-----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, UtKaz97Qvqgn4wN2LWhGNAEM+mv+O40zNr+IH0GOsXRzL0ufv4VWtm1m2w4kZIjn 7hAcJpsYoDmRpjU22Qc+Vw== 0000914039-99-000106.txt : 19990325 0000914039-99-000106.hdr.sgml : 19990325 ACCESSION NUMBER: 0000914039-99-000106 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BERKLEY W R CORP CENTRAL INDEX KEY: 0000011544 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 221867895 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-07849 FILM NUMBER: 99570747 BUSINESS ADDRESS: STREET 1: 165 MASON ST STREET 2: P O BOX 2518 CITY: GREENWICH STATE: CT ZIP: 06836-2518 BUSINESS PHONE: 2036293000 MAIL ADDRESS: STREET 1: 165 MASON ST STREET 2: PO BOX 2518 CITY: GREENWICH STATE: CT ZIP: 06836-2518 10-K 1 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______. Commission file number 0-7849 W. R. BERKLEY CORPORATION (Exact name of registrant as specified in its charter) Delaware 22-1867895 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 165 Mason Street, P.O. Box 2518, Greenwich, CT 06836-2518 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (203) 629-3000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, par value $.20 per share Series A Cumulative Redeemable Preferred Stock, par value $.10 per share 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 twelve 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Aggregate market value of voting stock held by non-affiliates of the registrant based on the closing price of such stock on the Nasdaq National Market as of February 26, 1999: $ 635,570,178. Number of shares of common stock, $.20 par value, outstanding as of February 26, 1999: 26,231,753 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's 1998 Annual Report to Stockholders for the year ended December 31, 1998 are incorporated herein by reference in Part II, and portions of the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, are incorporated herein by reference in Part III. 2 W. R. BERKLEY CORPORATION ANNUAL REPORT ON FORM 10-K December 31, 1998 Page SAFE HARBOR STATEMENT 3 PART I ITEM 1. BUSINESS 4 ITEM 2. PROPERTIES 23 ITEM 3. LEGAL PROCEEDINGS 24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 24 ITEM 6. SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1998 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 26 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 26 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 26 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 27 ITEM 11. EXECUTIVE COMPENSATION 30 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 30 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 30 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 30 2 3 SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, forward-looking statements are statements other than historical information or statements of current condition. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected or otherwise reflected in forward-looking statements, including pricing competition and other initiatives by competitors, product demand, catastrophe and storm losses, legislative and regulatory developments, interest rate levels, investment results and other conditions in the financial and securities markets, unforeseen technological or other issues associated with Year 2000 compliance efforts and the extent to which vendors, public utilities, financial institutions, governmental entities and other third parties that interface with the Company may fail to achieve Year 2000 compliance and other risks referred to from time to time in the Company's reports filed with the Securities and Exchange Commission. The inclusion of forward-looking statements in this report shall not be considered a representation by the Company that the objectives or plans of the Company, or other matters addressed by forward-looking statements, will be achieved. 3 4 PART I ITEM 1. BUSINESS General Description of the Company's Business W. R. Berkley Corporation (the "Company"), a Delaware corporation, is an insurance holding company which, through its subsidiaries, presently operates in all segments of the property casualty insurance business: regional property casualty insurance; reinsurance (conducted through Signet Star Holdings, Inc.); specialty lines of insurance (including excess and surplus lines and commercial transportation); alternative markets (including the management of alternative insurance market mechanisms); and international (conducted through Berkley International, LLC). The Company was founded on the concept that a group of autonomous regional and specialty insurance entities could compete effectively in selected markets within a very large industry. Decentralized control allows each subsidiary or regional group to respond to local or specialty market conditions while capitalizing on the effectiveness of centralized investment and reinsurance management and actuarial, financial and legal staff support. The Company's regional insurance operations are conducted primarily in the New England, Mid Atlantic, Midwest and Southern regions of the United States. Reinsurance, specialty insurance and alternative markets operations are conducted nationwide. Presently, international operations are conducted primarily in Argentina and the Philippines with Signet Star Reinsurance Company conducting business in Latin America and the Caribbean as well. Net premiums written, as reported on a generally accepted accounting principles ("GAAP") basis, by the Company's five major insurance industry segments for the five years ended December 31, 1998 were as follows:
Year Ended December 31, ------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ (Amounts in thousands) Net premiums written (1): Regional insurance operations $ 641,316 $ 618,768 $ 517,515 $ 460,732 $ 378,701 Reinsurance operations 269,634 206,652 218,200 196,299 176,130 Specialty insurance operations 254,003 219,272 214,738 171,520 143,113 Alternative markets operations 106,195 90,870 76,876 25,998 19,989 International operations 75,106 42,079 25,182 5,872 -- ------------ ------------ ------------ ------------ ------------ Total net premiums written $ 1,346,254 $ 1,177,641 $ 1,052,511 $ 860,421 $ 717,933 ============ ============ ============ ============ ============ Percentage of net premiums written: Regional insurance operations 47.6% 52.6% 49.2% 53.6% 52.7% Reinsurance operations 20.0 17.5 20.7 22.8 24.6 Specialty insurance operations 18.9 18.6 20.4 19.9 19.9 Alternative markets operations 7.9 7.7 7.3 3.0 2.8 International operations 5.6 3.6 2.4 .7 -- ------------ ------------ ------------ ------------ ------------ Total 100.0% 100.0% 100.0% 100.0% 100.0% ============ ============ ============ ============ ============
(1) Results for the regional, alternative markets and specialty insurance operations have been restated to reflect changes in the composition of the segments. 4 5 The following sections briefly describe the Company's insurance segments and subsidiaries. The statutory information contained herein is derived from that reported to state regulatory authorities in accordance with statutory accounting practices ("SAP"). The amounts of statutory net premiums shown for the subsidiaries exclude the effects of intercompany reinsurance. The descriptions contain each significant insurance subsidiary's rating by A.M. Best and Company, Inc. ("A.M. Best"). A.M. Best's ratings are based upon factors of concern to policyholders, insurance agents and brokers and are not directed toward the protection of investors. A.M. Best states: "Best's Ratings reflect [its] opinion as to the relative financial strength and performance of each insurer in comparison with others, based on [its] analysis of the information provided to [it]. These Ratings are not a warranty of an insurer's current or future ability to meet its contractual obligations." REGIONAL INSURANCE OPERATIONS The Company's regional property casualty subsidiaries write standard commercial and personal lines insurance for such risks as automobiles, homes and businesses. The Company's regional insurance operations have historically been conducted through ten principal operating subsidiaries. On January 20, 1999, the Company announced that it would restructure the management and back-office operations of these ten companies into four geographic segments based on markets served. The restructuring, which is in process and subject to varying regulatory and operational requirements, is expected to be completed before the end of 1999. It is intended that as part of the restructuring certain back office functions and operating redundancies will be minimized or eliminated. The new regional groups, and the primary regional company for each group, are as follows: - New England - Acadia Insurance Company - Mid Atlantic - Firemen's Insurance Company of Washington, D.C. - Midwest - Continental Western Insurance Company - Southern Tier - Union Standard Insurance Company In 1996, the Company acquired Berkley Regional Insurance Company ("BRIC") to act as an intermediate holding company. The Company contributed to BRIC all of the capital stock of the regional insurance companies. In 1997 and 1998 BRIC reinsured varying portions of the business written by the regional operations. In addition, BRIC is expanding its licenses so that it will be eligible to write personal and commercial lines on a direct basis nationally. BRIC's statutory surplus as of December 31, 1998 was $292,130,000. BRIC is rated A+ by A.M. Best. This A+ is a group rating which applies to each of the regional insurance companies and certain other subsidiaries as noted herein. A.M. Best has indicated that this rating is under review as a result of matters affecting the regional business. NEW ENGLAND REGIONAL INSURANCE GROUP The New England regional insurance operations are conducted by Acadia Insurance Company ("Acadia"). Acadia was organized by the Company and incorporated in April 1992. It writes multiple line property and casualty coverages in the States of Maine, New Hampshire, Vermont and Massachusetts and sells its personal and commercial coverages through independent agencies. Acadia's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $43,855,000 and $133,954,000, respectively. Acadia additionally utilizes its subsidiary, Cadillac Mountain Insurance Company, as a companion writer. 5 6 MID ATLANTIC REGIONAL INSURANCE GROUP The Mid Atlantic regional insurance group will consist of Firemen's Insurance Company of Washington, D.C. ("Firemen's), Berkley Insurance Company of the Carolinas ("BICC"), Chesapeake Bay Property and Casualty Insurance Company ("Chesapeake") and The Presque Isle Insurance Division of Firemen's. Firemen's will be the primary company in the Mid Atlantic group and it is anticipated that it will manage affairs of the group from a new office in Richmond, Virginia. Firemen's, Chesapeake and BICC sell their policies primarily through agents in the District of Columbia and the States of Maryland, North Carolina, Pennsylvania and Virginia. Firemen's Insurance Company of Washington, D.C. was originally incorporated by an Act of Congress in 1836 and re-domiciled to Maryland in 1994. Firemen's writes homeowners, other personal lines and commercial risks in the District of Columbia and in the States of Maryland, North Carolina and Virginia. In March 1995, Firemen's established The Presque Isle Insurance Division in order to expand its operations into the State of Pennsylvania. Firemen's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $39,159,000 and $56,863,000, respectively. Berkley Insurance Company of the Carolinas, a North Carolina domiciled company, was organized by the Company in December 1995. It writes personal and commercial lines in North Carolina and is expanding to surrounding states. Its statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $12,465,000 and $36,229,000, respectively. Chesapeake Bay Property and Casualty Insurance Company, a Maine domiciled company owned by Acadia, was formed in 1993. In 1997 Firemen's spun off Chesapeake Insurance Division into the operations of Chesapeake. Chesapeake writes personal and commercial lines in Virginia and is expanding to surrounding states. Chesapeake's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $9,021,000 and $31,001,000, respectively. MIDWEST REGIONAL INSURANCE GROUP The Midwest regional insurance group will consist of Continental Western Insurance Company ("Continental Western"), American West Insurance Company ("American West"), Tri-State Insurance Company of Minnesota ("Tri-State") and Union Insurance Company ("Union"). Continental Western will be the primary company in the group and will manage group affairs from its office in Urbandale, Iowa. Continental Western, Tri-State and Union obtain their business primarily in the smaller communities of the Midwest through independent insurance agencies, which represent them on a non-exclusive basis and are compensated on a commission basis. The following are brief descriptions of the companies in the Midwest regional group: Continental Western Insurance Company was organized in 1907. It writes a diverse commercial lines book of business as well as personal lines principally in the States of Iowa, Nebraska, Kansas, Illinois, Missouri, Wisconsin and Montana. Continental Western's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $76,899,000 and $165,467,000, respectively. 6 7 American West Insurance Company is a successor to a company that was organized in 1903 as a mutual insurance company and converted to a stock company in June 1986. Its business consists primarily of personal lines in the States of Minnesota, Montana, Wisconsin and South Dakota. American West's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $9,190,000 and $8,227,000, respectively. Tri-State Insurance Company of Minnesota was originally organized as a mutual insurance company. It writes commercial lines (specializing in grain elevator coverages), as well as personal lines, primarily in the States of Minnesota, Iowa, North and South Dakota, Nebraska, Wisconsin and Illinois. Tri-State's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $35,820,000 and $47,634,000, respectively. Union Insurance Company was organized originally in 1886 as a mutual insurance company. Union's business consists of personal lines as well as commercial lines insurance concentrated in the States of Nebraska, Kansas, Colorado and South Dakota. Union's statutory surplus and statutory net premiums written as of December 31,1998 and for the year then ended were $28,583,000 and $55,779,000, respectively. SOUTHERN TIER REGIONAL INSURANCE GROUP The Southern Tier regional insurance group will consist of Union Standard Insurance Company ("Union Standard") and Great River Insurance Company ("Great River"). Union Standard will be the primary company in the group and will manage group affairs from its office in Irving, Texas. Union Standard and Great River obtain their business primarily in the smaller communities of the Southwest through independent insurance agencies, which represent them on a non-exclusive basis and are compensated on a commission basis. The following are brief descriptions of the companies in the Southern Tier regional group: Union Standard Insurance Company is a successor to a company that was organized in 1970. Union Standard writes personal lines and commercial lines of insurance for small businesses in the States of Texas, Oklahoma, Arkansas and Colorado. Union Standard's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $29,156,000 and $64,393,000, respectively. Great River Insurance Company, a Mississippi domiciled company, was organized by the Company in December 1993. It writes personal and commercial lines in Mississippi and Tennessee and is expanding to surrounding states. Great River's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $11,547,000 and $41,770,000, respectively. Each of the ten regional operating subsidiaries described above is rated A+ by A.M. Best as a result of the group rating obtained by BRIC. 7 8 Regional operations: Business The following table sets forth the percentages of direct premiums written, by line, by the Company's regional insurance operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Commercial Multi-Peril 20.7% 20.5% 20.8% 21.5% 22.0% Workers' Compensation 18.6 19.3 20.1 20.8 18.7 Automobile: Personal 14.8 15.2 16.4 17.4 17.6 Commercial 20.8 19.6 17.4 15.6 16.4 General Liability 6.9 6.8 6.5 6.1 6.6 Homeowners 6.3 7.1 7.9 8.7 9.2 Fire and Allied Lines 4.7 5.0 4.7 4.6 4.8 Inland Marine 3.4 2.0 2.8 2.6 2.6 Other 3.8 4.5 3.4 2.7 2.1 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth the percentages of direct premiums written, by state, by the Company's regional insurance operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Maine 9.4% 10.2% 10.8% 10.8% 10.5% Iowa 7.5 7.7 8.4 9.4 11.1 Nebraska 7.0 7.5 8.2 9.1 11.0 Texas 6.3 6.8 7.5 8.0 9.2 New Hampshire 5.8 5.8 6.0 6.0 4.7 Minnesota 5.4 5.3 5.4 5.6 6.0 South Dakota 5.2 4.2 5.4 6.8 4.9 Mississippi 5.0 5.7 6.1 5.5 2.9 Pennsylvania 5.0 4.8 2.2 -- -- North Carolina 4.8 4.2 1.5 .1 -- Kansas 4.5 4.6 4.8 4.9 5.2 Virginia 4.1 4.2 3.7 2.9 2.1 Colorado 3.5 3.5 3.8 4.1 4.5 Missouri 3.4 3.6 3.6 3.8 3.8 Vermont 3.0 3.2 3.1 2.4 1.1 Illinois 2.6 2.8 3.1 3.5 3.8 Wisconsin 2.5 2.6 2.9 3.6 3.6 Massachusetts 2.2 0.2 0.7 -- -- Arkansas 1.7 1.8 1.8 2.1 2.8 Idaho 1.4 1.1 0.6 0.2 0.2 Oklahoma 1.3 1.3 1.3 1.4 1.5 Tennessee 1.3 1.0 0.4 -- -- Montana 1.2 1.3 1.4 1.4 1.4 North Dakota 1.0 1.2 1.6 2.6 3.2 District of Columbia 0.8 1.2 1.6 1.6 2.3 Other 4.1 4.2 4.2 4.2 4.2 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
8 9 REINSURANCE OPERATIONS The Company's reinsurance operations consist of six operating units, which specialize in underwriting property, casualty and surety reinsurance on both a treaty and a facultative basis. The Company's reinsurance operations are conducted by Signet Star Holdings, Inc. through its subsidiary Signet Star Reinsurance Company ("Signet Star"). For financial segment reporting purposes, the results of the alternative market division of Signet Star are included in the Company's alternative markets segment. Signet Star is rated A by A.M. Best. Signet Star's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $257,022,000 and $309,942,000, respectively. The Property Casualty Treaty Division The Property Casualty Treaty Division is the largest business unit in terms of personnel and premiums written. This division of Signet Star is committed exclusively to the broker market segment of the treaty reinsurance industry. It functions as a traditional reinsurer in specialty and standard reinsurance lines and has formed a professional liability division to target this market segment. Facultative ReSources, Inc. Facultative ReSources, Inc. ("Fac Re") specializes in individual certificate and program facultative business. Fac Re's highly experienced underwriters seek to offset the underwriting and pricing cycles in the underlying insurance business by developing risk management solutions and through superior risk selection. Fac Re develops its business through brokers and on a direct basis where the client does not choose to use an intermediary. The Fidelity and Surety Division The Fidelity and Surety Division ("F&S") operates as a lead reinsurer in a niche market of the United States property casualty industry where its highly specialized knowledge and expertise are essential to meet the needs of fidelity and surety primary writers. Business is marketed principally through brokers as well as directly to clients not served by intermediaries. The Latin American and Caribbean Division This business unit is devoted exclusively to Latin American and Caribbean business ("LACD"). This division handles most traditional lines of property and casualty treaty business and is developing a book of niche business for this international operating region. Gemini Insurance Company Gemini is an excess and surplus line insurance company created to provide Signet Star with primary issuing carrier capability and thereby generate "reverse flow" business. Under the reverse flow concept, a reinsurer writes primary business through a subsidiary or affiliated carrier that is then ceded back to the reinsurer. Gemini provides Signet Star with a controlled source of new business. It operates as an authorized insurance company in the State of Delaware and will operate nationwide, as necessary legal and regulatory requirements are met, as an approved excess and surplus line carrier. Gemini is rated A by A.M. Best. Gemini had statutory surplus of $23,528,000 as of December 31, 1998. StarNet Insurance Company In 1998 Signet Star acquired a corporate insurance vehicle to write reverse flow business on an admitted basis. This company was re-domesticated to Delaware effective February 28, 1999. Signet Star will seek to license StarNet broadly to serve as an adjunct to Gemini to write primary business on an admitted basis nationwide. StarNet is rated A by A.M. Best. StarNet had statutory surplus of $10,157,000 at December 31, 1998 and has not commenced operations. 9 10 Reinsurance Operations: Business The following table sets forth the percentages of gross premiums written, by line, by the Company's reinsurance operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Treaty: Casualty and other 39.7% 38.7% 45.1% 46.6% 43.3% Property and related lines 19.1 16.1 23.3 26.8 36.0 Professional and specialty 8.4 5.5 4.7 4.8 4.2 ----- ----- ----- ----- ----- Total Treaty 67.2 60.3 73.1 78.2 83.5 Facultative 14.8 15.4 11.7 14.2 10.9 Fidelity and Surety 6.8 10.5 9.5 7.6 5.6 Latin American and Caribbean 11.2 13.8 5.7 -- -- ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth the percentage of gross premiums written, by property versus casualty business, by the Company's reinsurance operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Property 31.4% 32.7% 35.2% 33.4% 40.2% Casualty 68.6 67.3 64.8 66.6 59.8 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
SPECIALTY INSURANCE OPERATIONS The Company's specialty lines of insurance consist primarily of excess and surplus lines ("E & S"), commercial transportation, professional liability, directors and officers liability and surety. Admiral Insurance Company The majority of the Company's E & S insurance business is conducted by Admiral Insurance Company ("Admiral"). Admiral specializes in general liability coverages, including products liability and professional liability. Admiral insures risks requiring specialized treatment not available in the conventional market, with coverage designed to meet the specific needs of the insured. Business is received from wholesale brokers via retail agents, whose clients are the insureds. E & S carriers operate on a non-admitted basis in the states where they write business. They are generally free from rate regulation and policy form requirements. Admiral's business is obtained on a nationwide basis from approximately 190 non-exclusive brokers, who are compensated on a commission basis. Admiral also writes directors and officers liability insurance through operations conducted by Monitor Liability Managers, Inc., an underwriting manager established by the Company. Admiral is rated A++ by A.M. Best. Admiral's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $220,792,000 and $100,511,000, respectively. Admiral is in the process of establishing an admitted company to compete for certain risks that might be subject to the commercial lines regulation enactments (see "Regulation") as well as other risks which prefer an admitted carrier. Admiral incorporated Admiral Indemnity Company ("Admiral Indemnity") in January 1999 for this purpose and capitalized it with $25,000,000. Admiral Indemnity is in the process of licensure and expects to be operational in 1999. Carolina Casualty Insurance Company The Company's commercial transportation operations are primarily conducted by Carolina Casualty Insurance Company ("Carolina"). Carolina writes liability, physical damage and cargo insurance for the transportation industry, concentrating on long-haul trucking companies. Public 10 11 transportation insurance for such risks as charter buses and school buses also makes up a substantial part of Carolina's book of business. Carolina's business is obtained nationwide from approximately 120 agents and brokers who are compensated on a commission basis. In June 1995, Carolina began writing surety bonds through operations conducted by Monitor Surety Managers, Inc., an underwriting manager established by the Company. In December 1998, Carolina began writing directors and officers liability insurance through operations conducted by Monitor Liability Managers, Inc., an underwriting manager established by the Company. Carolina is rated A by A.M. Best. Carolina's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $60,520,000 and $88,715,000, respectively. FICO Insurance Company FICO was established in 1988 and is presently owned by Firemen's. FICO writes commercial business consisting primarily of multiple dwelling coverages principally in the State of New York through operations conducted by Clermont Specialty Managers, Ltd., an underwriting manager which is owned by the Company. FICO is rated A+ by A.M. Best (BRIC group rating). FICO's statutory surplus and net premiums written as of December 31, 1998 and for the year then ended were $11,492,000 and $11,640,000, respectively. In 1999 as part of the regional restructuring FICO will become part of the specialty insurance operations. Nautilus Insurance Company Nautilus Insurance Company ("Nautilus") was established in 1985 as a subsidiary of Admiral to insure E & S risks which involve a lower degree of expected severity than those covered by Admiral. Nautilus obtains its business nationwide from approximately 135 non-exclusive general agents, some of which also provide business to Admiral. A substantial portion of Nautilus' business is written on a binding authority basis, subject to certain contractual limitations. Nautilus is rated A by A.M. Best. Nautilus' statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $66,557,000 and $52,606,000, respectively. Great Divide Insurance Company ("Great Divide"), a subsidiary of Nautilus, writes transportation risks, as well as other specialty lines, on an admitted basis. Preferred Employers Insurance Company Preferred Employers Insurance Company ("Preferred") was established in 1998 to insure workers' compensation in California, focusing on the small employer market. Preferred is rated A+ by A.M. Best (BRIC group rating). Preferred's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $9,739,000 and $531,000, respectively. Specialty Operations: Business The following table sets forth the percentages of gross premiums written, by line, by the Company's specialty insurance operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- General Liability 28.2% 34.1% 35.3% 37.6% 42.0% Automobile Liability 19.0 17.7 20.9 27.5 28.5 Professional Liability 16.9 14.7 12.1 7.0 6.3 Directors and Officers Liability 7.7 8.1 10.0 9.0 5.7 Fire and Allied Lines 7.1 7.5 7.1 4.9 4.6 Automobile Physical Damage 6.1 4.9 5.3 6.8 6.0 Medical Malpractice 6.1 4.0 3.3 2.3 2.6 Inland Marine 1.8 1.5 1.6 2.1 1.8 Workers Compensation 1.9 2.5 1.7 0.7 0.7 Commercial Multi-Peril 3.1 3.0 1.0 0.7 0.7 Surety 2.0 1.9 1.3 0.8 -- Other 0.1 0.1 0.4 0.6 1.1 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
11 12 ALTERNATIVE MARKETS The Company's alternative markets operations specialize in insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms for public entities, private employers and associations. Typical clients are those who are driven by various factors to seek less costly and more efficient techniques to manage their exposure to claims. The Company's alternative markets segment consists of: excess workers' compensation insurance written by Midwest Employers Casualty Company; reinsurance of alternative risk business; and insurance services operations which manage alternative market mechanisms. Midwest Employers Casualty Company In November 1995, the Company acquired Midwest Employers Casualty Company ("Midwest"). Midwest markets and underwrites excess workers' compensation ("EWC") insurance and related risk management services. EWC insurance is marketed to employers and employer groups which have elected and have qualified or been approved by state regulatory authorities to self-insure their workers' compensation programs. EWC insurance provides coverage to a self-insured employer once the employer's losses exceed the employer's retention amount. Midwest offers a complete line of EWC products, including specific and aggregate EWC insurance policies and surety bonds. Midwest is rated A- by A.M. Best. Midwest's statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $127,854,000 and $42,597,000, respectively. Signet Star - Alternative Markets Division Signet Star Reinsurance Company's Alternative Markets Division specializes in providing custom designed reinsurance products and services to alternative markets ("ARM") clients, such as captive insurance companies, risk retention groups, public entity insurance trusts and governmental pools. ARM clients are generally self-insured vehicles which provide insurance buyers with a mechanism for assuming part of their own risk, managing their exposures, modifying their loss costs and, ultimately, participating in the underwriting results. Signet Star has been an active reinsurer of ARM clients for over ten years and is considered to be one of the leading broker market reinsurers of ARM business. The Alternative Markets Division has access to substantial additional resources within the Company, which has enabled it to concentrate and coordinate the Company's focus on this growing sector of the reinsurance market. Insurance Services Operations The Company's insurance service operations offer a variety of products, which include underwriting and claims administration and alternative insurance market mechanisms. In addition, the insurance services operations subsidiaries of the Company provide agency and brokerage services to both affiliated and unaffiliated entities. Berkley Risk Administrators Company, LLC The Company acquired Berkley Risk Administrators Company, LLC (formerly known as Berkley Risk Services, LLC) and its subsidiaries ("Berkley Risk") operations beginning in 1988. In 1997 Berkley Risk Services, Inc. was restructured into a limited liability company. Berkley Risk, based in Minneapolis, Minnesota, is a property casualty risk management firm which specializes in the development and administration of group and single-employer alternative insurance funding techniques. Berkley Risk also manages entities which provide liability insurance and claim adjusting services to public entities and not-for-profit organizations. 12 13 The operations of Berkley Risk and Berkley Administrators are being functionally merged. During 1999 it is anticipated that the operations of Berkley Administrators will be fully incorporated into Berkley Risk. This consolidation was implemented in order to enhance the expertise and geographic scale of the two units, while taking advantage of economies of scale and eliminating redundant operational and administrative expenses. Berkley Administrators Berkley Administrators, a division of Tri-State headquartered in Minneapolis, Minnesota, provides risk management and administration services to its clients, including underwriting, loss control, policy issuance and claims handling. A significant portion of Berkley Administrators' present business is the administration of the Minnesota Workers' Compensation Assigned Risk Plan. Key Risk Management Services, Inc. The Company acquired Key Risk Management Services, Inc. ("Key Risk") in 1994. Key Risk, based in Greensboro, North Carolina, is a property casualty risk management firm which specializes in management and administration of group self-insured funds. A significant portion of Key Risk's business was the administration of the North Carolina Associated Industries Workers' Compensation Fund, which ceded a portfolio of loss reserves to a subsidiary of the Company. In 1998 the Company organized Key Risk Insurance Company as a North Carolina insurance company to be used by Key Risk to target businesses having self-insured funds. Key Risk Insurance has an A.M. Best rating of A+ (BRIC group rate). Its statutory surplus and statutory net premiums written as of December 31, 1998 and for the year then ended were $4,492,000 and $18,226,000, respectively. Berkley Risk Managers Berkley Risk Managers is a successor to a company acquired in 1990 (Rasmussen Agency, Inc.). Berkley Risk Managers, based in Somerset, New Jersey, is primarily involved in the development and administration of self-funded property casualty and health insurance programs primarily for municipalities and other governmental entities. All American Agency Facilities, Inc. All American Agency Facilities, Inc., based in Denver, Colorado, provides wholesale brokerage and general agency services on a nationwide basis for unaffiliated insurance carriers as well as certain of the Company's insurance subsidiaries. Berkley Care Network, Inc. The Company established Berkley Care Network, Inc. ("Berkley Care") in 1995. Berkley Care, based in Greensboro, North Carolina, is a managed health care company offering utilization review and case management services for workers' compensation carriers in North Carolina. In 1997, the Company acquired Berkley Care Network, Northeast to provide managed care services in the State of Connecticut, in 1998 it acquired a managed care operation and in 1999 acquired a vocational evaluation, assessment and rehabilitation facility, each located in Florida. 13 14 Alternative Markets Operations: Business The following table sets forth the percentages of revenues, by major source of business, of the alternative markets operations:
1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Midwest Employers Casualty Company 38.3% 46.1% 48.8% 14.8% --% Insurance Service Operations 31.7 35.8 37.5 63.1 78.6 Signet Star - Alternative Markets Division 21.6 18.0 13.7 22.1 21.4 Other Insurance Operations 8.4 .1 -- -- -- ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
International Operations In 1995, the Company and Northwestern Mutual Life International, Inc. ("NML"), a wholly-owned subsidiary of The Northwestern Mutual Life Insurance Company, entered into a joint venture to form Berkley International LLC ("Berkley International"), a limited liability company. The Company agreed to contribute up to $65 million to Berkley International in exchange for a 65% membership interest and NML agreed to contribute up to $35 million to Berkley International in exchange for a 35% membership interest. Berkley International owns 99.9% of Berkley International Argentina S.A. ("Berkley S.A."), an Argentine holding company. Berkley S.A. owns the following property casualty insurance companies: 79% of Union Berkley, Compania de Seguros, S.A.; 99.9% of Berkley, Compania Metropalitana de Seguros, which is the successor to Independencia, Compania Argentina de Seguros, S.A., and Oceano, Compania Argentina de Seguros, which have combined their operations; and 99.9% of Berkley International Aseguradora de Riesgos de Trabajo S.A. Berkley S.A. also owns 99.9% of Risk Management Services S.A., which is a third-party administrator, and 90% of Jackson Berkley Life. In addition, Berkley International directly owns 59% of Philippine Insurance Holdings, Inc., a Philippine holding company, as well as 64% of Family First, Inc., the direct sales and marketing operation. Philippine Insurance Holdings, Inc. owns 100% of the following companies: Berkley International Life Insurance Company, Inc., Berkley International Plans, Inc., and Berkley Insurance Company of the Philippines, Inc. Berkley International also owns 80% of Global Direct, LLC. 14 15 Results by Industry Segment Summary financial information about the Company's operating segments is presented on a GAAP basis in the following table (all amounts include realized capital gains and losses)(1):
Year Ended December 31, ----------------------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (Amounts in thousands) Regional Insurance Operations Total revenues $ 682,519 $ 635,142 $ 529,479 $ 467,009 $ 367,418 Income (loss) before income taxes (24,524) 47,624 35,169 38,171 24,587 Reinsurance Operations Total revenues 297,144 242,086 244,066 221,241 193,658 Income (loss) before income taxes 33,858 42,193 32,756 19,661 (8,954) Specialty Insurance Operations Total revenues 311,955 284,321 247,131 212,484 187,703 Income before income taxes 85,889 68,088 52,113 37,640 33,511 Alternative Markets Operations Total revenues 205,935 184,733 172,027 103,656 75,798 Income before income taxes 36,501 34,733 32,278 10,254 7,068 International Operations Total Revenues 80,287 45,360 26,435 7,313 -- Loss Before Income Taxes (7,017) (3,566) (1,283) (259) --
(1) Results for the regional, alternative markets and specialty operations have been restated to reflect changes in the composition of the segments. 15 16 The combined ratio represents a measure of underwriting profitability, excluding investment income. A number in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. Summary information for the Company's insurance companies and the insurance industry is presented in the following table (1), (2):
Year Ended December 31, -------------------------------------------------------- 1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- Regional Insurance Operations Loss ratio 76.0% 66.6% 66.8% 65.1% 65.3% Expense ratio 35.8 34.0 34.1 34.1 34.4 Policyholders' dividend ratio .9 .5 .6 .9 .9 ----- ----- ----- ----- ----- Combined ratio 112.7% 101.1% 101.5% 100.1% 100.6% ===== ===== ===== ===== ===== Reinsurance Operations Loss ratio 74.3% 69.2% 73.3% 78.1% 87.4% Expense ratio 31.5 32.1 30.1 26.4 27.7 ----- ----- ----- ----- ----- Combined ratio 105.8% 101.3% 103.4% 104.5% 115.1% ===== ===== ===== ===== ===== Specialty Insurance Operations Loss ratio 61.8% 61.9% 68.4% 77.9% 77.7% Expense ratio 31.7 33.3 30.9 28.2 25.4 Policyholders' dividend ratio .3 .5 .3 .3 .1 ----- ----- ----- ----- ----- Combined ratio 93.8% 95.7% 99.6% 106.4% 103.2% ===== ===== ===== ===== ===== Alternative Markets Operations Loss ratio 63.7% 73.1% 74.8% 72.3% 72.5% Expense ratio 36.0 35.8 34.9 31.9 27.7 ----- ----- ----- ----- ----- Combined ratio 99.7% 108.9% 109.7% 104.2% 100.2% ===== ===== ===== ===== ===== International Operations Loss ratio 59.7% 59.8% 49.7% 50.0% --% Expense ratio 48.5 54.6 49.9 58.3 -- ----- ----- ----- ----- ----- Combined ratio 108.2% 114.4% 99.6% 108.3% --% ===== ===== ===== ===== ===== Combined Insurance Operations Loss ratio 71.2% 66.4% 68.7% 70.7% 73.7% Expense ratio 34.9 34.4 33.1 31.3 30.8 Policyholders' dividend ratio .5 .4 .4 .5 .5 ----- ----- ----- ----- ----- Combined ratio 106.6% 101.2% 102.2% 102.5% 105.0% ===== ===== ===== ===== ===== Combined Insurance Operations Premiums to surplus ratio (3) 1.4 1.2 1.2 1.0 1.1 ===== ===== ===== ===== ===== Industry Ratios Combined ratio 105.0(4) 101.6%(5) 107.0%(5) 107.2%(5) 108.9%(5) Premiums to surplus ratio .8(4) .9%(6) 1.0%(6) 1.2%(6) 1.3%(6)
(1) Based on U.S. statutory accounting practices. (2) Results for the regional, alternative markets and specialty insurance operations have been restated to reflect changes in the composition of the segments. (3) Based on the Company's consolidated net premiums written to statutory surplus. (4) Estimated by A.M. Best (5) Source: A.M. Best Aggregates & Averages, for stock companies. (6) Source: A.M. Best Aggregates & Averages, for total industry. 16 17 Investments Investment results before income tax effects were as follows:
1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ----------- (Amounts in thousands) Average investments, at cost $2,996,707 $2,873,730 $2,538,806 $2,081,547 $ 1,853,030 ========== ========== ========== ========== =========== Investment income, before expenses $ 206,065 $ 205,812 $ 171,047 $ 143,527 $ 115,619 ========== ========== ========== ========== =========== Percent earned on average investments 6.9% 7.2% 6.7% 6.9% 6.2% ========== ========== ========== ========== =========== Realized gains (losses) $ 25,400 $ 13,186 $ 7,437 $ 10,357 $ (170) ========== ========== ========== ========== =========== Change in unrealized investment gains (losses) (1) $ 22,147 $ 66,306 $ (22,409) $ 142,475 $ (124,756) ========== ========== ========== ========== ===========
(1) The change in unrealized investment gains (losses) represents the difference between fair value and cost of investments at the beginning and end of the calendar year, including Investments carried at cost. The percentages of the fixed maturity portfolio categorized by contractual maturity, based on fair value, on the dates indicated, are set forth below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations.
December 31, --------------------------------------------- 1998 1997 1996 1995 1994 ----- ----- ----- ----- ----- 1 year or less 1.7% 4.4% 3.1% 4.2% 4.0% Over 1 year through 5 years 16.0 26.4 20.7 17.9 27.6 Over 5 years through 10 years 24.4 19.1 25.0 29.4 21.4 Over 10 years 37.2 29.2 27.1 26.2 27.0 Mortgage-backed securities 20.7 20.9 24.1 22.3 20.0 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
Loss and Loss Adjustment Expense Reserves In the property casualty industry, it is not unusual for significant periods of time, ranging up to several years or more, to elapse between the occurrence of an insured loss, the report of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. The Company's loss reserves reflect current estimates of the ultimate cost of closing outstanding claims; other than for its excess workers' compensation ("EWC") business, as discussed below, the Company does not discount its reserves to estimated present value for financial reporting purposes. In general, when a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis which provide for losses incurred but not yet reported to the insurer, potential inadequacy of case reserves, the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process ("LAE"), and a provision for potentially uncollectible reinsurance. Each insurance subsidiary's net retention for each line of insurance is taken into consideration in the computation of ultimate losses. 17 18 In examining reserve adequacy, historical data is reviewed and consideration is given to such factors as legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, judgmentally adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. Reserve amounts are necessarily based on management's informed estimates and judgments using data currently available. As additional experience and other data become available and are reviewed, these estimates and judgments are revised, resulting in increases or decreases to reserves for insured events of prior years. The reserving process implicitly recognizes the impact of inflation and other factors affecting loss costs by taking into account changes in historic claim patterns and perceived trends. There is no precise method to evaluate the impact of any specific factor on the adequacy of reserves, because the ultimate cost of closing claims is influenced by numerous factors. While the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to fluctuation. In particular, high levels of jury verdicts against insurers, as well as judicial decisions which "re-formulate" policies to expand their coverage to previously unforeseen theories of liability, including those regarding pollution and other environmental exposures, have produced unanticipated claims and increased the difficulty of estimating the loss and loss adjustment expense reserves provided by the Company. Due to the nature of EWC business and the long period of time over which losses are paid in this line of business, the Company discounts its liabilities for EWC losses and loss expenses. Discounting liabilities for losses and loss expenses gives recognition to the time value of money set aside to pay claims in the future and is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from Midwest's loss payout experience and is supplemented with data compiled by insurance companies writing workers' compensation on an excess-of-loss basis. The expected payout pattern has a very long duration because it reflects the nature of losses which generally penetrate self-insured retention limits contained in EWC policies. The Company has limited the expected payout duration to 30 years in order to introduce an additional level of conservatism into the discounting process. These liabilities have been discounted using "risk-free" discount rates determined by reference to the U.S. Treasury yield curve weighted for EWC premium volume to reflect the seasonality of the anticipated duration of losses associated with such coverages. The average discount rate for accident years 1998, 1997, 1996 and 1995 and prior was approximately 5.90%, 5.98%, 5.90% and 5.80%, respectively. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $186,964,000, $189,600,000 and $172,415,000 at December 31, 1998, 1997 and 1996, respectively. To date, known pollution and environmental claims at the Company's insurance company subsidiaries have not had a material impact on the Company's operations. Environmental claims have not materially impacted the Company because these subsidiaries generally did not insure the larger industrial companies which are subject to significant environmental exposures. The Company's net reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $33.4 million and $33.1 million at December 31, 1998 and 1997, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $69.3 million and $68.4 million at December 31, 1998 and 1997, respectively. Net incurred losses and loss expenses for reported pollution and environmental claims were approximately $2.2 million, $0.1 million and $6.9 million in 1998, 1997 and 1996, respectively. Net paid losses and loss expenses has averaged approximately $3 million for each of the last three years. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential affect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain. 18 19 The table below provides a reconciliation of the beginning and ending reserve balances, on a gross of reinsurance basis (dollars in thousands):
1998 1997 1996 ----------- ----------- ----------- Net reserves at beginning of year $ 1,433,011 $ 1,333,122 $ 1,209,250 ----------- ----------- ----------- Net reserves of acquired companies 2,189 4,984 -- Net provision for losses and loss expenses: Claims occurring during the current year (1) 948,580 747,977 675,674 Decrease in estimates for claims occurring in prior years (42,929) (21,313) (15,219) Amortization of discount 9,111 7,760 8,705 ----------- ----------- ----------- 914,762 734,424 669,160 ----------- ----------- ----------- Net payments for claims Current year 395,437 315,370 280,565 Prior years 365,178 324,149 264,723 ----------- ----------- ----------- 760,615 639,519 545,288 ----------- ----------- ----------- Net reserves at end of year 1,589,347 1,433,011 1,333,122 Ceded reserves at end of year 537,219 476,677 449,581 ----------- ----------- ----------- Gross reserves at end of year $ 2,126,566 $ 1,909,688 $ 1,782,703 =========== =========== ===========
A reconciliation, as of December 31, 1998, between the reserves reported in the accompanying consolidated financial statements which have been prepared in accordance with GAAP and those reported on a SAP basis is as follows (in thousands): Net reserves reported on a SAP basis Additions (deductions) to statutory reserves: $ 1,644,044 Loss reserve discounting (2) (70,669) Outstanding drafts reclassified as reserves 15,972 ----------- Net reserves reported on a GAAP basis 1,589,347 Ceded reserves reclassified as assets 537,219 ----------- Gross reserves reported on a GAAP basis $ 2,126,566 ===========
(1) Claims occurring during the current year is net of discount of $20,354,000, $29,783,000 and $28,885,000 for the years ended December 31, 1998, 1997 and 1996, respectively. (2) For statutory purposes, Midwest uses a discount rate of 3% as permitted by the Department of Insurance of the State of Ohio. For GAAP purposes, Midwest uses a discount rate based on the U. S. Treasury yield curve weighted for the expected payout period, as described above. The following table presents the development of net reserves for 1986 through 1998. The top line of the table shows the estimated reserves for unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This represents the estimated amount of losses and loss expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The upper portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1988 reserves have developed a $47 million redundancy over ten years. That amount has been reflected in income over the ten years. The impact on the results of operations of the past three years of changes in reserve estimates is shown in the reconciliation tables above. It should be noted that the table presents a "run off" of balance sheet reserves, rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years. For example, assume a claim that occurred in 1988 is reserved for $2,000 as of December 31, 1988. Assuming this claim was settled for $2,300 in 1998, the $300 deficiency would appear as a deficiency in each year from 1988 through 1997. 19 20
Year Ended December 31, 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ (Amounts in millions) Discounted net reserves for losses and loss expenses $ 531 $ 611 $ 643 $ 680 $ 710 $ 783 $ 895 $1,209 $1,333 $1,433 $1,589 Reserve discounting -- -- -- -- -- -- -- 152 172 190 187 Undiscounted net reserve Net Re-estimated as of: One year later 524 605 635 676 704 776 885 1,346 1,481 1,580 Two years later 518 599 632 659 694 775 872 1,305 1,406 Three years later 513 596 620 650 665 744 833 1,236 Four years later 511 587 612 637 655 708 789 Five years later 505 581 603 631 630 672 Six years later 510 585 588 609 600 Seven years later 514 574 569 585 Eight years later 507 557 550 Nine years later 495 541 Ten years later 484 Cumulative redundancy (deficiency) undiscounted $ 47 $ 70 $ 93 $ 95 $ 110 $ 111 $ 106 $ 125 $ 99 $ 43 -- ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== Cumulative amount of net liability paid through: One year later $ 114 $ 158 $ 139 $ 160 $ 169 $ 186 $ 221 $ 265 $ 332 $ 365 Two years later 217 234 235 264 275 221 355 434 523 Three years later 262 294 304 332 306 291 445 550 Four years later 295 334 345 346 344 334 501 Five years later 315 358 377 371 362 363 Six years later 331 380 395 384 375 Seven years later 348 392 402 394 Eight years later 357 396 409 Nine years later 359 400 Ten years later 363 Discounted net Reserves $ 783 $ 895 $1,209 $1,333 $1,433 $1,589 Ceded Reserves 1,233 1,176 451 450 477 535 ------ ------ ------ ------ ------ ------ Discounted gross Reserves 2,016 2,071 1,660 1,783 1,910 2,124 Reserve discounting -- -- 192 216 241 248 ------ ------ ------ ------ ------ ------ Gross reserve $2,016 $2,071 $1,852 $1,999 $2,151 $2,372 ====== ====== ====== ====== ====== ====== Gross Re-estimated as of One year later 2,010 2,043 1,827 1,965 2,132 Two years later 1,966 2,026 1,789 1,959 Three years later 1,955 1,983 1,754 Four years later 1,913 1,951 Five years later 1,855 Gross cumulative redundancy $ 161 $ 120 $ 98 $ 40 $ 19 ====== ====== ====== ====== ======
20 21 Regulation The Company's insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they do business, under statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. This regulation relates to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; deposits of securities for the benefit of policyholders; approval of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. In general, the Company's regional property casualty subsidiaries as well as Carolina, FICO, Great Divide, Preferred, Key Risk Insurance and Midwest must file all rates for personal and commercial insurance with the insurance department of each state in which they operate. The Company's E&S and reinsurance subsidiaries generally operate free of rate and form regulation. In addition to regulatory supervision of its insurance subsidiaries, the Company is subject to state statutes governing insurance holding company systems. Typically, such statutes require the Company periodically to file information with the state insurance commissioner, including information concerning its capital structure, ownership, financial condition and general business operations. Under the terms of applicable state statutes, any person or entity desiring to purchase more than a specified percentage (commonly 10%) of the Company's outstanding voting securities would be required to obtain regulatory approval of the purchase. Under Florida law, which is applicable to the Company due to its ownership of Carolina, a Florida domiciled insurer, the acquisition of more than 5% of the Company's capital stock must receive regulatory approval. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect their solvency. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources." During the past several years, various regulatory and legislative bodies adopted or proposed new laws or regulations to deal with the cyclical nature of the insurance industry, catastrophic events and their effects on shortage of capacity and pricing. These regulations, which have not had a material impact on the Company's operations, include (i) the creation of "market assistance plans" under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to cancel certain policies in mid-term, (iii) advance notice requirements or limitations imposed for certain policy non-renewals and (iv) limitations upon or decreases in rates permitted to be charged. The passage of Proposition 103 in the State of California did not have a material adverse impact on the Company's operations because the Company's subsidiaries operated in that State primarily on a non-admitted basis. The non-admitted market in California, however, has been subjected to increased levels of regulation. Admiral and Nautilus, both of which derive significant premiums from California, may be adversely impacted by increased regulation which causes business to remain in the admitted market. Additionally, a number of states have adopted and others are considering adopting forms of commercial lines deregulation laws which depending upon factors such as the relatively high amount of premium or revenue of an insured, would permit an insurer to write the insured without being subject to rate and/or form filing requirements. Various state and federal organizations, including Congressional committees and the National Association of Insurance Commissioners ("NAIC"), have been conducting reviews into various aspects of the insurance business. The NAIC has adopted risk based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. The implementation of RBC did not affect the operations of the Company's insurance subsidiaries since all of its subsidiaries have a RBC amount above the authorized control level RBC, as defined by the NAIC. The NAIC is considering model laws on commercial lines deregulation. Federal legislation is being considered which would either abolish or limit the current exemption of the insurance industry from portions of the antitrust laws, impose direct federal oversight or federal solvency standards. No 21 22 assurance can be given that future legislative or regulatory changes resulting from such activity will not adversely affect the Company's insurance subsidiaries. The Company's insurance subsidiaries are also subject to assessment by state guaranty funds when an insurer in that jurisdiction has been judicially declared insolvent and insufficient funds are available from the liquidated company to pay policyholders and claimants. The protection afforded under a state's guaranty fund to policyholders of the insolvent insurer varies from state to state. Generally, all licensed property casualty insurers are considered to be members of the fund, and assessments are based upon their pro rata share of direct written premiums. The NAIC Model Post-Assessment Guaranty Fund Act, which many states have adopted, limits assessments to an insurer to 2% of its subject premium and permits recoupment of assessments through rate setting. Likewise, several states (or underwriting organizations of which the Company's insurance subsidiaries are required to be members) have limited assessment authority with regard to deficits in certain lines of business. To date, assessments have not had a material adverse impact on operations. The Company receives funds from its insurance subsidiaries in the form of dividends and fees for certain management services. Annual dividends in excess of maximum amounts prescribed by state statutes ("extraordinary dividends") may not be paid without the approval of the insurance commissioner of the state in which an insurance subsidiary is domiciled. Similarly, the NAIC has adopted a new model investment law that may affect the statutory carrying values of certain investments; however, it is not possible to predict what impact the model law will have on the Company, as aspects of it have been adopted by only a few states at this time. Competition The property casualty insurance and reinsurance business is competitive, with over 2,000 insurance companies transacting business in the United States. The Company competes directly with a large number of these companies. The Company's strategy in this highly fragmented industry is to seek specialized areas or geographic regions where its insurance subsidiaries can gain a competitive advantage by responding quickly to changing market conditions. Each of the Company's subsidiaries establishes its own pricing practices. Such practices are based upon a Company-wide philosophy to price products with the general intent of making an underwriting profit. Competition in the industry generally changes with profitability. The regional property casualty subsidiaries compete with mutual and other regional stock companies as well as national carriers. Direct writers of property casualty insurance compete with the regional subsidiaries by writing insurance through their salaried employees, generally at a lower cost than through independent agents such as those used by the Company. Signet Star's competition comes from domestic and foreign reinsurers, some of which have greater financial resources than Signet Star and which place their business either on a direct basis or through the broker market. The E & S area is a highly specialized segment of the insurance industry. Admiral and Nautilus compete with other E & S carriers, some of which are larger and have greater resources than Admiral and Nautilus. Under certain market conditions, standard carriers may compete for the types of business written by Admiral and Nautilus. With the implementation of commercial lines deregulation (see "Regulation") in several states and with many other states in the process of considering or adopting such laws, competition for "E & S type risks" might increase significantly. Such standard carriers would under such deregulation be free to compete with more liberal rate and form requirements. In addition, there are regional and specialty carriers competing with Admiral and Nautilus when they underwrite business in their regions or specialties. Carolina and Great Divide's competition comes mainly from other specialty transportation insurers, regional carriers and large national multi-line companies. Each of FICO, Preferred and Key Risk compete with local regional companies as well as national carriers. Midwest's competition comes from insurance and reinsurance companies, some of which have greater financial resources than Midwest. Most of theses carriers write specific EWC coverage, 22 23 do not offer aggregate EWC coverage and tend to focus on risks larger than those targeted by Midwest. In addition, Midwest competes with other specialty EWC insurers. The Insurance Services Operations face competition from several large nationally known service organizations as well as local competitors. The International Operations compete with native insurance operations both large and small, which may be related to government entities, as well as with branch or local subsidiaries of multi-national companies. Employees As of February 21, 1999, the Company employed 4,218 persons. Of this number, the Company's subsidiaries employed 4,166 persons, of whom 2,085 were executive and administrative personnel and 2,081 were clerical personnel. The Company employed the remaining 52 persons in its parent company and investment operations, of whom 37 were executive and administrative personnel and 15 were clerical personnel. The restructuring of the management and back office operations of the regional insurance subsidiaries will result in reductions in employee levels at certain of those companies. Other information about the Company's business The Company maintains an ongoing interest in acquiring additional companies and developing new insurance entities, products and packages as opportunities arise. In addition, the insurance subsidiaries develop new coverages or lines of business to meet the needs of insureds. Seasonal weather variations affect the severity and frequency of losses sustained by the insurance and reinsurance subsidiaries. Although the effect on the Company's business of such natural catastrophes as tornadoes, hurricanes, hailstorms and earthquakes is mitigated by reinsurance, they nevertheless can have a significant impact on the results of any one or more reporting periods. The Company has no customer which accounts for 10 percent or more of its consolidated revenues. Compliance by the Company and its subsidiaries with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to protection of the environment, has not had a material effect upon the capital expenditures, earnings or competitive position of the Company. ITEM 2. PROPERTIES The Company and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. Such owned property is as follows: Location Company Size (sq. ft.) - -------- ------- -------------- Cherry Hill, New Jersey Admiral 42,000 Lincoln, Nebraska Union 43,000 Lincoln, Nebraska Continental Western 20,000 Luverne, Minnesota Tri-State 33,000 Meridian, Mississippi Great River 30,000 Scottsdale, Arizona Nautilus 34,000 Urbandale, Iowa Continental Western 80,000 Westbrook, Maine Acadia 54,000 In addition, the Company and its subsidiaries lease office facilities in various other cities under leases with varying terms and expiration dates. 23 24 ITEM 3. LEGAL PROCEEDINGS Claims under insurance policies written by the Company's insurance subsidiaries are investigated and settled either by claims adjusters employed by them, by their independent agents or by independent adjusters. Each insurance subsidiary employs a staff of claims adjusters at its home office and at some regional offices. Some independent agents may have the authority to settle small claims. Independent claims adjusting firms are used to assist in handling various claims in areas where insurance volume does not warrant the maintenance of a staff adjuster. If a claim or loss cannot be settled and results in litigation, the subsidiary generally retains outside counsel. At present, neither the Company nor any of its subsidiaries is engaged in any litigation known to the Company which is expected to have a material adverse effect upon the Company's business. As is common with property casualty insurance companies, the Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 1998 to a vote of holders of the Company's Common Stock. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "BKLY". The following table sets forth the high and low sale prices for the indicated periods, all as reported on such market.
Common Price Range Dividends Paid High Low Per Share ---------- ---------- ----------- 1998: Fourth Quarter $ 35 3/4 $ 27 1/2 $ .12 cash Third Quarter 40 15/16 29 13/16 $ .12 cash Second Quarter 49 40 1/16 $ .12 cash First Quarter 47 3/8 41 $ .11 cash 1997: Fourth Quarter $ 45 $ 39 $ .11 cash Third Quarter 43 1/16 36 $ .10 cash Second Quarter 39 1/4 31 5/16 $ .10 cash First Quarter 36 5/16 29 13/16 $ .09 cash
The closing price of the Common Stock on February 26, 1999, as reported on the Nasdaq National Market, was $28 5/8 per share. The approximate number of record holders of the Common Stock on February 26, 1999 was 783. 24 25 ITEM 6. SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1998
Year Ended December 31, 1998 1997 1996 1995 1994 ----------- ----------- ----------- ----------- ----------- (Amounts in thousands, except per share data) Net premiums written $ 1,346,254 $ 1,177,641 $ 1,052,511 $ 860,421 $ 717,933 Net premiums earned 1,278,399 1,111,747 981,221 803,336 655,038 Net investment income 202,420 199,588 164,490 137,332 109,683 Management fees and commissions 70,727 71,456 69,246 68,457 64,536 Realized investment gains (losses) 25,400 13,186 7,437 10,357 (170) Total revenues 1,582,517 1,400,310 1,225,166 1,021,943 830,790 Interest expense 48,819 48,869 31,963 28,209 27,601 Income before Federal income taxes 62,781 129,241 115,049 82,747 30,774 Federal income tax (expense) Benefit (5,465) (30,668) (25,102) (17,554) 1,552 Income before minority interest 57,316 98,573 89,947 65,193 32,326 Net income before preferred Dividends 58,760 99,047 90,263 60,882 35,094 Preferred dividends 7,548 7,828 13,909 11,062 10,356 Extraordinary loss 5,017 -- -- -- -- Net income attributable to common stockholders 46,195 91,219 76,354 49,820 24,738 Data per common share: Basic: Before extraordinary item 1.82 3.09 2.56 1.91 .96 Net income 1.64 3.09 2.56 1.91 .96 Diluted: Before extraordinary income 1.76 3.02 2.53 1.90 .95 Net income 1.59 3.02 2.53 1.90 .95 Stockholders' equity 28.80 28.72 25.13 23.59 17.79 Cash dividends declared $ .48 $ .42 $ .35 $ .32 $ .29 Weighted average shares outstanding: Basic 28,194 29,503 29,792 26,121 25,773 Diluted 29,115 30,185 30,130 26,262 25,951 Investments $ 3,302,103 $ 3,162,533 $ 2,991,606 $ 2,588,346 $ 1,901,715 Total assets 4,983,431 4,544,318 4,136,973 3,618,684 3,582,291 Reserves for losses and loss expenses 2,126,566 1,909,688 1,782,703 1,660,020 2,070,886 Long-term Debt 394,444 390,415 390,104 319,287 331,002 Company-obligated manditorily redeemable capital securities of a subsidiary trust holding solely 8.197% junior subordinated debentures 207,988 207,944 207,901 -- -- Stockholders' equity 861,281 947,292 879,732 929,815 597,601
25 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Reference is made to the information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained on pages 17 through 23 of the registrant's 1998 Annual Report to Stockholders, which information is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to the information under "Market Risk" under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained on pages 20 through 21 of the registrant's 1998 Annual Report to Stockholders, which information is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of the registrant are contained on pages 24 through 40 of registrant's 1998 Annual Report to Stockholders and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 26 27 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following information is provided as to the Directors and executive officers of the Company as of February 26, 1999:
Name Age Position ---- --- -------- William R. Berkley 53 Chairman of the Board and Chief Executive Officer John D. Vollaro 54 President, Chief Operating Officer and a Director Robert P. Cole 48 Senior Vice President Anthony J. Del Tufo 54 Senior Vice President, Chief Financial Officer and Treasurer Cornelius T. Finnegan, III 54 Senior Vice President, General Counsel and Secretary E. LeRoy Heer 60 Senior Vice President, Chief Corporate Actuary H. Raymond Lankford, Jr. 56 Senior Vice President, Alternative Markets Operations Ira S. Lederman 45 Senior Vice President, Assistant General Counsel and Assistant Secretary James G. Shiel 39 Senior Vice President - Investments Edward A. Thomas 50 Senior Vice President, Specialty Operations Donald J. Veldkamp 60 Senior Vice President, Technology and Distribution Systems Paul J. Hancock 37 Vice President - Actuary Edward F. Linekin 35 Vice President - Investments Clement P. Patafio 34 Vice President - Corporate Controller Scott A. Siegel 40 Vice President - Taxes George G. Daly 58 Director Robert B. Hodes 73 Director Henry Kaufman 71 Director Richard G. Merrill 68 Director Jack H. Nusbaum 58 Director Mark L. Shapiro 54 Director Martin Stone 70 Director
As permitted by Delaware law, the Board of Directors of the Company is divided into three classes, the classes being divided as equally as possible and each class having a term of three years. Directors generally serve until their respective successors are elected at the annual meeting of stockholders which ends their term. None of the Company's Directors has any family relationship with any other Director or executive officer. Each year the term of office of one class expires. In May 1998, the term of a class consisting of three Directors expired. Henry Kaufman, Martin Stone and John D. Vollaro were elected as Directors to hold office for a term of three years until the Annual Meeting of Stockholders in 2001 and until their successors are duly elected and qualify. George G. Daly was elected as Director to hold office for a term of two years until the Annual Meeting of Stockholders in 2000 and until his successor is duly elected and qualifies. William R. Berkley has been Chairman of the Board and Chief Executive Officer of the Company since its formation in 1967. He also served as President at various times from 1967 to 1995. He also serves as Chairman of the Board or Director of a number of public and private companies. These include The Greenwich Bank & Trust Company, a newly formed Connecticut chartered commercial bank; Westport National Bank, a newly formed federally chartered commercial bank; Pioneer Companies, Inc., a chemical manufacturing and marketing company; Strategic Distribution, Inc., an industrial products distribution and services company; and Interlaken Capital, Inc., a private investment firm with interests in various businesses. His current term as a Director expires in 2000. John D. Vollaro has been President and Chief Operating Officer of the Company since January 1996 and Director since September 1995. He was Chief Executive Officer of Signet Star Holdings, Inc., a subsidiary of the Company (formerly a joint venture between the 27 28 Company and General Re Corporation), from July 1993 to December 1995. He served as Executive Vice President of the Company from 1991 until 1993, as Chief Financial Officer and Treasurer of the Company from 1983 through 1993 and as Senior Vice President, Chief Financial Officer and Treasurer of the Company from 1983 to 1991. Mr. Vollaro's current term as a Director expires in 2001. Robert P. Cole has been Senior Vice President since January 1998. Prior thereto, he was Vice President since October 1996. Before joining the Company, Mr. Cole was, since 1992, a senior Officer of Christania General Insurance Corp. of N.Y., which was purchased by Folksamerica Reinsurance Company in 1996, and prior to that was associated with reinsurers for twenty years. Anthony J. Del Tufo has been Senior Vice President, Chief Financial Officer and Treasurer of the Company since September 1993. Before joining the Company, Mr. Del Tufo was a partner with KPMG LLP from 1975 to 1993. Cornelius T. Finnegan, III was named Senior Vice President - General Counsel and Secretary on February 1, 1999. Before joining the Company, Mr. Finnegan was a partner at the New York law firm of Willkie Farr & Gallagher for more than the last five years. E. LeRoy Heer has been Senior Vice President - Chief Corporate Actuary since January 1991. Prior thereto, he had been Vice President - Corporate Actuary since May 1978. H. Raymond Lankford, Jr. has been Senior Vice President - Alternative Markets Operations since May 1996. Prior thereto, he was President of All American Agency Facilities, Inc., a subsidiary of the Company, from October 1991, having joined All American in 1990. He has been in the insurance business in various capacities for more than 30 years. Ira S. Lederman has been Senior Vice President since January 1997. Additionally, he was named General Counsel of Berkley International in January 1998. He is also Assistant General Counsel, a position he has held since July 1989, and Assistant Secretary since May 1986. Previously, he was Vice President from May 1986 until January 1997. Prior thereto, he was Insurance Counsel of the Company since May 1986 and Associate Counsel from April 1983. James G. Shiel has been Senior Vice President - Investments of the Company since January 1997. Prior thereto, he was Vice President - Investments of the Company since January 1992. Since February 1994, he has been President of Berkley Dean & Company, Inc., a subsidiary of the Company, which he joined in 1987. Edward A. Thomas has been Senior Vice President - Specialty Operations of the Company since April 1991. Prior thereto, he was President of Signet Reinsurance Company, a subsidiary of the Company, for more than five years. Donald J. Veldkamp was named Senior Vice President, Technology and Distribution Systems in January 1998. He most recently served as Chairman of Union Insurance Company, a subsidiary of the Company, since July 1997. Prior to that, he was President of Union Insurance Company from May 1990 to July 1997 and President of Tri-State Insurance Company of Minnesota, also a subsidiary of the Company, from February 1980 to May 1990. Paul J. Hancock was elected Vice President - Actuary in May 1998. Previously, he was Assistant Vice President - Actuary since June 1997. Prior thereto, he was employed since July 1991 by Signet Star Reinsurance Company, a subsidiary of the Company, serving as Vice President and Corporate Actuarial Manager from August 1996 to June 1997 and Assistant Vice President from October 1995 to August 1996. Signet Star Reinsurance Company (formerly known as North Star Reinsurance Company) was purchased by the Company in July 1993. Edward F. Linekin was elected Vice President - Investments in May 1998. Mr. Linekin has been an employee of the Company since April 1995. He has been a Vice President of the Company's investment subsidiary, Berkley Dean & Company, Inc., since April 1995. Prior thereto, he was Assistant Portfolio Manager - Senior Investment Officer of Home Insurance Company from April 1993. 28 29 Clement P. Patafio has been Vice President - Corporate Controller since January 1997. Prior thereto, he was Assistant Vice President - Corporate Controller since July 1994 and Assistant Controller since May 1993. Before joining the Company, Mr. Patafio was with KPMG LLP from 1986 to 1993. Scott A. Siegel has been Vice President - Taxes since January 1997. Prior thereto, he was Director of Taxes since September 1991. Before joining the Company, Mr. Siegel was with KPMG LLP from 1981 to 1991. George G. Daly has been a Director of the Company since 1998. Dr. Daly is Dean of Stern School of Business, and Dean Richard R. West Professor of Business, New York University for more than the past five years. In addition to his academic career, Dr. Daly served as Chief Economist at the U.S. Office of Energy Research and Development in 1974. Robert B. Hodes has been a Director of the Company since 1970. Mr. Hodes is Counsel to the New York law firm of Willkie Farr & Gallagher, where prior thereto he had been a partner for more than five years. He is also a director of Crystal Oil Company; Globalstar Telecommunications, Limited; K&F Industries Inc.; Loral Space & Communications Ltd.; Mueller Industries, Inc.; R.V.I. Guaranty, Ltd.; LCH Investments N.V.; Restructured Capital Holdings, Ltd.; and Space Systems/Loral, Inc. Mr. Hodes' current term as a Director expires in 2000. Henry Kaufman has been a Director of the Company since 1994. Dr. Kaufman is President of Henry Kaufman & Co., Inc., an investment, economic and financial consulting company since its establishment in 1988. Dr. Kaufman serves as Chairman of the Board of Overseers, Stern School of Business of New York University; Chairman of the Board of Trustees, Institute of International Education; Member of the Board of Directors, Federal Home Loan Mortgage Corporation; Member of the Board of Directors, Lehman Brothers Holdings Inc.; Member of the Board of Trustees, New York University; Member of the International Capital Markets Advisory Committee of the Federal Reserve Bank of New York; Member of the Board of Trustees, Whitney Museum of American Art; Member of the Advisory Committee to the Investment Committee, International Monetary Fund Staff Retirement Plan; and Member of the Board of Governors, Tel-Aviv University. Dr. Kaufman's current term as a Director expires in 2001. Richard G. Merrill has been a Director of the Company since 1994. Mr. Merrill was Executive Vice President of Prudential Insurance Company of America from August 1987 to March 1991 when he retired. Prior thereto, Mr. Merrill served as Chairman and President of Prudential Asset Management Company since 1985. Mr. Merrill is a Director of Sysco Corp. Mr. Merrill's current term as a Director expires in 1999. Jack H. Nusbaum has been a Director of the Company since 1967. Mr. Nusbaum is the Chairman of the New York law firm of Willkie Farr & Gallagher where he has been a partner for more than the last five years. He is a director of Fine Host Corporation; Pioneer Companies, Inc.; Prime Hospitality Corp.; Strategic Distribution Inc.; and The Topps Company, Inc. Mr. Nusbaum's current term as a Director expires in 1999. Mark L. Shapiro has been a Director of the Company since 1974. Since September 1998, Mr. Shaprio has been a private investor. From July 1997 through August 1998, Mr. Shapiro was a Senior Consultant to the Export-Import Bank of the United States. Previously, he was a Managing Director in the investment banking firm of Schroder & Co. Inc. for more than the past five years. Mr. Shapiro's current term as a Director expires in 1999. Martin Stone has been a Director of the Company since 1990. Mr. Stone is Chairman of Professional Sports, Inc. (the Tucson Sidewinders AAA baseball team) and Chairman of Adirondack Corporation, all for more than the past five years. Mr. Stone is also a director of Canyon Ranch, Inc. and a member of the Advisory Board of Yosemite National Park. Mr. Stone's current term as a Director expires in 2001. 29 30 ITEM 11. EXECUTIVE COMPENSATION Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security ownership of certain beneficial owners Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. (b) Security ownership of management Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. (c) Changes in control Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Index to Financial Statements The Management's Discussion and Analysis and the Company's financial statements, together with the report thereon of KPMG LLP, appearing on pages 17 through 40 of the Company's 1998 Annual Report to Stockholders, are incorporated by reference in this Annual Report on Form 10-K. With the exception of the aforementioned information, the 1998 Annual Report to Shareholders is not deemed to be filed as part of this report. The schedules to the financial statements listed below should be read in conjunction with the financial statements in such 1998 Annual Report to Stockholders. Financial statement schedules not included in this Annual Report on Form 10-K have been omitted because they are not applicable or required information is shown in the financial statements or notes thereto. 30 31 Index to Financial Statement Schedules Page Independent Auditors' Report on Schedules and Consent 36 Schedule II - Condensed Financial Information of Registrant 37 Schedule III - Supplementary Insurance Information 41 Schedule IV - Reinsurance 42 Schedule VI - Supplementary Information concerning Property & Casualty Insurance Operations 43 (b) Reports on Form 8-K During the quarter ended December 31, 1998, the registrant filed the following Reports on Form 8-K: 1. Report dated October 23, 1998 with respect to a press release relating to earnings of the Company for the third quarter of 1998 (under Item 5 of Form 8-K). 2. Report dated November 16, 1998 with respect to a press release relating to the Company's retention of Morgan Stanley & Company to explore strategic opportunities for the Company's group of regional insurance companies (under Item 5 of Form 8-K). (c) Exhibits The exhibits filed as part of this report are listed on pages 34 and 35 hereof. 31 32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. W. R. BERKLEY CORPORATION By /s/ William R. Berkley --------------------------------------------- William R. Berkley, Chairman of the Board and Chief Executive Officer March 22, 1999 32 33 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ William R. Berkley Chairman of the Board and William R. Berkley Chief Executive Officer March 22, 1999 Principal executive officer /s/ John D. Vollaro President, Chief Operating March 22, 1999 John D. Vollaro Officer and Director /s/ George G. Daly Director March 22, 1999 George G. Daly /s/ Robert B. Hodes Director March 22, 1999 Robert B. Hodes /s/ Henry Kaufman Director March 22, 1999 Henry Kaufman /s/ Richard G. Merrill Director March 22, 1999 Richard G. Merrill /s/ Jack H. Nusbaum Director March 22, 1999 Jack H. Nusbaum /s/ Mark L. Shapiro Director March 22, 1999 Mark L. Shapiro /s/ Martin Stone Director March 22, 1999 Martin Stone /s/ Anthony J. Del Tufo Senior Vice President, March 22, 1999 Anthony J. Del Tufo Chief Financial Officer and Principal financial officer Treasurer /s/ Clement P. Patafio Vice President, March 22, 1999 Clement P. Patafio Corporate Controller 33 34 ITEM 14. (c) EXHIBITS Number (2.1) Agreement and Plan of Merger between the Company, Berkley Newco Corp. and MECC, Inc. (incorporated by reference to Exhibit 2.1 of the Company's current Report on Form 8-K (File No. 0-7849) filed with the Commission September 28, 1995). (2.2) Agreement and Plan of Restructuring, dated July 20, 1995, by and among the Company, Signet Star Holdings, Inc., Signet Star Reinsurance Company, Signet Reinsurance Company and General Re Corporation (incorporated by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K (File No. 0-7849) filed with the Commission on September 28, 1995). (3.1) Restated Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 30, 1994). (3.2) Amendment, dated May 12, 1998, to the Company's Restated Certificate of Incorporation, as amended (filed herewith). (3.3) By-laws (incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 22, 1993). (4) The instruments defining the rights of holders of the long-term debt securities of the Company are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Company agrees to furnish supplementally copies of these instruments to the Commission upon request. (10.1) The Company's 1982 Stock Option Plan (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1 (File No. 2-98396) filed with the Commission on June 14, 1985). (10.2) First Amended and Restated W. R. Berkley Corporation 1992 Stock Option Plan (filed herewith). (10.3) The Company's lease dated June 3, 1983 with the Ahneman, Devaul and Devaul Partnership, incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-1 (File No. 2-98396) filed with the Commission on June 14, 1985. (10.4) W.R. Berkley Corporation Deferred Compensation Plan for officers as amended January 1, 1991 (incorporated by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 26, 1996). (10.5) W. R. Berkley Corporation Deferred Compensation Plan for Directors as adopted March 7, 1996 (incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 26, 1996). (10.6) W. R. Berkley Corporation Annual Incentive Compensation Plan (incorporated by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 27, 1998). (10.7) W. R. Berkley Corporation Long Term Incentive Plan (incorporated by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 27, 1998). (13) 1998 Annual Report to Stockholders of W.R. Berkley Corporation (only those portions of such Annual Report that are incorporated by reference in this Report on Form 10-K are deemed filed) (filed herewith). 34 35 (21) Following is a list of the Company's significant subsidiaries. Subsidiaries of subsidiaries are indented and the parent of each such corporation owns 100% of the outstanding voting securities of such corporation except as noted below.
Jurisdiction of Percentage Incorporation owned ------------- ----- All American Agency Facilities, Inc. Delaware 100% Berkley Care Network, Inc. North Carolina 100% Berkley Regional Insurance Company: Missouri 100% Acadia Insurance Company: Maine 100% Chesapeake Bay Property and Casualty Insurance Company Maine 100% Berkley Insurance Company of the Carolinas North Carolina 100% Continental Western Insurance Company Iowa 100% Firemen's Insurance Company of Washington, D.C.: Maryland 100% FICO Insurance Company Maryland 100% Great River Insurance Company Mississippi 100% Tri-State Insurance Company of Minnesota: Minnesota 100% American West Insurance Company North Dakota 100% Union Insurance Company Nebraska 100% Union Standard Insurance Company Oklahoma 100% Berkley International, LLC New York 65% Carolina Casualty Insurance Company Florida 100% Clermont Specialty Managers, Ltd. New Jersey 100% J/I Holding Corporation: Delaware 100% Admiral Insurance Company: Delaware 100% Berkley Risk Services, LLC. Minnesota 100% Nautilus Insurance Company: Arizona 100% Great Divide Insurance Company North Dakota 100% Key Risk Management Services, Inc. North Carolina 100% Key Risk Insurance Company North Carolina 100% MECC, Inc.: Delaware 100% Midwest Employers Casualty Company: Ohio 100% Preferred Employers Insurance Company California 100% Monitor Liability Managers, Inc. Delaware 100% Monitor Surety Managers, Inc. Delaware 100% Queen's Island Insurance Company, Ltd. Bermuda 100% Rasmussen Agency, Inc. New Jersey 100% Signet Star Holdings, Inc.: Delaware 100% Signet Star Reinsurance Company Delaware 100% Facultative ReSources, Inc. Connecticut 100%
(23) See Independent Auditors' report on schedules and consent. (27) Financial Data Schedule. 35 36 INDEPENDENT AUDITORS' REPORT ON SCHEDULES AND CONSENT Board of Directors and Stockholders W. R. Berkley Corporation The audit referred to in our report dated February 25, 1999 included the related financial statement schedules as of December 31, 1998 and 1997 and for each of the years in the three-year period ended December 31, 1998 included in the Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We consent to the use of our reports incorporated by reference in the Registration Statements (No. 33-30684), (No. 33-95552) and (No. 333-00459) on Form S-3 and (No. 33-7488), (No. 33-88640), (No. 333-33935) and (No. 33-55726) on Form S-8 of W. R. Berkley Corporation. KPMG LLP New York, New York March 22, 1999 36 37 Schedule II W. R. Berkley Corporation Condensed Financial Information of Registrant Balance Sheets (Parent Company) (Amounts in thousands)
December 31, 1998 1997 ----------- ----------- Assets Cash (including invested cash) $ 137,422 $ 18,018 Fixed maturity securities: Held to maturity, at cost (fair value $5,563 and $5,600) 5,563 5,600 Available for sale at fair value (cost $898 and $116,622) 894 116,839 Equity securities, at fair value: Available for sale (cost $698 and $698) 755 690 Trading account (cost $698 and $619) 698 619 Investments in subsidiaries 1,353,201 1,389,085 Due from subsidiaries (principally deferred income taxes) 54,753 64,641 Current Federal income taxes receivable 11,620 6,783 Real estate, furniture & equipment at cost, less accumulated depreciation 19,514 20,673 Other assets 5,571 4,147 ----------- ----------- $ 1,589,991 $ 1,627,095 =========== =========== Liabilities, Debt and Stockholders' Equity Liabilities: Due to subsidiaries (principally deferred income taxes) $ 77,951 $ 58,830 Short-term debt 55,500 -- Deferred Federal income taxes 7,198 32,887 Other liabilities 29,421 25,520 ----------- ----------- 170,070 117,237 ----------- ----------- Long-term debt 350,651 354,622 Subsidiary trust junior subordinated debt 207,988 207,944 Stockholders' equity: Preferred stock 65 65 Common stock 7,281 7,281 Additional paid-in capital 429,612 428,760 Retained earnings (including accumulated Undistributed net income of Subsidiaries of $517,649 and $510,814 in 1998 and 1997, respectively) 601,908 569,160 Accumulated other comprehensive income 54,672 58,206 Treasury stock, at cost (232,256) (116,180) ----------- ----------- 861,282 947,292 ----------- ----------- $ 1,589,991 $ 1,627,095 =========== ===========
See note to condensed financial statements. 37 38 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statements of Operations (Parent Company) (Amounts in thousands)
Years ended December 31, ---------------------------------- 1998 1997 1996 -------- -------- -------- Management fees and investment income from affiliates, including dividends of $65,836, $33,911, and $60,264 for 1998, 1997 and 1996, respectively $ 72,812 $ 40,058 $ 72,377 Realized investment gains (losses) -- 2,739 486 Other income 10,506 10,972 4,058 -------- -------- -------- Total revenues 83,318 53,769 76,921 Expenses, other than interest expense (22,201) (23,801) (16,121) Interest expense (47,571) (47,645) (30,014) -------- -------- -------- Income (loss) before Federal income taxes 13,546 (17,677) 30,786 -------- -------- -------- Federal income taxes: Federal income taxes provided by Subsidiaries on a separate return Basis 44,370 54,884 41,002 Federal income tax provision on a Consolidated return basis (5,115) (30,849) (25,102) -------- -------- -------- Net benefit 39,255 24,035 15,900 -------- -------- -------- Income before undistributed equity in net income of subsidiaries 52,801 6,358 46,686 Equity in undistributed net income of subsidiaries 6,835 93,210 43,577 -------- -------- -------- Income before preferred dividends 59,636 99,568 90,263 Preferred dividends (8,424) (8,349) (13,909) -------- -------- -------- Net income before extraordinary loss 51,212 91,219 76,354 Extraordinary loss (5,017) -- -- -------- -------- -------- Net income attributable to common stockholders $ 46,195 $ 91,219 $ 76,354 ======== ======== ========
See note to condensed financial statements. 38 39 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statement of Cash Flows (Parent Company) (Amounts in thousands)
Years ended December 31, ------------------------------------- 1998 1997 1996 --------- --------- --------- Cash flows from operating activities: Net income before preferred dividends and extraordinary items $ 59,636 $ 99,568 $ 90,263 Adjustments to reconcile net income to net cash flows provided by operating activities: Equity in undistributed net income of subsidiaries (6,835) (93,210) (43,577) Tax payments received from subsidiaries 63,199 45,999 35,613 Federal income taxes provided by subsidiaries on a separate return basis (44,370) (54,884) (40,848) Change in Federal income taxes (29,342) (1,409) 4,840 Realized investment losses -- (2,739) (486) Other, net (1,790) 4,114 6,050 --------- --------- --------- Net cash provided by operating activities before trading account sales (purchases) 40,498 (2,561) 51,855 Trading account sales (purchases), net (79) 32,712 1,722 --------- --------- --------- Net cash provided by operating activities 40,419 30,151 53,577 --------- --------- --------- Cash flow used in investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities available for sale 3,167 19,954 13,121 Equity securities -- 1,432 786 Proceeds from maturities and prepayments of fixed maturity securities 112,643 -- -- Cost of purchases, excluding trading account: Fixed maturity securities -- (9,305) (130,003) Equity securities -- (2,098) -- Cost of companies acquired -- (7,238) (15,955) Investments in and advances to subsidiaries, net (5,775) (14,986) (38,936) Net additions to real estate, furniture & equipment 201 444 (21,270) Other, net -- 5,539 -- --------- --------- --------- Net cash used in investing activities 110,236 (6,258) (192,257) --------- --------- --------- Cash flows from financing activities: Net proceeds from issuance of common stock -- -- -- Net proceeds from issuance of long-term debt 39,882 -- 98,850 Net proceeds from issuance of short-term debt 55,500 -- -- Net proceeds from issuance of a subsidiary trust junior subordinated debt -- -- 207,900 Purchase of treasury shares (59,240) -- (24,152) Cash dividends to common stockholders (13,518) (11,695) (10,143) Cash dividends to preferred shareholders (7,356) (8,717) (12,824) Purchase of Preferred Stock -- (41,523) (77,572) Retirement of long-term debt (49,104) -- -- Other, net 2,585 755 1,257 --------- --------- --------- Net cash provided by financing activities (31,251) (61,180) 183,316 --------- --------- --------- Net increase in cash and invested cash 119,404 (37,287) 44,636 Cash and invested cash at beginning of year 18,018 55,305 10,669 --------- --------- --------- Cash and invested cash at end of year $ 137,422 $ 18,018 $ 55,305 ========= ========= =========
See note to condensed financial statements 39 40 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued December 31, 1998, 1997 and 1996 Note to Condensed Financial Statements (Parent Company) The accompanying condensed financial statements should be read in conjunction with the notes to consolidated financial statements included elsewhere herein. Reclassifications have been made in the 1997 and 1996 financial statements as originally reported to conform them to the presentation of the 1998 financial statements. The Company files a consolidated federal tax return with the results of its domestic insurance subsidiaries included on a statutory basis. Under present Company policy, Federal income taxes payable by (or refundable to) subsidiary companies on a separate-return basis are paid to (or refunded by) W. R. Berkley Corporation, and the Company pays the tax due on a consolidated return basis. Included in invested cash is $114,520,667 placed in a trust which will be used to service the remaining outstanding shares of the Series A Preferred Stock. The Company redeemed the Series A Preferred Stock on January 25, 1999. 40 41 Schedule III W. R. Berkley Corporation and Subsidiaries Supplementary Insurance Information December 31, 1998, 1997 and 1996 (Amounts in thousands)
Reserve for Deferred policy losses and Net Loss and acquisition loss Unearned Premiums investment Loss cost expenses premiums earned income expenses ---------- ---------- ---------- ---------- ---------- ---------- December 31, 1998 Regional $ 83,613 $ 495,164 $ 337,414 $ 622,280 $ 53,942 $ 476,920 Reinsurance 29,906 435,920 102,566 246,277 47,643 183,020 Specialty 37,148 745,790 167,648 235,055 59,345 145,624 Alternative markets 7,531 399,560 37,061 101,755 34,667 65,634 International 10,696 50,132 20,172 73,032 5,469 43,564 Corporate and adjustments -- -- -- -- 1,354 -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ 168,894 $2,126,566 $ 664,861 $1,278,399 $ 202,420 $ 914,762 ========== ========== ========== ========== ========== ========== December 31, 1997 Regional $ 79,726 $ 396,648 $ 315,978 $ 575,911 $ 51,920 $ 385,285 Reinsurance 22,620 389,285 77,159 195,825 45,520 135,530 Specialty 29,949 751,068 147,443 213,794 60,162 134,313 Alternative markets 7,618 344,302 31,018 86,229 34,390 55,386 International 5,824 28,385 17,786 39,988 3,623 23,910 Corporate and adjustments -- -- -- -- 3,973 -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ 145,737 $1,909,688 $ 589,384 $1,111,747 $ 199,588 $ 734,424 ========== ========== ========== ========== ========== ========== December 31, 1996 Regional $ 66,755 $ 365,981 $ 274,559 $ 482,419 $ 43,125 $ 324,425 Reinsurance 16,947 366,947 65,388 206,297 37,542 151,254 Specialty 27,436 731,468 140,206 187,795 50,130 130,134 Alternative markets 5,695 302,877 25,808 79,717 29,122 50,916 International 2,324 15,430 8,252 24,993 1,426 12,431 Corporate and adjustments -- -- -- -- 3,145 -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ 119,157 $1,782,703 $ 514,213 $ 981,221 $ 164,490 $ 669,160 ========== ========== ========== ========== ========== ========== Amortization of deferred policy Other operating acquisition cost and Net premiums Costs expenses written ---------- ---------- ---------- December 31, 1998 Regional $ 196,391 $ 33,732 $ 641,316 Reinsurance 62,855 15,084 269,634 Specialty 75,968 4,474 254,003 Alternative markets 30,903 72,897 106,195 International 28,495 15,244 75,106 Corporate and adjustments -- 20,112 -- ---------- ---------- ---------- Total $ 394,612 $ 161,543 $1,346,254 ========== ========== ========== December 31, 1997 Regional $ 168,474 $ 33,759 $ 618,768 Reinsurance 58,200 3,836 206,652 Specialty 73,056 8,865 219,272 Alternative markets 26,002 69,044 90,870 International 12,139 12,874 42,079 Corporate and adjustments -- 21,527 -- ---------- ---------- ---------- Total $ 337,871 $ 149,905 $1,177,641 ========== ========== ========== December 31, 1996 Regional $ 140,505 $ 29,380 $ 517,515 Reinsurance 52,925 4,529 218,200 Specialty 52,679 12,205 214,738 Alternative markets 25,679 67,604 76,876 International 11,854 3,433 25,182 Corporate and adjustments -- 8,201 -- ---------- ---------- ---------- Total $ 283,642 $ 125,352 $1,052,511 ========== ========== ==========
41 42 Schedule IV W. R. Berkley Corporation and Subsidiaries Reinsurance Years ended December 31, 1998, 1997 and 1996 (Amounts in thousands)
Assumed Percentage Ceded from of amount Direct to other other Net assumed to amount companies companies amount net ---------- ---------- ---------- ---------- ---------- Premiums written: Year ended December 31, 1998: Regional insurance $ 744,560 $ 108,741 $ 5,497 $ 641,316 .9% Reinsurance 1,240 27,544 295,938 269,634 109.8% Specialty insurance 364,564 120,111 9,550 254,003 3.8% Alternative Markets 62,942 15,078 58,331 106,195 54.9% International 95,870 20,764 -- 75,106 -- ---------- ---------- ---------- ---------- Total $1,269,176 $ 292,238 $ 369,316 $1,346,254 27.4% ========== ========== ========== ========== Year ended December 31, 1997: Regional insurance $ 691,431 $ 82,598 $ 9,935 $ 618,768 1.6% Reinsurance -- 17,059 223,711 206,652 108.3% Specialty insurance 329,266 118,868 8,874 219,272 4.0% Alternative Markets 56,759 7,384 41,495 90,870 45.7% International 56,924 14,845 -- 42,079 -- ---------- ---------- ---------- ---------- Total $1,134,380 $ 240,754 $ 284,015 $1,177,641 24.1% ========== ========== ========== ========== Year ended December 31, 1996: Regional insurance $ 587,565 $ 74,296 $ 4,246 $ 517,515 0.8% Reinsurance -- 10,708 228,908 218,200 104.9% Specialty insurance 318,977 115,571 11,332 214,738 5.3% Alternative Markets 59,297 5,353 22,932 76,876 29.8% International 29,263 4,081 -- 25,182 -- ---------- ---------- ---------- ---------- Total $ 995,102 $ 210,009 $ 267,418 $1,052,511 25.4% ========== ========== ========== ==========
42 43 Schedule VI W. R. Berkley Corporation and Subsidiaries Supplementary Information Concerning Property-Casualty Insurance Operations December 31, 1998, 1997 and 1996 (Amounts in thousands)
1998 1997 1996 ----------- ----------- ----------- Deferred policy acquisition costs $ 168,894 $ 145,737 $ 119,157 Reserves for losses and loss expenses 2,126,566 1,909,688 1,782,703 Unearned premium 664,861 589,384 514,213 Premiums earned 1,278,399 1,111,747 981,221 Net investment income 202,420 199,588 164,490 Losses and loss expenses incurred: Current Year 948,580 747,977 675,674 Prior Years (42,929) (21,313) (15,219) Amortization of discount 9,111 7,760 8,705 Amortization of deferred policy Acquisition costs 394,612 337,871 283,642 Paid losses and loss expenses 760,615 639,519 545,288 Net premiums written 1,346,254 1,177,641 1,052,511
43 44 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INDUSTRY OVERVIEW - -------------------------------------------------------------------------------- The demand for insurance is influenced primarily by general economic conditions, while the supply of insurance is directly related to available capacity, i.e., the level of policyholders' surplus employed in the industry and the willingness of insurance management to risk that capital. The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. In addition, investment rates of return may impact policy rates. These factors can have a significant impact on the ultimate adequacy of premium rates because a property casualty insurance policy is priced before its costs are known, as premiums usually are determined long before claims are reported. Over the past several years a significant increase in capacity has produced a trend of increasing price competition. This trend of increasing competition has intensified in 1998. OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 1998 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1997 - -------------------------------------------------------------------------------- Net income attributable to common stockholders ("Net Income") for 1998 declined to $46 million, or $1.59 per share diluted, from $91 million, or $3.02 diluted in 1997. The decline in earnings was due primarily to a deterioration in underwriting results, attributable to an increase in weather-related losses and the effects of competition on rate adequacy. The 1998 results include after-tax realized investment gains of $17 million, or $.57 diluted, compared with $9 million, or $.28 diluted, for 1997. Net premiums written in 1998 rose 14% to $1,346 million from $1,178 million written during 1997 due to growth recorded by all segments of the company. Net premiums written by the regional operations grew by 4% to $641 million from $619 million written in 1997. The growth was generated by the issuance of additional policies. Net premiums written by the reinsurance segment increased by 30% to $270 million from $207 million in 1997. This increase was substantially due to an increase in prorata treaty business. Net premiums written by the specialty operations grew by 16% to $254 million from $219 million in 1997, due to increases in all sectors of this business. This growth was due to an increase in units insured. Net premiums written by the alternative markets operations grew by 16% to $106 million from $91 million in 1997 due to the commencement of operations of Key Risk Insurance Company (which underwrote business previously managed on behalf of a self-insurance association). This increase more than offset a decline in premiums written by Midwest Employers Casualty Company. Net premiums written by the international operations grew by 79% to $75 million from $42 million. This increase was due to 1997 acquisitions in Argentina and the start-up of a life insurance and endowment insurance company in the Philippines. Pre-tax net investment income increased to $202 million from $200 million earned in 1997. This growth was due to an increase in investable assets produced by cash flow from operations, which was partially offset by the effects of the repurchase of Common Stock, and a decrease in pre-tax investment yield. The decline in pre-tax investment yield was due to an increase in the percentage of the portfolio invested in municipal bonds and lower yields earned on the trading portfolio, (see "Liquidity and Capital Resources"). Management fees and commissions consist primarily of fees earned by the alternative markets segment. Management fees and commissions remained at $71 million as intense competition inhibited growth. Realized investment gains increased to $25 million from $13 million in 1997. Realized gains on fixed income securities resulted primarily from the Company's strategy of maintaining an appropriate balance between the duration of its fixed income portfolio and the duration of its liabilities; realized gains on equity securities arise primarily as a result of a variety of factors which influence the Company's valuation criteria for such securities. The majority of the 1998 realized gains resulted from the sale of fixed maturity securities while the majority of 1997 realized gains resulted from the sale of equity securities. The combined ratio represents a measure of underwriting profitability, generally excluding investment income. A number in excess of 100 generally indicates an underwriting loss; a number below 100 generally indicates an underwriting gain. The consolidated combined ratio (on a statutory basis) of the Company's insurance operations 17 45 increased to 106.6% in 1998 from 101.2% in 1997 mainly due to an increase in the consolidated loss ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) increased to 71.2% from 66.4% due to a number of factors. weather-related losses for 1998 were $58.8 million compared with $32.8 million in 1997, which accounted for an increase of 1.6% of the loss ratio. The regional operations were adversely impacted by a rise in the frequency and severity of commercial property and liability claims, especially in the fourth quarter. The increase in severity resulted in an accrual for additional ceded premiums due under certain sliding scale reinsurance treaties. These factors were somewhat offset by favorable loss development on business written in prior years. Other operating costs and expenses, which consist of the expenses of the Company's insurance and alternative markets operations, as well as the Company's corporate and investment expenses, increased by 14% to $556 million from $488 million in 1997. The increase in other operating costs is primarily due to the substantial premium growth discussed above, which in turn results in an increase in underwriting expenses. The consolidated expense ratio of the Company's insurance operations (underwriting expenses expressed as a percentage of premiums written) increased to 34.9% for the 1998 period from 34.4% for the comparable 1997 period. This increase resulted primarily from the cost of expansion incurred by several regional companies and higher growth rate in international operations, which operate at a higher expense ratio than domestic operations. The Federal income tax provision resulted in an effective tax rate of 9% in 1998 (24% in 1997). The tax rate is lower than the statutory tax rate of 35% because a substantial portion of investment income is tax-exempt. The decrease in the effective tax rate in 1998 is due primarily to an increase in the percentage of pre-tax income that is tax-exempt. OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1996 - -------------------------------------------------------------------------------- Net income attributable to common stockholders ("Net Income") for 1997 was $91 million, or $3.02 per share diluted, compared with 1996 earnings of $76 million, or $2.53 diluted. The 1997 results include after-tax realized investment gains of $9 million, or $.28 diluted, compared with $5 million, or $.16 diluted, for 1996. Net premiums written in 1997 rose 12% to $1,178 million from $1,053 million written during 1996 due to growth recorded by the regional, specialty, alternative markets, and international operations. Net premiums written by the regional operations grew by 20% to $619 million from $518 million written in 1996. The majority of this increase was due to operating units which were started during the past several years. Net premiums written by the reinsurance segment decreased by 5% to $207 million from $218 million in 1996. This decrease was substantially due to a decrease in treaty business which more than offset premiums generated by the Latin American and Caribbean division that commenced operations in February 1996. Net premiums written by the specialty operations grew by 2% to $220 million from $215 million in 1996. This increase was due to an increase in premiums written by the excess and surplus operations, which more than offset a decline in premiums written by the transportation unit. Net premiums written by the alternative markets operations grew by 18% to $91 million from $77 million in 1996. This increase was due primarily to increased market penetration by Signet Star's alternative markets division. Net premiums written by the international operations grew by 67% to $42 million from $25 million. This increase was due to the July 1996 start-up of a workers' compensation company in Argentina. Pre-tax net investment income increased to $200 million from $164 million earned in 1996. This increase was partially due to an increase in average investable assets produced by the issuance of $210 million of capital trust securities issued in December 1996. Excluding the effects of the issuance of these securities, pre-tax net investment income was $193 million, an increase of $29 million over the comparable 1996 amount. This growth was mainly due to an increase in investable assets produced by cash flow from operations. In addition, an increase in investment income earned in the Company's trading activities contributed to the growth in investment income, (see "Liquidity and Capital Resources"). Management fees and commissions consist primarily of fees earned by the alternative markets segment. Management fees and commissions increased 3% to $71 million from $69 million in 1996. The increase in management fees and commissions is due primarily to a 1997 acquisition, as intense competition in the workers' compensation market continued to inhibit growth. Realized investment gains increased to $13 million from $7 million in 1996. Realized gains on fixed income securities resulted primarily from the Company's strategy of maintaining an appropriate balance between the dura- 18 46 tion of its fixed income portfolio and the duration of its liabilities; realized gains on equity securities arise primarily as a result of a variety of factors which influence the Company's valuation criteria for such securities. The majority of the 1997 and 1996 realized gains resulted from the sale of equity securities. The consolidated combined ratio (on a statutory basis) of the Company's insurance operations decreased to 101.2% in 1997 from 102.2% in 1996 due to an improvement in the consolidated loss ratio which was partially offset by an increase in the consolidated expense ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) decreased to 66.4% from 68.7%. This improvement was primarily due to a decrease in weather related losses incurred by the regional operations and better than expected experience on business written in prior years recorded by the specialty operations. Other operating costs and expenses, which consist of the expenses of the Company's insurance and alternative markets operations, as well as the Company's corporate and investment expenses, increased by 19% to $488 million from $409 million in 1996. The increase in other operating costs is primarily due to the substantial premium growth discussed above, which in turn results in an increase in underwriting expenses. The consolidated expense ratio of the Company's insurance operations (underwriting expenses expressed as a percentage of premiums written) increased to 34.4% for the 1997 period from 33.1% for the comparable 1996 period. This increase resulted primarily from higher commission expenses incurred to generate premium growth. The increase in interest expense is due to the issuance in December 1996 of $210 million Company-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely junior subordinated debentures, (see "Liquidity and Capital Resources"). The Federal income tax provision resulted in an effective tax rate of 24% in 1997 (22% in 1996). The tax rate is lower than the statutory tax rate of 35% because a substantial portion of investment income is tax-exempt. The increase in the effective rate in 1997 is due primarily to the increase in realized gains on investments which are taxed at the full corporate rate. Preferred dividends decreased as a result of the 1997 repurchase of 276,855 shares of the Series A Preferred Stock, (see "Liquidity and Capital Resources"). LIQUIDITY AND CAPITAL RESOURCES - -------------------------------------------------------------------------------- GENERAL The Company's subsidiaries are highly liquid, receiving substantial cash from premiums, investment income, management fees and proceeds from sales and maturities of portfolio investments. The principal outflows of cash are payments of claims, taxes, interest and operating expenses. The net cash provided from operating activities (before trading account transactions) was $224 million in 1998, $229 million in 1997 and $244 million in 1996. The 1998 cash flow was impacted favorably by the assumption of a portfolio of loss reserves for which the Company received proceeds of approximately $60 million. As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company is obligated to service its debt, pay consolidated Federal income taxes and pay its expenses. The Company also provides capital to its subsidiaries as required. Tax payments and management fees from the insurance subsidiaries are made under agreements which generally are subject to approval by state insurance departments. Maximum amounts of dividends that can be taken without regulatory approval are prescribed by statute, (see Note 17 of "Notes to Consolidated Financial Statements"). FINANCING ACTIVITY On January 19, 1996, the Company issued $100 million of 6.25% ten-year notes which are not redeemable until maturity and utilized a portion of the proceeds to retire $28.4 million of Signet Star's bank debt. In addition, a portion of the proceeds was used to retire $28 million of Series B Preferred Stock. On December 19, 1996, the Company issued $210 million of Company-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely 8.197% junior subordinated debentures of the Company due December 15, 2045 ("Capital Trust Securities") and utilized $38.4 million of the proceeds to retire the remaining outstanding shares of the Series B Preferred Stock. In addition, during December 1996 and January 1997, the Company utilized $39.2 million of the proceeds to retire 252,273 shares of the Series A Preferred Stock and placed $115.8 million in a trust to service the remaining outstanding Series A Preferred Stock. In the second and third quarters of 1997, 93,775 shares of the Series A Preferred Stock were purchased by subsidiaries of the Company. The Company utilized the balance of the proceeds in the trust to redeem the remaining Series A Preferred Stock on January 25, 1999. 19 47 In February 1998, the Company repurchased $16.3 million face value of its 9.875% and 8.7% senior notes and debentures for $19.7 million and issued $20.2 of short-term debt to finance these purchases. In April 1998, the Company repurchased an additional $18.4 million of its 9.875% and 8.7% senior debentures for $22.1 million. In April 1998, the Company issued $40 million face value of its 6.375% medium-term notes due April 15, 2005. A portion of the proceeds from the issuance of the medium-term notes was used to repay the short-term debt issued in connection with the repurchased debentures and to retire $10 million face value of its 8.95% senior notes, which matured on May 20, 1998. In addition, in December 1998, one of the Company's subsidiaries issued an $8 million five-year note. During 1996, the Company purchased 862,500 shares of Common Stock for approximately $24.2 million. During 1998, the Company purchased 3,172,222 shares of common stock for approximately $117.9 million, leaving a balance of 2,000,000 shares as of December 31, 1998, available for repurchase under its current authorization. As of December 31, 1998, the Company had $55.5 million of outstanding short-term debt under its unsecured line-of-credit . As of December 31, 1998, the Company had an additional $19.5 million of short-term debt available under its line-of-credit. The Company has on file two "shelf" registration statements with the Securities and Exchange Commission with a combined remaining balance of $150 million in additional equity and/or debt securities. The securities may be offered from time to time as determined by funding requirements and market conditions. INVESTMENTS In its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities which, combined with expected cash flow, is believed adequate to meet foreseeable payment obligations. As part of this strategy, the Company attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations. The Company's investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, active management of the portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as changes in financial market conditions alter the assumptions underlying the purchase of certain securities. The investment portfolio, valued on a cost basis, grew in 1998 by $138 million to approximately $3,197 million primarily due to the combined effects of net cash flow from operations and the financing activities discussed above. The Company's investments are currently comprised of fixed income securities and trading securities. At December 31, 1998, the portfolio mix of the fixed income was as follows: tax-exempt securities were 42% (38% in 1997); U.S. Government securities and cash equivalents were 23% (24% in 1997); mortgage-backed securities remained at 18%; corporate fixed maturity securities were 15% (17% in 1997); and the balance of 2% (3% in 1997) was invested in other fixed income securities. The Company had net trading account assets (trading account equity securities plus trading account receivables from brokers and clearing organizations less trading account securities sold but not yet purchased) of $320.7 million as of December 31, 1998, as compared to $256.3 million as of December 31, 1997. The net trading account represented approximately 10% and 8% of the Company's net invested assets as of December 31, 1998 and 1997, respectively. MARKET RISK The Company's market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of the Company's investment portfolio as a result of fluctuations in prices, interest rates and currency exchange rates. As discussed above, the Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations. The Company's investments are categorized as either non-trading securities or trading securities. The principal market risk for the Company's non-trading securities is interest rate risk. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The following table outlines the groups of non-trading fixed maturity securities, and the components of the interest rate risk:
Market Effective Fair Value Group Yield Duration (000's) - -------------------------------------------------------------------------------- U. S. Government securities 4.95 5.55 303,388 - -------------------------------------------------------------------------------- State and municipal 4.48 6.42 1,237,067 - -------------------------------------------------------------------------------- Corporate 6.56 5.64 434,300 - -------------------------------------------------------------------------------- Mortgage-backed securities 6.74 6.62 515,333 - -------------------------------------------------------------------------------- Total 5.36 6.22 2,490,088 - --------------------------------------------------------------------------------
20 48 As a general rule, a porfolio's duration measures the expected change in porfolio value due to a change in interest rates. The porfolio's duration is further modified to accurately reflect a porfolio's expected price movement as interest rates change. Based upon a pricing model, the Company determines the estimated change in fair value of the non-trading securities, assuming immediate parallel shifts in the treasury yield curve while keeping spreads between individual securities and treasury securities static. The fair value at specified levels at December 31, 1998 is as follows:
Estimated Fair Estimated Value of Financial Change in Instruments Fair Value Change in interest rates $(000's) $(000's) - -------------------------------------------------------------------------------- 300 basis point rise $2,059,015 $ (431,073) - -------------------------------------------------------------------------------- 200 basis point rise 2,192,513 (297,575) - -------------------------------------------------------------------------------- 100 basis point rise 2,338,061 (152,027) - -------------------------------------------------------------------------------- Base scenario 2,490,088 -- - -------------------------------------------------------------------------------- 100 basis point decline 2,651,272 161,184 - -------------------------------------------------------------------------------- 200 basis point decline 2,831,218 341,130 - -------------------------------------------------------------------------------- 300 basis point decline 3,033,714 543,626 - --------------------------------------------------------------------------------
The estimated changes in fair value, based upon the above table, would be offset by the Company's liabilities if they were discounted and marked to market. The Company does, however, discount its excess workers' compensation (EWC) reserves and if interest rates were to rise 300 basis points, the reserves would be decreased by $6 million, while a 300 basis point decline, would cause an increase in EWC reserves of $10 million. These fluctuations would partially offset the change in the investment portfolio. The Company's trading securities are used for merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies, which are the targets in announced tender offers and mergers. Merger arbitrage differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes merger arbitrage investments less vulnerable to changes in general stock market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales. Additionally, the merger arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. Based upon these characteristics, the Company's trading securities are primarily exposed to the completion of announced deals, which are subject to regulatory as well as political and other risks. The Company also has net assets held by its foreign subsidiaries that are subject to foreign currency risk. As of December 31, 1998, the Company had $19.7 million (net of minority interest) invested in subsidiaries in Argentina, as well as $5.6 million (net of minority interest) invested in subsidiaries in the Philippines. As of December 31, 1998, approximately 70% and 60% of the invested assets in Argentina and the Philippines were denominated in US Dollars, respectively. The effect of foreign subsidiaries maintaining US Dollar denominated assets is a hedge against fluctuations in foreign currency. Argentina has established a currency board exchange rate mechanism that creates a dollar for dollar relationship between the US Dollar and the Argentine Peso. Because of this dollar for dollar relationship, devaluation risk is viewed to be low. In addition, the investments in Argentina are hedged, in that the assets and liabilities are matched for both duration and denomination, based on the currencies of their contracts. The Company's investment in the Philippines is affected by fluctuations in the exchange rate between the US Dollar and the Philippine Peso. For every one percent change in the exchange rate, the Company's unrealized foreign currency gain/(loss) would change approximately $56,000, net of minority interest. FEDERAL INCOME TAXES The Company files a consolidated Federal income tax return. At December 31, 1998, the Company had a deferred tax liability of $74 million, which primarily relates to unrealized investment gains and intangible assets, and a deferred tax asset of $67 million, which primarily relates to the discounting of loss reserves for Federal income tax purposes. The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. REINSURANCE - -------------------------------------------------------------------------------- The Company follows the customary industry practice of reinsuring a portion of its exposures, paying to reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased principally to reduce net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming 21 49 reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial, financially sound carriers. REGIONAL OPERATIONS In 1998, all regional subsidiaries generally retained $300,000 on individual property casualty risks. Acadia Insurance Company retained up to $1.5 million per bond for surety business. Other regional companies writing surety business retained up to $450,000 ($325,000 prior to October 1, 1997). The regional group also maintained catastrophe reinsurance protection for approximately 95% of weather-related losses above $6 million per occurrence up to a maximum of $34 million. In addition, certain of the regional operating units carried additional aggregate catastrophe protection of $13.5 million in excess of $4 million for storms exceeding $500,000; $5 million in excess of $6.5 million for storms exceeding $1.0 million; and $4.5 million in excess of $7 million for storms exceeding $1.5 million. REINSURANCE OPERATIONS Signet Star's catastrophe retrocession program provides coverage for property losses in four layers as follows: (i) 100% of $7.5 million in excess of $6.0 million per occurrence; (ii) 95% of $6.5 million in excess of $13.5 million per occurrence; (iii) 95% of $10.0 million in excess of $20.0 million per occurrence; and (iv) 95% of $5.0 million in excess of $30 million and 100% of $15 million (for California only and only under certain conditions) and 100% of $15 million or $10 million (for Florida only and only under certain conditions). In 1998, Signet Star had a variable quota share program on its casualty facultative business with retentions varying from $425,000 up to $2.5 million depending on the certificate limit. Property facultative business is covered on a per risk basis for $700,000 in excess of $300,000 and 95% of $4 million in excess of $1 million. These coverages apply to Signet Star's individual certificate and master certificate business. During 1998, Signet Star had retrocession coverage for its fidelity and surety business for 100% of each loss up to $2.5 million in excess of $750,000 per occurrence and 100% of each loss up to $2.5 million in excess of $3.25 million per occurrence and 86.5% of each surety loss up to $13 million in excess of $5.75 million per occurrence. During 1998, the Latin American and Caribbean division retained $250,000 per risk for property, marine, energy and aviation business and $500,000 per risk for casualty. SPECIALTY OPERATIONS Admiral's retention in 1998 was $183,750 per risk for most classes of business and varied between $2.0 million and $5.0 million based upon policy size, per insured, for business written by Monitor Liability Managers. In addition, in 1998, Admiral had additional protection on an aggregate basis for its directors and officers liability business. Nautilus generally retained $140,000 per risk in 1998 and Carolina maintained its retention at $300,000 on property liability exposures. In 1998, Carolina (on business underwritten by Monitor Surety Managers) retained up to $1.5 million on a per principal per bond basis. Great Divide retained $187,500 per risk in 1998. The specialty group (except Carolina) is also covered under the regional group's property catastrophe protection for 95% of $34 million in excess of $6 million. Preferred Employer's retention in 1998 was $300,000 per risk. ALTERNATIVE MARKETS OPERATIONS Midwest's retention is generally $1 million per occurrence above the self-insured's underlying retention. Key Risk Insurance Company's retention in 1998 was $300,000 per risk. Signet Star's alternative market division maintains specific retrocessional coverage on certain treaties and is also covered under the reinsurance group's catastrophe retrocessional program. INTERNATIONAL OPERATIONS The international operations generally retained between $50,000 and $250,000 per occurrence or individual risk. YEAR 2000 - -------------------------------------------------------------------------------- The Company continues to address system requirements with regard to Year 2000 compliance issues and believes that the majority of the systems have been tested and determined by the Company to be Year 2000 compliant. The project of Year 2000 readiness is broken down into the following phases: (1) inventorying Year 2000 items, (2) prioritizing the identified items, (3) evaluating Year 2000 compliance and alternative solutions for items determined to be material to the Company, (4) replacing or repairing material items that are determined not to be Year 2000 compliant and (5) testing and changing items which are material. The process, which began in 1996, is substantially complete, and it is expected that all critical primary systems will be tested and substantially functional by April 1999. This includes both operational and financial systems upon which the Company is dependent. As to embedded chips, the Company expects to be compliant by April 1999 with respect to those chips which are integral to its operating systems. Compliance with respect to the remainder of the Company's embedded chips is expected to be achieved by the third quarter of 1999. Additionally, the Company is communicating with third parties with which it has a material relation- 22 50 ship, e.g. independent insurance agents, and financial institutions, to identify Year 2000 issues with respect to those third parties. Due to these communications, the Company has no reason to believe that those third parties will not be in general compliance with Year 2000 readiness; the Company is unable to determine whether all such third parties will achieve Year 2000 readiness in such manner as not to result in any material adverse effect on the company. It is the Company's practice in the normal course of business to upgrade technology, including hardware and software, as appropriate. As a result of this practice, much of its Year 2000 readiness has been accomplished in the ordinary course. Through December 31, 1998, the Company has incurred approximately $6 million of costs which have been expensed as incurred, and estimates an additional $2 million to be incurred in 1999 to complete Year 2000 compliance. The total cost associated with Year 2000 compliance is not expected to be material to the Company's financial position. Notwithstanding the above, a failure by the Company or a third party to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, including the uncertainty of the Year 2000 readiness of third parties with whom the Company deals, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. The Company has not implemented a formal contingency plan with respect to Year 2000 compliance issues; however, the Company and its various operating units are considering the necessity for and feasibility of contingency alternatives. The Year 2000 issue is also a concern from an underwriting standpoint to the extent of possible liability for coverage under general liability, property, directors and officers liability and other policies. Through December 31, 1998, no significant losses have arisen or come to light with respect to Year 2000 claims exposure for the Company's insurance and reinsurance subsidiaries. Additionally, certain of the Company's insurance subsidiaries may either include or exclude insurance coverage for Year 2000 exposures. However, due in part to the potential for judicial decisions which reformulate policies to expand their coverage for previously unforeseen theories of liability which may produce unanticipated claims, proposed legislative reform and because there is no prior history of such claims, the amount of any potential Year 2000 coverage liabilities is not determinable. The discussion herein with regard to Year 2000 compliance contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. These risks could include unforeseen technological or other issues associated with Year 2000 compliance efforts and the extent to which vendors, public utilities, insurance agents, financial institutions, governmental entities and other third parties that interface with the Company may fail to achieve Year 2000 compliance. The inclusion of such forward-looking statements herein shall not be considered a representation by the Company that the objectives or plans of the Company, or other matters addressed by the forward-looking statements, will be achieved. CAPITALIZATION - -------------------------------------------------------------------------------- For the year ended December 31, 1998, stockholders' equity decreased by approximately $86 million. The decrease in stockholders' equity is attributable to the Company's repurchase of shares of its Common Stock, which was partially offset by an increase in retained earnings. Accordingly, the Company's total capitalization decreased to $1,464 million at December 31, 1998 and the percentage of the Company's capital attributable to long-term debt increased to 27% at December 31, 1998 from 25% at December 31, 1997. OTHER ITEMS - -------------------------------------------------------------------------------- The Company is in the process of restructuring the management and back-office operations of its group of 10 regional insurance companies into four geographic segments based on markets served. The consolidation of management and administrative functions, which should be completed before the end of 1999, is expected to decrease costs of operations beginning in late 1999. The Company expects to take a one-time after-tax charge of between $9 million and $13 million in the first quarter of 1999 to cover costs directly related to the restructuring. 23 51 CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
Years ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Revenues: Net premiums written $ 1,346,254 $ 1,177,641 $ 1,052,511 Change in net unearned premiums (67,855) (65,894) (71,290) - ---------------------------------------------------------------------------------------------------------------- Premiums earned 1,278,399 1,111,747 981,221 Net investment income 202,420 199,588 164,490 Management fees and commissions 70,727 71,456 69,246 Realized investment gains 25,400 13,186 7,437 Other income 5,571 4,333 2,772 - ---------------------------------------------------------------------------------------------------------------- Total revenues 1,582,517 1,400,310 1,225,166 Operating costs and expenses: Losses and loss expenses (914,762) (734,424) (669,160) Other operating costs and expenses (556,155) (487,776) (408,994) Interest expense (48,819) (48,869) (31,963) - ---------------------------------------------------------------------------------------------------------------- Income before income taxes and minority interest 62,781 129,241 115,049 Federal income tax expense (5,465) (30,668) (25,102) - ---------------------------------------------------------------------------------------------------------------- Income before minority interest 57,316 98,573 89,947 Minority interest 1,444 474 316 - ---------------------------------------------------------------------------------------------------------------- Net income before preferred dividends 58,760 99,047 90,263 Preferred dividends (7,548) (7,828) (13,909) - ---------------------------------------------------------------------------------------------------------------- Net income before extraordinary loss 51,212 91,219 76,354 Extraordinary loss on early extinguishment of long-term debt (net of taxes of $2,701) (5,017) -- -- - ---------------------------------------------------------------------------------------------------------------- Net income attributable to common stockholders $ 46,195 $ 91,219 $76,354 - ---------------------------------------------------------------------------------------------------------------- Earnings per share: Basic Net income before extraordinary loss $ 1.82) $ 3.09 $ 2.56 Extraordinary loss on early extinguishment of long-term debt (.18) -- -- - ---------------------------------------------------------------------------------------------------------------- Net income attributable to common stockholders $ 1.64 $ 3.09 $ 2.56 - ---------------------------------------------------------------------------------------------------------------- Diluted Net income before extraordinary loss $ 1.76) $ 3.02 $ 2.53 Extraordinary loss on early extinguishment of long-term debt (.17) -- -- - ---------------------------------------------------------------------------------------------------------------- Net income attributable to common stockholders $ 1.59 $ 3.02 $ 2.53 - ----------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 24 52 CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data)
December 31, 1998 1997 - ---------------------------------------------------------------------------------------------------------- ASSETS Investments: Invested cash $ 370,155 $ 259,178 Fixed maturity securities: Held to maturity, at cost (fair value $183,469 and $194,919) 170,150 182,172 Available for sale, at fair value (cost $2,224,244 and $2,240,901) 2,306,619 2,322,971 Equity securities, at fair value: Available for sale (cost $59,890 and $76,134) 65,869 86,243 Trading account (cost $373,164 and $301,136) 389,310 311,969 Cash 16,123 21,669 Premiums and fees receivable 377,501 331,774 Due from reinsurers 513,297 432,516 Accrued investment income 37,842 36,930 Prepaid reinsurance premiums 79,530 72,148 Deferred policy acquisition costs 168,894 145,737 Real estate, furniture and equipment at cost, less accumulated depreciation 136,884 126,831 Excess of cost over net assets acquired 76,645 73,142 Trading account receivable from broker and clearing organizations 229,520 103,823 Other assets 45,092 37,215 - ---------------------------------------------------------------------------------------------------------- $ 4,983,431 $ 4,544,318 - ---------------------------------------------------------------------------------------------------------- LIABILITIES, RESERVES, DEBT AND STOCKHOLDERS' EQUITY Liabilities and reserves: Reserves for losses and loss expenses $ 2,126,566 $ 1,909,688 Unearned premiums 664,861 589,384 Due to reinsurers 130,517 95,140 Deferred Federal income taxes 6,877 32,887 Trading securities sold but not yet purchased, at fair value (proceeds $283,310 and $162,360) 298,165 159,456 Short-term debt 55,500 -- Other liabilities 213,453 187,755 - ---------------------------------------------------------------------------------------------------------- 3,495,939 2,974,310 - ---------------------------------------------------------------------------------------------------------- Long-term debt 394,444 390,415 - ---------------------------------------------------------------------------------------------------------- Company-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely 8.197% Junior Subordinated debentures of the corporation due December 15, 2045 207,988 207,944 - ---------------------------------------------------------------------------------------------------------- Minority interest 23,779 24,357 - ---------------------------------------------------------------------------------------------------------- Stockholders' equity: Preferred stock, par value $.10 per share: Authorized 5,000,000 shares: 7 3/8% Series A Cumulative Redeemable Preferred Stock 653,952 shares issued and outstanding 65 65 Common stock, par value $.20 per share: Authorized 80,000,000 shares, issued and outstanding, net of treasury shares, 26,504,404 and 29,568,335 shares 7,281 7,281 Additional paid-in capital 429,611 428,760 Retained earnings 601,908 569,160 Accumulated other comprehensive income 54,672 58,206 Treasury stock, at cost, 9,899,663 and 6,835,510 shares (232,256) (116,180) - ---------------------------------------------------------------------------------------------------------- 861,281 947,292 - ---------------------------------------------------------------------------------------------------------- $ 4,983,431 $ 4,544,318 - ----------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 25 53 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands, except per share data) Years ended December 31, 1998, 1997 and 1996
Preferred and common stock and Accumulated Total additional other stockholders' paid-in Retained comprehensive Treasury equity capital earnings income stock - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 $ 929,815 $ 552,068 $ 424,261 $ 48,450 $ (94,964) Net income attributable to common stockholders 76,354 -- 76,354 -- -- Change in other comprehensive income (17,375) -- -- (17,375) -- Issuance of common shares 1,746 750 -- -- 996 Purchase of treasury stock (24,152) -- -- -- (24,152) Repurchase of preferred stock (77,572) (77,572) -- -- -- Accretion of Series B Preferred Stock 1,193 1,193 -- -- -- Dividends to common stockholders ($.35 per share) (10,277) -- (10,277) -- -- - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 879,732 476,439 490,338 31,075 (118,120) Net income attributable to common stockholders 91,219 -- 91,219 -- -- Change in other comprehensive income 27,131 -- -- 27,131 -- Issuance of common shares 3,130 1,190 -- -- 1,940 Repurchase of preferred stock (41,523) (41,523) -- -- -- Dividends to common stockholders ($.42 per share) (12,397) -- (12,397) -- -- - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 947,292 436,106 569,160 58,206 (116,180) Net income attributable to common stockholders 46,195 -- 46,195 -- -- Change in other comprehensive income (3,534) -- -- (3,534) -- Issuance of common shares 2,719 851 -- -- 1,868 Purchase of treasury stock (117,944) -- -- -- (117,944) Dividends to common stockholders ($.48 per share) (13,447) -- (13,447) -- -- - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1998 $ 861,281 $ 436,957 $ 601,908 $ 54,672 $(232,256) ==========================================================================================================================
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands)
1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------- Net income attributable to common stockholders $46,195 $ 91,219 $76,354 - -------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Income Unrealized holding gain (losses) on investment securities arising during the period (net of taxes of ($9,941), $10,915, and ($11,915)) (18,462) 20,271 (22,209) Less: Reclassification adjustment for net change in unrealized gains during the period (net of taxes of $8,890, $4,615 and $2,603) 16,510 8,571 4,834 - -------------------------------------------------------------------------------------------------------------------------- Net unrealized gain (loss) (1,952) 28,842 (17,375) Change in unrealized foreign exchange (losses) (1,582) (1,711) -- - -------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Income (3,534) 27,131 (17,375) - -------------------------------------------------------------------------------------------------------------------------- Comprehensive income $42,661 $118,350 $58,979 - --------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 26 54 CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Years ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income before minority interest, preferred dividends and extraordinary items $ 57,316 $ 98,573 $ 89,947 Adjustments to reconcile net income to net cash flows provided by operating activities: Increase in reserves for losses and loss expenses, net of due to/from reinsurers 169,285 137,312 126,006 Depreciation and amortization 22,658 11,852 8,590 Change in unearned premiums and prepaid reinsurance premiums 68,095 67,023 71,290 Change in premiums and fees receivable (45,727) (64,858) (25,348) Change in Federal income taxes (26,923) (1,408) 5,719 Change in deferred policy acquisition costs (22,057) (24,465) (29,640) Realized investment gains (25,400) (13,186) (7,437) Other, net 27,023 18,601 4,690 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities before trading account sales (purchases) 224,270 229,444 243,817 Trading account sales (purchases), net (4,567) (89,245) (79,906) - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 219,703 140,199 163,911 - ---------------------------------------------------------------------------------------------------------------------- Cash flows used in investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities available for sale 715,459 718,789 471,057 Equity securities 52,727 43,204 46,698 Proceeds from maturities and prepayments of fixed maturity securities 297,303 120,944 219,673 Cost of purchases, excluding trading account: Fixed maturity securities available for sale (1,033,190) (984,961) (723,159) Fixed maturity securities held to maturity (3,034) -- (105,675) Equity securities (33,217) (28,028) (26,988) Cost of acquired companies, net of acquired cash and invested cash (3,304) 585 (11,739) Net additions to real estate, furniture and equipment (27,167) (17,898) (46,983) Other, net 3,956 (9,904) (5,083) - ---------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (30,467) (157,269) (182,199) - ---------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net proceeds from issuance of short-term debt 55,500 -- -- Net proceeds from issuance of long-term debt 47,882 -- 98,850 Purchase of common treasury shares (117,944) -- (24,152) Repurchase of long-term debt (49,104) -- -- Cash dividends to common stockholders (13,518) (11,695) (10,143) Cash dividends to preferred stockholders (7,356) (8,717) (12,824) Net proceeds from issuance of Company-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely 8.197% junior subordinated debentures -- -- 207,900 Repurchase of preferred stock -- (41,523) (77,572) Payment of subsidiary debt -- -- (28,306) Other, net 735 13,367 4,103 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (83,805) (48,568) 157,856 - ---------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and invested cash 105,431 (65,638) 139,568 Cash and invested cash at beginning of year 280,847 346,485 206,917 - ---------------------------------------------------------------------------------------------------------------------- Cash and invested cash at end of year $ 386,278 $ 280,847 $ 346,485 ====================================================================================================================== Supplemental disclosure of cash flow information: Interest paid on debt $ 48,976 $ 45,950 $ 28,296 ====================================================================================================================== Federal income taxes paid $ 31,755 $ 32,258 $ 19,171 ======================================================================================================================
See accompanying notes to consolidated financial statements. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 27 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended December 31, 1998, 1997, and 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------- (A) Principles of consolidation and basis of presentation The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries ("the Company"), have been prepared on the basis of generally accepted accounting principles ("GAAP"). All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 1997 and 1996 financial statements to conform them to the presentation of the 1998 financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. (B) Revenue recognition Insurance premiums written are recognized as earned generally on a pro-rata basis over the contract period. Management fees on insurance service contracts are recorded as earned primarily on a pro-rata basis over the policy period. Commission income is recognized as earned on the effective date of the applicable insurance policies. (C) Investments The Company has classified its investments into three categories. Securities that the Company has the positive intent and ability to hold to maturity are classified as "held to maturity" and reported at amortized cost. Securities which the Company purchased with the intent to sell in the near-term are classified as "trading" and are reported at estimated fair value, with unrealized gains and losses reflected in the statement of operations. The remaining securities are classified as "available for sale" and carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as comprehensive income and a separate component of stockholders' equity. Realized gains or losses represent the difference between the cost of securities sold and the proceeds realized upon sale. The cost of securities is adjusted where appropriate to include a provision for significant decline in value which is considered to be other than temporary. The Company uses the specific identification method where possible and the first-in, first-out method in other instances, to determine the cost of securities sold. Realized gains or losses, including any provision for decline in value, are included in the statement of operations. (D) Trading account The long portfolio positions are presented in the balance sheet as trading account assets. The short sales and short call options used in trading account activities are presented as trading securities sold but not yet purchased. The trading account receivable from broker and clearing organizations is comprised of unsettled trades within the trading account and the net margin balances held by the clearing broker. (E) Per share data Basic per share data is based upon the weighted average number of shares outstanding during the year. Diluted per share data reflects the potential dilution that would occur if employee stock-based compensation plans were exercised. Shares issued in connection with loans to shareholders are not considered to be outstanding for the purposes of calculating basic per share amounts and have been excluded from stockholders' equity. (F) Deferred policy acquisition costs Acquisition costs (primarily commissions and premium taxes) incurred in writing insurance and reinsurance business are deferred and amortized ratably over the terms of the related contracts. Deferred policy acquisition costs are limited to the amounts estimated to be recoverable from the applicable unearned premiums and the related anticipated investment income by giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force. (G) Reserves for losses and loss expenses Reserves for losses and loss expenses are an accumulation of amounts determined on the basis of (1) evaluation of claims for business written directly by the Company; (2) estimates received from other companies for reinsurance assumed; and (3) estimates for losses incurred but not reported (based on Company and industry experience). These estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in results of operations in the period in which they are determined. 28 56 A subsidiary of the Company discounts its liabilities for excess workers' compensation ("EWC") losses and loss expenses using a "risk-free" rate. EWC liabilities are discounted because of the long period of time over which it pays losses. The Company believes that utilizing a "risk-free" rate to discount these reserves more closely reflects the economics associated with the EWC line of business (see Note 14 of notes to consolidated financial statements). Loss reserve porfolio assumed transactions are accounted for in accordance with FAS 113. At December 31, 1998, $62,380,000 of these transactions were reflected as other liabilities. (H) Reinsurance ceded Ceded unearned premiums are reported as prepaid reinsurance premiums and estimated amounts of reinsurance recoverable on unpaid losses are included in due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge the liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The Company has provided reserves for uncollectible reinsurance. (I) Excess of cost over net assets acquired Costs in excess of the net assets of subsidiaries acquired are being amortized on a straight-line basis over 25 to 40 years. The Company continually evaluates the amortization period of its intangible assets. Estimates of useful lives are revised when circumstances or events indicate that the original estimate is no longer appropriate. Amortization (including adjustments) of the excess of cost over net assets acquired was $3,178,000, $2,950,000 and $3,334,000 for 1998, 1997 and 1996, respectively. (J) Federal income taxes The Company files a consolidated Federal income tax return. The Company's method of accounting for income taxes is the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are measured using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse. (K) Stock options The Company accounts for its stock options in accordance with Financial Accounting Standards Board ("FASB") Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123), which provides that stock-based compensation may be disclosed in the footnotes to financial statements. (L) Foreign currency Revenues and expenses in foreign currencies are translated at the weighted average exchange rate during the year. Assets and liabilities are translated at the rate of exchange in effect at the close of the period. Gains or losses (losses of $3,293,000 and $1,711,000 as of December 31, 1998 and 1997, respectively) resulting from translating foreign currency financial statements are reported as a component of common stockholders' equity. Gains or losses (gains of $1,543,000 and $1,408,000 for 1998 and 1997, respectively) resulting from foreign currency transactions (transactions denominated in a currency other than the entity's functional currency) are included in other income in the statement of operations. (M) Real estate, furniture and equipment Real estate, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is calculated using the estimated useful lives of the respective assets. Included in the statement of operations is depreciation expense of $17,114,000, $12,799,000 and $12,234,000 for 1998, 1997 and 1996, respectively. (N) Segment disclosure The Company presents its segment disclosure in accordance with FAS 131 "Disclosures About Segments of an Enterprise and Related Information." FAS 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's operating segments. (O) Other Comprehensive Income As of January 1, 1998, the Company adopted FAS No. 130 "Reporting Comprehensive Income." This statement establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income encompasses all changes in stockholder's equity (except those arising from transactions with shareholders) and includes net income, net unrealized capital gains or losses on available-for-sale securities and foreign currency W. R. BERKLEY CORPORATION AND SUBSIDIARIES 29 57 translation adjustments. As this new standard only requires additional information in the financial statements, it does not affect the Company's financial position. The Company has presented the disclosures required under FAS 130 in its consolidated statements of Comprehensive Income. (P) Recent accounting pronouncements The American Institute of Certified Public Accountants (AICPA) issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance Related Assessments," which will be effective for fiscal periods beginning in 1999. SOP 97-3 provides guidance on accounting and disclosure of insurance-related assessments. The Company does not expect this statement to have a material impact on the Company's financial position or results of operation. In March 1998, the AICPA issued SOP 98-1, effective January 1, 1999, "Accounting for the cost of computer software developed or obtained for internal use." The SOP requires that certain internal and external costs be expensed or capitalized when incurred to develop or obtain software for internal use. The Company does not expect this statement to have a material impact on the Company's financial position or results of operations. In April 1998, the AICPA issued SOP 98-5, effective January 1, 1999, "Reporting on the costs of start-up activities." The SOP requires that costs incurred in start-up activities must be expensed as incurred. As of December 31, 1998, the Company had recorded an immaterial amount of unamortized start-up costs which will be expensed in 1999. In June 1998, the FASB issued SFAS 133, effective January 1, 2000, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments. This statement relates to the presentation of information and would have no impact on the Company's results of operations or financial condition. (2) ACQUISITIONS - -------------------------------------------------------------------------------- During 1998, 1997 and 1996, several international and other acquisitions were completed for an aggregate consideration of approximately $13,389,000, $7,238,000 and $15,955,000, respectively. The acquisitions were accounted for as purchases and, accordingly, the results of operations of the companies have been included from the respective dates of acquisition. Proforma results of operations have been omitted as such effects are not significant. Net assets of the acquired companies for 1998, 1997 and 1996 were as follows: Investments in fixed maturity and equity securities of $1,786,000, $2,192,000 and $6,434,000; cash and invested cash of $10,085,000, $7,823,000 and $4,216,000; excess of cost over net assets acquired of $6,847,000, $2,688,000 and $7,138,000; and other liabilities, net of other assets of $5,329,000, $5,465,000 and $1,833,000. (3) COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES - -------------------------------------------------------------------------------- Neither the Company nor any of its subsidiaries is engaged in any litigation known to the Company which management believes will have a material adverse effect upon the Company's business. As is common with other insurance companies, the Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. (4) LEASE OBLIGATIONS - -------------------------------------------------------------------------------- The Company and several of its subsidiaries use office space and equipment under leases expiring at various dates through September 1, 2004. These leases are considered operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was approximately: $14,095,000, $12,564,000, and $11,098,000 for 1998, 1997 and 1996, respectively. Future minimum lease payments (without provision for sublease income) are $14,134,000 in 1999; $12,401,000 in 2000; $8,980,000 in 2001; $7,101,000 in 2002; $5,434,000 in 2003; and $7,147,000 thereafter. 30 58 (5) DEBT
- ---------------------------------------------------------------------------------------- Long-term debt consists of the following: Description Rate Maturity Face Value Carrying Value - ---------------------------------------------------------------------------------------- Senior Notes 6.31% March 6, 2000 $ 25,000,000 $ 24,970,000 Senior Notes 6.71% March 4, 2003 25,000,000 24,922,000 Notes Payable (a) December 31, 2003 8,000,000 8,000,000 Senior Subordinated Notes 6.50% July 1, 2003 35,793,000 35,793,000 Senior Notes 6.375% April 15, 2005 40,000,000 39,797,000 Senior Notes 6.25% January 15, 2006 100,000,000 99,112,000 Senior Notes 9.875% May 15, 2008 88,800,000 86,203,000 Senior Debentures 8.70% January 1, 2022 76,503,000 75,647,000 - ---------------------------------------------------------------------------------------- $399,096,000 $394,444,000 - ----------------------------------------------------------------------------------------
(a) Libor plus 50 basis points The difference between the face value of long-term debt and the carrying value is unamortized discount. All outstanding long-term debt is not redeemable until maturity and ranks on a parity with all other outstanding indebtedness of the Company. The Company has on file two "shelf" registration statements with the Securities and Exchange Commission with a combined remaining balance of $150 million in additional equity and/or debt securities. The securities may be offered from time to time as determined by funding requirements and market conditions. SHORT-TERM DEBT As of December 31, 1998, the Company had $55.5 million of outstanding short-term debt under its unsecured line-of-credit. During 1998, the average interest rate of the Company's short-term debt was 5.59%. The Company had an additional $19.5 million of short-term debt available under its line-of-credit. (6) COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF A SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE CORPORATION DUE DECEMBER 15, 2045 - -------------------------------------------------------------------------------- The Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures ("Capital Trust Securities") were issued by the W.R. Berkley Capital Trust, ("the Trust"), in 1996. All of the common securities of the Trust are owned by the Company. The sole assets of the Trust are $210,000,000 aggregate principal amount of 8.197% Junior Subordinated Debentures due December 15, 2045, issued by the Company (the "Junior Subordinated Debentures"). The Company's guarantee of payments of cash distributions and payments on liquidation of the Trust and redemption of the Capital Trust Securities, when taken together with the Company's obligations under the Trust Agreement under which the Capital Trust Securities were issued, the Junior Subordinated Debentures and the Indenture under which the Junior Subordinated Debentures were issued, including its obligations to pay costs, expenses, debts and liabilities of the Trust (other than with respect to the Capital Trust Securities), provide a full and unconditional guarantee of the Trust's obligations under the Capital Trust Securities. The Company records the preferential cumulative cash dividends arising from the payments of interest on the Junior Subordinated Debentures as interest expense in its consolidated statement of operations. The Capital Trust Securities are subject to mandatory redemption in a like amount (i) in whole but not in part, on the stated maturity date, upon repayment of the Junior Subordinated Debentures, (ii) in whole but not in part, at any time contemporaneously with the optional prepayment of the Junior Subordinated Debentures by the Company upon the occurrence and continuation of a certain event and (iii) in whole or in part, on or after December 15, 2006, contemporaneously with the optional prepayment by the Company of Junior Subordinated Debentures. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 31 59 (7) REINSURANCE CEDED - -------------------------------------------------------------------------------- The Company follows the customary industry practice of reinsuring a portion of its exposures principally to reduce net liability on individual risks and to protect against catastrophic losses. The following amounts arising under reinsurance ceded contracts have been deducted in arriving at the amounts reflected in the statement of operations:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Premiums written $292,238 $240,754 $210,009 - -------------------------------------------------------------------------------- Premiums earned $286,170 $239,233 $216,127 - -------------------------------------------------------------------------------- Losses and loss expenses $211,389 $129,405 $120,784 - --------------------------------------------------------------------------------
(8) SUPPLEMENTAL FINANCIAL STATEMENT DATA - -------------------------------------------------------------------------------- Other operating costs and expenses consist of the following:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Amortization of deferred policy acquisition costs $394,612 $337,871 $283,642 Other operating costs and expenses of insurance operations 77,596 65,993 50,288 Other costs and expenses 83,947 83,912 75,064 - -------------------------------------------------------------------------------- Total $556,155 $487,776 $408,994 - --------------------------------------------------------------------------------
(9) STOCK OPTION PLAN - -------------------------------------------------------------------------------- The Company has a stock option plan ("the Stock Option Plan") under which 2,625,000 shares of Common Stock were reserved for issuance. In May 1997, the Corporation restated the Stock Option Plan to increase the number of shares of Common Stock authorized for issuance under the Stock Option Plan from 2,625,000 to 7,125,000. Pursuant to the Stock Option Plan, options may be granted at prices determined by the Board of Directors but not less than fair market value on the date of grant. The following table summarizes option information, including options granted under both the 1992 and prior plans:
1998 1997 1996 ----------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price - ------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 3,218,762 $ 29.52 2,491,222 $ 26.03 1,521,339 $ 23.62 Granted 1,036,975 47.08 1,154,354 34.68 1,100,813 29.02 Exercised 106,938 23.57 280,498 20.87 64,216 19.71 Canceled 219,466 30.56 146,316 27.42 66,714 26.65 - ------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 3,929,333 $ 34.25 3,218,762 $ 29.52 2,491,222 $ 26.03 - ------------------------------------------------------------------------------------------------------------------- Options exercisable at year end 640,161 $ 23.72 558,210 $ 22.66 527,832 $ 20.31 - ------------------------------------------------------------------------------------------------------------------- Options available for future grant 3,073,916 3,892,439 401,208 - -------------------------------------------------------------------------------------------------------------------
The fair value of the options granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1998 and 1997, respectively: (a) dividend yield of 1%, (b) expected volatility of 20%, (c) risk free interest rate of 5.79% and 6.70%, and (d) expected life of 7.5 years. The following table summarizes information about stock options outstanding at December 31, 1998 and 1997: 32 60
Options Outstanding Options Exercisable --------------------------------------------------- Weighted Weighted Range of Remaining Weighted Average Exercise Number Contractual Average Number Exercise Prices Outstanding Life Price Exercisable Price - -------------------------------------------------------------------------------------------- December 31, 1998 $14 to $27 731,983 4.4 $23.25 554,759 $22.67 27 to 32 1,034,346 7.1 29.12 84,502 30.35 32 to 48 2,163,004 8.8 40.43 900 47.38 - -------------------------------------------------------------------------------------------- Total 3,929,333 7.6 $34.25 640,161 $23.72 - -------------------------------------------------------------------------------------------- December 31, 1997 $14 to $27 917,795 5.4 $23.42 523,214 $22.14 27 to 32 1,129,363 8.2 29.11 34,996 30.48 32 to 42 1,171,604 9.3 34.68 0 0 - -------------------------------------------------------------------------------------------- Total 3,218,762 7.8 $29.52 558,210 $22.66 - --------------------------------------------------------------------------------------------
Had compensation costs for the Company's 1998 and 1997 grants been determined under the cost recognition alternative of FAS 123, the effect on the Company's net income and net income attributable to common shareholders would have been:
Net Income Basic Earnings per Share Diluted Earnings per Share ---------------------- ------------------------ -------------------------- As Reported Proforma As Reported Proforma As Reported Proforma - ----------------------------------------------------------------------------------------------------------------------- 1998 Before Extraordinary Item $51,212 $48,078 $1.82 $1.71 $1.76 $1.65 Attributable to Common Shareholders $46,195 $43,061 $1.64 $1.53 $1.59 $1.48 - ----------------------------------------------------------------------------------------------------------------------- 1997 Attributable to Common Shareholders $91,219 $88,966 $3.09 $3.02 $3.02 $2.95 - -----------------------------------------------------------------------------------------------------------------------
(10) COMPENSATION PLAN - -------------------------------------------------------------------------------- The Company and its subsidiaries have profit sharing retirement plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary's profitability. Employees become eligible to participate in the Retirement Plans on the first day of the month following the first full three months in which they are employed. Profit sharing expense amounted to $8,524,000, $8,402,000 and $7,370,000 for 1998, 1997 and 1996, respectively. In May 1997, the Common Stockholders approved the Long-Term Incentive Compensation Plan ("LTIP"). The LTIP provides for incentive compensation to key executives, is based on long-term corporate performance, and is based upon criteria established by the Compensation and Stock Option Committee of the Board of Directors (the Committee). Key employees are awarded participation units ("units") as determined by such Committee. The Units vest and become exercisable over a maximum term of five years from the date of their award. The units are payable in cash or up to 50% in shares of Common Stock. In 1997, 266,250 units were awarded which amounted to an expense of $1,705,000. There was no LTIP expense in 1998. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 33 61 (11) INVESTMENTS - -------------------------------------------------------------------------------- At December 31, 1998 and 1997, there were no investments, other than investments in United States government securities, which exceeded 10% of stockholders' equity. At December 31, 1998 and 1997, investments were as follows: (Dollars in thousands)
Gross Gross unrealized unrealized Fair Carrying Type of investment Cost(a) gains losses value value - ----------------------------------------------------------------------------------------------------------------------------- December 31, 1998 Fixed maturity securities held to maturity: State and municipal $ 60,492 $ 6,528 $ (72) $ 66,948 $ 60,492 Corporate 13,353 772 -- 14,125 13,353 Mortgage-backed securities 96,305 6,091 -- 102,396 96,305 - ----------------------------------------------------------------------------------------------------------------------------- Total fixed maturity securities held to maturity 170,150 13,391 (72) 183,469 170,150 - ----------------------------------------------------------------------------------------------------------------------------- Fixed maturity securities available for sale: United States Government(b) 293,761 9,797 (170) 303,388 303,388 State and municipal 1,117,691 53,387 (959) 1,170,119 1,170,119 Corporate 411,234 15,047 (6,106) 420,175 420,175 Mortgage-backed securities 401,558 12,278 (899) 412,937 412,937 - ----------------------------------------------------------------------------------------------------------------------------- Total fixed maturity securities available for sale 2,224,244 90,509 (8,134) 2,306,619 2,306,619 - ----------------------------------------------------------------------------------------------------------------------------- Common stocks 8,150 4,712 (341) 12,521 12,521 Preferred stocks 51,740 1,750 (142) 53,348 53,348 - ----------------------------------------------------------------------------------------------------------------------------- Total equity securities available for sale 59,890 6,462 (483) 65,869 65,869 - ----------------------------------------------------------------------------------------------------------------------------- Trading account 373,164 23,371 (7,225) 389,310 389,310 - ----------------------------------------------------------------------------------------------------------------------------- Invested cash(c) 370,155 -- -- 370,155 370,155 - ----------------------------------------------------------------------------------------------------------------------------- Total investments $3,197,603 $ 133,733 $ (15,914) $3,315,422 $3,302,103 ============================================================================================================================= December 31, 1997 Fixed maturity securities held to maturity: State and municipal $ 78,879 $ 5,735 $ (48) $ 84,566 $ 78,879 Corporate 13,831 476 -- 14,307 13,831 Mortgage-backed securities 89,462 6,584 -- 96,046 89,462 - ----------------------------------------------------------------------------------------------------------------------------- Total fixed maturity securities held to maturity 182,172 12,795 (48) 194,919 182,172 - ----------------------------------------------------------------------------------------------------------------------------- Fixed maturity securities available for sale: United States Government(b) 413,722 10,224 (53) 423,893 423,893 State and municipal 957,329 43,891 (405) 1,000,815 1,000,815 Corporate 450,986 16,521 (601) 466,906 466,906 Mortgage-backed securities 418,864 12,960 (467) 431,357 431,357 - ----------------------------------------------------------------------------------------------------------------------------- Total fixed maturity securities available for sale 2,240,901 83,596 (1,526) 2,322,971 2,322,971 - ----------------------------------------------------------------------------------------------------------------------------- Common stocks 16,512 8,524 (8) 25,028 25,028 Preferred stocks 59,622 1,639 (46) 61,215 61,215 - ----------------------------------------------------------------------------------------------------------------------------- Total equity securities available for sale 76,134 10,163 (54) 86,243 86,243 - ----------------------------------------------------------------------------------------------------------------------------- Trading account 301,136 15,922 (5,089) 311,969 311,969 Invested cash(c) 259,178 -- -- 259,178 259,178 - ----------------------------------------------------------------------------------------------------------------------------- Total investments $3,059,521 $ 122,476 $ (6,717) $3,175,280 $3,162,533 =============================================================================================================================
(a) Adjusted as necessary for amortization of premium or discount. (b) Includes United States government agencies and authorities. (c) Short-term investments which mature within three months of the date of purchase. 34 62 The amortized cost and fair value of fixed maturity securities at December 31, 1998, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations:
(Dollars in thousands) 1998 - --------------------------------------------------------------------------------------------------------- Cost Fair value - --------------------------------------------------------------------------------------------------------- Due in one year or less $ 42,862 $ 43,213 Due after one year through five years 389,555 397,394 Due after five years through ten years 576,917 608,750 Due after ten years 887,197 925,398 Mortgage-backed securities 497,863 515,333 - --------------------------------------------------------------------------------------------------------- Total $2,394,394 $2,490,088 =========================================================================================================
Realized gains (losses) and the change in difference between fair value and cost of investments, before applicable income taxes, are as follows:
(Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Realized gains (losses): Fixed maturity securities(a) $ 23,004 $ (3,308) $ 1,850 Equity securities 3,506 16,537 5,285 Net change in provision for decline in value(b): Fixed maturity securities -- 103 (152) Equity securities -- 581 -- Other (1,110) (727) 454 - --------------------------------------------------------------------------------------------------------- 25,400 13,186 7,437 - --------------------------------------------------------------------------------------------------------- Change in difference between fair value and cost of investments: Fixed maturity securities 877 58,476 (36,232) Equity securities (4,130) (5,356) 6,386 - --------------------------------------------------------------------------------------------------------- (3,253) 53,120 (29,846) - --------------------------------------------------------------------------------------------------------- Total $ 22,147 $ 66,306 $ (22,409) =========================================================================================================
(a) During 1998, 1997 and 1996, gross gains of $26,054,000, $7,988,000 and $5,904,000, respectively, and gross losses of $3,050,000, $11,296,000 and $4,054,000, respectively, were realized. (b) The provision for decline in value of investments is $2,800,000, $2,800,000 and $3,485,000 as of December 31, 1998, 1997 and 1996, respectively. Investment income consists of the following:
(Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Investment income earned on: Fixed maturity securities $ 156,961 $ 159,199 $ 146,431 Invested cash 9,771 10,829 6,698 Equity securities 4,670 5,139 4,039 Trading account(a) 32,997 28,831 12,331 Other 1,666 1,814 1,548 - --------------------------------------------------------------------------------------------------------- Gross investment income 206,065 205,812 171,047 Interest on funds held under reinsurance treaties (3,645) (6,224) (6,557) - --------------------------------------------------------------------------------------------------------- Net investment income $ 202,420 $ 199,588 $ 164,490 =========================================================================================================
(a) The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Merger arbitrage differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes merger arbitrage investments less vulnerable to changes in general financial market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales. The arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. Therefore, just as long portfolio positions may incur losses during market declines, hedge positions may also incur losses during market advances. As of December 31, 1998, the notional amount of long option contracts outstanding is $19,918,000 and short option contracts outstanding is $35,434,000. Investment income earned from net trading account activity includes unrealized trading gains of $1,291,000, $13,737,000, and $2,013,000 for 1998, 1997 and 1996, respectively. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 35 63 (12) STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- COMMON EQUITY The Company has calculated per share data in accordance with FAS 128. Treasury shares have been excluded from average outstanding shares from the date of acquisition. The weighted average number of shares used in the computation of basic earnings per share was 28,194,000, 29,503,000 and 29,792,000 for 1998, 1997 and 1996, respectively. The weighted average number of shares used in the computations of diluted earnings per share was 29,115,000, 30,185,000 and 30,130,000 for 1998, 1997 and 1996, respectively. The difference in calculating basic and diluted earnings per share is attributable entirely to the dilutive effect of stock-based compensation plans. Changes in shares of Common Stock outstanding, net of treasury shares, are as follows:
(in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Balance, beginning of year 29,568 29,454 30,252 Shares issued 108 114 65 Shares repurchased (3,172) -- (863) - -------------------------------------------------------------------------------- Balance, end of year 26,504 29,568 29,454 ================================================================================
PREFERRED EQUITY As of December 31, 1996, 930,807 shares of 7 3/8% Series A Cumulative Redeemable Preferred Stock were issued and outstanding. During January 1997, the Company purchased 183,080 shares of Series A Preferred Stock for an aggregate cost of $28,506,000. In the second and third quarters of 1997, 93,775 shares of the Series A Preferred Stock were purchased by subsidiaries of the Company. On January 25, 1999, all remaining outstanding shares of the Series A Preferred Stock were retired for $150 per share. (13) FEDERAL INCOME TAXES - -------------------------------------------------------------------------------- Federal income tax expense (before the extraordinary item) consists of:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Current expense $ 30,283 $ 21,999 $ 26,096 Deferred expense (benefit) (24,818) 8,669 (994) - -------------------------------------------------------------------------------- Total expense $ 5,465 $ 30,668 $ 25,102 - --------------------------------------------------------------------------------
A reconciliation of Federal income tax expense and the amounts computed by applying the Federal income tax rate of 35% to pre-tax income is as follows:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Computed "expected" tax expense $ 21,973 $ 45,234 $ 40,267 Tax-exempt investment income (18,412) (15,432) (15,471) Other, net 1,904 866 306 - -------------------------------------------------------------------------------- Total expense $ 5,465 $ 30,668 $ 25,102 ================================================================================
At December 31, 1998 and 1997, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
(Dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- DEFERRED TAX ASSET Loss reserve discounting $ 62,288 $ 49,638 Other 11,389 3,912 - -------------------------------------------------------------------------------- Gross deferred tax asset 73,677 53,550 Less: valuation allowance (7,000) (7,000) - -------------------------------------------------------------------------------- Deferred tax asset 66,677 46,550 ================================================================================ DEFERRED TAX LIABILITY Amortization of intangibles 11,460 12,025 Expense recognition differences 19,872 17,044 Realized investment gains 2,960 6,163 Deferred taxes on unrealized investment gains 31,070 32,261 Depreciation 5,900 5,437 Other 2,292 6,507 - -------------------------------------------------------------------------------- Deferred tax liability 73,554 79,437 - -------------------------------------------------------------------------------- Net deferred tax liability $ 6,877 $ 32,887 ================================================================================
Federal income tax expense applicable to realized investment gains was $8,890,000, $4,615,000 and $2,603,000 in 1998, 1997 and 1996, respectively. The Company had a current income tax receivable of $10,532,000 and $5,869,000 at December 31, 1998 and 1997, respectively. The Company's tax returns through December 31, 1994 have been examined by the Internal Revenue Service. The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this net asset. 36 64 (14) RESERVES FOR LOSSES AND LOSS EXPENSES - -------------------------------------------------------------------------------- The table below provides a reconciliation of the beginning and ending reserve balances, on a gross of reinsurance basis:
(Dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Net reserves at beginning of year $ 1,433,011 $ 1,333,122 $ 1,209,250 - ---------------------------------------------------------------------------------------------------------- Net reserves of companies acquired 2,189 4,984 -- Net provision for losses and loss expenses: Claims occurring during the current year 948,580 747,977 675,674 Decrease in estimates for claims occurring in prior years (42,929) (21,313) (15,219) Amortization of discount 9,111 7,760 8,705 - ---------------------------------------------------------------------------------------------------------- 914,762 734,424 669,160 - ---------------------------------------------------------------------------------------------------------- Net payments for claims Current year 395,437 315,370 280,565 Prior years 365,178 324,149 264,723 - ---------------------------------------------------------------------------------------------------------- 760,615 639,519 545,288 - ---------------------------------------------------------------------------------------------------------- Net reserves at end of year 1,589,347 1,433,011 1,333,122 Ceded reserves at the end of year 537,219 476,677 449,581 - ---------------------------------------------------------------------------------------------------------- Gross reserves at the end of year $ 2,126,566 $ 1,909,688 $ 1,782,703 ==========================================================================================================
Due to the nature of Excess Workers Compensation ("EWC") business and the long period of time over which losses are paid in this line of business, the Company discounts the liability for losses and loss expenses established for the EWC line of business. Discounting liabilities for losses and loss expenses gives recognition to the time value of money. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company's loss payout experience and is supplemented with data compiled from insurance companies writing workers' compensation on an excess-of-loss basis. The expected payout pattern has a very long duration because it reflects the nature of losses generally which penetrate self-insured retention limits contained in EWC policies. The Company has limited the estimated payout duration to 30 years in order to introduce an additional level of conservatism into the discounting process. The liabilities for losses and loss expenses have been discounted using "risk-free" discount rates determined by reference to the U.S. Treasury yield curve weighted for the EWC premium volume to reflect the seasonality of the anticipated duration of losses associated with such coverages. The weighted average discount rate for accident years 1998, 1997, 1996 and 1995 and prior is 5.90%, 5.98%, 5.90% and 5.80%, respectively. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $186,964,000, $189,600,000, and $172,415,000 at December 31, 1998, 1997 and 1996, respectively. For statutory purposes, the Company uses a discount rate of 3.0% as permitted by the Department of Insurance of the State of Ohio. To date, known pollution and environmental claims at the insurance company subsidiaries have not had a material impact on the Company's operations. Environmental claims have not materially impacted the Company because its subsidiaries generally did not insure larger industrial companies which are subject to significant environmental exposures. The Company's net reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $33.4 million and $33.1 million at December 31, 1998 and 1997, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $69.3 million and $68.4 million at December 31, 1998 and 1997, respectively. Net incurred losses and loss expenses for reported pollution and environmental claims were approximately $2.2 million, $.1 million and $6.9 million in 1998, 1997 and 1996, respectively. Net paid losses and loss expenses have averaged approximately $3 million for each of the last three years. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 37 65 (15) INDUSTRY SEGMENTS - -------------------------------------------------------------------------------- The Company's operations are presently conducted through five basic segments: regional property casualty insurance; reinsurance; specialty lines of insurance; alternative markets operations; and international. The regional property casualty insurance segment writes standard commercial and personal lines insurance for such risks as automobiles, homes and business. The Company's reinsurance segment specializes in underwriting property, casualty and surety reinsurance on both a treaty and facultative basis. The specialty lines of insurance consist primarily of excess and surplus lines, commercial transportation, professional liability, directors and officers liability and surety. The company's alternative markets segment specializes in insuring, reinsuring, and administering self-insurance programs and other alternative risk transfer mechanisms for public entities, private employers and associations. Finally, the international operations represent the Company's joint venture with Northwestern Mutual Life International, (65% owned by the Company), which writes property and casualty, as well as life insurance, internationally. For the years ended December 31, 1998 and 1997, the joint venture wrote life premiums of $8.0 million and $.6 million, respectively. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Income tax expense (benefits) were calculated in accordance with the Company's tax sharing agreements, which provide for the recognition of tax loss carryforwards only to the extent of taxes previously paid. summary financial information about the Company's operating segments is presented in the following table. Income before income taxes by segment consists of revenues less expenses related to the respective segment's operations. These amounts include realized gains (losses) where applicable. Intersegment revenues consist primarily of dividends, interest on intercompany debt and fees paid by subsidiaries for portfolio management and other services to the Company. Identifiable assets by segment are those assets used in the operation of each segment.
Income Revenues (Loss) ------------------------------------------------------------ before Income Tax Investment Unaffiliated Inter- income Expense (Dollars in thousands) Income Customers Segment Total taxes (Benefits) - ---------------------------------------------------------------------------------------------------------------------------------- December 31, 1998: Regional $ 53,942 $ 680,505 $ 2,014 $ 682,519 $ (24,524) $ 3,323 Reinsurance 47,643 296,100 1,044 297,144 33,858 6,911 Specialty 59,345 309,047 2,908 311,955 85,889 24,349 Alternative Markets 34,667 205,024 911 205,935 36,501 9,505 International 5,469 80,287 -- 80,287 (7,017) 349 Corporate and other 7,927 11,554 81,983 93,537 9,288 5,465 Adjustments and eliminations (6,573) -- (88,860) (88,860) (71,214) (44,437) - ---------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 202,420 $ 1,582,517 -- $ 1,582,517 $ 62,781 $ 5,465 - ---------------------------------------------------------------------------------------------------------------------------------- December 31, 1997: Regional $ 51,920 $ 634,468 $ 674 $ 635,142 $ 47,624 $ 14,833 Reinsurance 45,520 241,204 882 242,086 42,193 10,641 Specialty 60,162 281,630 2,691 284,321 68,088 18,529 Alternative Markets 34,390 183,904 829 184,733 34,733 10,257 International 3,623 45,360 -- 45,360 (3,566) (181) Corporate and other 10,565 13,744 48,351 62,095 (19,815) 30,849 Adjustments and eliminations (6,592) -- (53,427) (53,427) (40,016) (54,260) - ---------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 199,588 $ 1,400,310 -- $ 1,400,310 $ 129,241 $ 30,668 - ---------------------------------------------------------------------------------------------------------------------------------- December 31, 1996: Regional $ 43,125 $ 528,369 $ 1,110 $ 529,479 $ 35,169 $ 9,960 Reinsurance 37,542 243,848 218 244,066 32,756 7,798 Specialty 50,130 245,545 1,586 247,131 52,113 13,551 Alternative Markets 29,122 171,809 218 172,027 32,278 11,427 International 1,426 26,435 -- 26,435 (1,283) -- Corporate and other 6,922 9,160 78,179 87,339 25,311 25,102 Adjustments and eliminations (3,777) -- (81,311) (81,311) (61,295) (42,736) - ---------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 164,490 $ 1,225,166 $ -- $ 1,225,166 $ 115,049 $ 25,102 - ----------------------------------------------------------------------------------------------------------------------------------
38 66 Interest expense for the reinsurance segment was $2,327,000, $2,327,000 and $2,602,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Additionally, corporate interest expense (net of intercompany amounts) was $46,492,000, $46,542,000 and $29,361,000 for the corresponding periods. Identifiable assets by segment are as follows:
December 31, 1998 1997 1996 - -------------------------------------------------------------------------------- Regional $ 1,370,849 $ 1,264,962 $ 1,099,602 Reinsurance 996,186 863,784 737,160 Specialty 1,502,366 1,403,068 1,229,968 Alternative Markets 863,578 749,724 660,283 International 151,832 119,792 60,452 Corporate and other 1,545,744 1,602,907 1,599,177 Elimination (1,447,124) (1,459,919) (1,249,669) - -------------------------------------------------------------------------------- Consolidated $ 4,983,431 $ 4,544,318 $ 4,136,973 ================================================================================
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS - -------------------------------------------------------------------------------- The following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1998 and 1997:
(Dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Carrying Carrying Amount Fair value Amount Fair value - -------------------------------------------------------------------------------- Investments $3,302,103 $3,315,422 $3,162,533 $3,175,280 Long-term debt 394,444 435,702 390,415 434,035 Capital Trust Securities 207,988 206,464 207,944 213,217 - --------------------------------------------------------------------------------
The estimated fair value of investments is based on quoted market prices as of the respective reporting dates. The fair value of the long-term debt is based on rates available for borrowings similar to the Company's outstanding debt as of the respective reporting dates. (17) DIVIDENDS FROM SUBSIDIARIES AND STATUTORY FINANCIAL INFORMATION - -------------------------------------------------------------------------------- The Company's insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 1999, the maximum amount of dividends which can be paid without such approval is approximately $117,174,000. Combined net income and policyholders' surplus of the Company's consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Net income $ 67,014 $121,300 $ 84,249 - -------------------------------------------------------------------------------- Policyholders' surplus $941,853 $971,749 $881,380 - --------------------------------------------------------------------------------
The significant variances between statutory accounting practices and GAAP are: For statutory purposes, bonds are carried at amortized cost, acquisition costs are charged to operations as incurred, deferred federal income taxes are not provided for temporary differences between book and tax assets and liabilities, EWC reserves are discounted at a 3.0% rate, and certain assets designated as "non-admitted assets" are charged against surplus. At December 31, 1998 and 1997, bonds with a fair value of $185,206,000 and $160,369,000 were on deposit with various state insurance departments as required by state laws. The National Association of Insurance Commissioners ("NAIC") has risk-based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. RBC did not affect the operations of the Company's insurance subsidiaries since all of its subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC. W. R. BERKLEY CORPORATION AND SUBSIDIARIES 39 67 (18) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) - -------------------------------------------------------------------------------- The following is a summary of quarterly financial data: (Dollars in thousands except per share data)
Three months ended ------------------------------------------------------------------------------------------------- March 31, June 30, September 30, December 31, 1998 1997 1998 1997 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Revenues $ 383,275 $ 329,822 $ 396,910 $ 335,926 $ 394,425 $ 355,650 $ 407,907 $ 378,912 - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) before preferred dividends $ 25,673 $ 28,544 $ 22,743 $ 20,633 $ 12,261 $ 25,573 $ (1,917) $ 24,297 - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) before extraordinary loss $ 23,786 $ 26,427 $ 20,856 $ 18,625 $ 10,374 $ 23,721 $ (3,804) $ 22,446 - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) attributable to common stockholders $ 21,351 $ 26,427 $ 18,274 $ 18,625 $ 10,374 $ 23,721 $ (3,804) $ 22,446 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings per share: Basic Before extraordinary (loss) $ .81 $ .90 $ .73 $ .63 $ .37 $ .80 $ (.14) .76 Net Income (loss) $ .73 $ .90 $ .64 $ .63 $ .37 $ .80 $ (.14) .76 Diluted Before extraordinary (loss $ .78 $ .88 $ .70 $ .62 $ .36 $ .78 $ (.14) .74 Net Income (loss) $ .71 $ .88 $ .61 $ .62 $ .36 $ .78 $ (.14) .74 - ------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT - -------------------------------------------------------------------------------- Board of Directors and Stockholders W.R. Berkley Corporation We have audited the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of W. R. Berkley Corporation and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. New York, New York KPMG LLP February 25, 1999 40 EX-3.2 2 EX-3.2 1 Exhibit 3.2 CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF W.R. BERKLEY CORPORATION The undersigned, being the Chairman of W.R. BERKLEY CORPORATION, a corporation existing under the laws of the State of Delaware, hereby certifies that: 1. The first paragraph of Article Fourth of the Restated Certificate of Incorporation of said corporation be and it hereby is amended to read as follows: FOURTH: The aggregate number of shares of capital stock of all classes which the Corporation shall have authority to issue is eighty-five million (85,000,000) shares, of which eighty million (80,000,000) shares are to be Common Stock of the par value of twenty cents ($.20) each, and five million (5,000,000) shares are to be Preferred Stock of the par value of ten cents ($.10) each. 2. The amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, I have signed this certificate this 12 day of May, 1998. /s/ William R. Berkley William R. Berkley, Chairman Attest: /s/ Ira S. Lederman - --------------------------------- Ira S. Lederman, Assistant Secretary EX-10.2 3 EX-10.2 1 Exhibit 10.2 FIRST AMENDED AND RESTATED W. R. BERKLEY CORPORATION 1992 STOCK OPTION PLAN * * * * * * ARTICLE I. PURPOSE This First Amended and Restated W. R. Berkley Corporation 1992 Stock Option Plan (the "Plan") is intended as an incentive and to encourage stock ownership by certain employees of W. R. Berkley Corporation (the "Company") and of its subsidiaries and affiliates in order to increase their proprietary interest in the Company's success. The Plan is the first amendment and restatement of the Company's 1992 Stock Option Plan, and the provisions of the Plan, as so amended and restated, shall apply to all currently outstanding options under the Plan, as well as options granted prospectively under the Plan. The word "Company" when used in the Plan with reference to employment shall include subsidiaries of the Company. The word "subsidiary" when used in the Plan shall mean any subsidiary of the Company within the meaning of Section 424(f) of the Internal Revenue Code of 1986, as amended ("Code"). The word "affiliate" when used in the Plan shall mean any entity in which the Company has a direct or indirect controlling interest. 2 ARTICLE II. ADMINISTRATION The Plan shall be administered by a committee (the "Committee") appointed by the Board of Directors of the Company (the "Board") from among its members, which shall consist of not less than two members thereof, provided that the full Board may, in its discretion, from time to time exercise the power and authority of the Committee under the Plan. Subject to the provisions of the Plan, the Committee shall have authority, in its discretion: (a) to determine which of the eligible employees of the Company and its subsidiaries and affiliates shall be granted options; (b) to authorize the granting of options and designate whether such options shall be "incentive stock options" under Section 422 of the Code or "non-statutory stock options"; (c) to determine the times when options shall be granted and the number of shares subject to such options; (d) to determine the option price of the shares subject to each option, which price shall be not less than the minimum specified in ARTICLE VI; (e) to determine the time or times when each option becomes exercisable, and the duration of the exercise period; (f) to accelerate the vesting and/or exercisability of any outstanding options; (g) to prescribe the form or forms of the option agreements under the Plan (which forms shall be consistent with the Plan but need not be identical); (h) to adopt, amend, and rescind such rules and regulations as, in its opinion, may be advisable in the administration of the Plan; and (i) to construe and interpret the Plan, the rules and regulations -2- 3 and the option agreements under the Plan and to make all other determinations deemed necessary or advisable for the administration of the Plan. All decisions, determinations and interpretations of the Committee shall be final and binding on all Optionees. ARTICLE III. STOCK The stock to be optioned under the Plan shall be shares of authorized but unissued Common Stock of the Company, par value $.20 per share, or previously issued shares of Common Stock reacquired by the Company (the "Stock"). The total number of shares of Stock which may be purchased pursuant to options granted under the Plan shall not exceed, in the aggregate, 4,750,000 shares, except as such number of shares shall be adjusted in accordance with the provisions of ARTICLE X hereof. The maximum number of shares of Stock with respect to which options may be granted under the Plan to any single optionee during any calendar year shall not exceed 1,000,000 shares, except as such number shall be adjusted in accordance with the provisions of ARTICLE X hereof. In the event that any outstanding option under the Plan for any reason expires or is terminated prior to the end of the period during which options may be granted, the shares of Stock subject to the unexercised portion of such option may again be subject to options granted under the Plan. -3- 4 ARTICLE IV. ELIGIBILITY OF PARTICIPANTS; LIMITATION ON GRANTS OF OPTIONS (a) Officers and key employees of the Company or any of its subsidiaries (including directors who are also employees of the foregoing) are eligible for grants of incentive stock options which meet the requirements of Section 422 of the Code. (b) Officers, key employees and directors (including directors who are not employees) of the Company or any of its subsidiaries or affiliates are eligible for grants of non-statutory stock options. For purposes of the Plan, a "non-statutory stock option" means an option which, at the time of grant, is not designated as an "incentive stock option" within the meaning of Section 422 of the Code. (c) With respect to incentive stock options, if the aggregate fair market value (determined as of the time the option is granted) of the Stock with respect to which any incentive stock option becomes exercisable for the first time by an optionee in any calendar year (under the Plan or any other stock option plan of the Company or any parent or subsidiary thereof) exceeds $100,000, such options shall be treated as non-statutory stock options to the extent of such excess. -4- 5 ARTICLE V. OPTIONS Options granted pursuant to the Plan shall be evidenced by agreements in such form as the Committee shall from time to time approve, which agreements need not contain uniform terms and conditions but shall comply with and be subject to all the terms and conditions of the Plan and the applicable provisions of the Code. More than one option may be granted to any optionee. ARTICLE VI. OPTION PRICE In the case of each option granted under the Plan, the option price shall be not less than the fair market value of the Stock on the date of grant of such option, such fair market value to be determined by the Committee in its discretion; provided, however that in the case of an incentive stock option granted to an individual who owns, at the time the option is granted, stock possessing more than ten percent of the total combined voting power of all classes of stock of the Company or any parent or subsidiary thereof (a "Ten Percent Shareholder"), the option price shall not be less than 110% of such fair market value. In no event, however, shall the option price be less than an amount equal to the par value of the Stock. -5- 6 ARTICLE VII. EXERCISE AND TERM OF OPTIONS The option agreement may specify periods of time during which options may not be exercised in whole or in part. Except as may be so specified, any option may be exercised in whole at any time or in part from time to time during the applicable option period. The Committee, in its discretion, may accelerate the vesting and/or exercisability of any outstanding option. Unless otherwise determined by the Committee at the time of grant, the vesting and exercisability of an optionee's outstanding options shall accelerate upon a termination of employment by reason of the optionee's death or disability. The Committee shall have the authority to define the term "disability" for this purpose and/or to determine whether an optionee's employment has terminated by reason of disability. Any other provision of the Plan to the contrary notwithstanding, no option may be exercised after the date ten years from the date of grant of such option or, in the case of an incentive stock option granted to a Ten Percent Shareholder, five years from the date of grant of such option. The Committee, in its discretion, may, with the consent of any optionee, cancel any outstanding option. -6- 7 ARTICLE VIII. PAYMENT FOR SHARES Except as provided in the next succeeding paragraph, payment for shares of Stock purchased upon exercise of an option granted hereunder shall be made in full (i) in cash or cash equivalents, (ii) in shares of Stock which have been held by the optionee for at least six months prior to the date of such exercise, or (iii) in any combination of these two methods. In addition, the Committee may, in its discretion, allow for the exercise of options in accordance with broker-loan procedures adopted by the Committee from time to time. If the Committee shall so determine and at the election of the optionee, payment for shares of Stock purchased upon exercise of an option granted hereunder shall be made in installments, as shall be provided in the applicable option agreement. If payment is made in installments, the optionee shall deliver to the Company his promissory note payable to the Company for an amount equal to the difference between the full purchase price of the shares then being purchased and the amount of any down payment. The optionee shall pay the balance of the purchase price, together with interest thereon (if the Committee shall provide in the applicable option agreement for the payment of interest thereon) as provided by the Committee in the applicable option agreement; provided, however, that in any event the entire amount of the purchase price shall be due and payable by the end of five years from the date of purchase. Dividends on partly paid shares issued to such optionee (other than dividends -7- 8 in Stock) shall be declared and paid only upon the basis of the percentage of the purchase price actually received thereon by the Company, and, if so provided in the option agreement, any such dividends paid prior to final payment for the shares shall be applied by the Company against installments of the purchase price in the order of their maturity. The optionee shall not have the right to exercise any voting rights with respect to the shares until such time as the purchase price therefor is fully paid. Certificates for partly paid shares shall, immediately upon issue, be delivered to the Company, endorsed in blank by the optionee or accompanied by a separate stock power so endorsed, in pledge as security for the payment of the unpaid balance of the purchase price. The certificates issued to represent partly paid shares shall state thereon the total amount of the consideration to be paid therefor and the amount paid thereon. At the time of exercise of any option, the Committee shall require the optionee to pay to the Company an amount sufficient to pay all federal, state and local withholding taxes applicable, in the Committee's judgment, to the exercise of such option, and the optionee's right to exercise shall be contingent upon such payment. Such payment to the Company may be effected through (a) payment by the optionee to the Company of the aggregate withholding taxes in cash or cash equivalents; (b) at the discretion of the Committee, the Company's withholding from the number of shares of Stock that would otherwise be delivered to the optionee upon exercise of the option, a number of shares of Stock with an aggregate fair market value on the date of -8- 9 exercise (as determined by the Committee) equal to the aggregate amount of withholding taxes; or (c) at the discretion of the Committee, any combination of these two methods. ARTICLE IX. NON-TRANSFERABILITY OF OPTION RIGHTS (a) Except as provided in paragraph (b) below, an option granted under the Plan may not be transferred except by will or the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by the optionee. (b) Notwithstanding paragraph (a) above, at the discretion of the Committee, an option, other than an incentive stock option, may be transferred by the optionee to one or more members of the optionee's immediate family, or to a trust or a partnership established for the benefit of one or more members of the optionee's immediate family. For the purposes of this paragraph (b), "immediate family" means an optionee's spouse, children and grandchildren, whether natural or adopted. ARTICLE X. ADJUSTMENT FOR RECAPITALIZATION, MERGER, ETC. The aggregate number of shares of Stock which may be purchased pursuant to options granted hereunder, the maximum number of shares of Stock with respect to which options may be granted to any single optionee during any calendar year, the number of shares of Stock covered by each outstanding option and the price per share thereof shall be appropriately adjusted for any increase or decrease in the number of outstanding shares of -9- 10 Stock resulting from a stock split or other subdivision or consolidation of shares of Stock, or for other capital adjustments or payments of stock dividends or distributions or other increases or decreases in the outstanding shares of Stock effected without receipt of consideration by the Company. If the Company shall be sold, reorganized, consolidated, or merged with another corporation, or if all or substantially all of the assets of the Company shall be sold or exchanged (a "Corporate Event"), (i) each optionee shall, at the time of such Corporate Event, be entitled to receive upon the exercise of his option the same number and kind of shares of common stock or the same amount of property, cash or other securities as he would have been entitled to receive upon the occurrence of such Corporate Event as if he had been, immediately prior to such event, the holder of the number of shares of Stock covered by his option, and (ii) if the Company is not the surviving corporation in such Corporate Event, the Company shall require the successor corporation or parent thereof to assume such outstanding options; provided, however, that the Committee may, in its discretion and in lieu of requiring such assumption, provide that all outstanding options shall terminate as of the consummation of such Corporate Event, and accelerate the exercisability of all outstanding options to any date prior to the date of such Corporate Event. The foregoing adjustments and the manner of application of the foregoing provisions shall be determined by the Committee -10- 11 in its sole discretion. Any such adjustment may provide for the elimination of any fractional share which might otherwise become subject to an option. ARTICLE XI. CHANGE OF CONTROL In the event of a Change of Control, each outstanding option under the Plan (including options granted prior to this first amendment and restatement) shall vest and become immediately exercisable in full as of the date immediately preceding the date of such Change of Control, or such other date, not later than the date of such Change of Control, as shall be established by the Committee in its discretion. For purposes of the Plan, a "Change of Control" shall mean: (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of Stock (the "Outstanding Company Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, -11- 12 (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company, (iv) any acquisition by William R. Berkley or any entity directly or indirectly controlled by William R. Berkley, (v) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii), and (iii) of subsection (c) of this ARTICLE XI or (vi) any acquisition that is approved in advance by the Board at a time when the Incumbent Board (as hereinafter defined) constitutes at least a majority of the Board (an "Approved Acquisition"); or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation of a Corporate Event, unless, following such Corporate Event, (i) all or substantially all of -12- 13 the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Stock and Outstanding Company Voting Securities immediately prior to such Corporate Event beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Corporate Event (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Corporate Event, of the Outstanding Company Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person other than (1) William R. Berkley or any entity directly or indirectly controlled by William R. Berkley, (2) any corporation resulting from such Corporate Event, or (3) any employee benefit plan (or related trust) of the Company or such corporation resulting from such Corporate Event, beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Corporate Event or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Corporate Event, or was acquired pursuant to an Approved Acquisition and (iii) at least a majority of the members of the board of directors of the -13- 14 corporation resulting from such Corporate Event were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Corporate Event; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. ARTICLE XII. NO OBLIGATION TO EXERCISE OPTION Granting of an option shall impose no obligation on the recipient to exercise such option. ARTICLE XIII. USE OF PROCEEDS The proceeds received from the sale of Stock pursuant to the Plan shall be used for general corporate purposes. ARTICLE XIV. RIGHTS AS A STOCKHOLDER An optionee or a transferee of an option shall have no rights as a stockholder with respect to any shares covered by his option until he shall have become the holder of record of such shares, and he shall not be entitled to any dividends or distributions or other rights in respect of such shares for which the record date is prior to the date on which he shall have become the holder of record thereof. -14- 15 ARTICLE XV. COMPLIANCE WITH THE LAW The Company shall have no liability for failure to (or delay in) issue or transfer any shares of Stock subject to options under the Plan resulting from its inability to obtain (or any delay in obtaining) all requisite regulatory authority, if counsel for the Company deems such authority necessary for lawful issuance or transfer of any such shares. Appropriate legends may be placed on the Stock certificates evidencing shares issued upon exercise of options to reflect such transfer restrictions. ARTICLE XVI. GRANT LIMITATION FOR INCENTIVE STOCK OPTIONS No incentive stock option shall be granted hereunder after the date which is ten years from the earlier of (i) the date the Plan, as amended and restated, is adopted by the Board, and (ii) the date the Plan, as amended and restated, is approved by the Company's stockholders. ARTICLE XVII. AMENDMENT OR DISCONTINUANCE OF PLAN The Board may, without the consent of the optionees, at any time terminate the Plan entirely and at any time or from time to time amend or modify the Plan, provided that no such action shall adversely affect any option theretofore granted hereunder without the consent of the applicable optionee, and provided further that no such action by the Board, without approval of the stockholders, may (a) increase the total number of shares of -15- 16 Stock which may be purchased pursuant to options granted under the Plan, except as contemplated in ARTICLE X; or (b) change the class of employees eligible to receive incentive stock options under the Plan. * * * As amended as of May 14, 1997 -16- EX-27 4 EX-27
7 1,000 U.S. DOLLAR YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1 2,306,619 170,150 183,469 455,179 0 0 2,931,948 386,278 0 168,894 4,983,431 2,126,566 664,861 0 0 657,932 0 65 7,281 853,935 4,983,431 1,278,399 202,420 25,400 5,571 914,762 0 0 62,781 5,465 51,212 0 (5,017) 0 46,195 1.64 1.59 1,433,011 948,580 (42,929) 395,437 365,178 1,589,347 (42,929)
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