-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BlyJQQM0U/E0XH12CSca0GnXM3NxPDCNFtbkbI6l+fIVm8aw2FRUjFIwq3cLhx4C CAXm197seoJxy5THcc7Mxw== 0000899243-02-002305.txt : 20020814 0000899243-02-002305.hdr.sgml : 20020814 20020814132414 ACCESSION NUMBER: 0000899243-02-002305 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HIGHLANDS INSURANCE GROUP INC CENTRAL INDEX KEY: 0001002816 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 752370945 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14028 FILM NUMBER: 02733853 BUSINESS ADDRESS: STREET 1: 1000 LENOX DRIVE E CITY: LAWRENCEVILLE STATE: NJ ZIP: 08648 BUSINESS PHONE: 7139529555 MAIL ADDRESS: STREET 1: 1000 LENOX DRIVE E CITY: LAWRENCEVILLE STATE: NJ ZIP: 08648 10-Q 1 d10q.txt FORM 10-Q ================================================================================ 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 quarterly period ended June 30, 2002 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ________ HIGHLANDS INSURANCE GROUP, INC. (Exact Name of Registrant as Specified in its Charter) 1-14028 (Commission File Number) Delaware 75-2370945 (State or Other Jurisdiction (I.R.S. Employer Of Incorporation Or Organization) Identification Number) 1000 Lenox Drive, Lawrenceville, New Jersey 08648 (Address of Principal Executive Offices) (Zip Code) (609) 896-1921 (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 [_] The number of shares of the Registrant's Common Stock, par value $.01 per share, outstanding at June 30, 2002 was 12,978,533. ================================================================================ 1 HIGHLANDS INSURANCE GROUP, INC. TABLE OF CONTENTS PART I - Financial Information Item Page 1. Financial Statements: Consolidated Balance Sheets June 30, 2002 (Unaudited) and December 31, 2001 3 Consolidated Statements of Operations (Unaudited) - Three Months and Six Months Ended June 30, 2002 and 2001 5 Consolidated Statements of Stockholders' Equity Six Months Ended June 30, 2002 (Unaudited) and Year Ended December 31, 2001 6 Consolidated Statements of Comprehensive Income (Loss) (Unaudited) - Three Months and Six Months Ended June 30, 2002 and 2001 7 Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended June 30, 2002 and 2001 8 Condensed Notes to Unaudited Consolidated Financial Statements 9 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 3. Quantitative and Qualitative Disclosures About Market Risk 15 PART II - Other Information 1. Legal Proceedings 16 4. Submission of Matters to a Vote of Security Holders 18 6. Exhibits and Reports on Form 8-K 18 Signatures 19 2 HIGHLANDS INSURANCE GROUP, INC. CONSOLIDATED BALANCE SHEETS (dollars in thousands)
June 30, December 31, ASSETS 2002 2001 ------ ----------- ------------ (Unaudited) Investments: Fixed maturity securities - available-for-sale, at fair value (amortized cost of $641,754 at 6/30/02 and $723,410 at 12/31/01) $ 636,700 714,243 Equity securities, at fair value (cost of $24,049 at 6/30/02 and $28,940 at 12/31/01) 24,153 29,665 Other investments, at cost 2 54 ---------- --------- Total investments 660,855 743,962 Cash and cash equivalents 104,564 109,634 Premiums in course of collection, net 38,701 85,838 Premiums due under retrospectively rated policies 91,773 108,952 Receivable from reinsurers 679,550 691,938 Prepaid reinsurance premiums 3,108 7,523 Funds on deposit with reinsurers 20,035 20,035 Accrued investment income 8,797 9,723 Other assets 36,586 43,007 ---------- --------- Total assets $1,643,969 1,820,612 ========== =========
See Condensed Notes to Unaudited Consolidated Financial Statements. 3 HIGHLANDS INSURANCE GROUP, INC. CONSOLIDATED BALANCE SHEETS, (Continued) (dollars in thousands)
June 30, December 31, LIABILITIES AND STOCKHOLDERS' EQUITY 2002 2001 ------------------------------------ ----------- ------------- (Unaudited) Loss and loss adjustment expense reserves $1,571,691 1,599,127 Unearned premiums 52,999 168,480 Senior bank debt 47,504 49,004 Convertible subordinated debentures 62,702 62,297 Accounts payable and accrued liabilities 70,965 99,751 ---------- --------- Total liabilities 1,805,861 1,978,659 ---------- --------- Mandatorily redeemable preferred stock 5,235 5,235 ---------- --------- Commitments and contingent liabilities Stockholders' equity: Common stock, $.01 par value; 50,000,000 shares authorized; 12,978,533 issued and outstanding in 2002 and in 2001 137 137 Additional paid-in capital 228,872 228,872 Accumulated other comprehensive loss (3,209) (8,582) Treasury stock, at cost (739,400 shares in 2002 and 2001, including 445,900 shares held by subsidiaries in 2002 and 2001) (9,459) (9,459) Deferred compensation on restricted stock (313) (313) Retained loss (383,155) (373,937) ---------- --------- Total stockholders' equity (deficit) (167,127) (163,282) ---------- --------- Total liabilities and stockholders' equity $1,643,969 1,820,612 ========== =========
See Condensed Notes to Unaudited Consolidated Financial Statements. 4 HIGHLANDS INSURANCE GROUP, INC CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (dollars in thousands, except per share data)
Three Months Six Months Ended June 30, Ended June 30, ------------------------------------ --------------------------------- 2002 2001 2002 2001 ------------ ------------- ------------ ------------- Revenues: Net premiums earned $ 60,325 144,646 144,691 271,699 Net investment income 11,724 14,318 24,216 30,605 Net realized investment gains (losses) (2,307) 495 (1,754) 1,065 ----------- ------------ ------------ ------------ Total revenues 69,742 159,459 167,153 303,369 ----------- ------------ ------------ ------------ Expenses: Loss and loss adjustment expense incurred 61,441 124,025 140,833 238,055 Underwriting expenses 12,083 51,730 31,794 92,940 Debt interest and amortization expense 2,944 3,187 5,169 5,940 Other expenses (income), net (556) 139 683 660 ----------- ------------ ------------ ------------ Total expenses 75,912 179,081 178,479 337,595 ----------- ------------ ------------ ------------ Loss before income tax (6,170) (19,622) (11,326) (34,226) Income tax expense (benefit) 2 119 (6) 126 ----------- ------------ ------------ ------------ Net loss before extraordinary item (6,172) (19,741) (11,320) (34,352) Extraordinary item - write-off of negative goodwill -- -- 2,259 -- ----------- ------------ ------------ ----------- Net loss (6,172) (19,741) (9,061) (34,352) Dividends on mandatorily redeemable preferred 79 78 156 152 ----------- ------------ ------------ ------------ Net loss attributable to common stockholders $ (6,251) (19,819) (9,218) (34,504) =========== ============ ============ ============ Earnings per common share: Loss before extraordinary items $ (0.48) (1.50) (0.88) (2.61) Extraordinary item -- -- 17 -- ----------- ------------ ------------ ----------- Net loss attributable to common stockholders $ (0.48) (1.50) (0.71) (2.61) =========== ============ ============ ============ Weighted average number of common shares outstanding 12,979 13,229 12,979 13,228 =========== ============ ============ ============
See Condensed Notes to Unaudited Consolidated Financial Statements. 5 HIGHLANDS INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands)
For the six For the year months ended ended June 30, December 31, 2002 2001 ------------ ------------ (Unaudited) Common stock: Balance, beginning of year $ 137 140 Issuance (cancellation) of common stock, par value -- (3) ------------ ------------ Balance, end of period 137 137 ------------ ------------ Additional paid-in capital: Balance, beginning of year 228,872 231,566 Issuance (cancellation) of common stock, net -- (2,694) ------------ ------------ Balance, end of period 228,872 228,872 ------------ ------------ Accumulated other comprehensive income (loss): Balance, beginning of year (8,582) (12,572) Changes in net unrealized gain (losses), net of tax 3,492 7,015 Change in valuation allowance for deferred taxes on unrealized investment gains and losses 1,866 (2,955) Other 15 (70) ------------ ------------ Balance, end of period (3,209) (8,582) ------------ ------------ Treasury stock, at cost: Balance, beginning of year (9,459) (9,459) Acquisition of treasury stock -- -- ------------ ----------- Balance, end of period (9,459) (9,459) ------------ ------------ Deferred compensation on restricted stock: Balance, beginning of year (313) (3,097) Net retirement (issuance) of restricted stock -- 2,784 ------------ ------------ Balance, end of period (313) (313) ------------ ------------ Retained (loss) earnings: Balance, beginning of year (373,937) (32,029) Net income (loss) attributable to common stockholders (9,218) (341,908) ------------ ------------ Balance, end of period (383,155) (373,937) ------------ ------------ Total stockholders' equity (deficit) $ (167,127) (163,282) ============ ============
See Condensed Notes to Unaudited Consolidated Financial Statements. 6 HIGHLANDS INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited) (dollars in thousands)
Three Months Six Months Ended June 30, Ended June 30, --------------------------- ---------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------- Net income (loss) attributable to common stockholders $ (6,251) (19,819) (9,218) (34,504) ---------- ---------- ---------- ---------- Other comprehensive income (loss), net of taxes: Increase (decrease) in unrealized gain or loss on investments, net of taxes of $5,199 and $(1,913) for the three months and $1,266 and $3,205 for the six months ended June 30, 2002 and 2001, respectively 9,655 (3,552) 2,352 5,953 Reclassification adjustments for realized gains in net income, net of taxes of $808 and $(174) for the three months and $614 and $(373) for the six months ended June 30, 2002 and 2001, respectively 1,499 (321) 1,140 (692) Change in valuation allowance for deferred taxes on unrealized investment gains and losses 5,992 -- 1,866 -- Other 24 56 15 (61) ---------- ---------- ---------- ---------- Other comprehensive income (loss), net of taxes 17,170 (3,817) 5,373 5,200 ---------- ---------- ---------- ---------- Comprehensive income (loss) $ 10,919 (23,636) (3,845) (29,304) ========== ========== ========== ==========
See Condensed Notes to Unaudited Consolidated Financial Statements. 7 HIGHLANDS INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (dollars in thousands)
Six Months Ended June 30, ------------------------------- 2002 2001 --------------- ------------- Cash flows used in operating activities: Net income (loss) $ (9,061) (34,352) -------------- --------------- Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 3,389 3,079 Net realized investment gains 1,754 (1,065) Deferred tax expense -- -- Extraordinary item - write-off of negative goodwill (2,259) -- Change in: Premiums in course of collection 47,137 (26,882) Premiums due under retrospectively rated policies 17,179 (422) Receivables from reinsurers 12,388 (26,995) Prepaid reinsurance premiums 4,415 610 Funds on deposit with reinsurers -- (570) Deferred policy acquisition costs -- (2,143) Loss and loss adjustment expense reserves (27,436) 33,359 Unearned premiums (115,481) 19,320 Other operating assets and liabilities (26,269) 13,135 --------------- --------------- Total adjustments (85,183) 11,426 --------------- --------------- Net cash used in operating activities (94,244) (22,926) -------------- -------------- Cash flows from investing activities: Proceeds from sales: Fixed maturity securities available-for-sale 135,295 8,350 Equity securities 5,594 -- Other invested assets 80 2,018 Maturities or calls: Fixed maturity securities available-for-sale 23,861 85,798 Investment purchases: Fixed maturity securities available-for-sale (73,869) (82,435) Equity securities -- -- Net additions to property and equipment (287) (1,512) -------------- -------------- Net cash provided by investing activities 90,674 12,219 -------------- -------------- Cash flows from financing activities: Repayment of senior bank debt (1,500) -- -------------- -------------- Net cash used in financing activities (1,500) -- -------------- ------------- Net (decrease) increase in cash and cash equivalents (5,070) (10,707) Cash and cash equivalents at beginning of period 109,634 109,763 -------------- -------------- Cash and cash equivalents at end of period $ 104,564 99,056 ============== =============== Supplemental disclosure of cash flow information: Interest paid $ -- 2,244 ============== ===============
See Condensed Notes to Unaudited Consolidated Financial Statements. 8 HIGHLANDS INSURANCE GROUP, INC. CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2002 1. Basis of Presentation The accompanying consolidated financial statements as of June 30, 2002 and for the three and six months ended June 30, 2002 and 2001 are unaudited and include the accounts of Highlands Insurance Group, Inc., ("Highlands Group") and its subsidiaries (the "Company"). In the opinion of management, all adjustments, consisting of normal recurring adjustments necessary for a fair presentation, have been reflected. The results for the period are not necessarily indicative of the results to be expected for the entire year. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Form 10-K for the year ended December 31, 2001. The independent auditors report on the Company's 2001 consolidated financial statements reflects a disclaimer of opinion due to the significant uncertainty regarding the Company's ability to continue as a going concern. Highlands Group is an insurance holding company for Highlands Holding Company, Inc. and its subsidiaries ("Highlands"), American Reliance, Inc. and its subsidiaries ("American Reliance"), and Highlands Holdings (U.K.) Limited and its subsidiary ("Highlands UK") (a foreign reinsurance company located in the United Kingdom), and certain other immaterial companies. For reporting purposes, the Company considers all of its property and casualty insurance operations as one segment. All material intercompany accounts and transactions have been eliminated. The accompanying consolidated financial statements have been prepared as though the Company will continue as a going concern. The Company has been in default under the terms of its bank debt for noncompliance with certain financial ratios. The Company does not have sufficient funds to satisfy the $47.5 million principal which was due on April 30, 2002. The Company is currently negotiating a forebearance agreement with its senior debt lenders in anticipation of filing a plan under Chapter 11 of the Bankruptcy Code. The California Department of Insurance is conducting an examination of the financial statements of Pacific National Insurance Company and its subsidiary, Pacific Automobile Insurance Company (collectively, "Pacific") as of December 31, 2001. The California Department has received a report from an independent consultant indicating that the loss and expense reserves of those two companies may be materially understated at December 31, 2001. Pacific and its external actuaries have notified the California Department of their disagreement with the conclusions in the report. Discussions between Pacific and the California Department are continuing. On May 16, 2002, the Indiana Insurance Department issued Orders of Supervision covering two of the Company's subsidiaries domiciled in Indiana, Statesman Insurance Company and American Professionals Insurance Company. In February 2002, the Texas Department of Insurance issued Supervisory Orders to the Company's Texas insurance subsidiaries, including Highlands Insurance Company, the Company's principal insurance subsidiary. By their terms, the orders are also binding on all the companies' affiliates. A Supervisory Order for another of the insurance subsidiaries, State Capital Insurance Company, was issued by the North Carolina Department of Insurance in December 2001, and in October 2001, the Wisconsin Commissioner of Insurance issued a Stipulation and Order covering Northwestern National Casualty Company, the Company's second largest insurance subsidiary, and NN Insurance Company, another of the Company's insurance subsidiaries. In addition to these orders, the Company's insurance subsidiaries have had their licenses to transact business suspended, amended to permit servicing of existing business, or revoked in numerous states. Except where prohibited by law, the Company is not renewing any business upon policy term expiration. These matters raise substantial doubt regarding the Company's ability to continue as a going concern. Certain financial information that is normally included in annual financial statements prepared in accordance with generally accepted accounting principles but is not required for interim reporting purposes has 9 been condensed or omitted. Certain reclassifications have been made to the prior year's financial statements to conform to the current year's presentation. 2. Extraordinary Item In July 2001, the FASB issued Statement No. 141, Business Combinations and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 became effective January 1, 2002 and requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FAS Statement No. 121, Accounting for the Impairment of Long Lived Assets and for Long-Lived Assets to be Disposed Of. As of December 31, 2001, the Company had recorded negative goodwill in the amount of $2.3 million. Upon adoption of Statement 142 on January 1, 2002, the remaining balance of negative goodwill was recognized as an extraordinary item. 3. Earnings Per Share The following tables set forth the computation of basic and diluted earnings per share (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, ------------------------------- ------------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ------ NUMERATOR: Net income (loss) attributable to common stockholders as reported and for basic earnings per share $ (6,251) (19,819) (9,218) (34,504) Effect of dilutive securities - after tax debt expense applicable -- -- -- -- ----------- ----------- ----------- ----------- Numerator for diluted earnings (loss) per common share - income available to common stockholders after assumed conversions, if appropriate $ (6,251) (19,819) (9,218) (34,504) =========== =========== =========== =========== DENOMINATOR: Denominator for basic earnings (loss) per share - weighted average shares outstanding 12,979 13,229 12,979 13,228 Effect of dilutive securities: Common stock warrants and outstanding stock options (based on treasury stock method) -- -- -- -- Convertible subordinated debentures, if appropriate -- -- -- -- ----------- ----------- ----------- ---------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 12,979 13,229 12,979 13,228 =========== =========== =========== =========== Basic earnings (loss) per share $ (0.48) (1.50) (0.71) (2.61) Diluted earnings (loss) per share $ (0.48) (1.50) (0.71) (2.61) =========== =========== =========== ===========
The convertible subordinated debentures ("Debentures"), which are convertible into approximately 3.7 million shares, were outstanding during the six months ended June 30, 2002 and 2001, but were not included in the computation of diluted earnings per share because the assumed conversion would be antidilutive. Common 10 stock warrants attached to the Debentures for approximately 3.8 million shares for 2002 and 5 million shares for 2001 were not included in the earnings per share calculation as they were antidilutive. Stock options for 654,492 and 1,150,266 shares for 2002 and 2001, respectively, were not included in earnings per share calculations as they were antidilutive. 4. Contingent Liabilities: The information set forth in Item 1 of Part II of this report is incorporated herein by reference. The Company is a party to various claims and legal actions arising in the ordinary course of its insurance business which, in the opinion of management, will not have a material effect on the Company's financial position or results of operations. 11 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The results of the Company's consolidated operations for the periods indicated are set forth below:
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ----------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ --------- (dollars in thousands) Consolidated Results: Gross premiums written $ 15,735 159,775 45,660 322,305 Net premiums written $ 9,738 141,282 33,624 291,628 ============ ============ ============ ============ Net premiums earned $ 60,325 144,646 144,691 271,699 Loss and loss adjustment expense incurred (61,441) (124,025) (140,833) (238,055) Underwriting expenses (12,083) (51,730) (31,794) (92,940) ------------ ------------ ------------ ------------ Underwriting loss (13,199) (31,109) (27,936) (59,296) Net investment income 11,724 14,318 24,216 30,605 Net realized investment gains (2,307) 495 (1,754) 1,065 Debt interest and amortization expense (2,944) (3,187) (5,169) (5,940) Other (expenses) income, net 556 (139) (660) (660) ------------ ------------ ------------ ------------ Loss before taxes (6,170) (19,622) (11,326) (34,226) Income tax expense 2 119 (6) 126 ------------ ------------ ------------ ------------ Net loss $ (6,172) (19,741) (11,320) (34,352) Dividends on mandatorily redeemable preferred stock 79 78 156 152 ------------ ------------ ------------ ------------ Net loss attributable to common stockholders before extraordinary gains (6,251) (19,819) (11,476) (34,504) Extraordinary item - write-off of negative goodwill -- -- 2,259 -- ------------ ------------ ------------ ------------ Net loss attributable to common stockholders $ (6,251) (19,819) (9,218) (34,504) ============ ============ ============ ============ Earnings (loss) per common share: Loss before extraordinary items $ (0.48) (1.50) (0.88) (2.61) Extraordinary item -- -- .17 -- ----------- ----------- ------------ ------------ (0.48) (1.50) (0.71) (2.61) ============ ============ ============ ============ Ratios: Loss 101.8% 85.7% 97.3% 87.6% Expense 20.0% 35.8% 22.0% 34.2% ----------- ----------- ----------- ----------- Combined 121.8% 121.5% 119.3% 121.8% =========== =========== =========== ===========
Period to Period Comparisons Gross Premiums Written. Gross premiums written for the three months and six months ended June 30, 2002 and 2001 were $15.7 million, $159.8 million, $45.7 million and $322.3 million, respectively. The $144.1 million 12 and $276.6 or 90.2% and 85.8% decrease in 2002 compared to 2001 is due primarily to the Company's implementation of its plan to not renew any business upon policy term expiration, except where prohibited by law. The Company estimates ultimate losses for retrospectively rated policies and then adjusts gross premiums written and premiums due from policyholders for changes in estimated ultimate losses and loss adjustment expenses from the date of the prior valuation. These adjustments may cause gross premiums written, net premiums written and net premiums earned to fluctuate significantly from period to period. Gross premiums for these items for the three months and six months ended June 30, 2002 were $22.5 million and $25.5 million, respectively. Due to a policy backlog in 2001, an immaterial amount of such premium was included in the first half of that year. Experience rated contracts, such as retrospectively rated policies, reduce but do not eliminate risk to the insurer. Net Premiums Written. Net premiums written for the three months and six months ended June 30, 2002 and 2001 were $9.7 million, $141.3 million, $33.6 million and $291.6 million, respectively. The decrease of $131.6 million and $258 million or 93.1% and 88.5% in 2002 compared to 2001 is due to the same issues affecting gross premiums written. Included in these amounts for the three months and six months ended June 30, 2002 were $22.5 million and $25.5 million of retrospectively rated policies, respectively. Net Premiums Earned. Net premiums earned for the three months six months ended June 30, 2002 and 2001 were $60.3 million, $144.6 million, $144.7 million and $271.7 million, respectively. The decrease of $84.3 million and $127 million or 58.3% and 46.7% in 2002 compared to 2001 is due to the same reasons affecting net premiums written, but the effect is less due to the earnings pattern of net premiums written. Net premiums written are initially deferred and earned based upon the terms of the underlying policies which causes earning trends to lag behind written premium trends during periods of increasing or decreasing net premiums written. Included in these amounts for the three months and six months ended June 30, 2002 were $11.6 million and $9.6 million of retrospectively rated policies, respectively. Loss and Loss Adjustment Expense Incurred. Loss and loss and adjustment expenses incurred for the three months and six months ended June 30, 2002 and 2001 were $61.4 million, $124.0 million, $140.8 million and $238.1 million, respectively. The loss and loss adjustment expense ratio for the three months and six months ended June 30, 2002 and 2001 was 101.8%, 85.7%, 97.3%, and 87.6%, respectively. The difference in the loss ratio is due to prior year reserve development of $5.0 million, settlements of disputed items of $6.0 million in the current period and higher loss ratios being applied to 2002 premiums versus same periods in 2001. Underwriting Expenses. Underwriting expenses for the three months and six months ended June 30, 2002 and 2001 were $12.1 million, $51.7 million, $31.8 million and $92.9 million, respectively. The underwriting expense ratio for the three months and six months ended June 30, 2002 and 2001 was 20%, 35.8%, 22% and 34.2%, respectively. The decline in the 2002 underwriting expense ratio, compared to the 2001 expense ratio, of 12.2 points is primarily related to the non-recognition in 2002 of deferred acquisition costs of $49.6 million that would have been amortized in 2002 that were written off at December 31, 2001. Investment Results. Net investment income for the three months and six months ended June 30, 2002 and 2001 was $11.7 million, $14.3 million, $24.2 million and $30.6 million, respectively. Net investment income decreased $2.6 million and $6.4 from 2001 primarily due to reductions in the investment portfolio's average amortized cost and lower interest rates. Net realized investment gains (losses) for the Company were $(2.3) million, $.5 million, $(1.7) million and $1.1 million for the three months and six months ended June 30, 2002 and 2001, respectively. Included in both the three month and six month realized loss in 2002 are losses relating to $3.0 million of bonds with other than temporary impairment. Debt Interest and Amortization Expense. Debt interest and amortization expense for the three months and six months ended June 30, 2002 and 2001 was $2.9 million, $3.2 million, $5.2 million and $5.9 million, respectively. The reduction in 2002 compared to 2001 reflects the paydowns of the Company's senior bank debt as well as lower interest rates in 2002. Other Expenses. Other expenses consist of parent company expenses and miscellaneous expenses from the insurance subsidiaries offset by miscellaneous income. 13 Income Taxes. The Company provides for income taxes on its statements of operations pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). The total tax expense for the three months and six months ended June 30, 2002 and 2001 was $2 thousand, $119 thousand, $(6) thousand and $126 thousand, respectively. Extraordinary Item. In July 2001, the FASB issued Statement No. 141, Business Combinations and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 became effective January 1, 2002 and requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FAS Statement No. 121, Accounting for the Impairment of Long Lived Assets and for Long-Lived Assets to be Disposed Of. As of December 31, 2001, the Company had recorded negative goodwill in the amount of $2.3 million. Upon adoption of Statement 142 on January 1, 2002, the remaining balance of negative goodwill was recognized as an extraordinary item. Liquidity and Capital Resources Highlands Group is a holding company, the principal assets of which at June 30, 2002 are all of the capital stock of Highlands Holding Company, Inc. and American Reliance, Inc. The Company's property and casualty insurance business is conducted by its wholly-owned insurance subsidiaries. The liquidity and capital resource considerations for the Highlands Group are different than those of the Company's insurance operations. As described more fully below, due to the Company's current financial condition, the Highlands Group is currently negotiating a forebearance agreement with its senior debt lenders in anticipation of filing a plan under Chapter 11 of the Bankruptcy Code. Holding Company As a holding company, Highlands Group's principal requirements for funds are to pay operating expenses, franchise and other taxes and debt service. Operating expenses and franchise and other taxes imposed on the Company are not material. The Company has outstanding $47.5 million in outstanding senior bank debt and $62.7 million principal amount of convertible subordinated debentures. The bank debt, which is collaterized by a first lien on the stock of the Company's principal insurance subsidiaries, matured on April 30, 2002 and has not been paid. The Company and the lender banks executed the Eighth Amendment and Waiver to the Credit Agreement dated as of May 1, 2002 which waived certain events of default and extended the maturity of the senior bank debt to June 30, 2002. The convertible subordinated debentures are due December 31, 2005; however, by virtue of the cross default provisions of the debentures, if the senior bank debt becomes due and is not paid, the holders of the debentures have the right to declare the debentures in default and accelerate their maturity. Highlands Group's only significant sources of funds are dividends and tax sharing payments from its subsidiaries. As a result of orders issued by state insurance regulators and losses incurred by the Company's insurance subsidiaries, no further payments from the insurance subsidiaries are likely to be made. As a result, the Highlands Group is currently negotiating a forebearance agreement with its senior debt lenders in anticipation of filing a plan under Chapter 11 of the Bankruptcy Code. As a result of the losses incurred by the Company's insurance subsidiaries, one or more state insurance commissioners could seek to place the Company's insurance subsidiaries that are under their jurisdiction in rehabilitation or liquidation. If an insurance subsidiary were placed in rehabilitation or liquidation, the Company would lose control of that insurance subsidiary. See Part II, Item 1 - Legal Proceedings for a 14 discussion of Regulatory Proceedings. Insurance Subsidiaries Insurance Operations. The principal sources of funds for the insurance subsidiaries are premiums and amounts earned from the investment of such premiums. The principal uses of funds by these subsidiaries are loss payments and related expenses, underwriting expenses, other operating expenses and dividends and tax sharing payments to Highlands Group. As a result of the insurance subsidiaries ceasing to write any new business and not renewing existing business, premium income to the Company has been materially reduced. In the insurance industry, liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its operations, including its investment portfolio, in order to meet its financial commitments, which are principally obligations under the insurance policies it has written. Liquidity requirements of insurance companies are influenced significantly by product mix and the profitability of the products. Continuing operating losses, including those from future catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements for the insurance subsidiaries. The Company's insurance subsidiaries have not purchased any catastrophe reinsurance for the current period due to the decreasing exposures of the companies and the prohibitive cost of such reinsurance. The liquidity requirements of the insurance subsidiaries are met by that portion of the investment portfolio that is held in cash and highly liquid securities. Forward Looking Information The statements included in this Form 10-Q for the quarter ended June 30, 2002, regarding future financial performance and results and other statements that are not historical facts are forward-looking statements. The words "expect," "project," "estimate," "predict," "anticipate," "believes" and similar expressions are also intended to identify forward-looking statements. Such statements are subject to numerous risks, uncertainties and assumptions, including but not limited to, the uncertainties relating to industry and market conditions, natural disasters and other catastrophes, and other risks and uncertainties described in the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and in the Company's other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in the Company's investment strategies, types of financial instruments held or the risks associated with such instruments which would materially alter the market risk disclosures made in the Company's Annual statement on Form 10-K for the year ended December 31, 2001. 15 PART II Other Information ITEM 1. Legal Proceedings Halliburton. From 1958 to 1986, the Company issued fixed premium, guaranteed cost (not retrospectively rated) insurance policies to Brown & Root Company ("Brown & Root"), a subsidiary of Halliburton Company. Beginning in 1987, the Company's insurance policies with Halliburton (including Brown & Root) were written on a retrospectively rated or high-deductible basis. Since the mid-1990's, a large number of third party asbestos claims have been made against Halliburton. Through December 31, 2001, the Company paid $1.2 million on behalf of Halliburton under the fixed premium policies on asbestos claims, and billed Halliburton $8.5 million under the retrospectively rated and high-deductible policies on asbestos claims. Halliburton has not paid this billed amount and has questioned the proper allocation of the asbestos claims between the fixed premium and the retrospectively rated and high-deductible policies. On April 5, 2000, the Company filed an action in the Delaware Court of Chancery ("Delaware Action") asserting that indemnification obligations exist pursuant to the Distribution Agreement dated October 10, 1995 between the Company and Halliburton, which was executed as part of the distribution by Halliburton of the shares of the Company's common stock to Halliburton's stockholders and the public. The action is seeking (i) a declaratory judgment that Halliburton is responsible for indemnifying the Company for losses and expenses incurred on the Halliburton/Brown & Root policies; (ii) an injunction ordering Halliburton to assume responsibility for such losses and expenses; (iii) a judgment against Halliburton for non-payment of the amounts billed under the retrospectively rated and high-deductible policies; and (iv) a declaration estopping Brown & Root from invoking insurance under the fixed premium policies. On July 13, 2000, the Company amended its complaint in the Delaware Action, adding a count seeking a declaratory judgment that the Company is not liable under the fixed premium policies because those policies were terminated pursuant to the Investment Agreement dated October 10, 1995 among the Company, Halliburton, Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda) L.P. The Company also filed a motion for a preliminary injunction enjoining Halliburton from instituting, continuing or prosecuting any action in any other jurisdiction arising out of or related to the subject matter of the Delaware Action. On July 26, 2000, Halliburton filed motions to dismiss the Delaware Action on the grounds of forum non conveniens and failure to state a claim upon which relief can be granted. On September 8, 2000, the Company filed a motion for judgment on the pleadings in the Delaware Action. On March 21, 2001, the Chancery Court in the Delaware Action issued its decision in favor of the Company, finding that the fixed premium policies had been terminated pursuant to the Investment Agreement. An order was issued to that effect on April 3, 2001. Halliburton filed an appeal of the order to the Delaware Supreme Court on April 18, 2001 and on March 13, 2002, the Delaware Supreme Court issued an order affirming the decision of the Chancery Court. On March 28, 2002, Halliburton filed a motion with the Delaware Supreme Court requesting reargument. On July 11, 2002, the Delaware Supreme Court denied Halliburton's motion. On July 19, 2002, the Company filed a motion for summary judgment with Delaware Chancery Court requesting reimbursement of approximately $10 million paid by the Company on behalf of Halliburton, principally for asbestos claims, and litigation expenses. On April 24, 2000, Halliburton filed an action in the District Court of Harris County, Texas ("Texas Action") seeking (i) a declaratory judgment that the Company is liable for costs and expenses under the fixed premium policies; (ii) a declaratory judgment that Halliburton has the right to select the policy under which such coverage is to be paid; and (iii) damages. The Company filed its answer in the Texas Action on July 26, 2000 denying the allegations in Halliburton's complaint. On July 27, 2000, Halliburton filed an amended petition in the Texas Action adding Brown & Root as plaintiff. On November 6, 2000, Halliburton filed a second amended petition in the Texas Action adding Highlands Group as a defendant. Proceedings in the Texas Action have largely been held in abeyance by the parties pending the resolution of the Delaware Action, although there is no assurance that Halliburton will not attempt to activate the Texas Action in the future. 16 If the Company is not ultimately successful in the litigation described above, it could have a material adverse impact on the Company. The Company believes, however, that the positions it has taken in the Delaware Action and Texas Action are meritorious, and that, ultimately, the Company will not be responsible for a material amount, if any, of Halliburton's asbestos liability. Liquidator of LMI Insurance Company. On February 26, 2002, the Liquidator of LMI Insurance Company ("LMI"), a former subsidiary of the Company now in liquidation, filed an action against Pacific National Insurance Company, a subsidiary of the Company, in the Court of Common Pleas, Franklin County, Ohio. The complaint alleges that a voidable transfer or fraudulent payment in the amount of $7 million was made by LMI to Pacific National. On March 29, 2002, the Liquidator of LMI filed an action in the Court of Common Pleas, Franklin County, Ohio against the Registrant and its present and former officers and directors, certain of the Registrant's subsidiaries, and current and former officers and directors of the named subsidiaries. The complaint alleges the following: (i) breach of representations and warranties contained in the Form A filed in 1996 and the amended and restated Form A filed in 1997 with the Ohio Department of Insurance when the Registrant acquired control of LMI; (ii) waste of the assets of LMI by failing to maintain adequate records of LMI; (iii) breach of a group services agreement among LMI and other subsidiaries of the Registrant; (iv) failure of the officers and directors of the Registrant and the named subsidiaries to implement controls to ensure performance of the subsidiaries under the group services agreement; and (v) breach of fiduciary duty by the officers and directors of the Registrant by failing to maintain and preserve the assets of LMI and negligently permitting the Registrant's subsidiaries to waste LMI's assets. The Liquidator is seeking damages in excess of $25,000 to be determined at trial on each of claims in the complaint plus interest, costs and attorney's fees. The Registrant and the other defendants filed answers to both complaints on June 2, 2002. The Company believes that these complaints are completely without merit and the defendants are vigorously defending them. Regulatory Proceedings. The California Department of Insurance is conducting an examination of the financial statements of Pacific National Insurance Company and its subsidiary, Pacific Automobile Insurance Company (collectively, "Pacific") as of December 31, 2001. The California Department has received a report from an independent consultant indicating that the loss and expense reserves of those two companies may be materially understated at December 31, 2001. Pacific and its external actuaries have notified the California Department of their disagreement with the conclusions in the report. Discussions between Pacific and the California Department are continuing. On May 16, 2002, the Indiana Insurance Department issued Orders of Supervision covering two of the Company's subsidiaries domiciled in Indiana, Statesman Insurance Company and American Professionals Insurance Company. In February 2002, the Texas Department of Insurance issued Supervisory Orders to the Company's Texas insurance subsidiaries, including Highlands Insurance Company, the Company's principal insurance subsidiary. By their terms, the orders are also binding on all the companies' affiliates. A Supervisory Order for another of the insurance subsidiaries, State Capital Insurance Company, was issued by the North Carolina Department of Insurance in December 2001, and in October 2001, the Wisconsin Commissioner of Insurance issued a Stipulation and Order covering Northwestern National Casualty Company, the Company's second largest insurance subsidiary, and NN Insurance Company, another of the Company's insurance subsidiaries. In addition to these orders, the Company's insurance subsidiaries have had their licenses to transact business suspended, amended to permit servicing of existing business or revoked in numerous states. 17 ITEM 4. Submission of Matters to a Vote of Security Holders None. ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.22 - Eighth Amendment and waiver to Credit Agreement dated as of May 1, 2002 among Registrant, Various Lending Institutions and the JP Morgan Chase Bank, as Administrative Agent. 10.23 - Employment Agreement between Company and Stephen L. Kibblehouse pursuant to Section 1350 of Title 18 of the United States Code 99.1 - Statement of Chief Executive Officer pursuant to Section 1350 of Title 18 of the United States Code 99.2 - Statement of Chief Financial Officer pursuant to Section 1350 of Title 18 of the United States Code (b) Reports on Form 8-K None 18 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. HIGHLANDS INSURANCE GROUP, INC. (Registrant) Date: August 14, 2002 By /s/ Stephen L. Kibblehouse ------------------------------------------ Stephen L. Kibblehouse Chief Executive Officer (Authorized Signatory) Date: August 14, 2002 By /s/ Albert J. Marino ------------------------------------------ Albert J. Marino Chief Financial Officer and Treasurer (Authorized Signatory) 19 EX-10.22 3 dex1022.txt 8TH AMENDMENT AND WAIVER TO CREDIT AGREEMENT EXHIBIT 10.22 EIGHTH AMENDMENT AND WAIVER TO CREDIT AGREEMENT EIGHTH AMENDMENT AND WAIVER TO CREDIT AGREEMENT (this "Amendment"), dated as of May 1, 2002, among HIGHLANDS INSURANCE GROUP, INC., a Delaware corporation (the "Borrower"), the lenders party to the Credit Agreement referred to below (the "Banks") and JPMORGAN CHASE BANK (formerly known as The Chase Manhattan Bank), as administrative agent (the "Administrative Agent"). Unless otherwise defined herein, all capitalized terms used herein and defined in the Credit Agreement are used herein as so defined. W I T N E S S E T H: WHEREAS, the Borrower, the Banks and the Administrative Agent are parties to a Credit Agreement, dated as of April 30, 1997 (as amended, modified or supplemented to, but not including, the date hereof, the "Credit Agreement"); WHEREAS, the Borrower, the Banks and the Administrative Agent are parties to a Waiver to the Credit Agreement dated as of December 31, 2001; and WHEREAS, subject to the terms and conditions of this Amendment, the parties hereto wish to amend and modify the Credit Agreement as provided herein; NOW, THEREFORE, it is agreed: 1. Subject to the terms and conditions set forth herein, the Banks hereby waive for the period from March 1, 2002 to June 30, 2002 (such period, hereinafter referred to as the "Waiver Period") (i) any Default or Event of Default that has arisen as a result of the failure of the Borrower to comply with Sections 6.05, 7.01, 7.11, 7.12, 7.13, 7.14 and 7.15 of the Credit Agreement and (ii) any Event of Default under Sections 8.01 and 8.09 of the Credit Agreement. The waivers set forth in this Section 1 shall cease to have any further force or effect after the Waiver Period. 2. Section 9 of the Credit Agreement is hereby amended by deleting the definition of "Maturity Date" and inserting in lieu thereof the following new definition: "Maturity Date" shall mean June 30, 2002. 3. In order to induce the Banks to enter into this Amendment, the Borrower hereby represents and warrants that (i) the representations, warranties and agreements contained in Section 5 of the Credit Agreement are true and correct in all material respects both before and after giving effect to the Amendment Effective Date (as hereinafter defined) except to the extent such representations and warranties expressly relate to an earlier date and (ii) there exists no Default or Event of Default on and as of the Amendment Effective Date other than as may have been waived pursuant to Section 1 hereof. 4. With the goal of fostering the continued economic viability of the Regulated Insurance Companies for the benefit of all policyholders and creditors, the Borrower agrees that it will cause one or more of the Regulated Insurance Companies to retain, no later than ten (10) days following the Amendment Effective Date, a financial advisor (the "Advisor") to assist the Regulated Insurance Companies in the development of a comprehensive, strategic operational plan and related financial model for the run-off of the insurance business of such Regulated Insurance Companies (the "Plan"). The Plan shall be deliverable to the Administrative Agent within ninety (90) days after the date of retention of the Advisor and shall include, among other things, a schedule of operational, financial and other performance goals to be achieved by the Regulated Insurance Companies over the next five (5) years. In addition, the Borrower shall deliver interim written status reports regarding the Plan to the Administrative Agent on or about June 3, 2002 and June 17, 2002, respectively. 5. The Borrower hereby covenants that it shall promptly deliver to the Administrative Agent, and continue to deliver after the date hereof, copies of any and all orders, directives, stipulations, consent decrees, memoranda, correspondence or any other communications from or with any Applicable Regulatory Insurance Authority. 6. This Amendment shall become effective as of the date (the "Amendment Effective Date") when the Borrower and Required Banks shall have signed a counterpart hereof (whether the same or different counterparts) and shall have delivered (including by way of facsimile transmission) the same to the Administrative Agent at the Notice Office. 7. The waivers contained in this Amendment are limited to the Waiver Period and as otherwise herein as specified and shall not constitute a modification, acceptance or waiver of any other provision of the Credit Agreement or any other Credit Document. Except for the waivers specifically granted above in Section 1, the Banks and the Administrative Agent expressly reserve the option to exercise any and all rights and remedies afforded to them (i) as a result of any other Default or Event of Default of any other provision of the Credit Agreement (or any provision beyond the specific waivers granted hereby) or any other Credit Document or (ii) that may be available to them under common law or otherwise. 8. This Amendment may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which shall together constitute one and the same instrument. A complete set of counterparts shall be lodged with the Borrower and the Administrative Agent. 9. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF NEW YORK. 10. From and after the Amendment Effective Date, all references in the Credit Agreement and in the other Credit Documents to the Credit Agreements shall be deemed to be references to the Credit Agreement as modified hereby. * * * 2 IN WITNESS WHEREOF, the parties hereto have caused their duly authorized officers to execute and deliver this Modifications as of the date first above written. HIGHLANDS INSURANCE GROUP, INC. By ------------------------------------ Title: JPMORGAN CHASE BANK, Individually and as Administrative Agent By ------------------------------------ Title: FLEET NATIONAL BANK By ------------------------------------ Title: BANK OF MONTREAL By ------------------------------------ Title: BANK ONE, NA By ------------------------------------ Title: DRESDNER BANK AG, New York and Grand Cayman Branches By ------------------------------------ Title: By ------------------------------------ Title: BANK OF AMERICA By ------------------------------------ Title: EX-10.23 4 dex1023.txt EMPLOYMENT AGREEMENT EXHIBIT 10.23 Employment Agreement THIS EMPLOYMENT AGREEMENT (this "Agreement") is entered into as of the 1st day of April, 2002, between Highlands Insurance Company, a Texas corporation (the "Company"), and Stephen L. Kibblehouse ("Employee"). WHEREAS, it is the mutual desire of the Company and Employee that the Company employ Employee on the terms and conditions described in this Agreement. Now, THEREFORE, in consideration of the premises and the mutual covenants hereinafter set forth and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: 1. Employment. The Company hereby employs Employee for the Employment Period specified in Section 2 below as Chief Executive Officer and President of the Company and its affiliates. Employee hereby accepts such employment and agrees to diligently and to the best of Employee's abilities perform the duties and services appropriate to such positions and to devote his full business time and efforts to the performance of the duties of such positions, which shall include, but not be limited to, managing the operations of the Company. Employee further agrees to at all times comply with and be subject to such policies and procedures the Company may establish from time to time, so long as such policies and procedures do not violate any applicable laws or regulations. 2. Employment Period. The period of Employee's employment under this Agreement (the "Employment Period") shall commence on April 1, 2002 and shall end upon the termination of the Employment Period pursuant to Section 6 below. 3. Compensation. (a) As compensation for all services rendered and to be rendered by Employee pursuant to this Agreement, the Company agrees to pay Employee: (i) during the Employment Period, an annual salary (the "Base Annual Salary") of $350,000, and (ii) an annual incentive Bonus based on the performance of the Company and its affiliates as measured by the achievement of specified performance objectives. The objectives will be determined by the board of directors of the Company (the "Board of Directors") in its sole discretion (b) The Base Annual Salary shall be reviewed no less frequently than annually by the Board of Directors and may be increased upon the approval of the Board of Directors in its sole discretion. The Base Annual Salary shall accrue and be payable in accordance with the payroll practices of the Company as in effect from time to time. 4. Other Employment Benefits. During the Employment Period, Employee shall be entitled to such other benefits as are customarily accorded the executives of the Company, including, without limitation, the right to participate in employee benefit programs maintained by the Company, including a health and life insurance program and disability and retirement plans, provided, that nothing contained herein shall be construed to require the Company to establish or maintain any policy or program. Employee will be entitled to five weeks vacation annually. 5. Expenses. Upon submission of expense vouchers and corresponding receipts and related documentation in accordance with Company policies then in effect, the Company shall promptly reimburse Employee for all reasonable expenses incurred by Employee on behalf of the Company or in accordance with Employee's performance of Employee's duties hereunder including, without limitation, all reasonable travel, entertainment and lodging expenses incurred by Employee in connection with the performance of his duties hereunder. 6. Termination. The Employment Period may be terminated pursuant to any one or more of the following provisions: (a) The Employment Period may be terminated at any time by the Company upon thirty (30) day's prior written notice to Employee or by Employee upon thirty (30) day's prior written notice to the Company. Upon such termination of the Employment Period, all of Employee's rights under Sections 3, 4, and 5 above shall immediately terminate, except that the Company will pay to Employee all amounts accrued in respect of periods prior to such termination. If such termination is by the Company without Cause (as hereinafter defined) or by Employee with Good Reason (as hereinafter defined), the Company shall pay to Employee severance pay in an amount equal to the Base Annual Salary in effect at the time the termination notice was given times one and a half (1.5) (the "Severance Amount"). Such Severance Amount shall at the option of Employee be payable either (i) in installments during the eighteen (18) month period following the Employment Period on the same basis as salary would otherwise be payable to Employee during the Employment Period, or (ii) in a lump sum on the last day of the Employment Period. (b) The term "Cause" shall mean (i) fraud, dishonesty or similar willful misconduct on the part of Employee, (ii) a material breach by Employee of any of his representations or obligations under this Agreement (provided that Employee shall first be notified of and be given a reasonable opportunity to cure such breach), (iii) gross negligence by Employee in the performance of the services contemplated by this Agreement, or (iv) conviction of Employee (or the entering of a plea of guilty, nolo contendere or request for deferred adjudication) for fraud, misappropriation, embezzlement, financial misconduct, any felony or any lesser criminal offense which carries a potential penalty of imprisonment for a term of one year or more, whether or not a lesser penalty is assessed. The term "Good Reason" shall mean, without Employee's written consent, (i) any reduction in the amount of the Base Annual Salary, (ii) any material reduction in Employee's title, duties, or responsibilities with the Company, or (iii) the failure of the Board of Directors to discharge an employee of the Company, at the request of Employee, for an act that would constitute "Cause" under clause (i), (iii) or (iv) of the immediately prior sentence, or (iv) a material breach by the Company of its obligations under this Agreement. Notwithstanding the foregoing sentence, the occurrence of any of the events described in the foregoing sentence will not constitute Good Reason unless Employee gives the Company written notice that such event constitutes Good Reason, and the Company thereafter fails to cure the event within thirty (30) days after receipt of such notice. (c) If Employee shall terminate his employment with the Company without Good Reason or if the Company shall terminate his employment with the Company for Cause, the Employment Period shall terminate as of the date of such termination, all of Employee's rights under Sections 3, 4 and 5 above shall immediately terminate, and the Company shall pay to Employee only the amount of salary and pro rated portion of any bonus accrued to Employee under this Agreement through the date of such termination without Good Reason or for Cause. (d) If during the Employment Period, either (i) Employee shall die or (ii) Employee shall be unable to discharge his duties hereunder for a period of four consecutive months, or for a total of six months in any 12-month period, by reason of physical or mental illness, injury or incapacity ("Disability"), and the Company shall give notice to Employee to terminate the Employment Period on account of such Disability, the Employment Period shall end and all of Employee's rights under Sections 3, 4, and 5 above shall immediately terminate. In the case of such termination, the Company shall promptly pay to Employee or Employee's estate or legal representative, as the case may be, the amount of salary and pro rated portion of any bonus accrued to Employee under this Agreement through the date of such termination of the Employment Period and the Severance Amount. In the case of termination because of death, the notice date for computation of the Severance Amount shall be deemed to be the date of death. During any period prior to the termination of the Employment Period in which Employee is unable to discharge his duties hereunder on account of Disability, the Base Annual Salary shall be reduced by the amount of any Company sponsored disability benefits paid to Employee during such period. (e) The Severance Amount paid to Employee shall be in consideration of Employee's continuing obligations hereunder after termination of the Employment Period (including, without limitation, Employee's obligations under Section 9 hereof). Employee shall not be under any duty or obligation to seek or accept other employment following a termination of the Employment Period pursuant to which the Severance Amount is owing, and the Severance Amount shall not be reduced by any amounts earned by Employee from subsequent employment or as a self-employed individual during the period the Severance Amount is being paid. Employee's rights under this Section 6 are Employee's sole and exclusive rights against the Company or its affiliates under this Agreement and the Company's sole and exclusive liability to Employee under this Agreement, for the termination of his employment relationship with the Company. Employee covenants not to sue or lodge any claim, demand or cause of action against the Company based upon Employee's termination of employment under this Agreement for any moneys other than those specified in Section 6(a) or Section 6(d). If Employee breaches this covenant, the Company shall be entitled to recover from Employee all sums expended by the Company (including costs and attorneys' fees) in connection with such suit, claim, demand, or cause of action. If the Company breaches this Agreement, Employee shall be entitled to recover from Company all sums expended by Employee (including costs and attorneys fees) in connection with a suit, claim, demand, or cause of action to enforce the terms of this Agreement. Nothing contained in Section 6 shall be construed to be a waiver by Employee of any benefits accrued for or due Employee through the date of termination of Employee's employment under any employee benefit plan (as such term is defined in the Employees' Retirement Income Security Act of 1974, as amended) maintained by the Company. 7. Representations by Employee. Employee hereby represents and warrants to the Company that (a) Employee's execution and delivery of this Agreement and his performance of his duties and obligations hereunder will not conflict with, or cause a default under, or give any party a right to damages under, or to terminate, any other agreement to which Employee is a party or by which he is bound, and (b) there are no restrictions, agreements or understandings that would make unlawful Employee's execution or delivery of this Agreement or his employment hereunder. 8. Taxes and Other Deductions. The Company shall have the right to deduct from any compensation paid to Employee or his estate or legal representative under this Agreement all taxes and other amounts which may be required to be deducted or withheld by law (including, without limitation, income tax withholding and social security payments), whether such laws are now in effect or become effective after the date of this Agreement. 9. Nonsolicitation; Confidentiality (a) During the Employment Period and for an additional period of two years following the Employment Period (the "Restriction Period"), Employee shall not, directly or indirectly, solicit any employee of the Company to terminate his or her employment with the Company. (b) During and after the Employment Period, Employee shall not use for his personal benefit, or disclose, communicate or divulge to, or use for the direct or indirect benefit of any person, firm, association or company other than the Company, any Confidential Information. "Confidential Information" means information relating to the processes, products, services, customers, agents or operations of the Company or any affiliate thereof that is not generally known, is proprietary to the Company or such affiliate and is made known to Employee or learned or acquired by Employee while in the employ of the Company. However, Confidential Information shall not include under any circumstances any information with respect to the foregoing matters that becomes publicly available through no fault of Employee. All materials or articles of information of any kind furnished to Employee by the Company or developed by Employee in the course of his employment hereunder are and shall remain the sole property of the Company; and if the Company requests the return of such information at any time during, upon or after the Employment Period, Employee shall immediately deliver the same to the Company. (c) Employee acknowledges that, in view of the nature of the business in which the Company is engaged, the restrictions contained in Sections 9(a) and 9(b) above (the "Restrictions") are reasonable and necessary in order to protect the legitimate interests of the Company, and that any violation thereof would result in irreparable injury to the Company, and Employee therefore further acknowledges that, in the event Employee violates, or threatens to violate, any of such Restrictions, the Company shall be entitled to obtain from any court of competent jurisdiction, without the posting of any bond or other security, preliminary and permanent injunctive relief, which rights shall be cumulative and in addition to any other rights or remedies in law or equity to which the Company may be entitled. (d) If any Restriction, or any part thereof, shall be determined in any judicial or administrative proceeding to be invalid or unenforceable, the remainder of the Restrictions shall not thereby be affected and shall be given full effect, without regard to the invalid provisions. If the period of time or the area specified in the Restriction Period or the Restrictions shall be determined in any judicial or administrative proceeding to be unreasonable, then the court or administrative body shall have the power to reduce the period of time or the area covered and, in its reduced form, such provisions shall then be enforceable and shall be enforced. (e) If Employee violates any of the Restrictions, the applicable Restriction Period shall be tolled from the time of the commencement of any such violation until such time as such violation shall be cured by Employee to the reasonable satisfaction of the Company. (f) During the Employment Period, Employee may not engage, directly or indirectly, in any other business, investment, or activity which (i) substantially interferes with Employee's performance of his duties hereunder, (ii) is contrary to the best interests of the Company and its affiliates, or (iii) requires such portion of Employee's business time as to render compliance with Section 1 impracticable. Employee acknowledges and agrees that Employee owes certain duties to the Company under applicable law and agrees to do no act which would intentionally injure the Company's business, interests or reputation. In keeping with Employee's fiduciary duties to the Company, Employee agrees that he shall not knowingly become involved in a conflict of interest with the Company, or upon discovery thereof, allow such a conflict to continue. Moreover, Employee agrees that he shall disclose to the Board of Directors any facts which might reasonably be expected to involve a possible conflict of interest with the Company. (g) Employee may not serve on the Board of Directors of any entity other than the Company or its affiliates during the Employment Period without the approval of the Board of Directors in accordance with the Company's policies and procedures regarding such service. 10. Notices. Any notice or communication given pursuant to this Agreement must be in writing and (a) delivered personally, (b) sent by telefacsimile or other similar facsimile transmission, (c) delivered by overnight express or (d) sent by registered or certified mail, postage prepaid, as follows: (i) If to Employee: Stephen L. Kibblehouse 4700 Frost Lane Doylestown, Pennsylvania 18901 (ii) If to the Company: Highlands Insurance Company 1000 Lenox Drive Lawrenceville, NJ 08648 Attention: Secretary Facsimile Number: (609) 219-1774 All notices and other communications required or permitted under this Agreement that are addressed as provided in this Section will (A) if delivered personally or by overnight express, be deemed given upon delivery; (B) if delivered by telefacsimile or similar facsimile transmission, be deemed given when electronically confirmed; and (C) if sent by registered or certified mail, be deemed given when received. Either party from time to time may change his or its address for the purpose of notices to that party by giving a similar notice specifying a new address, but no such notice will be deemed to have been given until it is actually received by the party sought to be charged with the contents thereof. 11. Entire Agreement. This Agreement constitutes the entire agreement between the parties hereto with respect to the subject matter hereof and (other than as to the employee benefit plans and practices of the Company) supersedes all prior communications, agreements, understandings, representations and warranties, whether oral or written, between the parties hereto with respect to the subject matter hereof except for the Retention Agreement dated April 6, 2001 between the Company and Employee ("Retention Agreement") which remains in effect. Other than the employee benefit plans and practices of the Company and the Retention Agreement, there are no oral or written agreements, understandings, representations or warranties between the parties hereto with respect to the subject matter hereof other than those set forth in this Agreement. 12. Assignment and Amendment of Agreement. This Agreement is binding upon the parties hereto and their respective successors and permitted assignees. Because Employee's duties and services hereunder are special, personal and unique in nature, Employee may not transfer, sell or otherwise assign his rights, obligations or benefits under this Agreement. This Agreement may be modified or amended only by a writing duly executed on behalf of each party hereto. 13. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the Laws of the State of New Jersey (without regard to the principles of conflicts of law) applicable to a contract executed and to be performed in such state. 14. No Third Party Rights. Except as specifically provided in this Agreement, this Agreement is not intended and may not be construed to create any rights (including third party beneficiary rights) in any parties other than Employee and the Company, and their respective successors and permitted assignees. 15. Headings, Gender, etc. The headings used in this Agreement have been inserted for convenience and do not constitute matter to be construed or interested in connection with this Agreement. Unless the context of this Agreement otherwise requires, (a) words of any gender will be deemed to include each other gender, (b) words using the singular or plural number also will include the plural or singular number, respectively, (c) the terms "hereof," "herein", "hereby," hereunder," "hereto," and derivative or similar words will refer to this entire Agreement, (d) the terms "Article" or "Section" will refer to the specified Article or Section of this Agreement, and (e) the conjunction "or" will denote any one or more, or any combination or all, of the specified items or matters involved in the applicable list. 16. Waiver and Remedies. Any term or condition of this Agreement may be waived at any time by the party who or that is entitled to the benefit thereof. Any such waiver will be in writing and will be executed by such party. A waiver on one occasion will not be deemed to be a waiver of the same or any other breach on a future occasion. All remedies, either under this Agreement, or by law or otherwise afforded, will be cumulative and not alternative. 17. Invalid Provisions. Subject to the provisions of Section 9(d) above, if any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future law, and if the rights or obligations of any party hereto under this Agreement will not be materially and adversely affective thereby, (a) such provision will be fully severable, (b) this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, (c) the remaining provisions of the Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom, and (d) in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as a part of this Agreement a legal, valid, and enforceable provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible. 18. Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the Company and Employee have executed this Agreement as of the day and year first above written. COMPANY: HIGHLANDS INSURANCE COMPANY By:_______________________________________ Georgean Wardzinski Senior Vice President EMPLOYEE: __________________________________________ Stephen L. Kibblehouse EX-99.1 5 dex991.txt CERTIFICATION OF CEO Exhibit 99.1 Statement of Chief Executive Officer Pursuant to Section 1350 of Title 18 of the United States Code Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Stephen L. Kibblehouse, the Chief Executive Officer of Highlands Insurance Group, Inc., (the "Company"), hereby certifies that: 1. The Company's Form 10-Q Quarterly Report for the period ended June 30, 2002 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 14, 2002 /s/ Stephen L. Kibblehouse ----------------------------------- Stephen L. Kibblehouse Chief Executive Officer EX-99.2 6 dex992.txt CERTIFICATION OF CFO Exhibit 99.2 Statement of Chief Financial Officer Pursuant to Section 1350 of Title 18 of the United States Code Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Albert J. Marino, the Treasurer and Chief Financial Officer of Highlands Insurance Group, Inc., (the "Company"), hereby certifies that: 1. The Company's Form 10-Q Quarterly Report for the period ended June 30, 2002 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 14, 2002 /s/ Albert J. Marino -------------------------------------------- Albert J. Marino Chief Financial Officer & Treasurer -----END PRIVACY-ENHANCED MESSAGE-----