro forma earnings per share for such
periods would have been a net loss of $0.31 (basic and diluted) and net
income of $0.54 (basic) and $0.53 (diluted), respectively.
9
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. SALE OF CALFARM INSURANCE COMPANY (CONTINUED)
Since CalFarm was acquired by Zenith Insurance in 1985, CalFarm's cumulative
combined ratio was approximately 100% and its cumulative underwriting income
was approximately zero. In addition to the loss of any underwriting income
provided by CalFarm, Zenith's consolidated net income would be reduced by the
investment income associated with the net reduction of approximately
$15,000,000 of consolidated investments caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$139,000 for the six month period ended June 30, 1999, $278,000 for the
comparable period ended June 30, 1998 and $139,000 for the three months ended
June 30, 1998. Using such change in investment income, the underwriting
income previously reported by CalFarm and the gain on the sale of CalFarm,
pro forma net (loss) income would be as follows:
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
Net (loss) income as reported (1998 restated) $(3,400) $7,300 $ 101,000 $ 14,400
Less: underwriting income of CalFarm after tax (1,661) (26) (1,122)
Less: gain on sale of CalFarm after tax (104,335)
Less: change in investment income after tax (139) (139) (278)
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
Pro forma net (loss) income $(3,400) $ 5,500 $ (3,500) $ 13,000
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
Net (loss) income per common share -
Basic $(0.20) $0.32 $ (0.20) $0.76
Diluted (0.20) 0.32 (0.20) 0.76
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES
CONTINGENCIES SURROUNDING FAIR VALUES OF RISCORP ASSETS ACQUIRED AND LIABILITIES
ASSUMED AND SETTLEMENT OF CERTAIN LITIGATION BETWEEN ZENITH INSURANCE AND
RISCORP
On April 1, 1998, pursuant to an Asset Purchase Agreement dated June 17, 1997
(as amended from time to time, the "Asset Purchase Agreement") between Zenith
Insurance and RISCORP, Zenith Insurance acquired substantially all of the
assets and certain liabilities of RISCORP related to RISCORP's workers'
compensation business (the "RISCORP Acquisition"). The total purchase price for
such acquired assets and liabilities was determined by a three-step process in
which RISCORP and its external accounting and actuarial consultants and Zenith
Insurance and its external accounting and actuarial consultants made and
presented their estimates of the GAAP values of the assets and liabilities
acquired by Zenith Insurance to an independent third-party, acting as a Neutral
Auditor and Neutral Actuary. Such estimates varied considerably, particularly
with respect to the value of premiums receivable and the liability for unpaid
losses and loss adjustment expenses. On March 19, 1999, the Neutral Auditor and
Neutral Actuary issued its report determining the disputes between the parties.
10
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
The carrying values of premiums receivable and the liability for unpaid
losses and loss adjustment expenses at June 30, 1999 and December 31, 1998
reflect management's estimates using available current information. Different
actuarial assumptions, particularly assumptions about long-lived workers'
compensation claims, suggest that the ultimate liability for unpaid losses
and loss adjustment expenses could be higher than Zenith's carrying value of
reserves for such claims at June 30, 1999 and December 31, 1998. Also,
Zenith's claims handling practices vary in certain respects from those
employed by RISCORP. The ultimate amount of premiums receivable for
retrospectively-rated policies is determined, in part, by the amount and
timing of losses sustained under such policies. Also, certain of Zenith's
billing and collections procedures differ from those employed by RISCORP and
Zenith is continuing to ascertain the impact such differences may have on the
collectibility of premiums receivable. Subsequent re-interpretation of
currently available data or any new information that becomes available with
respect to premiums receivable and liabilities for unpaid losses and loss
adjustment expenses acquired from RISCORP may change the estimates of the
carrying values of such amounts and such changes, if any, will be reflected
in the results of operations of the period in which they occur. Zenith
Insurance has purchased reinsurance protection relating to development of the
loss and loss adjustment expense reserves assumed from RISCORP. Such
reinsurance would allow Zenith Insurance to recover up to $50,000,000 in
excess of $182,000,000 for net unpaid losses and allocated loss adjustment
expenses acquired from RISCORP. Future adverse loss development, if any, of
the reserves acquired from RISCORP is recoverable up to the $50,000,000
limit, although the benefit of such reinsurance recoverable would be deferred
and recognized over the recovery period of such reinsurance, whereas future
loss development, if any, would be a non-cash charge to operations in the
period in which it occurs. After deducting reinsurance premiums of
$16,000,000, Zenith has recorded reinsurance recoverable of $26,887,000 and a
deferred benefit of $10,887,000 at June 30, 1999.
11
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Zenith Insurance and RISCORP have entered into a settlement agreement, dated
July 7, 1999 (the "Settlement Agreement"), providing for the resolution of
certain claims arising out of the RISCORP Acquisition. Pursuant to the
Settlement Agreement, Zenith Insurance and RISCORP (i) have dismissed
litigation pending between them in the United States District Courts for the
Middle District of Florida, Tampa Division, and the Southern District of New
York; (ii) have agreed that RISCORP may request that the Neutral Auditor and
Neutral Actuary review an alleged error concerning the proper treatment of
certain reinsurance treaties in its determinations with respect to the
purchase price for the RISCORP Acquisition, without waiving whatever rights
they may have to litigation of such issue, determine whether the issue was
properly in dispute before the Neutral Auditor and Neutral Actuary and, if
so, determine the merits of the issue and whether a correction is
appropriate; (iii) have agreed that any other disputes arising under the
Asset Purchase Agreement or the Settlement Agreement, including any future
claims for indemnification by either Zenith Insurance or RISCORP, are to be
resolved by binding arbitration; (iv) have agreed that Zenith is to receive
$6,000,000 from an escrow account established pursuant to the Asset Purchase
Agreement, with RISCORP to receive the balance of the escrow account; and (v)
have agreed to an allocation between them of any recovery received as a
result of refund claims that RISCORP has made to the Florida Department of
Labor and Employment Security, Division of Workers' Compensation. In a
submission made to the Neutral Auditor and Neutral Actuary, RISCORP has
claimed that the purchase price for the RISCORP Acquisition should be
adjusted by either $5,872,000 or $23,365,000 as a result of alleged errors in
the Neutral Auditor and Neutral Actuary's original computation with respect
to the purchase price. Zenith disputes RISCORP's claim. In the third quarter
of 1999, a certain portion of the $6,000,000 proceeds from the settlement of
the RISCORP litigation may be accounted for as a reduction of operating
expenses to the extent that such proceeds represent compensation to Zenith
Insurance for certain of the expenses incurred to operate the former RISCORP
business.
OTHER LITIGATION
Zenith National and its subsidiaries are defendants in various other litigation
in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, such litigation is either without merit or the
ultimate liability, if any, will not have a material adverse effect on the
consolidated financial condition or results of operations of Zenith.
NOTE 5. CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting
(statutory accounting is a comprehensive basis of accounting based on prescribed
accounting practices, which include state laws, regulations and general
administrative rules, as well as a variety of publications of the NAIC). The
NAIC is now considering amendments to the Codification that would also be
effective upon implementation. The NAIC has recommended an effective date of
January 1, 2001. The Codification provides guidance for the areas where
statutory accounting has been silent and changes current statutory accounting in
some areas.
It is not known whether the state of California Department of Insurance will
adopt the Codification, and whether the Department of Insurance will make any
changes to that guidance. Implementation of the Codification may affect the
surplus level and the capitalization requirements of Zenith National's insurance
subsidiaries on a statutory basis. Zenith has not determined the impact of the
Codification.
12
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6. SEGMENT INFORMATION
Zenith classifies its business into six segments: Workers' Compensation,
Reinsurance, Other Property-Casualty, Real Estate Operations, Investment and
Parent. Segments are designated based on the types of products and services
provided and based on the risks associated with the products and services.
Workers' Compensation represents insurance coverage for the statutorily
prescribed benefits that employers are required to pay to their employees
injured in the course of employment. The Workers' Compensation segment
information includes the former RISCORP operations acquired effective April
1, 1998. Reinsurance represents the book of assumed reinsurance of
accumulated losses from catastrophes and the reinsurance of large property
risks. Other Property-Casualty (which includes the gain on the sale of
CalFarm) represents multiple product line direct insurance other than
workers' compensation, primarily in California through March 31, 1999, the
effective date of the sale of CalFarm. Real Estate Operations develop land
and primarily construct private residences for sale in Las Vegas, Nevada.
Investment represents investment income and realized gains on investments,
primarily from debt securities. Parent represents the holding company
operations of Zenith National owning, directly or indirectly, all of the
capital stock of the property and casualty insurance and non-insurance
companies.
13
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
The accounting policies of the segments are consistent with GAAP. Zenith
evaluates insurance segment performance based on the combined ratios and income
or loss from operations before income taxes, not including investment income or
realized gains or losses.
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Other Real
Workers' Property- Estate
(Dollars in thousands) Compensation Casualty Reinsurance Operations Investments Parent Total
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
For the Six Months Ended June 30, 1999
- -------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $139,767 $54,108 $17,679 $211,554
Net investment income $26,271 26,271
Realized gains on
investments 4,065 4,065
Real estate sales $25,206 25,206
Service fee income 1,544 1,544
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Total revenues 141,311 54,108 17,679 25,206 30,336 286,640
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Segment (loss) income,
before taxes (29,868) (22) (1,366) 1,817 30,336 $ (6,046) (5,149)
Gain on sale of CalFarm 160,335 160,335
Interest expense (4,136) (4,136)
Income tax benefit (expense) 10,014 (55,993) 458 (636) (10,145) 2,116 (54,186)
Segment assets 531,310 33,454 74,582 975,719 10,583 1,625,648
Combined ratios 121.4% 100.0% 107.7% 114.8%
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
- -------------------------------------------------------------------------------------------------------------------------------
For the Six Months Ended June 30, 1998
- -------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 130,002 $ 111,155 $15,181 $ 256,338
Net investment income $ 25,926 25,926
Realized gains on
investments 6,174 6,174
Real estate sales 20,432 20,432
Service fee income 1,392 1,392
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Total revenues 131,394 111,155 15,181 20,432 32,100 310,262
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Segment (loss) income,
before taxes (16,177) 1,751 7,893 394 32,100 $ (3,722) 22,239
Interest expense (1,508) (1,508)
Income tax benefit (expense) 4,737 (513) (2,311) (138) (10,846) 1,232 (7,839)
Segment assets 591,991 96,951 30,698 62,378 1,026,824 10,528 1,819,370
Combined ratios 112.6% 98.4% 48.0% 102.6%
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
14
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The principal source of consolidated earnings of Zenith National Insurance
Corp. ("Zenith National") and subsidiaries (collectively, "Zenith") is the
income, including investment income, from the operations of its
property-casualty insurance operations and its investment portfolio. The
property-casualty insurance operations comprise Workers' Compensation,
Reinsurance and, through March 31, 1999, Other Property-Casualty. Zenith's
Real Estate Operations develop land and primarily construct private
residences for sale in Las Vegas, Nevada. Zenith National owns, directly or
indirectly, all of the capital stock of its subsidiaries. The comparative
results of such operations are set forth in the table below, followed by a
discussion of significant changes.
The comparability of the three months and six months ended June 30, 1999 as
compared to the corresponding periods in 1998 is affected by the purchase of
substantially all of the assets and certain liabilities of the former
operations of RISCORP, Inc. and certain of its subsidiaries (collectively,
"RISCORP") effective April 1, 1998, and by the sale of CalFarm Insurance
Company ("CalFarm"), a wholly-owned subsidiary of Zenith Insurance Company
("Zenith Insurance"), a wholly-owned subsidiary of Zenith National, to
Nationwide Mutual Insurance Company effective March 31, 1999.
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
Net investment income, after taxes $ 8,661 $ 8,959 $ 17,549 $ 17,241
Realized gains on investments, after taxes 1,645 2,440 2,642 4,013
- -------------------------------------------------------------------------------------------------------------------------------
Sub-total 10,306 11,399 20,191 21,254
- -------------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting results, after taxes:
Loss excluding catastrophes (9,420) (3,002) (16,812) (1,370)
Catastrophe losses (2,730) (3,965) (3,250)
- -------------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss, after taxes (12,150) (3,002) (20,777) (4,620)
- -------------------------------------------------------------------------------------------------------------------------------
Income from Real Estate Operations, after taxes 526 104 1,181 256
Interest expense, after taxes (1,375) (335) (2,688) (980)
Parent expenses, after taxes (707) (866) (1,242) (1,510)
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income before gain on sale of CalFarm
Insurance Company (3,400) 7,300 (3,335) 14,400
- -------------------------------------------------------------------------------------------------------------------------------
Gain on sale of CalFarm Insurance Company after tax 104,335
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (3,400) $ 7,300 $ 101,000 $ 14,400
- -------------------------------------------------------------------------------------------------------------------------------
15
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Premiums earned, underwriting results and combined ratios before taxes for the
three and six months ended June 30, 1999 and 1998 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
Premiums earned:
Workers' Compensation
California $ 27,593 $ 30,548 $ 56,143 $ 60,444
Outside California 40,417 43,659 83,624 69,558
----------------------------------------------------------
Total Workers' Compensation 68,010 74,207 139,767 130,002
Other Property-Casualty 56,079 54,108 111,155
Reinsurance 7,967 7,268 17,679 15,181
----------------------------------------------------------
Total $ 75,977 $137,554 $211,554 $256,338
==========================================================
Underwriting income (loss) before taxes:
Workers' Compensation $ (16,699) $(11,055) $(29,868) $(16,376)
Other Property-Casualty 2,472 (22) 1,751
Reinsurance (1,560) 4,187 (1,366) 7,893
----------------------------------------------------------
Total $ (18,259) $ (4,396) $(31,256) $ (6,732)
==========================================================
Combined loss and expense ratios:
Workers' Compensation
Loss and loss adjustment expenses 84.6% 76.7% 85.1% 76.4%
Underwriting expenses 40.0% 38.2% 36.3% 36.2%
----------------------------------------------------------
Combined ratio 124.6% 114.9% 121.4% 112.6%
Other Property-Casualty
Loss and loss adjustment expenses 64.6% 66.5% 67.2%
Underwriting expenses 31.0% 33.5% 31.2%
--------------------------------------------
Combined ratio 95.6% 100.0% 98.4%
Reinsurance
Loss and loss adjustment expenses 106.7% 19.7% 93.6% 29.5%
Underwriting expenses 12.9% 22.7% 14.1% 18.5%
----------------------------------------------------------
Combined ratio 119.6% 42.4% 107.7% 48.0%
Total
Loss and loss adjustment expenses 86.9% 68.8% 81.1% 69.6%
Underwriting expenses 37.1% 34.4% 33.7% 33.0%
----------------------------------------------------------
Combined ratio 124.0% 103.2% 114.8% 102.6%
==========================================================
16
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The profitability of the property-casualty insurance operations is
principally dependent upon the adequacy of rates charged to the insured for
insurance protection; the frequency and severity of claims; the ability to
accurately estimate and accrue reported and unreported losses in the correct
period; the level of dividends paid to policyholders; the ability to manage
claims costs and keep operating expenses in line with premium volume; and the
ability to service claims, maintain policies and acquire business
efficiently. Some of the factors that continue to impact the business and
economic environment in which Zenith operates include: an uncertain political
and regulatory environment, both state and federal; the outlook for economic
growth in geographic areas where Zenith operates; the expansion of the
Workers' Compensation business outside of California; the use by others in
the industry of creative reinsurance; a highly competitive insurance
industry; and the changing environment for controlling medical; legal and
rehabilitation costs, as well as fraud and abuse. Although management is
currently unable to predict the effect of any of the foregoing, these factors
and related trends and uncertainties could have a material effect of Zenith's
future operations and financial condition.
ACQUISITION OF ZENITH'S COMMON STOCK BY FAIRFAX FINANCIAL HOLDINGS LIMITED
Pursuant to a Stock Purchase Agreement, dated June 25, 1999 (the "Stock
Purchase Agreement"), between Fairfax Financial Holdings Limited, a Canada
corporation ("Fairfax"), and Reliance Insurance Company ("Reliance"), Fairfax
has agreed to purchase the 6,574,445 shares of the common stock of Zenith
National owned by Reliance and its affiliates (the "Transaction"). Fairfax
reported that consummation of the Transaction is expected to occur in the
second half of 1999 and is subject to various closing conditions, including
the receipt of applicable insurance and other regulatory approvals. Reliance
has covenanted that, effective on consummation of the Transaction, it will
arrange for the resignation from the Zenith's Board of Directors of each of
Messrs. Saul P. Steinberg, Robert M. Steinberg and George E. Bello.
17
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In connection with the Transaction, Zenith National and Fairfax have entered
into a standstill agreement, dated June 30, 1999 (the "Standstill
Agreement"), pursuant to which Fairfax has agreed that, without the prior
written consent of a majority of the Board of Directors of Zenith National
who are not affiliates, officers, directors or employees of Fairfax or any
corporation or other entity controlled by or affiliated with Fairfax
(collectively, the "Purchaser Group"), the Purchaser Group will not, (a)
participate in (i) any acquisition of any securities (or beneficial ownership
thereof) or assets of Zenith, except by way of distributions or offerings
made available to holders of Zenith securities generally, (ii) any business
combination involving Zenith, except to the extent of selling Zenith common
stock owned or acquired pursuant to the Transaction or by way of other
distributions made available to holders of Zenith securities generally, (iii)
any recapitalization, restructuring, liquidation, dissolution or other
extraordinary transaction with respect to Zenith, or (iv) any solicitation of
proxies or consents to vote any securities of Zenith, (b) seek to acquire or
affect control of Zenith or influence the management, Board of Directors or
policies of Zenith, (c) enter into any arrangements with any third party
regarding any of the foregoing, or (d) take any action which would force
Zenith to make a public announcement regarding the types of matters set forth
in clause (a) above. The Purchaser Group also has agreed not to ask, subject
to a limited exception, Zenith (or its directors, officers, employees, or
agents) directly or indirectly, to amend, waive or terminate any of the
foregoing provisions of the Standstill Agreement. The Standstill Agreement
will remain in effect until the earlier of (i) five years from the
consummation of the Transaction, or (ii) the date on which Stanley R. Zax is
no longer the full-time Chairman of the Board and President of Zenith.
The effectiveness of the covenants and agreements of Fairfax under the
Standstill Agreement was conditioned on the execution and delivery to Fairfax
and Zenith of waivers, with respect to the Transaction, of rights held by
certain employees of Zenith or one of its affiliates pursuant to such
employees' employment agreements. In a letter dated July 8, 1999, Fairfax
acknowledged the receipt of waivers; waived the condition as to any not
received; and indicated that its covenants and agreements in the Standstill
Agreement are in full force and effect.
SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance completed the sale of all of the
issued and outstanding capital stock of CalFarm for approximately $273,000,000
in cash to Nationwide Mutual Insurance Company. CalFarm wrote Zenith's Other
Property-Casualty business, principally in California, through March 31, 1999.
The gain on the sale, net of tax, was approximately $104,000,000.
Approximately $59,000,000 of cash was transferred from Zenith Insurance to
CalFarm in connection with the cessation of CalFarm's participation in the
intercompany reinsurance pooling agreement to which Zenith Insurance and its
wholly-owned property-casualty insurance subsidiaries are parties (the
"de-pooling transaction"). Zenith Insurance and its wholly-owned
property-casualty subsidiaries, other than CalFarm, will continue to
participate in an intercompany reinsurance pooling agreement.
After accounting for applicable taxes and expenses, the net proceeds from the
sale that are available to Zenith Insurance for investment are approximately
$211,000,000, compared to cash and investments of approximately $226,000,000
that are excluded from Zenith's Consolidated Balance Sheet with the sale of
CalFarm.
18
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Since CalFarm was acquired by Zenith Insurance in 1985, CalFarm's cumulative
combined ratio was approximately 100% and its cumulative underwriting income
was approximately zero. In addition to the loss of any underwriting income
provided by CalFarm, Zenith's consolidated net income would be reduced by the
investment income associated with the net reduction of approximately
$15,000,000 of consolidated investments caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$139,000 for the six month period ended June 30, 1999 and 1998, respectively,
and $278,000 for the comparable period ended June 30, 1998 and $139,000 for
the three months ended June 30, 1998. Using such change in investment income,
the underwriting income previously reported by CalFarm and the gain on the
sale of CalFarm, pro forma net (loss) income would be as follows:
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income as reported (1998 restated) $(3,400) $ 7,300 $ 101,000 $ 14,400
Less: underwriting income of CalFarm after tax (1,661) (26) (1,122)
Less: gain on sale of CalFarm after tax (104,335)
Less: change in investment income (139) (139) (278)
- ------------------------------------------------------------------------------------------------------------------------------
Pro forma net (loss) income $(3,400) $ 5,500 $ (3,500) $ 13,000
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income per common share -
Basic $ (0.20) $ 0.32 $ (0.20) $ 0.76
Diluted (0.20) 0.32 (0.20) 0.76
- ------------------------------------------------------------------------------------------------------------------------------
CONTINGENCIES SURROUNDING FAIR VALUES OF RISCORP ASSETS ACQUIRED AND
LIABILITIES ASSUMED AND SETTLEMENT OF CERTAIN LITIGATION BETWEEN ZENITH
INSURANCE AND RISCORP
On April 1, 1998, pursuant to an Asset Purchase Agreement dated June 17, 1997
(as amended from time to time, the "Asset Purchase Agreement") between Zenith
Insurance and RISCORP, Zenith Insurance acquired substantially all of the
assets and certain liabilities of RISCORP related to RISCORP's workers'
compensation business (the "RISCORP Acquisition"). The total purchase price
for such acquired assets and liabilities was determined by a three-step
process in which RISCORP and its external accounting and actuarial
consultants and Zenith Insurance and its external accounting and actuarial
consultants made and presented their estimates of the GAAP values of the
assets and liabilities acquired by Zenith Insurance to an independent
third-party, acting as a Neutral Auditor and Neutral Actuary. Such estimates
varied considerably, particularly with respect to the value of premiums
receivable and the liability for unpaid losses and loss adjustment expenses.
On March 19, 1999, the Neutral Auditor and Neutral Actuary issued its report
determining the disputes between the parties.
19
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The carrying values of premiums receivable and the liability for unpaid
losses and loss adjustment expenses at June 30, 1999 and December 31, 1998
reflect management's estimates using available current information. Different
actuarial assumptions, particularly assumptions about long-lived workers'
compensation claims, suggest that the ultimate liability for unpaid losses
and loss adjustment expenses could be higher than Zenith's carrying value of
reserves for such claims at June 30, 1999 and December 31, 1998. Also,
Zenith's claims handling practices vary in certain respects from those
employed by RISCORP. The ultimate amount of premiums receivable for
retrospectively-rated policies is determined, in part, by the amount and
timing of losses sustained under such policies. Also, certain of Zenith's
billing and collections procedures differ from those employed by RISCORP and
Zenith is continuing to ascertain the impact such differences may have on the
collectibility of premiums receivable. Subsequent re-interpretation of
currently available data or any new information that becomes available with
respect to premiums receivable and liabilities for unpaid losses and loss
adjustment expenses acquired from RISCORP may change the estimates of the
carrying values of such amounts and such changes, if any, will be reflected
in the results of operations of the period in which they occur. Zenith
Insurance has purchased reinsurance protection relating to development of the
loss and loss adjustment expense reserves assumed from RISCORP. Such
reinsurance would allow Zenith Insurance to recover up to $50,000,000 in
excess of $182,000,000 for net unpaid losses and allocated loss adjustment
expenses acquired from RISCORP. Future adverse loss development, if any, of
the reserves acquired from RISCORP is recoverable up to the $50,000,000
limit, although the benefit of such reinsurance recoverable would be deferred
and recognized over the recovery period of such reinsurance, whereas future
loss development, if any, would be a non-cash charge to operations in the
period in which it occurs. After deducting reinsurance premiums of
$16,000,000, Zenith has recorded reinsurance recoverable of $26,887,000 and a
deferred benefit of $10,887,000 at June 30, 1999.
20
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Zenith Insurance and RISCORP have entered into a settlement agreement, dated
July 7, 1999 (the "Settlement Agreement"), providing for the resolution of
certain claims arising out of the RISCORP Acquisition. Pursuant to the
Settlement Agreement, Zenith Insurance and RISCORP (i) have dismissed
litigation pending between them in the United States District Courts for the
Middle District of Florida, Tampa Division, and the Southern District of New
York; (ii) have agreed that RISCORP may request that the Neutral Auditor and
Neutral Actuary review an alleged error concerning the proper treatment of
certain reinsurance treaties in its determinations with respect to the
purchase price for the RISCORP Acquisition, without waiving whatever rights
they may have to litigation of such issue, determine whether the issue was
properly in dispute before the Neutral Auditor and Neutral Actuary and, if
so, determine the merits of the issue and whether a correction is
appropriate; (iii) have agreed that any other disputes arising under the
Asset Purchase Agreement or the Settlement Agreement, including any future
claims for indemnification by either Zenith Insurance or RISCORP, are to be
resolved by binding arbitration; (iv) have agreed that Zenith is to receive
$6,000,000 from an escrow account established pursuant to the Asset Purchase
Agreement, with RISCORP to receive the balance of the escrow account; and (v)
have agreed to an allocation between them of any recovery received as a
result of refund claims that RISCORP has made to the Florida Department of
Labor and Employment Security, Division of Workers' Compensation. In a
submission made to the Neutral Auditor and Neutral Actuary, RISCORP has
claimed that the purchase price for the RISCORP Acquisition should be
adjusted by either $5,872,000 or $23,365,000 as a result of alleged errors in
the Neutral Auditor and Neutral Actuary's original computation with respect
to the purchase price. Zenith disputes RISCORP's claim. In the third quarter
of 1999, a certain portion of the $6,000,000 proceeds from the settlement of
the RISCORP litigation may be accounted for as a reduction of operating
expenses to the extent that such proceeds represent compensation to Zenith
Insurance for certain of the expenses incurred to operate the former RISCORP
business.
WORKERS' COMPENSATION
Premiums earned in the Workers' Compensation operation increased in the six
months ended June 30, 1999 compared to the corresponding period in 1998,
principally as a result of the RISCORP Acquisition, which contributed
$48,172,000 of workers' compensation premiums earned in the six months ended
June 30, 1999 as compared to $24,770,000 in the six months ended June 30,
1998.
Excluding the effect of the additional premiums from the RISCORP Acquisition,
premiums earned in the Workers' Compensation operation, both inside and
outside of California, decreased in the three and six months ended June 30,
1999 compared to the corresponding periods in 1998, principally as a result
of Zenith's endeavoring to maintain rate adequacy in the face of intense
competition in the national workers' compensation insurance industry.
21
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Underwriting losses in the Workers' Compensation operation increased in the
three and six months ended June 30, 1999 compared to the corresponding
periods in 1998. The increase in such underwriting losses was attributable,
principally, to the following reasons: First, the three and six months ended
June 30, 1999 include the results of the former RISCORP business, which was
acquired effective April 1, 1998. Loss ratios in the former RISCORP
operations, except in Florida, are considerably higher than those experienced
elsewhere in Zenith's Workers' Compensation operations. Excess costs
associated with operating and integrating the former RISCORP business also
adversely impacted underwriting results in the periods that include the
former RISCORP operations. Second, Zenith's estimate of the incurred loss
ratio for its workers' compensation business, excluding the former RISCORP
operations and other Florida business, in the three and six months ended June
30, 1999 was higher than such estimate for both the three and six months
ended June 30, 1998. Third, Zenith has reduced expenses during 1999 and 1998,
principally through reductions in the number of employees, throughout its
Workers' Compensation operations. However, such reductions have been offset
by a reduction of premium income for the three and six months ended June 30,
1999 compared to the three and six months ended June 30, 1998. Zenith is
unable to predict when its Workers' Compensation operation will return to
underwriting profitability that is consistent with Zenith's historical
experience.
OTHER PROPERTY-CASUALTY
Zenith's Other Property-Casualty business was operated primarily by CalFarm,
which was sold effective March 31, 1999. In the first quarter of 1999, the
Other Property-Casualty underwriting results were adversely impacted by
continuing losses in the Health line of business, increased severity and
frequency of weather related property losses and increased expenses
attributable to improvements in information systems. The first six months of
1998 were adversely impacted by approximately $5,000,000 before taxes
attributable to California wind and storm damage.
REINSURANCE
Reinsurance premiums earned increased in the six months ended June 30, 1999,
compared to the corresponding period in 1998, due principally to additional
premiums in the first quarter of 1999 for reinstatement of treaties impacted
by catastrophes. The underwriting results for the three and six months ended
June 30, 1999 were adversely impacted by catastrophe losses of approximately
$4,200,000 and $6,100,000, before taxes, respectively, of additional losses
from Hurricane Georges, and other catastrophe losses that occurred in 1998 as
compared to no such catastrophe losses, in the corresponding periods in 1998.
22
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
REAL ESTATE OPERATIONS
Zenith recognized total revenues from its Real Estate Operations of
$14,438,000 and $25,206,000 for the three and six months ended June 30, 1999,
respectively, and $8,684,000 and $20,432,000 for the three and six months
ended June 30, 1998, respectively. The results of operations for the three
and six months ended June 30, 1999 benefited from a higher number of home
sales as compared to the corresponding periods in 1998 in addition to a gain
from a land sale of $472,000 in the first six months of 1999. Construction in
progress, including undeveloped land, was $73,119,000 and $69,387,000 at June
30, 1999 and December 31, 1998, respectively. In addition to continuing home
construction, Zenith may use some land presently owned for commercial and
multi-family dwelling construction. Increased interest rates or other factors
could affect the rate of home sales.
INVESTMENTS
The yields on invested assets, which vary with the general level of interest
rates, the average life of invested assets and the amount of funds available
for investment, were as follows:
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------------
1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
Investment yield, before taxes 5.4% 5.8% 5.4% 5.8%
Investment yield, after taxes 3.6% 4.0% 3.6% 3.9%
- ----------------------------------------------------------------------------------------------------------------
Bonds with an investment grade rating represented 93% and 96% of the
consolidated carrying values of fixed maturities at June 30, 1999 and
December 31, 1998, respectively. The average maturity of the investment
portfolio was 5.5 years at June 30, 1999 and 5.2 years at December 31, 1998.
The total fair value of fixed maturity investments and the unrealized gain
(loss) on held-to-maturity and available-for-sale fixed maturity investments,
were as follows:
- ---------------------------------------------------------------------------------------------------------------------
Unrealized Gain (Loss) on Fixed Maturities
Total Fair Held-to-Maturity Available-for-Sale
Value of ---------------- ------------------
(Dollars in thousands) Fixed Maturities* Before Tax Before Tax After Tax
- ------------------------------------------------------------------------------------------------------------------
At June 30, 1999 $855,512 $ 298 $(12,599) $(8,189)
At December 31, 1998 959,119 1,569 9,864 6,412
- ------------------------------------------------------------------------------------------------------------------
* Includes short-term investments
23
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
INVESTMENTS (CONTINUED)
At June 30, 1999 and December 31, 1998, 96% of Zenith's consolidated
portfolio of fixed maturity investments were classified as available-for sale
with the unrealized appreciation or depreciation recorded as a separate
component of stockholders' equity. The change in fair value of fixed maturity
investments available-for-sale resulted in a decrease in stockholders' equity
of $14,601,000 after deferred taxes from December 31, 1998 to June 30, 1999.
Stockholders' equity will continue to be affected by volatility in the fixed
maturity securities market and fluctuations in interest rates through changes
in the values of fixed maturity securities, which are classified as
available-for-sale.
The change in the carrying value of Zenith's consolidated investment
portfolio during the six months ended June 30, 1999 was as follows:
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------------
Carrying value at the beginning of the year $1,048,681
Purchases at cost 198,868
Investments of CalFarm at date of sale (170,050)
Maturities and redemptions (73,565)
Proceeds from sales of investments:
Investments available-for-sale (47,152)
Other investments (5,515)
Total proceeds from sales of investments --------- (52,667)
Net realized gains:
Investments available-for-sale 1,801
Other investments 2,264
Total net realized gains --------- 4,065
Change in unrealized gains (22,026)
Increase in short-term investments 21,658
Net accretion of bonds and preferred stocks and other changes 501
- --------------------------------------------------------------------------------- -------------- --------------------
Carrying value at June 30, 1999 $ 955,465
- --------------------------------------------------------------------------------- -------------- --------------------
LIQUIDITY AND CAPITAL RESOURCES
Zenith is principally dependent upon its portfolio of marketable securities
and the investment yields thereon; dividends from its insurance subsidiaries,
whose operations are supported by their own cash flows; and available lines
of credit to pay its expenses, service outstanding debt, pay any cash
dividends which may be declared to its stockholders and fund the land
acquisitions by the Real Estate Operations.
On March 26, 1999, Zenith Insurance paid the remaining balance of
approximately $53,700,000, including interest, due to RISCORP pursuant to the
RISCORP Acquisition. On April 1, 1999, Zenith Insurance received
approximately $273,000,000 from Nationwide Mutual Insurance Company in
connection with the sale of the capital stock of CalFarm and paid
approximately $59,000,000 to CalFarm in connection with the de-pooling
transaction.
24
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Net cash used in operations in the six months ended June 30, 1999 was
$39,657,000 as compared to net cash used in operations of $16,723,000 for the
six months ended June 30, 1998. During the three and six months ended June
30, 1999, cash was used principally to pay loss and loss adjustment expense
reserves in the former RISCORP operation. Net cash flows from operations will
continue to be adversely affected by the payment of reserves in the former
RISCORP operations.
Zenith has three revolving, unsecured lines of credit amounting to
$100,000,000, all of which was available at June 30, 1999.
At June 30, 1999, Zenith was authorized to repurchase up to 1,036,000 shares
of Zenith common stock pursuant to a share purchase program authorized by its
Board of Directors. These purchases are discretionary and can be adequately
funded from Zenith's existing sources of liquidity.
Zenith's Real Estate Operations maintain certain bank credit facilities to
provide financing for development and construction of private residences for
sale. At June 30, 1999, the maximum permitted under facilities was
$34,613,000, although in practice, such amount will not be outstanding. The
agreements provide that funding and repayment of development and construction
loans are made in tandem for each project. A development loan will always
precede a construction loan for a project and the proceeds of the
construction loan are required to first be used to pay off the respective
development loan. The balance outstanding under the borrowing is $15,374,000.
Zenith's Real Estate Operations are obligated under various notes arising
from its purchase of several parcels of land. The amount outstanding for such
notes at June 30, 1999 was $1,367,000.
In June of 1999, Zenith Insurance declared a dividend of $100,000,000 payable
to Zenith National. The dividend was approved by the California Department of
Insurance on June 24, 1999. The dividend was paid on July 6, 1999. Subject to
working capital needs, Zenith National currently intends to add such funds
to, and invest them as part of, its investment portfolio. Zenith has been
informed by A.M. Best Company ("Best") that the payment of the dividend will
result in a downgrade of Best's rating of Zenith`s insurance company
affiliates from A+ to A.
YEAR 2000
The Year 2000 Problem refers to the inability of information technology
("IT") and non-information technology ("non-IT") systems to accurately
process dates during and after 1999. IT systems include computer hardware and
software. Non-IT systems include equipment that incorporates embedded micro
controllers such as elevators, security systems and HVAC systems. If not
corrected, the processes of IT and non-IT systems that are date sensitive
could fail or miscalculate data resulting in disruptions of operations such
as a temporary inability to process transactions, send and receive electronic
data with third parties or otherwise engage in normal business activities.
There may also be a negative impact on the economic and social infrastructure
on which Zenith depends.
25
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In early 1996, Zenith formed a Year 2000 team consisting of staff familiar with
Zenith's IT and non-IT systems to coordinate the elimination, to the extent
possible, of Zenith's exposure to the Year 2000 Problem. Reports of the Year
2000 team's efforts are presented to Zenith's Board of Directors periodically.
Since 1996, Zenith has been systematically replacing and modifying its
internal systems to function correctly with dates from 1999 forward, thereby
rendering them "Year 2000 Compliant." Internal systems ("Internal Systems")
consist of (1) core information technology systems supporting corporate level
accounting and financial reporting processes ("Core Corporate IT Systems");
(2) core information technology systems supporting operational processes
involving (a) underwriting, premium collection and claims processes in
Zenith's insurance operations (including those systems acquired in the
RISCORP Acquisition) and (b) land acquisitions, development, construction,
sales and escrow tracking/monitoring in the Real Estate operations ("Core
Operational IT Systems"); (3) computer networks and communications
infrastructure ("IT Infrastructure"); (4) personal and laptop computers
including applications ("Other IT Equipment"); and (5) owned facility systems
which rely on non-computer equipment incorporating embedded microprocessors,
such as elevators, HVAC and security as well as office equipment such as
facsimile and copy machines and postage meters ("Facilities and Other Non-IT
Systems"). The majority of Zenith's Year 2000 compliance efforts have been
staffed internally, although Zenith has engaged and will continue to engage
technical consultants to assist its internal staff, as well as to assist
Zenith in reviewing its progress.
The Internal Systems are being corrected through a process with five phases,
some of which are concurrent: (1) Inventory (listing IT and non-IT systems and
their components); (2) Assessment (identifying possible Year 2000-related
failures and developing strategies to repair, replace, or eliminate them); (3)
Remediation (creating or acquiring corrections to identified deficiencies); (4)
Validation (confirming whether corrections would be successful); and (5)
Implementation (installing corrections into the business operations for general
use).
26
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The status and scheduled completion dates of efforts to make the Internal
Systems supporting Zenith's operations Year 2000 Compliant are as follows:
- ----------------------------------------------------------------------------------------------------------------------------
Inventory Assessment Remediation Validation Implementation
--------------- --------------- --------------- --------------- --------------
Core Corporate IT Systems Completed Completed Completed Completed Completed
Core Operational IT Systems:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed Completed Completed
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed Completed Completed
IT Infrastructure:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed 8/31/99 8/31/99
Reinsurance Completed Completed Completed 8/31/99 8/31/99
Real Estate Operations Completed Completed Completed Completed Completed
Other IT Equipment:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed Completed Completed
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed Completed Completed
Facilities and Other Non-IT Systems:
- ---------------------------------------------
Woodland Hills, CA Completed Completed Completed Completed Completed
Sarasota, FL Completed Completed Completed Completed Completed
- --------------------------------------------------------------------------------------------------------------------------
The above table excludes the scheduled completion dates for the Other Property &
Casualty Operations which were disposed of through the sale of the capital stock
of CalFarm on March 31, 1999.
Zenith plans to further test and refine the Internal Systems during the second
half of 1999, to assure that they function in Zenith's operating environment on
an interconnected basis. Also during this period, Zenith will limit software
changes into its production operating environment to minimize risk of
invalidating remediation efforts.
Zenith's Year 2000 efforts also include a systematic assessment of the Year 2000
Compliant status of third parties upon which Zenith relies in its business
operations, including major suppliers of services and products, owners of its
leased facilities and principal business partners (collectively, "Key External
Dependencies"). Zenith has used letters, questionnaires, surveys and interviews
to determine whether these Key External Dependencies will achieve Year 2000
Compliant status. To date, Zenith has been unable, in most cases, to obtain
reliable information, and is therefore uncertain about the state of readiness of
many of its Key External Dependencies. Although none of the Key External
Dependencies has informed Zenith that it has a Year 2000 issue that would have a
material effect on Zenith, few have provided definitive statements, written
assurances or warranties that they will be Year 2000 Compliant. Zenith intends
to continue its systematic assessment, including follow-ups of its Key External
Dependencies.
27
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
All companies are faced with certain unknown risks arising from Year 2000 issues
that may impact them negatively. Zenith's Year 2000 efforts have been designed
to mitigate to the extent possible its risks from Year 2000-related failures
faced by Zenith. Despite Zenith's Year 2000-related efforts, Zenith recognizes
the possibility of some negative impact on its operations resulting from Year
2000-related failures. Zenith believes that the most reasonably likely
worst-case, Year 2000 scenarios could include failures of Zenith's Internal
Systems, a failure of one or more of its critical Key External Dependencies,
such as financial institutions, agents/brokers or reinsurers, and/or the
contamination of Zenith's IT systems due to receipt of corrupted data. Such a
scenario could result in a disruption of Zenith's normal business activities and
could have a material adverse effect on its financial condition and results of
operations. In the quarter ended September 30, 1998, Zenith began developing
contingency plans to substantially reduce material business disruptions from
such risks. Zenith intends such plans to include measures, such as 1)
acceleration into the last quarter of 1999 the performance of obligations and
duties otherwise owed in the first quarter of 2000; 2) identification of
alternatives to Key External Dependencies that may not be Year 2000 Compliant
and therefore unable to meet Zenith's needs; and 3) certain activities in
Zenith's pre-existing Business Recovery/Resumption Plan designed for Zenith to
operate during, and to recover from, catastrophes. All contingency plans are
expected to be in place by September 30, 1999. Contingency plan testing
commenced in the quarter ended June 30, 1999. Additional testing is scheduled
through September 30, 1999.
Zenith has been planning to upgrade its IT Infrastructure and its other IT
equipment for some time; however, because of the Year 2000 problem, certain
components of those plans were accelerated and completed by mid-1999. The
table below sets out the costs for either repairing Zenith's IT systems ("IT
Repair Costs") or for replacing them ("IT Replacement Costs").
Percent
Expenditures Expended Estimate Total
as of as of to Estimated IT
(Dollars in thousands) 6/30/99 6/30/99 Complete Expenditure
- ----------------------------------------- ------------------ ------------------- ------------------ ------------------
IT Repair Costs $ 6,363 91% $ 600 $ 6,963
IT Replacement Costs:
Software 881 100% 881
Hardware 2,234 100% 2,234
Related Expenditures 417 63% 246 663
- --------------------------------------------------------------------------------------------------------------------
Total $ 9,895 92% $ 846 $10,741
- --------------------------------------------------------------------------------------------------------------------
The above table includes amounts incurred for the Other Property & Casualty
Operations through March 31, 1999 and does not include any estimates to complete
for the Other Property & Casualty Operations since they were disposed of through
the sale of the capital stock of CalFarm on March 31, 1999.
IT Repair Costs and IT Replacement Costs include external costs and the cost of
dedicated information technology personnel. IT Repair Costs are expensed as they
are incurred; IT Replacement Costs are capitalized in accordance with Statement
of Position 98-1. The internal cost of user participation in acceptance testing
has not been measured and is not included in the foregoing estimates. Although
not quantified at this time, costs associated with non-IT systems and
contingency planning are not expected to be significant. All Year 2000-related
costs have been, and will continue to be, funded from internal sources. No
planned information technology projects were deferred because of Year
2000-related efforts.
28
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The reader is directed to the section of this Report entitled "Forward-Looking
Information" and cautioned that the foregoing discussion on the Year 2000
Problem must be read in conjunction with such section. The forward looking
information on the Year 2000 Problem, including its impact on Zenith, future
costs, scheduled completion dates and the success of Zenith's efforts in
preparing for it are based on management's best estimates of future events. Such
estimates, however, are subject to the inherent uncertainty of the ultimate
effect and the extent of the Year 2000 Problem and the availability of technical
resources and hardware.
CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting
(statutory accounting is a comprehensive basis of accounting based on prescribed
accounting practices, which include state laws, regulations and general
administrative rules, as well as a variety of publications of the NAIC). The
NAIC is now considering amendments to the Codification that would also be
effective upon implementation. The NAIC has recommended an effective date of
January 1, 2001. The Codification provides guidance for the areas where
statutory accounting has been silent and changes current statutory accounting in
some areas.
It is not known whether the state of California Department of Insurance will
adopt the Codification, and whether the Department of Insurance will make any
changes to that guidance. Implementation of the Codification may affect the
surplus level and the capitalization requirements of Zenith's insurance
subsidiaries on a statutory basis. Zenith has not determined the impact of the
Codification.
29
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements if accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those discussed. Forward-looking statements include those
related to the plans and objectives of management for future operations, future
economic performance, or projections of revenues, income, earnings per share,
capital expenditures, dividends, capital structure, or other financial items.
Statements containing words such as EXPECT, ANTICIPATE, BELIEVE, or similar
words that are used in Management's Discussion and Analysis of Financial
Condition and Results of Operations, in other parts of this report or in other
written or oral information conveyed by or on behalf of Zenith are intended to
identify forward-looking statements. Zenith undertakes no obligation to update
such forward-looking statements, which are subject to a number of risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include but are not limited to the
following: (1) heightened competition, particularly intense price competition;
(2) adverse state and federal legislation and regulation; (3) changes in
interest rates causing a reduction of investment income; (4) general economic
and business conditions which are less favorable than expected; (5)
unanticipated changes in industry trends; (6) adequacy of loss reserves; (7)
catastrophic events; (8) ability to timely and accurately complete the Year 2000
conversion process; (9) impact of any failure of third parties with whom Zenith
does business to be Year 2000 compliant; (10) uncertainties related to the
RISCORP Acquisition, including (a) the ability of Zenith to integrate on a
profitable basis the business acquired from RISCORP, (b) the value of
transferred assets and transferred liabilities, and (c) the resolution of
RISCORP's claim that the Neutral Auditor and Neutral Actuary allegedly made an
error in its determinations with respect to the purchase price for the RISCORP
Acquisition; (11) changing environment for controlling medical, legal and
rehabilitation costs, as well as fraud and abuse; and (12) other risks detailed
herein and from time to time in Zenith's other reports and filings with the
Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 1999, approximately 96% of the carrying value of fixed maturity
investments are categorized as available-for-sale, for which category changes in
fair value are reflected in stockholders' equity. The fair value of the fixed
income investment portfolio is exposed to interest rate risk - the risk of loss
in fair value resulting from adverse changes in prevailing market rates of
interest for similar financial instruments. In addition, certain mortgage-backed
securities are exposed to accelerated prepayment risk in that a decline in
interest rates could prompt mortgage holders to refinance existing mortgages at
lower rates. However, Zenith has the ability to hold fixed income investments to
maturity.
Zenith relies on the experience and judgment of senior management to monitor
and control market risk. Zenith does not utilize financial instrument hedges
or derivative financial instruments to manage risks, nor does it enter into
any swap, forward or options contracts, but will attempt to mitigate its
exposure through active portfolio management. The allocation among various
types of securities is adjusted from time to time based on market conditions,
credit conditions, tax policy, fluctuations in interest rates and other
factors. In addition, Zenith places the majority of its investments in high
quality, marketable securities and limits the amount of credit exposure with
respect to any single issuer.
30
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
The table below provides information about Zenith's financial instruments as
of June 30, 1999 for which fair values are subject to changes in interest
rates. For fixed maturity investments, the table presents fair value and
weighted average interest rates by expected maturity dates. Such investments
include preferred stocks that are redeemable or have sinking fund provisions,
corporate bonds, municipal bonds, government bonds and mortgage backed
securities. For debt obligations, the table presents principal cash flows by
expected maturity dates.
- -------------------------------------------------------------------------------------------------------------------------------
Expected Maturity Date
-----------------------------------------------------------------------------------------
(Dollars in thousands) 1999 2000 2001 2002 2003 Thereafter Total
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ----------- ------------
Fixed maturities:
Held-to-maturity and
available-for-sale securities:
Fixed rate $26,801 $113,828 $60,696 $67,585 $57,774 $367,634 $694,318
Weighted average interest
rate 5.2% 5.5% 5.8% 6.4% 7.1% 7.8%
Trading Securities:
Fixed rate $2,946 2,946
Weighted average interest
rate 6.5%
Short-term investments $158,248 158,248
Debt obligations:
9% senior notes payable 3,375 $6,750 $6,750 $78,375 95,250
8.55% redeemable securities 3,207 6,413 6,413 6,413 $6,413 $235,325 264,184
Payable to banks and other
notes payable 4,646 13,033 130 81 34 406 18,330
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ----------- ------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Stockholders' Meeting of Zenith was held on May 20, 1999. Two
matters were presented to a vote of the Stockholders.
One matter was the election of Directors. The tabulation of votes for the
nominees, all of whom were elected, follows:
- -----------------------------------------------------------------------------------------------------------------
Director Votes For Votes Withheld
- ----------------------------------------- ----------------------------------- -----------------------------------
George E. Bello 14,207,988 73,602
Max M. Kampelman 13,531,243 750,347
Robert J. Miller 14,208,120 73,470
William Steele Sessions 14,189,397 92,193
Harvey J. Silbert 14,107,711 173,879
Robert M. Steinberg 14,023,487 258,103
Saul P. Steinberg 13,632,146 649,444
Gerald Tsai, Jr. 14,190,653 90,937
Michael Wm. Zavis 14,208,232 73,358
Stanley R. Zax 14,205,232 76,358
- ----------------------------------------- ----------------------------------- -----------------------------------
With respect to the election of Directors, there were no votes cast against
any Directors, no abstentions and no broker non-votes.
31
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED)
The second matter was a vote to approve Amendment No. 1 to the 1996 Employee
Stock Option Plan, a non-qualified stock option plan for officers and
employees of Zenith and its subsidiaries. Amendment No. 1 increases by
250,000 the number of shares available for issuance pursuant to new awards.
The matter was approved by the Stockholders. A tabulation of votes follows:
- ------------------------------------------------------------------------------------------------------------------
For Against Abstain Brokers' Non-Votes
- ------------------------------ --------------------------- --------------------------- ---------------------------
12,194,147 682,353 1,405,089 1
- ------------------------------ --------------------------- --------------------------- ---------------------------
PART II, OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Certificate of Incorporation of Zenith as in effect immediately prior
to November 22, 1985. (Incorporated herein by reference to Exhibit 3
to Zenith's amendment on Form 8, date of amendment October 10, 1985,
to Zenith's Current Report on Form 8-K, date of report July 26, 1985.)
Certificate of Amendment to Certificate of Incorporation of Zenith,
effective November 22, 1985. (Incorporated herein by reference to
Zenith's Current Report on Form 8-K, date of report
November 22, 1985.)
3.2 By-laws of Zenith, as currently in effect. (Incorporated herein by
reference to Exhibit 3.2 to Zenith's Annual Report on Form 10-K for
the year ended December 31, 1988)
10.1 Amendment No. 1, dated December 8, 1998, to Zenith National Insurance
Corp. 1996 Employee Stock Option Plan.
10.2 Loan Revision Agreement, dated June 30, 1999, to the promissory note,
dated July 1, 1997, between Zenith National Insurance Corp. and City
National Bank.
10.3 Standstill Agreement, dated June 30, 1999, between Zenith National
Insurance Corp. and Fairfax Financial Holdings Limited.
10.4 Settlement Agreement, dated July 7, 1999, between Zenith Insurance
Company, RISCORP, Inc., RISCORP Management Services, Inc., 1390 Main
Street Services, Inc., RISCORP of Illinois, Inc., Independent
Association Administrators Incorporated, RISCORP Insurance Services,
Inc., RISCORP Managed Care Services, Inc., CompSource, Inc., RISCORP
Real Estate Holdings, Inc., RISCORP Acquisition, Inc., RISCORP West,
Inc., RISCORP of Florida, Inc., RISCORP Insurance Company, RISCORP
Property & Casualty Insurance Company, RISCORP National Insurance
Company, RISCORP Services, Inc., RISCORP Staffing Solutions Holding
Company, RISCORP Staffing Solutions, Inc. I and RISCORP Staffing
Solutions, Inc., II.
32
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
(a) Exhibits (continued)
11 Statement re computation of per share earnings. (Note 2 of the
Consolidated Financial Statements (unaudited) included in Item 1 of
Part I of this Quarterly Report on Form 10-Q is incorporated herein by
reference.)
27 Financial data schedule
(b) Reports on Form 8-K
Zenith filed a Current Report on Form 8-K, dated July 6, 1999, on
July 12, 1999 in connection with (1) the acquisition of Zenith common
stock by Fairfax Financial Holdings Limited, (2) the settlement
agreement between Zenith Insurance Company and RISCORP, Inc. and (3)
the dividend from Zenith Insurance to Zenith.
33
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
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.
ZENITH NATIONAL INSURANCE CORP.
Registrant
Date: August 13, 1999 /s/ Stanley R. Zax
--------------------------------------
Stanley R. Zax
Chairman of the Board and President
(Principal Executive Officer)
Date: August 13, 1999 /s/ Fredricka Taubitz
---------------------------------------
Fredricka Taubitz
Executive Vice President
& Chief Financial Officer
(Principal Accounting Officer)
34