-----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, J0OWTouVJJWK38/tLMfw/qdCux/NLfqOc7Dh+UnbW2Xul7kldPNbNXVEgfUIFqk5 iw7oCqK0W4msn2nKbEvndg== 0000950134-98-002639.txt : 19980331 0000950134-98-002639.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950134-98-002639 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: GAINSCO INC CENTRAL INDEX KEY: 0000786344 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 751617013 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-09828 FILM NUMBER: 98578333 BUSINESS ADDRESS: STREET 1: 500 COMMERCE ST CITY: FORT WORTH STATE: TX ZIP: 76102 BUSINESS PHONE: 8173362500 MAIL ADDRESS: STREET 2: P O BOX 2933 CITY: FORTH WORTH STATE: TX ZIP: 76113-2933 10-K405 1 FORM 10-K FOR YEAR ENDED DECEMBER 31, 1997 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15 (d) of The Securities Exchange Act of 1934 For the fiscal year ended Commission file number 1-9828 December 31, 1997 GAINSCO, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1617013 (State of Incorporation) (I.R.S. Employer Identification No.) 500 Commerce Street Fort Worth, Texas 76102 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (817) 336-2500 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock ($.10 par value) The New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No --- --- The aggregate market value of the voting stock held by non-affiliates of the registrant (17,757,596 shares) as of the close of the business on February 28, 1998 was $145,390,317 (based on the closing sale price of $8.1875 per share). As of February 28, 1998, there were 20,857,024 shares of the registrant's $.10 Par Value Common Stock outstanding. 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. [X] Documents incorporated by reference:
Document Form 10-K Part -------- -------------- Proxy Statement for the 1998 Annual Meeting to be held May 18, 1998 III Exhibits to Form 10-K Annual Reports filed with the SEC for fiscal years ended December 31, 1988, 1990, 1991, 1992, 1993, 1994, 1995 and 1996 IV Exhibits to Form S-1's filed with the SEC and effective November 6, 1986 (No. 33-7846) and November 14, 1988 (No. 33-25226) IV
2 PART I ITEM 1. BUSINESS GENERAL DESCRIPTION GAINSCO, INC. is a holding company, the only operations of which are to provide administrative and financial services for its wholly-owned subsidiaries. The term "Company" as used in this document includes GAINSCO, INC. and its subsidiaries, unless the context otherwise requires. The Company was incorporated in Texas on October 11, 1978. It completed its initial public offering on November 14, 1986. The Company is a property and casualty insurance company concentrating its efforts on certain specialty excess and surplus markets within the commercial auto, auto garage and general liability insurance lines. The Company's insurance operations are conducted through three insurance companies, General Agents Insurance Company of America, Inc., an Oklahoma corporation, MGA Insurance Company, Inc., a Texas corporation, and GAINSCO County Mutual Insurance Company, a Texas chartered company. The Company is approved to write insurance in 49 states and the District of Columbia on a non-admitted basis and in 45 states on an admitted basis. The Company markets its lines of insurance through 186 non-affiliated general agents' offices. Approximately 71% of the Company's gross premiums written during 1997 resulted from risks located in California, Florida, Kentucky, Louisiana, Pennsylvania, Tennessee and Texas. Excess and surplus lines of insurance are generally written on classes of risks which admitted insurers will not write; many of which are too small in premium size for larger companies to handle efficiently. For a description of the product lines presently written by the Company, see "Business-Product Lines." Because of the lack of availability of coverage from admitted insurers, premium levels for excess and surplus policies are generally higher than for standard coverages provided by admitted insurers. State insurance authorities permit excess and surplus lines companies greater rate and policy form flexibility than admitted companies. The Company, therefore, sets its policy premiums by applying its own judgment after consideration of the risks involved. Part of its analysis includes the review of historical premium rate and loss cost information as compiled and reported by independent rating bureaus. The Company's current premiums typically range from 160% to 275% of the loss costs published by the rating organizations. These loss cost multipliers approximate a range of 100% to 170% of manual rates. The strategy of the Company is to identify various types of risks where it can price its coverages favorably and maximize the potential for underwriting profit. This strategy has resulted in changes in product mix and product design from time to time. 2 3 The Company, through a wholly-owned subsidiary, has developed and is marketing a computer software package related to general agency operations. Through another wholly-owned subsidiary, the Company is engaged in the premium finance business. Through MGA Insurance Company, Inc., a wholly-owned subsidiary, the Company earns fee revenues by acting as a servicing carrier for the Commercial Automobile Insurance Procedures of Arkansas, California, Louisiana, and Mississippi and the Commercial Assignment Procedure of Pennsylvania. Through GAINSCO County Mutual Insurance Company, the Company has fronting agreements with two non-affiliated insurance companies. The business written under these agreements is ceded 100% to reinsurers rated "A- (Excellent)" or better by A. M. Best Company (Best's) and 100% of the liabilities are fully collateralized with pledged investment grade securities or letters of credit. PRODUCT LINES The Company's principal products serve certain specialty markets within the commercial auto, auto garage and general liability insurance lines. The following table sets forth, for each product line, gross premiums written (before ceding any amounts to reinsurers), percentage of gross premiums written for the periods indicated and the number of policies in force at the end of each period.
Years ended December 31 --------------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------------- Gross Premiums Written: (Dollar amounts in thousands) Commercial Auto $56,704 57% 62,328 57% 62,517 58% Auto Garage 23,279 23% 26,871 24% 25,270 23% General Liability 17,829 18% 19,744 18% 19,052 18% Other Lines 1,964 2% 1,057 1% 1,233 1% ------- ------- ------- ------- ------- ------- Total $99,776 100% 110,000 100% 108,072 100% ======= ======= ======= ======= ======= ======= Policies in Force (End of Period) 35,962 35,903 34,309
Commercial Auto The commercial auto coverage underwritten by the Company includes risks associated with local haulers of specialized freight (e.g. sand and gravel), tradespersons' vehicles and trucking companies (other than long haulers). Policies are written only for vehicles primarily operated within the state of garaging and one state beyond or 1,000 miles, whichever is the greater distance. Liability and physical damage coverages for these risks are currently limited to $1,000,000 per accident and $100,000 per unit, respectively. Auto Garage The Company's auto garage program includes garage liability, garage keepers' legal liability and dealers' open lot coverages. The maximum limit on these coverages is $1,000,000. The Company targets its coverage to used car dealers, recreational vehicle dealers, automobile repair shops and wrecker/towing risks. 3 4 General Liability The Company underwrites general liability insurance with liability limits up to $1,000,000 for small businesses such as car washes, janitorial services, small contractors, apartment buildings, rental dwellings and retail stores. The Company does not underwrite professional liability, manufacturers' products liability, liquor liability, heavy contracting liability, oil well drilling liability, marine liability or municipality risks. Other Lines The Company also issues a variety of other property and casualty insurance coverages including monoline property insurance. The Company's restricted commercial property policy covers fire, extended coverage, vandalism and malicious mischief for commercial establishments. This policy covers property damage up to $200,000. REINSURANCE The Company purchases reinsurance in order to reduce its liability on individual risks and to protect against catastrophe claims. A reinsurance transaction takes place when an insurance company transfers, or "cedes", to another insurer a portion or all of its exposure. The reinsurer assumes the exposure in return for a portion or all of the premium. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company is required to pay the claim if the reinsurer fails to meet its obligations under the reinsurance agreement. The Company writes casualty policy limits of $1,000,000. For policies with an effective date occurring from 1992 through 1994, the Company has excess reinsurance for 100% of casualty claims exceeding $300,000 up to the $1,000,000 policy limits. For policies with an effective date occurring in 1995 or after, the Company has excess reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 policy limits which results in a maximum net claim retention per risk of $500,000. The Company's maximum net claim retention per risk is $300,000 for policies with an effective date occurring from 1992 through 1994. Excess casualty reinsurance carried by the Company includes "extra-contractual obligations" coverage. This coverage protects the Company against claims arising out of certain legal liability theories not directly based on the terms and conditions of the Company's policies of insurance. Extra-contractual obligation claims are covered 90% under the excess casualty reinsurance treaty up to its respective limits. The Company is operating under excess casualty reinsurance treaties with three reinsurance companies, each of which reinsures a given percentage of ceded risks. The Company's excess reinsurance is provided in varying amounts by these reinsurers which are rated "A- (Excellent)" or better by A. M. Best Company. See 4 5 "Business--Rating." The following table identifies each such reinsurer and sets forth the percentage of the coverage assumed by each of them:
Percentage of Risk Reinsured ---------------------------- 1998 1997 1996 ---- ---- ---- Excess Reinsurer Dorinco Reinsurance Company 35% 50% 50% Great Lakes American Reinsurance Company -- 40% -- Liberty Mutual Insurance Company 20% -- -- PMA Reinsurance Corporation 35% -- 50% Republic Western Insurance Company 10% 10% -- ---- ---- ---- 100% 100% 100% ==== ==== ====
The Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims which exceed $500,000 but do not exceed $8,000,000. From time to time the Company makes use of facultative reinsurance to cede unusual risks on a negotiated basis. Beginning in 1995, the Company has entered into reinsurance fronting arrangements with non-affiliated insurance companies. The Company retains no portion as the business written under these agreements is 100% ceded. Although these cessions are made to authorized reinsurers rated "A- (Excellent)" or better by Best's, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. The Company has signed contracts in force for its reinsurance treaties for all years through 1997. The Company has written confirmations from reinsurers for 1998 regarding the basic terms and provisions under which they will assume the Company's risks, but, as of the date hereof, formal reinsurance treaty contracts with these reinsurers have not been executed. It is customary in the industry for insurance companies and reinsurers to operate under such commitments pending the execution of formal reinsurance treaties. No assurance can be given that such reinsurance treaties will be executed or, if executed, that the terms and provisions thereof will not be modified. MARKETING AND DISTRIBUTION The Company markets its insurance products through 186 non-affiliated general agents' offices, commonly referred to as wholesale agents. These general agents each represent several insurance companies, some of which may compete with the Company. The general agents solicit business from independent local agents or brokers, commonly referred to as retail agents, who are in direct contact with insurance buyers. The Company has elected to utilize general agents to market its insurance products in order to avoid the fixed costs of a branch office system. These general agents have experience in the specialty lines of coverages in which the Company concentrates and, in many instances, a long business history with members of the Company's management. The Company requires that its general agents have a specified level of errors and omissions insurance coverage, which indirectly protects the Company against certain negligence on the part 5 6 of general agents. The Company performs annual financial reviews and does limited quarterly reviews on each of its agent entities. Strict financial solvency and liquidity levels must be maintained by each general agent. The Company has errors and omissions insurance coverage to protect against negligence on the part of its employees. The Company has developed underwriting manuals to be used by its general agents. The general agents are authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. The Company has devoted extensive resources to the development of detailed underwriting manuals so that its general agents can consistently price and select risks, and the Company believes its manuals have been a significant factor in consistently producing superior underwriting results. All manuals stipulate minimum rates to be charged for the various classes of coverage offered. The general agents are compensated on a commission basis which varies by line of business. In addition, the general agency contracts between the Company and its general agents contain significant profit contingency inducements designed to reward those general agents with superior claim ratios who write certain minimum levels of premium with the Company. The general agents also retain a portion of the payment made by the insured as policy fee in connection with the issuance of most of the Company's non-admitted policies. Certain coverages, such as auto liability, may only be written in some states by companies with the authority to write insurance on an admitted basis in such states. The Company currently is approved to write insurance on an admitted basis in 45 states and plans to seek authority to write insurance on an admitted basis in all of the remaining states, but no assurance can be given of when or if this goal will be reached. UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES The Company maintains reserves for the payment of claims and claim adjustment expenses for both reported and unreported claims. Claim reserves are estimates, at a given point in time, of amounts that the Company expects to pay on incurred claims based on facts and circumstances then known. The amount of claim reserves for reported claims is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of claim reserves for unreported claims and case reserve development is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. Ultimate liability may be greater or lower than current reserves. Reserves are continually monitored by the Company using new information on reported claims and a variety of statistical techniques. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. 6 7 The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:
As of and for the years ended December 31 ---------------------------------- 1997 1996 1995 -------- -------- -------- (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $105,691 95,011 80,729 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 26,713 24,650 19,972 -------- -------- -------- Net unpaid claims and claim adjustment expenses, beginning of period 78,978 70,361 60,757 -------- -------- -------- Net claims and claim adjustment expenses incurred related to: Current period 53,969 53,037 48,064 Prior periods 8,117 5,342 401 -------- -------- -------- Total net claims and claim adjustment expenses incurred 62,086 58,379 48,465 -------- -------- -------- Net claim and claim adjustment expenses paid related to: Current period 17,807 17,178 14,131 Prior periods 39,554 32,584 26,953(1) -------- -------- -------- Total net claim and claim adjustment expenses paid 57,361 49,762 41,084 -------- -------- -------- Commutation of reinsurance treaties -- -- (2,223)(1) -------- -------- -------- Net unpaid claims and claim adjustment expenses, end of period 83,703 78,978 70,361 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 29,524 26,713 24,650(1) -------- -------- -------- Unpaid claims and claim adjustment expenses, end of period $113,227 105,691 95,011 ======== ======== ========
(1) The Company commuted its 1993 and 1994 quota-share reinsurance treaties in 1995, and thereby reassumed all risks and the related unpaid claims and claim adjustment expenses of $2,223,000 (see note 4 to the consolidated financial statements). This was accounted for using the paid claim method, whereby unpaid claims and claim adjustment expenses were increased $2,223,000 and paid claims and claim adjustment expenses were decreased $2,223,000, thus preventing distortion of claims and claim adjustment expenses incurred. The development in claims and claim adjustment expenses incurred from prior periods was largely a result of claim reserve increases recorded for commercial auto claims in Kentucky for the 1996 and 1995 accident years and adverse development in claim adjustment expense reserves for commercial auto in the 1996, 1995 and 1994 accident years. 7 8 The following table sets forth, as of December 31, 1997, 1996, and 1995, differences between the amount of net unpaid claims and claim adjustment expenses reported in the Company's statements, prepared in accordance with statutory accounting principles ("SAP"), and filed with the various state insurance departments, and those reported in the consolidated financial statements prepared in accordance with generally accepted accounting principles ("GAAP"):
As of December 31 ------------------------------------------ 1997 1996 1995 -------- -------- -------- (Amounts in thousands) Net reserves reported on a SAP basis $ 84,406 79,976 71,169 Adjustments: Estimated recovery for salvage and subrogation (703) (998) (808) -------- -------- -------- Net reserves reported on a GAAP basis $ 83,703 78,978 70,361 ======== ======== ========
The following table represents the development of GAAP balance sheet reserves for the period 1987 through 1997. The top line of the table shows the reserves for unpaid claims and claim adjustment expenses for the current and all prior years as recorded at the balance sheet date for each of the indicated years. The reserves represent the estimated amount of claims and claim adjustment expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including claims that have been incurred but not yet reported to the Company. The upper portion of the following table shows the net cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The lower portion of the table shows the reestimated amount of the previously recorded net reserves based on experience as of the end of each succeeding year, including net cumulative payments made since the end of the respective year. For example, the 1990 liability for net claims and claim adjustment expenses reestimated seven years later (as of December 31, 1997) was $28,908,000 of which $28,734,000 has been paid, leaving a net reserve of $174,000 for claims and claim adjustment expenses in 1990 and prior years remaining unpaid as of December 31, 1997. "Net cumulative redundancy (deficiency)" represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1990 net reserve for unpaid claims and claim adjustment expenses indicates a $2,000 net deficiency from December 31, 1990 to December 31, 1997 (seven years later). Conditions and trends that have affected development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table. 8 9
As of and for the years ended December 31 ------------------------------------------------------------------------------------------------------------ 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Unpaid claims & claim adjustment expenses: Gross 27,352 29,538 35,744 45,214 53,148 66,517 72,656 80,729 95,011 105,691 113,227 Ceded 18,865 15,005 15,695 16,308 15,105 16,594 16,701 19,972 24,650 26,713 29,524 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net 8,487 14,533 20,049 28,906 38,043 49,923 55,955 60,757 70,361 78,978 83,703 Net cumulative paid as of: One year later 3,766 4,902 7,545 10,251 15,037 22,470 24,090 24,730 32,584 39,554 Two years later 5,895 8,660 12,340 18,145 26,819 37,032 39,182 41,874 56,605 Three years later 7,332 10,642 16,413 23,255 33,879 45,884 48,688 55,338 Four years later 8,069 12,606 19,085 26,171 37,292 51,082 54,428 Five years later 8,721 13,815 20,633 26,970 39,999 54,092 Six years later 9,064 14,249 21,020 28,399 41,143 Seven years later 9,312 14,140 21,700 28,734 Eight years later 9,329 14,632 21,871 Nine years later 9,686 14,752 Ten years later 9,706 Net reserves reestimated as of: One year later 8,869 13,645 20,060 28,354 38,528 54,150 59,573 61,157 75,703 87,095 Two years later 9,166 13,694 20,566 28,479 42,235 57,223 59,922 62,296 80,356 Three years later 9,154 14,024 21,214 30,035 43,217 57,459 59,247 63,871 Four years later 9,355 14,675 22,431 30,129 42,493 56,832 58,414 Five years later 9,543 15,248 22,332 29,022 42,191 56,337 Six years later 9,672 15,174 22,034 29,073 41,984 Seven years later 9,606 14,572 21,965 28,908 Eight years later 9,509 14,753 21,950 Nine years later 9,787 14,782 Ten years later 9,766 Net cumulative redundancy (deficiency) (1,279) (249) (1,901) (2) (3,941) (6,415) (2,459) (3,115) (9,995) (8,117)
The Company has an indicated deficiency of approximately 10% of unpaid claims and claim adjustment expenses (C & CAE) for the 1996 year for reasons mentioned previously. Net unpaid C & CAE at December 31, 1997 was approximately $83,703,000, which the Company believes is adequate. OPERATING RATIOS CLAIMS, EXPENSE AND COMBINED RATIOS: Claims and expense ratios are traditionally used to interpret the underwriting experience of property and casualty insurance companies. Statutory Accounting Principles (SAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned because claims may occur over the life of a particular insurance policy. Underwriting expenses on a SAP basis are stated as a percentage of net premiums written rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. Underwriting profit margin is achieved when the combined ratio is less than 100%. The 9 10 Company's claims, expense and combined ratios and the property and casualty industry's claims, expense and combined ratios, both on a SAP basis, are shown in the following table:
Years ended December 31 ------------------------------------------------------------------ 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ COMPANY RATIOS Claims Ratio 60.0% 54.3% 48.7% 47.9% 51.4% Expense Ratio 34.4% 34.5% 34.2% 34.4% 33.9% ------ ------ ------ ------ ------ Combined Ratio 94.4% 88.8% 82.9% 82.3% 85.3% ====== ====== ====== ====== ====== INDUSTRY RATIOS (1) Claims Ratio 73.7% 78.4% 78.9% 81.1% 79.5% Expense Ratio 26.7% 26.3% 26.1% 26.0% 26.2% ------ ------ ------ ------ ------ Combined Ratio 100.4% 104.7% 105.0% 107.1% 105.7% ====== ====== ====== ====== ======
(1) The property and casualty industry as a whole, not companies with comparable lines of coverage, was used in the calculation of these ratios by Best's. Ratios for 1997 are estimated. The Company has continued to produce favorable claims ratios when compared to the industry. This has resulted from the Company maintaining its high underwriting standards and closely monitoring its pricing structure and adjusting it when needed. The unfavorable variance to the industry with regard to the expense ratios is because of the specific lines that the Company writes and the profit contingency inducements. The Company's commission expense ratio is higher than the average of the overall industry on a net premiums written basis. Its higher expense ratios are more than offset by lower claims ratios (favorable by an estimated 13.7 percentage points in 1997 and 24.1 percentage points in 1996, when compared to the industry) which results in the favorable combined ratio variances of an estimated 6.0 and 15.9 percentage points in 1997 and 1996, respectively. It should be noted that the Company ratios relate only to insurance operations. The holding company provides administrative and financial services for its wholly-owned subsidiaries. The allocation of the holding company's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented. Generally Accepted Accounting Principles (GAAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned as they are on a SAP basis. However, earned premiums include net policy fees earned whereas on a SAP basis policy fees earned are recorded on a gross basis. The GAAP expense ratio is based on premiums earned and includes the change in policy acquisition costs and underwriting expenses. Other differences include the treatment of the allowance for doubtful accounts. The following table presents the Company's claims, expense and combined ratios on a GAAP basis: 10 11
Years ended December 31 -------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Claims Ratio 60.7% 54.7% 49.8% 48.8% 51.7% Expense Ratio 33.7% 33.8% 33.1% 34.4% 33.0% ---- ---- ---- ---- ---- Combined Ratio 94.4% 88.5% 82.9% 83.2% 84.7% ==== ==== ==== ==== ====
PREMIUM TO SURPLUS RATIO: The following table shows, for the periods indicated, the Company's statutory ratios of statutory net premiums written to statutory policyholders' surplus. While there is no statutory requirement which establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners (NAIC) provide that this ratio should be no greater than 3 to 1.
As of and for the years ended December 31 -------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (Amounts in thousands, except ratios) Net premiums written $ 98,858 109,227 108,689 91,170 79,278 Policyholders' surplus $ 78,496 59,012 50,140 42,350 35,906 Ratio 1.26 to 1 1.85 to 1 2.17 to 1 2.15 to 1 2.21 to 1
INVESTMENTS The Company's investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes the Company's investment policy, which is to maximize after-tax yield while maintaining safety of capital together with adequate liquidity for insurance operations. The investment portfolio consists primarily of fixed maturity tax-exempt municipal bonds and United States Government securities. The Company does not invest in high yield ("junk") securities. As of December 31, 1997 and 1996, the Company had no high-yield fixed maturity securities nor non-performing fixed maturity securities. Furthermore, the Company has never bought nor sold either high-yield fixed maturity securities or derivatives. The Company does not actively trade its bonds, however, it does classify certain bond securities as available for sale. The Company holds no equity securities in issuers of high-yield debt securities. 11 12 The following table sets forth, for the periods indicated, the Company's investment results, before income tax effects:
As of and for the years ended December 31 --------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (Dollar amounts in thousands) Average investments (1) $209,121 192,221 170,881 148,688 128,632 Investment income 9,731 9,161 8,157 6,868 6,159 Return on average investments (2) 4.7% 4.8% 4.8% 4.6% 4.8% Taxable equivalent return on average investments 6.5% 6.6% 6.6% 6.4% 6.6% Net realized gains 327 472 108 135 4 Net unrealized gains (losses) $2,422 1,559 2,772 (1,829) 2,395
- ---------- (1) Average investments is the average of beginning and ending investments at amortized cost, computed on an annual basis. (2) Includes taxable and tax-exempt securities. The following table sets forth the composition of the investment portfolio of the Company.
As of December 31 ---------------------------------------------------------------------------------------- 1997 1996 1995 ------------------------ ------------------------ ------------------------ (Dollar amounts in thousands) Amortized Fair Amortized Fair Amortized Fair Type of Investment Cost Value Cost Value Cost Value - ------------------ -------- -------- -------- -------- -------- -------- Fixed Maturities: Bonds held to maturity: U.S. government securities $ 5,404 5,476 7,731 7,748 9,606 9,733 Tax-exempt state and municipal bonds 84,330 85,052 97,199 97,977 87,696 88,689 Bonds available for sale: U.S. government securities 27,322 27,404 -- -- -- -- Tax-exempt state and municipal bonds 94,700 96,246 76,880 77,644 77,478 79,130 Certificates of deposit 595 595 595 595 620 620 -------- -------- -------- -------- -------- -------- Total fixed maturities 212,351 214,773 182,405 183,964 175,400 178,172 -------- -------- -------- -------- -------- -------- Short-term investments 2,823 2,823 20,662 20,662 5,975 5,975 -------- -------- -------- -------- -------- -------- Total investments $215,174 217,596 203,067 204,626 181,375 184,147 ======== ======== ======== ======== ======== ========
12 13 The maturity distribution of the Company's investments in fixed maturities is as follows:
As of December 31 ----------------------------------------------------------- 1997 1996 ------------------------- ------------------------- (Dollar amounts in thousands) Amortized Amortized Cost Percent Cost Percent -------- -------- -------- -------- Within 1 year $ 35,142 16.6% $ 18,754 10.3% Beyond 1 year but within 5 years 140,571 66.2% 135,052 74.1% Beyond 5 years but within 10 years 30,608 14.4% 23,059 12.6% Beyond 10 years but within 20 years 6,030 2.8% 5,540 3.0% -------- -------- -------- -------- $212,351 100.0% $182,405 100.0% ======== ======== ======== ========
RATING Best's insurance reports, property-casualty, has currently assigned an "A+ (Superior)" pooled rating to the Company. Best's ratings are based on an analysis of the financial condition and operation of an insurance company as they relate to the industry in general. Best's generally reviews its ratings on a quarterly basis. GOVERNMENT REGULATION The Company's insurance companies are subject to varied governmental regulation in the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the Company's business and is concerned primarily with the protection of policyholders rather than shareholders. The Company is also subject to statutes governing insurance holding company systems in the states of Oklahoma and Texas. These statutes require the Company to file periodic information with the state regulatory authorities, including information concerning its capital structure, ownership, financial condition and general business operation. These statutes also limit certain transactions between the Company and its insurance companies, including the amount of dividends which may be declared and paid by the insurance companies (see note 6 to the consolidated financial statements). Additionally, the Texas statutes restrict the ability of any one person to acquire 10% or more of the Company's voting securities without prior regulatory approval while the Oklahoma statute restricts the ability of any one person to acquire 15% or more of the Company's voting securities without prior regulatory approval. COMPETITION The property and casualty insurance industry is highly competitive, with over 2,500 insurance companies transacting business in the United States. The Company underwrites specialty lines of insurance on risks not generally insured by many of the large standard property and casualty insurers. However, few barriers exist to prevent property and casualty insurance companies from entering into the Company's segments of the industry. To the extent this occurs, the Company can be at a competitive disadvantage because many of these companies have substantially greater financial and other resources and can offer a broader variety of specialty risk coverages. The Company's competitive advantages are 1) specialized expertise in its product lines which enables it to price with a great deal of accuracy and 2) superior service in underwriting and claims handling which provides its agents with a competitive advantage and a stable market. 13 14 EMPLOYEES As of December 31, 1997, the Company employed 168 persons, of which 12 were officers, 142 were staff and administrative personnel, and 14 were part-time employees. EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning the executive officers of the Company as of February 28, 1998 is set forth below:
Name Age Position with the Company ---- --- ------------------------- Joseph D. Macchia 62 Chairman of the Board, President and Chief Executive Officer Daniel J. Coots 46 Senior Vice President, Treasurer, Chief Financial Officer and Director Norman Alberigo 55 Vice President Richard M. Buxton 49 Vice President Brigitte G. Doyle 47 Vice President J. Landis Graham 43 Vice President Richard A. Laabs 42 Vice President Joseph W. Pitts 34 Vice President Carolyn E. Ray 45 Vice President Sharon B. Sholden 39 Vice President Sam Rosen 62 Secretary and Director
Mr. Joseph D. Macchia is the founder of the Company and has served as Chairman of the Board, President and Chief Executive Officer since its formation in 1978. Mr. Macchia has been engaged in the property and casualty insurance business since 1961. Mr. Daniel J. Coots has served as Vice President, Treasurer and Chief Financial Officer of the Company since 1987. In 1991 Mr. Coots was promoted to Senior Vice President. Mr. Coots has been engaged in the property and casualty insurance business since 1983. Mr. Norman Alberigo has served as Vice President of the Company since 1988. From 1986 to 1988, Mr. Alberigo served as Assistant Vice President of the Company. Mr. Alberigo has been engaged in the property and casualty insurance business since 1970. Mr. Richard M. Buxton has served as Vice President of the Company since December of 1996. From 1986 to 1996 Mr. Buxton was with KN Energy, Inc. in the position of Vice President of Strategic Planning and Financial Services. Ms. Brigitte G. Doyle has served as Vice President of the Company since June of 1997. From 1994 to May of 1997, Ms. Doyle served as Assistant Vice President of the Company. Ms. Doyle has served in various management capacities with the Company since 1984. Ms. Doyle has been engaged in the property and casualty business since 1984. 14 15 Mr. J. Landis Graham has served as Vice President of the Company since September of 1993. From 1988 to 1993, Mr. Graham was with Maryland Casualty Company in the position of Claim Manager. Mr. Graham has been engaged in the property and casualty insurance business since 1976. Mr. Richard A. Laabs has served as Vice President of the Company since June of 1996. From August of 1995 to May of 1996, Mr. Laabs served as Assistant Vice President of the Company. From 1990 to 1995, Mr. Laabs was with Scottsdale Insurance Company in the position of Senior Information Systems Services Director. Mr. Laabs has been engaged in the property and casualty insurance business since 1978. Mr. Joseph W. Pitts has served as Vice President of the Company since August of 1997. From 1992 to 1997, Mr. Pitts was with USAA in the position of Actuary and Manager. Mr. Pitts has been engaged in the property and casualty business since 1988. Ms. Carolyn E. Ray has served as Vice President of the Company since 1986. From 1984 to 1985, Ms. Ray served as Assistant Vice President of the Company. Ms. Ray has been engaged in the property and casualty insurance business since 1976. Ms. Sharon B. Sholden has served as Vice President of the Company since December of 1997. From August 1995 to 1997, Ms. Sholden served as Program Manager for TIG Insurance. From 1993 to 1995, Ms. Sholden was with Associates Insurance in the position of Vice President. Ms. Sholden has been engaged in the property and casualty business since 1982. Mr. Sam Rosen has served as the Secretary and a Director of the Company since 1983. Mr. Rosen is a partner with the law firm of Shannon, Gracey, Ratliff & Miller, L.L.P. He has been a partner in that firm or its predecessors since 1966. ITEM 2. PROPERTY The Company owns its Corporate offices which provide approximately 35,000 square feet of office space, and additionally provides parking. Future expansion will be possible by converting the parking area into office space. The Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including a 10,000 square foot office building, which previously served as its corporate offices. The Company currently has this property under lease. ITEM 3. LEGAL PROCEEDINGS In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims which arise in the normal course of its insurance business. 15 16 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 16 17 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. The Company's Common Stock is listed on the New York Stock Exchange (Symbol: GNA). The following table sets forth for the fiscal periods indicated the high and low closing sales prices per share of the Common Stock as reported by the American Stock Exchange, as adjusted for stock dividends through July 30, 1996 and by the New York Stock Exchange from July 31, 1996 through December 31, 1997. The prices reported reflect actual sales transactions on these exchanges.
High Low ---- --- 1995 First Quarter 10 7 1995 Second Quarter 10 1/2 9 5/16 1995 Third Quarter 9 1/2 8 7/16 1995 Fourth Quarter 11 7/8 8 5/16 1996 First Quarter 11 3/4 9 3/4 1996 Second Quarter 11 5/8 9 7/8 1996 Third Quarter 10 3/4 9 3/8 1996 Fourth Quarter 10 3/4 8 3/4 1997 First Quarter 9 7/8 8 7/8 1997 Second Quarter 9 3/8 8 1/8 1997 Third Quarter 9 7/8 8 7/8 1997 Fourth Quarter 10 1/16 8 1/8
Cash dividends of $.01 per share were paid to shareholders of record on March 31, June 30 and September 30, 1995. Cash dividends of $.0125 per share were paid to shareholders of record on December 31, 1995, March 29 and June 28, 1996. Cash dividends of $.015 per share were paid to shareholders of record on September 30 and December 31, 1996 and March 31, June 30 and September 30, 1997. Cash dividends of $.0175 per share were paid to shareholders of record on December 31, 1997. On February 18, 1998, the Company declared a $.0175 per share cash dividend payable to shareholders of record on March 31, 1998. The Company depends on cash flow from cash dividends paid by its subsidiaries. 17 18 Stock dividends of 5% were paid to shareholders of record on March 31 and September 30, 1995. In November, 1995, the Board of Directors discontinued the semi-annual stock dividends. The Company purchased 243,932 shares of its Common Stock during 1997. Additionally, a total of 17,200 shares were purchased in January and February of 1998. The Company has not purchased shares of its stock since February of 1998 and has no plans to purchase additional shares. As of February 28, 1998, there were 432 shareholders of record of the Company's Common Stock. 18 19 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 1997 and 1996, and the consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997, and the report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated financial statements and the notes thereto, and the other financial information included herein.
Years ended December 31 ------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (Amounts in thousands, except per share data) Income Data: Gross premiums written (1) $ 99,776 110,000 108,072 98,164 85,373 Ceded premiums written 1,637 1,749 1,968 8,710 7,412 -------- -------- -------- -------- -------- Net premiums written 98,139 108,251 106,104 89,454 77,961 Decrease (increase) in unearned premiums 4,117 (1,458) (8,849) (5,059) (2,099) -------- -------- -------- -------- -------- Net premiums earned 102,256 106,793 97,255 84,395 75,862 Net investment income 9,731 9,161 8,157 6,868 6,159 Net realized gains 327 472 108 135 4 Insurance services 2,631 2,379 2,183 2,056 2,388 -------- -------- -------- -------- -------- Total revenues 114,945 118,805 107,703 93,454 84,413 -------- -------- -------- -------- -------- Claims and claim adjustment expenses 62,086 58,379 48,465 41,189 39,239 Policy acquisition costs 22,552 23,828 19,679 17,392 16,183 Underwriting and operating expenses 15,545 15,499 15,579 14,505 12,604 -------- -------- -------- -------- -------- Total expenses 100,183 97,706 83,723 73,086 68,026 -------- -------- -------- -------- -------- Income before income taxes 14,762 21,099 23,980 20,368 16,387 Income tax expense 2,838 5,079 6,352 5,199 3,147 -------- -------- -------- -------- -------- Net income (2) $ 11,924 16,020 17,628 15,169 13,240 ======== ======== ======== ======== ======== Earnings Per Share (3): Basic $ .57 .75 .82 .71 .62 ======== ======== ======== ======== ======== Diluted $ .56 .74 .81 .70 .61 ======== ======== ======== ======== ======== GAAP Operating Ratios: Claims ratio 60.7% 54.7% 49.8% 48.8% 51.7% Expense ratio 33.7% 33.8% 33.1% 34.4% 33.0% -------- -------- -------- -------- -------- Combined ratio 94.4% 88.5% 82.9% 83.2% 84.7% ======== ======== ======== ======== ========
19 20
As of December 31 ---------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Balance Sheet Data: Investments $216,802 203,831 183,027 160,300 136,989 Premiums receivable 14,250 15,825 15,914 12,262 10,888 Ceded unpaid claims and claim adjustment expenses 29,524 26,713 24,650 19,972 16,701 Ceded unearned premiums 19,146 16,280 6,008 5,977 5,536 Deferred policy acquisition costs 11,618 12,634 12,115 9,831 8,509 Property and equipment 6,941 6,981 6,562 6,336 6,274 Total assets 313,685 296,846 264,156 230,576 199,187 Unpaid claims and claim adjustment expenses 113,227 105,692 95,011 80,729 72,656 Unearned premiums 64,005 65,255 53,525 44,645 39,145 Note payable -- -- 1,750 3,500 4,500 Total liabilities 195,123 187,493 164,714 149,029 132,369 Shareholders' equity 118,562 109,353 99,442 81,547 66,818 Shareholders' equity per share (4) $ 5.68 5.19 4.62 3.79 3.14 Return on beginning equity 11% 16% 22% 23% 24% ======== ======== ======== ======== ========
- ---------- (1) Excludes premiums of $40,136,000 in 1997, $31,603,000 in 1996, $8,893,000 in 1995, $5,056,000 in 1994 and $5,418,000 in 1993 from the Company's fronting arrangements and the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company is a servicing carrier. (2) Includes after tax net realized gains of $212,000, $307,000, $70,000, $87,000 and $3,000 for 1997, 1996, 1995, 1994, and 1993, respectively. (3) All years retroactively adjusted for stock dividends and stock splits effected as stock dividends as follows: two 5% in 1995, two 5% in 1994 and two 5% in 1993. All prior years have been restated to comply with Statement of Financial Accounting Standards No. 128, "Earnings Per Share". (4) Based on number of shares outstanding at the end of each year, retroactively adjusted for stock dividends and stock splits effected as stock dividends. 20 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OPERATIONS Net income for 1997 decreased 26% to $11,923,526, or $.56 per share (diluted) compared to 1996 net income of $16,019,567, or $.74 per share (diluted) and 1995 net income of $17,627,855, or $.81 per share (diluted). The Company recorded an 11% return on beginning equity and a GAAP combined ratio of 94.4% in 1997. The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The revenue item "Insurance services" includes revenues from the computer software, the plan servicing, the premium finance and the fronting reinsurance operations. The expense item "Underwriting and operating expenses" includes the operating expenses of these operations. RESULTS OF OPERATIONS Gross premiums written in 1997 of $99,775,854 were 9% below the $110,000,103 recorded in 1996. In 1996, gross premiums written increased 2% over the 1995 level. The cancellation of the Kentucky coal truck program and a taxi program in New Jersey contributed 3 percentage points (points) of decrease while increased competition in the Florida, Georgia, Pennsylvania and Virginia markets contributed another 4 points of decrease in 1997. In 1996, the small growth rate was the result of Texas contributing 4 points of decrease due to intensified competition. The following table compares the major product lines between the years for gross premiums written:
1997 1996 1995 ------------------------ ------------------------ ------------------------ (Amounts in thousands) Commercial auto $ 56,704 57% $ 62,328 57% $ 62,517 58% Auto garage 23,279 23% 26,871 24% 25,270 23% General liability 17,829 18% 19,744 18% 19,052 18% Other lines 1,964 2% 1,057 1% 1,233 1% -------- -------- -------- -------- -------- -------- Total $ 99,776 100% $110,000 100% $108,072 100% ======== ======== ======== ======== ======== ========
COMMERCIAL AUTO was down 9% in 1997 from 1996 and flat in 1996 from 1995. Kentucky contributed 4 points of decrease with Georgia, New Jersey, Pennsylvania and Virginia accounting for the remaining 5 points of decrease. A decision was made during the year to discontinue writing Kentucky coal truck risks and a New Jersey taxi cab program because of adverse claim results. In Pennsylvania several new carriers have entered the market and they are specifically targeting the Company's lines of business. In Georgia and Virginia competition has dramatically intensified with regard to pricing. In 1996, the flat premium growth was the result of decreases from Texas and Pennsylvania being offset with growth from Kentucky. The AUTO GARAGE product line resulted in a 13% decrease in 1997 after a 6% increase in 1996. The majority of the decrease came from Connecticut, Florida, Pennsylvania and Virginia. In Connecticut several new entrants to the market increased the competition by writing garage lines they had not previously written. Competition in Florida was in the form of price cutting from existing markets. In Pennsylvania the auto garage situation was similar to commercial auto, i.e., new carriers entered the market and targeted the Company's lines of 21 22 business. In 1996 the auto garage line recorded a 6% increase with Florida, Kentucky and Pennsylvania all producing significant increases. The GENERAL LIABILITY line decreased 10% in 1997 after an increase of 4% in 1996. California and Florida accounted for 6 points and 2 points of decrease, respectively. An underwriting decision was made in California to not renew large general contractors in light of the Montrose case. In Florida, increased competition from new and existing companies contributed to the decrease. In 1996, California and Florida were contributors to the increase while Texas was down. For 1997, gross premiums written percentages by significant state/product line are as follows: Texas commercial auto (22%), Kentucky commercial auto (6%), Pennsylvania commercial auto (6%), Texas general liability (6%), and Florida auto garage (5%) with no other individual state/product line comprising 5% or more. The persistency rate increased to 46% in 1997 from 45% in 1996. Premiums earned decreased 4% in 1997 to $102,255,979 and increased 10% in 1996 to $106,792,928 as a direct result of the level of premiums written. Net investment income increased 6% in 1997 over 1996 and increased 12% in 1996 over 1995. These increases are the result of growth in the portfolio due to continued positive cash flows from operations. The return on average investments for 1997 is 4.7% versus 4.8% in 1996 and 1995. Inflation can cause interest rates to increase, which would cause the Company's interest income to increase. Because of the Company's profitability in the underwriting operations, the Company achieves the highest after tax net income by investing predominantly in tax-exempt securities as compared to taxable fixed income securities. At December 31, 1997, 83% of the Company's investments were in investment grade tax-exempt bonds with an average maturity of approximately 3.4 years. Since the majority of the Company's investments are tax-exempt, the yields appear lower than those of the industry; however, the industry as a whole has a significantly larger percentage of investments in taxable securities with substantially longer maturities. On a taxable equivalent basis the return on average investments was 6.5% in 1997 and 6.6% in 1996 and 1995. The Company has the ability to hold its fixed maturity securities until their maturity date. The Company does not actively trade its bonds, however, it does classify certain bond securities as available for sale. At December 31, 1997, approximately 16% of the Company's investments were in U.S. Treasury securities and 1% were in short-term money market funds. The Company has not and does not intend to invest in derivatives or high-yield ("junk") securities, nor equity securities in issuers of "junk" debt securities. The Company does not have any non-performing fixed maturity securities. The Company recorded net realized capital gains of $326,905 in 1997 versus $471,956 in 1996 and $108,024 in 1995. All of these gains were generated from the bonds available for sale category of the fixed maturity portfolio. Insurance services revenues increased $252,165 from 1996 to 1997 following an increase of $196,645 in 1996 from 1995. The table below presents the components.
1997 1996 1995 ---------- ---------- ---------- Plan servicing $1,048,835 1,187,656 1,335,852 Fee income 608,287 343,266 62,428 Computer software 657,592 473,499 475,317 Premium finance 286,347 345,679 281,383 Other 30,258 29,054 27,529 ---------- ---------- ---------- Total $2,631,319 2,379,154 2,182,509 ========== ========== ==========
22 23 Plan servicing revenues from commercial automobile plans decreased 12% in 1997 from 1996 following an 11% decrease in 1996. Written premiums in 1997 are 14% below 1996 as a result of decreases in the Louisiana and Pennsylvania plans. In 1996, the California, Louisiana and Pennsylvania plans all recorded decreases in written premiums from 1995. These plans are depopulating as risks are moving into the voluntary market due to lower pricing. The Company continues to pursue management contracts with other states to administer their commercial automobile plans and is seeking a larger participation in existing plans. Fee income increased $265,021 in 1997 over 1996 and $280,838 in 1996 over 1995 as a result of continued significant growth in the fronting reinsurance operation. Revenues in the computer software operation increased 39% in 1997 from 1996 after being flat from 1995 to 1996. A significant increase in system sales occurred in 1997 as a result of marketing initiatives implemented in late 1996. New management brought in during the third quarter of 1995 has improved this operation and revenues are expected to show increases in the future. Revenues from the premium finance operation are down 17% in 1997 from the 1996 level which was 23% above the 1995 level. The decrease is a result of the taxi cab programs that were discontinued, increased competition and the decision to offer interest free payment plans from the Company's insurance companies in order to increase premium writings. Amounts financed in 1997 were 32% below 1996 which had increased 5% over 1995. Premium finance notes receivable were approximately $1,400,000 at December 31, 1997 versus $1,991,000 at December 31, 1996 and the average return was 17% for 1997 and 1996 versus 19% in 1995. Claims and claim adjustment expenses (C & CAE) increased $3,706,923 in 1997 over 1996 and $9,913,707 in 1996 over 1995. The C & CAE ratio was 60.7% in 1997, 54.7% in 1996 and 49.8% in 1995. The increase in the C & CAE ratio of 6 percentage points in 1997 is the result of claim reserve increases recorded for commercial auto claims in Kentucky from the 1995 and 1996 accident years and adverse development in claim adjustment expense reserves for commercial auto in the 1994, 1995 and 1996 accident years. The increase in the C & CAE ratio of 4.9 percentage points in 1996 was also related to commercial auto claims in the 1995 and 1994 accident years. While the Company writes a material amount of business in areas where catastrophes have recently occurred, the gross and net claims incurred from these events were immaterial because the Company primarily writes liability coverages. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related coverages in its policies. Approximately 2% of the Company's premium writings are for product liability coverages and this is limited to non-manufacturing risks only. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. The decrease in commissions from 1996 to 1997 is related to the decrease in gross premiums written. The increase in commissions from 1995 to 1996 is related to the increase in gross premiums written and to a decrease of approximately $1,669,000 in commission income from reinsurance treaties. The ratio of commissions to gross premiums written increased to 22% in 1997 and 1996 from the 20% level in 1995. The increase in 1996 is a result of a decrease in commission income. The ratio of commissions to premiums earned was 21% for 1997 as compared to 23% for 1996 and 1995. The decrease in 1997 was related to the decrease in the commission expense rate in 1997 attributable to lower contingent commissions resulting from higher C & CAE ratios. 23 24 The change in deferred policy acquisition costs and deferred ceding commission income (DAC) resulted in a net decrease to income of $1,015,802 for 1997 and a net increase to income of $519,257 and $2,284,138 for 1996 and 1995, respectively. The change in the amount of the increase or decrease in DAC between the comparable periods is directly related to the rate at which unearned premiums are growing or declining as a result of premium writings. Since DAC (asset) is a function of unearned premiums (liability), an increase in the growth rate of net unearned premiums would correspondingly result in an increase in the growth rate of DAC and vice versa. The ratio of DAC to net unearned premiums was 25.9%, 25.8% and 25.5% at December 31, 1997, 1996 and 1995, respectively. Underwriting and operating expenses were up slightly in 1997 from 1996, and down slightly in 1996 from 1995. As a percent of operating revenues (premiums earned and insurance services revenues) the ratio remained relatively flat at 14.8% in 1997 while 1996 decreased to 14.2% from the 1995 level of 15.7%. The increase in the rate in 1997 is related to the 4% decrease in operating revenues for 1997. The decrease in 1996 was the result of savings from variable expenses in personnel costs and in the plan servicing operation. In March 1997, the Company began converting its computer systems to be year 2000 compliant. At December 31, 1997, approximately 70 percent of the Company's systems were compliant, with all systems expected to be compliant by the end of 1998. The total cost of the project is estimated to be $850,000 and is being funded through operating cash flows. The Company is expensing all costs associated with these system changes. As of December 31, 1997, the amount expensed was immaterial. The effective tax rate of the Company was 19% in 1997, 24% in 1996, and 26% in 1995. The lower rates in 1997 and 1996 are largely the result of tax-exempt net investment income representing a larger portion of income than in 1995. For the Company, the fresh start adjustment (tax benefit) was immaterial for all years presented. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note 5 of Notes to Consolidated Financial Statements. For 1998 the Company is targeting premiums written to be within a $105-115 million range with a GAAP combined ratio of 87.5-92.5% and a return on beginning equity of better than 11.5%. While the Company is optimistic these forward-looking goals can be attained, no assurances can be given they will occur. LIQUIDITY AND CAPITAL RESOURCES The primary sources of the Company's liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 1997, the Company held short-term investments and cash of $3,519,906 which the Company believes is adequate liquidity for the payment of claims and other short-term commitments. With regard to long term liquidity, the average duration of the investment portfolio is approximately 3 years. The fair value of the fixed maturity portfolio at December 31, 1997 was $2,422,271 above amortized cost. With regard to the availability of funds to the holding company, see Note 6 of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies. Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 1997 and 1996, the balance on deposit for the benefit of such policyholders totaled approximately $12,965,000 and $12,615,000, respectively. The increase in investments is primarily attributable to continued positive cash flows from operating activities which are the result of continued and substantial underwriting profits. Premiums receivable and Deferred policy acquisition costs decreased as a result of the decrease in premiums written. Ceded unpaid claims and claim adjustment expenses as well as ceded unearned premiums increased largely as a result of the increase in fronting reinsurance activity mentioned previously. 24 25 Unpaid claims and claim adjustment expenses increased largely as a result of increases to reserves on retained business as well as material increases from plan servicing and fronting reinsurance. Unearned premiums decreased because of the decrease in premiums written, offset to some extent by an increase in fronting reinsurance. Accounts payable decreased because of contingent payables based upon profitability levels that have decreased. Drafts payable increased because a large amount of drafts were issued in the fourth quarter of 1997 in an aggressive effort to bring specifically targeted claims to an early and fair conclusion. The Company's liquidity position remains strong as a result of cash flows from underwriting and investment activities. The unrealized gains or losses on fixed maturities available for sale are presented, net of tax, as a separate component of shareholders' equity (see Note 2 of Notes to Consolidated Financial Statements). The net unrealized gain on the fixed maturities classified as held to maturity was $794,166 at December 31, 1997. The Company purchased 243,932 shares of its common stock during 1997 at a cost of $2,113,560 or $8.66 per share which accounts for the increase in Treasury stock. During 1997, the Financial Accounting Standards Board issued Statement 130, "Reporting Comprehensive Income". The Statement is effective for fiscal years beginning after December 15, 1997 and will be adopted by the Company in the first quarter of 1998. The Company is not aware of any current recommendations by the regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory capital significantly exceeds the benchmark capital level under the Risk Based Capital formula for its major insurance companies. FORWARD LOOKING STATEMENTS This Form 10-K Report and the Company's shareholder reports contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Important factors include, but are not limited to, (i) heightened competition, including price competition from existing competitors, from newly formed competitors and from the entry into the Company's markets of standard insurance companies which historically have not competed in the Company's specialty markets, (ii) contraction of the markets for the Company's various lines of business, (iii) development and performance of new specialty programs, (iv) the ongoing level of claims and claims-related expenses, (v) adequacy of claim reserves, and (vi) general economic conditions. 25 26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated Financial Statements are on pages 34 through 58:
Page ----- Report of Management 34 Independent Auditors' Report 35 Consolidated Balance Sheets as of December 31, 1997 and 1996 36-37 Consolidated Statements of Operations for the Years Ended December 31, 1997, 1996, and 1995 38 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1996, and 1995 39-40 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996, and 1995 41-42 Notes to Consolidated Financial Statements December 31, 1997, 1996, and 1995 43-58
The following Consolidated Financial Statements Schedules are on pages 59 through 70:
Schedule Page Independent Auditors' Report on Supplementary Information 59 I Summary of Investments 60 II Condensed Financial Information of the Registrant 61-67 III Supplementary Insurance Information 68 IV Reinsurance 69 VI Supplemental Information 70
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 26 27 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item with regard to Executive Officers is included in Part 1 of this report under the heading "Executive Officers of the Registrant". The other information required by this item is hereby incorporated by reference from the Registrant's definitive 1998 Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is hereby incorporated by reference from the Registrant's definitive 1998 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is hereby incorporated by reference from the Registrant's definitive 1998 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is hereby incorporated by reference from the Registrant's definitive 1998 Proxy Statement. 27 28 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of the report: 1. The following financial statements filed under Part II, Item 8: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1997 and 1996 Consolidated Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements, December 31, 1997, 1996 and 1995 2. The following Consolidated Financial Statement Schedules are filed Under Part II, Item 8:
Schedule Description -------- ----------- I Summary of Investments II Condensed Financial Information of the Registrant III Supplementary Insurance Information IV Reinsurance VI Supplemental Information
3. The following Exhibits:
Exhibit No. - ----------- 3.1 Restated Articles of Incorporation of Registrant (Exhibit 3.1)(1)
28 29 3.2 Articles of Amendment to the Articles of Incorporation dated June 9, 1988 (Exhibit 3.2)(2) 3.6 Articles of Amendment to Articles of Incorporation effective August 13, 1993 (Exhibit 3.6)(7) 3.7 Bylaws of Registrant as restated on February 18, 1998 (11) 4.2 Rights Agreement, dated as of March 3, 1988, between the Registrant and Team Bank/Fort Worth, N.A. (incorporated by reference to Exhibit 1 to the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 15, 1988) (Exhibit 4.2)(3) 4.3 Amendment No. 1 dated as of March 5, 1990 to Rights Agreement dated as of March 3, 1988 between GAINSCO, INC. and Team Bank as Rights Agent (Exhibit 4.2)(5) 4.4 Amendment No. 2 dated as of May 25, 1993 to Rights Agreement between GAINSCO, INC. and Society National Bank (successor to Team Bank (formerly Texas American Bank/Fort Worth, N.A.)), as Rights Agent (Exhibit 4.4)(7) 4.6 Revised Form of Common Stock Certificate (Exhibit 4.6) (10) 10.2 (Restated) Incentive Compensation Plan of the Registrant (Exhibit 10.2)(2) 10.16 1990 Stock Option Plan of the Registrant (Exhibit 10.16)(4) 10.23 Surplus Debenture issued by GAINSCO County Mutual Insurance Company. (Exhibit 10.23)(6) 10.24 Management Contract between GAINSCO County Mutual Insurance Company and GAINSCO Service Corp. (Exhibit 10.24)(6) 10.25 Certificate of Authority and accompanying Commissioner's Order granting Certificate of Authority, allowing for charter amendments and extension of charter (Exhibit 10.25)(6) 10.27 Amendment to Surplus Debenture issued by GAINSCO County Mutual Insurance Company (Exhibit 10.27)(7) 10.28 Agreement dated August 26, 1994 appointing Continental Stock Transfer & Trust Company transfer agent and registrar (Exhibit 10.28)(8). 10.29 Amendment No. 3 to Rights Agreement and appointment of Continental Stock Transfer & Trust Company as Successor Rights Agent, made September 30, 1994 (Exhibit 10.29)(8).
29 30 10.31 1995 Stock Option Plan of the Registrant (Exhibit 10.31) (9) 10.32 Clarification to the GAINSCO, INC. Executive Incentive Compensation Plan (Exhibit 10.32) (9) 10.36 Form of Change of Control Agreements (11) 11 (Not required to be filed as an Exhibit. See footnote (1)(l) on page 48 of this 10-K Report for information called for by number 11 of the Exhibit Table to Item 601 of SK) 22.2 Subsidiaries of Registrant (11) 24.2 Consent of KPMG Peat Marwick LLP to incorporation by reference (11) 25.1 Powers of Attorney (11) 27 Financial Data Schedule (11) (1) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration Statement No. 33-7846 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 6, 1986. (2) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration 33-25226 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 14, 1988. (3) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. (4) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. (5) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (6) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (7) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
30 31 (8) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (9) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (10) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. (11) Filed herewith, See Exhibit Index.
(b) Reports on Form 8-K During the last quarter of the fiscal year ended December 31, 1997, no reports on Form 8-K have been filed by the Company. (c) Exhibits required by Item 601 of Regulation SK The exhibits listed in Item 14(a) 3 of this Report, and not incorporated by reference to a separate file are filed herewith. 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. GAINSCO, INC. (Registrant) /s/ Joseph D. Macchia - ----------------------------------- By: Joseph D. Macchia, President Date: 03/30/98 ------------------------------ 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.
Name Title Date ---- ----- ---- /s/ Joseph D. Macchia Chairman of the Board, 3/30/98 - -------------------------- President and Chief --------------------------- Joseph D. Macchia Executive Officer /s/ Daniel J. Coots Senior Vice President and 3/30/98 - -------------------------- Chief Financial Officer --------------------------- Daniel J. Coots /s/ Sam Rosen Secretary and Director 3/30/98 - -------------------------- --------------------------- Sam Rosen Director 3/30/98 - -------------------------- --------------------------- Jack L. Johnson John C. Goff* Director 3/30/98 - -------------------------- --------------------------- John C. Goff Robert J. McGee, Jr.* Director 3/30/98 - -------------------------- --------------------------- Robert J. McGee Joel C. Puckett* Director 3/30/98 - -------------------------- --------------------------- Joel C. Puckett Harden H. Wiedemann* Director 3/30/98 - -------------------------- --------------------------- Harden H. Wiedemann John H. Williams* Director 3/30/98 - -------------------------- --------------------------- John H. Williams
*By: /s/ Joseph D. Macchia ----------------------------------- Joseph D. Macchia, Attorney in-fact Under Power of Attorney 32 33 Subsequent to the filing of the Annual Report on this Form, an Annual Report to Security Holders covering the Registrant's last fiscal year and a Proxy Statement and Form of Proxy will be sent to more than ten of the Registrant's security holders with respect to the Annual Meeting. 33 34 REPORT OF MANAGEMENT The accompanying consolidated financial statements were prepared by the Company, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with generally accepted accounting principles and include some amounts that are based upon the Company's best estimates and judgement. Financial information presented elsewhere in this report is consistent with the accompanying consolidated financial statements. The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's criteria, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against claims from unauthorized use or disposition. The Company's consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. The auditors have full access to each member of management in conducting their audits. The Audit Committee of the Board of Directors, comprised solely of directors from outside of the Company, meets regularly with management and the independent auditors to review the work and procedures of each. The auditors have free access to the Audit Committee, without management being present, to discuss the results of their work as well as the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon recommendation of the Audit Committee, appoints the independent auditors, subject to shareholder approval. /s/ Joseph D. Macchia ------------------------------- Joseph D. Macchia Chairman of the Board, President and Chief Executive Officer /s/ Daniel J. Coots ------------------------------ Daniel J. Coots Senior Vice President and Chief Financial Officer 34 35 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders GAINSCO, INC.: We have audited the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. 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 GAINSCO, INC. and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. We have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1995, 1994 and 1993, and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 1994 and 1993, and we expressed unqualified opinions on those consolidated financial statements. In our opinion, the information set forth in the selected consolidated financial data for each of the years in the five- year period ended December 31, 1997, appearing on pages 19 and 20, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived. KPMG Peat Marwick LLP Dallas, Texas February 16, 1998 35 36 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996
Assets 1997 1996 ------ ------------- ------------- Investments (note 2): Fixed maturities: Bonds held to maturity, at amortized cost (fair value: $90,527,669 - 1997, $105,725,155 - 1996) $ 89,733,503 104,930,347 Bonds available for sale, at fair value (amortized cost: $122,022,184 - 1997, $76,879,562 - 1996) 123,650,289 77,643,677 Certificates of deposit, at cost (which approximates fair value) 595,000 595,000 Short-term investments, at cost (which approximates fair value) 2,823,393 20,662,282 -------------- ------------- Total investments 216,802,185 203,831,306 Cash 696,513 1,044,740 Accrued investment income 4,714,828 4,308,185 Premiums receivable (net of allowance for doubtful accounts: $81,000 - 1997, $101,000 - 1996) (note 1) 14,249,890 15,824,543 Reinsurance balances receivable 2,604,511 2,156,326 Ceded unpaid claims and claim adjustment expenses (note 1) 29,524,026 26,713,154 Ceded unearned premiums 19,146,272 16,280,013 Deferred policy acquisition costs (note 1) 11,618,136 12,633,938 Property and equipment (net of accumulated depreciation and amortization: $5,710,365 - 1997, $4,778,524 - 1996) (note 1) 6,941,232 6,981,380 Current Federal income taxes 796,631 424,148 Deferred Federal income taxes (notes 1 and 5) 2,676,555 2,956,510 Management contract 1,737,570 1,787,570 Other assets 2,176,957 1,903,963 -------------- ------------- Total assets $ 313,685,306 296,845,776 ============== =============
See accompanying notes to consolidated financial statements. 36 37 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996
Liabilities and Shareholders' Equity 1997 1996 ------------- ------------- Liabilities: Unpaid claims and claim adjustment expenses (notes 1 and 4) $ 113,227,009 105,691,588 Unearned premiums (note 4) 64,004,507 65,255,153 Commissions payable 2,207,421 2,689,337 Accounts payable 3,542,075 4,670,947 Reinsurance balances payable 745,805 1,057,923 Deferred revenue 635,807 593,300 Drafts payable 9,393,375 6,219,044 Dividends payable (note 6) 365,300 316,312 Other liabilities 1,001,747 999,590 ------------- ------------- Total liabilities 195,123,046 187,493,194 ------------- ------------- Shareholders' Equity (note 6): Preferred stock ($100 par value, 10,000,000 shares authorized, none issued) -- -- Common stock ($.10 par value, 250,000,000 shares authorized, 21,701,118 issued at December 31, 1997 and 21,670,369 issued at December 31, 1996) 2,170,112 2,167,037 Additional paid-in capital 87,697,754 87,610,379 Net unrealized gains on fixed maturities 1,058,268 496,675 Retained earnings 35,188,460 24,517,265 Treasury stock, at cost (826,894 shares in 1997, 582,962 shares in 1996) (note 1) (7,552,334) (5,438,774) ------------- ------------- Total shareholders' equity 118,562,260 109,352,582 ------------- ------------- Commitments and contingencies (notes 4, 7, and 8) Total liabilities and shareholders' equity $ 313,685,306 296,845,776 ============= =============
See accompanying notes to consolidated financial statements. 37 38 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 -------------- ------------- ------------ Revenues: Net premiums earned (note 4) $ 102,255,979 106,792,928 97,254,816 Net investment income (note 2) 9,731,132 9,160,518 8,157,484 Net realized gains (note 1) 326,905 471,956 108,024 Insurance services 2,631,319 2,379,154 2,182,509 -------------- ------------ ------------ 114,945,335 118,804,556 107,702,833 -------------- ------------ ------------ Expenses: Claims and claim adjustment expenses (notes 1 and 4) 62,085,643 58,378,720 48,465,013 Commissions 21,536,034 24,347,250 21,962,839 Change in deferred policy acquisition costs and deferred ceding commission income (note 1) 1,015,802 (519,257) (2,284,138) Underwriting and operating expenses 15,546,068 15,499,641 15,579,260 -------------- ------------ ------------ 100,183,547 97,706,354 83,722,974 -------------- ------------ ------------ Income before Federal income taxes 14,761,788 21,098,202 23,979,859 Federal income taxes (note 5): Current expense 2,860,704 5,145,780 6,412,007 Deferred benefit (22,442) (67,145) (60,003) -------------- ------------ ------------ 2,838,262 5,078,635 6,352,004 -------------- ------------ ------------ Net income $ 11,923,526 16,019,567 17,627,855 ============== ============ ============ Earnings per share (notes 1 and 6): .57 .75 .82 === === === Basic .56 .74 .81 === === === Diluted
See accompanying notes to consolidated financial statements. 38 39 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity Years ended December 31, 1997, 1996, and 1995
1997 1996 1995 ----------- ----------- ----------- Common stock: Balance at beginning of year $ 2,167,037 2,163,748 1,961,137 Issue of shares as stock dividends (2,009,797 in 1995) (note 6) -- -- 200,980 Exercise of options to purchase shares (30,749 in 1997, 32,888 in 1996 and 16,316 in 1995) 3,075 3,289 1,631 ----------- ----------- ----------- Balance at end of year 2,170,112 2,167,037 2,163,748 ----------- ----------- ----------- Additional paid-in capital: Balance at beginning of year 87,610,379 87,543,175 69,671,214 Issue of shares as stock dividends (2,009,797 in 1995) (note 6) -- -- 17,835,103 Exercise of options to purchase shares (30,749 in 1997, 32,888 in 1996 and 16,316 in 1995) 87,375 67,204 36,858 ----------- ----------- ----------- Balance at end of year $87,697,754 87,610,379 87,543,175 ----------- ----------- -----------
(continued) 39 40 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity Years ended December 31, 1997, 1996, and 1995
1997 1996 1995 ------------- ------------- ------------- Net unrealized gains (losses) on fixed maturities: Balance at beginning of year $ 496,675 1,073,597 (55,686) Change during year 561,593 (576,922) 1,129,283 ------------- ------------- ------------- Balance at end of year 1,058,268 496,675 1,073,597 ------------- ------------- ------------- Retained earnings: Balance at beginning of year 24,517,265 9,673,968 10,982,494 Net income for year 11,923,526 16,019,567 17,627,855 Cash dividends (note 6) (1,310,518) (1,176,270) (893,943) Tax benefit on non-qualified stock options exercised 58,187 -- -- Stock dividends (note 6) -- -- (18,042,438) ------------- ------------- ------------- Balance at end of year 35,188,460 24,517,265 9,673,968 ------------- ------------- ------------- Treasury stock: Balance at beginning of year (5,438,774) (1,012,592) (1,012,592) Change during year (2,113,560) (4,426,182) -- ------------- ------------- ------------- Balance at end of year (7,552,334) (5,438,774) (1,012,592) ------------- ------------- ------------- Total shareholders' equity at end of year $ 118,562,260 109,352,582 99,441,896 ============= ============= =============
See accompanying notes to consolidated financial statements. 40 41 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 11,923,526 16,019,567 17,627,855 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 4,756,982 4,720,625 4,092,621 Change in deferred Federal income taxes (22,442) (67,145) (60,003) Change in accrued investment income (406,643) 231,051 (251,412) Change in premiums receivable 1,574,653 89,191 (3,651,377) Change in reinsurance balances receivable (448,185) 1,349,492 627,739 Change in ceded unpaid claims and claim adjustment expenses (2,810,872) (2,062,548) (4,678,318) Change in ceded unearned premiums (2,866,259) (10,271,826) (31,218) Change in deferred policy acquisition costs and deferred ceding commission income 1,015,802 (519,257) (2,284,138) Change in management contract 50,000 50,000 50,000 Change in other assets (272,994) (260,110) 297,216 Change in unpaid claims and claim adjustment expenses 7,535,421 10,680,125 14,282,664 Change in unearned premiums (1,250,646) 11,729,830 8,880,310 Change in commissions payable (481,916) 481,984 15,734 Change in accounts payable (1,128,872) 35,232 (626,356) Change in reinsurance balances payable (312,118) (759,133) (4,186,811) Change in deferred revenue 42,507 100,907 71,985 Change in drafts payable 3,174,331 3,649,779 (2,035,093) Change in other liabilities 2,157 (388,508) (40,592) Change in current Federal income taxes (314,296) (1,472,129) 998,521 ------------ ------------ ------------ Net cash provided by operating activities $ 19,760,136 33,337,127 29,099,327 ------------ ------------ ------------
(continued) 41 42 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Cash flows from investing activities: Bonds held to maturity: Matured $ 16,594,930 10,831,897 45,123,950 Purchased (3,434,618) (19,694,034) (41,967,879) Bonds available for sale: Sold 37,694,342 38,403,636 10,741,080 Matured 7,544,426 8,179,440 3,506,400 Purchased (92,169,999) (48,506,215) (46,243,440) Certificates of deposit matured 420,000 450,000 395,000 Certificates of deposit purchased (420,000) (425,000) (445,000) Property and equipment purchased (891,693) (1,385,136) (836,114) Net change in short-term investments 17,838,889 (14,686,870) 4,418,610 ------------ ------------ ------------ Net cash used for investing activities (16,823,723) (26,832,282) (25,307,393) ------------ ------------ ------------ Cash flows from financing activities: Payments on note payable -- (1,750,000) (1,750,000) Cash dividends paid (1,261,530) (1,129,024) (819,972) Payment for fractional shares resulting from stock dividends -- -- (6,358) Proceeds from exercise of common stock options 90,450 70,493 38,489 Treasury stock acquired (2,113,560) (4,426,182) -- ------------ ------------ ------------ Net cash used for financing activities (3,284,640) (7,234,713) (2,537,841) ------------ ------------ ------------ Net increase (decrease) in cash (348,227) (729,868) 1,254,093 Cash at beginning of year 1,044,740 1,774,608 520,515 ------------ ------------ ------------ Cash at end of year $ 696,513 1,044,740 1,774,608 ============ ============ ============
See accompanying notes to consolidated financial statements. 42 43 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 (1) SUMMARY OF ACCOUNTING POLICIES (a) Basis of Consolidation The accompanying consolidated financial statements include the accounts of GAINSCO, INC. (the Company) and its wholly-owned subsidiaries, General Agents Insurance Company of America, Inc. (General Agents), General Agents Premium Finance Company (GAPFCO), Agents Processing Systems, Inc., Risk Retention Administrators, Inc. and GAINSCO Service Corp. (GSC). General Agents has one wholly-owned subsidiary, MGA Insurance Company, Inc. (MGAI) which, in turn, owns 100% of MGA Agency, Inc. GSC has one wholly- owned subsidiary, MGA Premium Finance Company. GSC controls the management contract and charter of GAINSCO County Mutual Insurance Company (GCM) and its accounts have been included in the accompanying consolidated financial statements. All significant intercompany accounts have been eliminated in consolidation. The accompanying consolidated financial statements are prepared in conformity with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Nature of Operations The Company is predominantly a property and casualty insurance company concentrating its efforts on certain specialty excess and surplus markets within the commercial auto, auto garage and general liability insurance lines. The Company is approved to write insurance in 49 states and the District of Columbia on a non-admitted basis and in 45 states on an admitted basis. The Company markets its lines of insurance through 186 non-affiliated general agents' offices. Approximately 71% of the Company's gross premiums written during 1997 resulted from risks located in California, Florida, Kentucky, Louisiana, Pennsylvania, Tennessee and Texas. 43 44 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 (c) Investments Bonds held to maturity are stated at amortized cost, bonds available for sale are stated at fair value. Short-term investments are stated at cost. The "specific identification" method is used to determine costs of investments sold. Since investments not available for sale are held until maturity, provisions for possible losses are recorded only when the values have experienced impairment considered "other than temporary". Proceeds from the sale of bond securities totalled $37,694,342, $38,403,636 and $10,741,080 in 1997, 1996 and 1995, respectively. The realized gains were $384,184, $516,997 and $108,024 in 1997, 1996 and 1995, respectively. The realized losses were $57,279, $45,041 and $0 in 1997, 1996 and 1995, respectively. (d) Financial Instruments For premiums receivable, which include premium finance notes receivable, and all other accounts (except investments) defined as financial instruments in Financial Accounting Standards Board (FASB) Statement 107, "Disclosures About Fair Values of Financial Instruments," the carrying amount approximates fair value due to the short-term nature of these instruments. These balances are disclosed on the face of the balance sheet. Fair values for investments, disclosed in note 2, were obtained from independent brokers and published valuation guides. (e) Deferred Policy Acquisition Costs and Deferred Ceding Commission Income Policy acquisition costs, principally commissions, marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The marketing expenses are predominately salaries, salary related expenses and travel expenses of the Company's marketing representatives who actively solicit business from the independent general agents. 44 45 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The change in the resulting deferred asset is charged (credited) to operations. Information relating to these net deferred amounts, as of and for the years ended December 31, 1997, 1996 and 1995 is summarized as follows:
1997 1996 1995 ---------- ---------- ---------- Asset balance, beginning of period $ 12,633,938 12,114,681 9,830,543 ---------- ---------- ---------- Deferred commissions 19,912,479 21,932,779 21,394,072 Deferred marketing and underwriting expenses 5,335,856 5,854,088 5,506,882 Deferred ceding commission income (85,152) (76,765) (71,227) Amortization (26,178,985) (27,190,845) (24,545,589) ---------- ---------- ---------- Net change (1,015,802) 519,257 2,284,138 ---------- ----------- ---------- Asset balance, end of period $ 11,618,136 12,633,938 12,114,681 ========== ========== ==========
(f) Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets (30 years for buildings and primarily 5 years for furniture, equipment and software). The following schedule summarizes the components of property and equipment:
As of December 31 ---------------------------------- 1997 1996 --------- --------- Land $ 865,383 865,383 Buildings 6,265,159 5,766,278 Furniture and equipment 3,239,458 2,935,259 Software 2,281,597 2,192,984 Accumulated depreciation and amortization (5,710,365) (4,778,524) --------- --------- $ 6,941,232 6,981,380 ========= =========
There are no material capital leases. 45 46 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 (g) Software Costs The Company capitalizes certain costs of developing computer software intended for resale. Costs relating to programs for internal use are recorded in property and equipment and are amortized using the straight-line method over five years or the estimated useful life, whichever is shorter. The deferred cost is also reduced by incidental sales of programs developed for internal use. (h) Treasury Stock The Company records treasury stock in accordance with the "cost method" described in Accounting Principles Board Opinon (APB) 6. The Company held 826,894 shares and 582,962 shares as treasury stock at December 31, 1997 and 1996, respectively, with a cost basis of $9.13 and $9.33 per share, respectively. (i) Premium Revenues Premiums are recognized as earned on a pro rata basis over the period the Company is at risk under the related policy. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of policies in force. (j) Claims and Claim Adjustment Expenses Claims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience. Liabilities for unpaid claims and claim adjustment expenses are based on estimates of ultimate cost of settlement. Changes in claim estimates resulting from the continuous review process and differences between estimates and ultimate payments are reflected in expense for the year in which the revision of these estimates first became known. 46 47 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:
As of and for the years ended December 31 -------------------------------------- 1997 1996 1995 -------- -------- ------ (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $ 105,691 95,011 80,729 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 26,713 24,650 19,972 -------- -------- ------ Net unpaid claims and claim adjustment expenses, beginning of period 78,978 70,361 60,757 -------- -------- ------ Net claims and claim adjustment expenses incurred related to: Current period 53,969 53,037 48,064 Prior periods 8,117 5,342 401 -------- -------- ------ Total net claims and claim adjustment expenses incurred 62,086 58,379 48,465 -------- -------- ------ Net claim and claim adjustment expenses paid related to: Current period 17,807 17,178 14,131 Prior periods 39,554 32,584 26,953(1) -------- -------- ------ Total net claim and claim adjustment expenses paid 57,361 49,762 41,084 -------- -------- ------ Commutation of reinsurance treaties - - (2,223)(1) -------- -------- ------ Net unpaid claims and claim adjustment expenses, end of period 83,703 78,978 70,361 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 29,524 26,713 24,650(1) -------- -------- ------ Unpaid claims and claim adjustment expenses, end of period $ 113,227 105,691 95,011 ======== ======== ======
(1) The Company commuted its 1993 and 1994 quota-share reinsurance treaties in 1995 and thereby reassumed all risks and the related unpaid claims and claim adjustment expenses of $2,223,000 (see note 4 to the consolidated financial statements). This was accounted for using the paid claim method, whereby unpaid claims and claim adjustment expenses were increased $2,223,000 and paid claims and claim adjustment expenses were decreased $2,223,000, thus preventing distortion of claims and claim adjustment expenses incurred. 47 48 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The development in net claims and claim adjustment expenses incurred from prior periods was largely a result of claim reserve increases recorded for commercial auto claims in Kentucky for the 1996 and 1995 accident years and adverse development in claim adjustment expense reserves for commercial auto in the 1996, 1995 and 1994 accident years. (k) Income Taxes The Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the deferred method which provides for timing differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses and the nondeductible portion of the change in unearned premiums. The Company paid income taxes of $3,175,000, $6,617,909 and $5,413,486 during 1997, 1996 and 1995, respectively. (l) Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
1997 1996 1995 ---------- ---------- ---------- Numerator: Net Income $ 11,923,526 16,019,567 17,627,855 ------------ ------------ ------------ Denominator: Denominator for basic earnings per share- weighted average shares 20,996,386 21,441,389 21,512,741 Effect of dilutive securities: Employee stock options 248,863 280,274 309,549 ------------ ------------ ------------ Denominator for diluted earnings per share- weighted average shares and assumed conversions 21,245,249 21,721,663 21,822,290 ============ ============ ============ Basic earnings per share $ .57 $ .75 $ .82 ============ ============ ============ Diluted earnings per share $ .56 $ .74 $ .81 ============ ============ ============
48 49 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 (m) Stock-Based Compensation In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (Statement 123). Statement 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under Statement 123, the Company elects to measure compensation costs using the intrinsic value based method of accounting prescribed by APB 25. (n) Accounting Pronouncements In February 1997, the FASB issued Statement 128, "Earnings Per Share". The Statement was effective for financial statements issued for periods ending after December 15, 1997. Earnings per share for prior years presented in these financial statements have been restated to comply with Statement 128. (2) INVESTMENTS The following schedule summarizes the components of net investment income:
Years ended December 31 -------------------------------------------------------------- Investment income on: 1997 1996 1995 ------------- ------------- ------------- Fixed maturities $ 9,218,089 8,331,441 7,481,087 Short-term investments 782,051 1,055,481 870,210 ------------- ------------- ------------- 10,000,140 9,386,922 8,351,297 Investment expenses (269,008) (226,404) (193,813) ------------- ------------- ------------- Net investment income $ 9,731,132 9,160,518 8,157,484 ============= ============= =============
49 50 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The following schedule summarizes the amortized cost and estimated fair values of investments in debt securities:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ------------- ----------- --------- (Amounts in thousands) Fixed Maturities: Bonds held to maturity: US Government Securities-1997 $ 5,404 79 (7) 5,476 US Government Securities-1996 7,731 41 (24) 7,748 Tax-exempt state & municipal bonds-1997 84,330 855 (133) 85,052 Tax-exempt state & municipal bonds-1996 97,199 875 (97) 97,977 Bonds available for sale: US Government Securities-1997 27,322 83 (1) 27,404 US Government Securities-1996 - - - - Tax-exempt state & municipal bonds-1997 94,700 1,580 (34) 96,246 Tax-exempt state & municipal bonds-1996 76,880 896 (132) 77,644 Certificates of Deposit - 1997 595 - - 595 Certificates of Deposit - 1996 595 - - 595 Total Fixed Maturities-1997 $ 212,351 2,597 (175) 214,773 Total Fixed Maturities-1996 182,405 1,812 (253) 183,964
The amortized cost and estimated fair value of debt securities at December 31, 1997 and 1996, by maturity, are shown below.
1997 1996 ------------------------- -------------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value ---------- ---------- ---------- ---------- (Amounts in thousands) Due in one year or less $ 35,142 35,187 18,754 19,061 Due after one year but within five years 140,571 141,871 135,052 136,185 Due after five years but within ten years 30,608 31,527 23,059 23,165 Due after ten years but within twenty years 6,030 6,188 5,540 5,553 ---------- ---------- ---------- ---------- $ 212,351 214,773 182,405 183,964 ========== ========== ========== ==========
50 51 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 Investments of $1,100,000 were maintained in escrow at December 31, 1996 on behalf of certain insurance companies under the terms of their reinsurance agreements with General Agents. In addition, investments of $12,965,000 and $12,615,000, at December 31, 1997 and 1996, respectively, were on deposit with various regulatory bodies as required by law. The FASB has issued Statement 115 "Accounting for Certain Investments in Debt and Equity Securities" (Statement 115). Under this statement, the Company carries certain debt securities classified as "available for sale" at fair value. The unrealized gain or loss, net of tax, is presented as a separate component of shareholders' equity. (3) NOTE PAYABLE TO BANK The Company made a principal payment of $1,750,000 in May, 1996. This payment represented the retirement of the note. Interest was paid monthly at a rate that approximated the prime lending rate. The Company recorded interest expense (which approximates interest paid) of $61,335 and $221,934 in 1996 and 1995, respectively. (4) REINSURANCE In 1997, 1996 and 1995, General Agents and MGAI (the Insurers) wrote casualty policy limits of $1,000,000. For policies with an effective date occurring in 1995 or after, the Insurers have excess reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 policy limits. The Company's excess reinsurance is provided in varying amounts by three reinsurers rated "A- (Excellent)" or better by A. M. Best Company. In 1995, the Insurers terminated the quota-share reinsurance treaties that were in effect for 1994 and 1993. Under the terms of the termination agreement, the reinsurer returned assets to the Insurers equal to the remaining unpaid claims and claim adjustment expenses of $2,223,000. The Insurers reassumed all risks and the reinsurer was relieved of any further liability with respect to risks previously covered by the contract. During 1996 and 1995, GCM entered into fronting arrangements with non-affiliated insurance companies. GCM retains no portion as the business written under these agreements is 100% ceded. Although these cessions are made to authorized reinsurers rated "A- (Excellent)" or better by A. M. Best Company, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. The balances in such accounts as of December 31, 1997 and 1996 total $29,943,000 and $20,174,000, respectively. The amounts deducted in the consolidated financial statements for reinsurance ceded as of and for the years ended December 31, 1997, 1996, and 1995 respectively, are set forth in the following table. 51 52 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 Premiums and claims ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi and Pennsylvania are designated as "plan servicing".
1997 1996 1995 ------------- ------------- ------------- Premiums earned $ 1,709,053 1,929,455 3,809,853 Premiums earned - plan servicing $ 4,090,774 4,760,785 5,307,038 Premiums earned - fronting arrangements $ 33,106,441 16,081,808 721,752 Claims and claim adjustment expenses $ 2,200,182 (206,429) 13,188,258 Claims and claim adjustment expenses - plan servicing $ 4,569,993 6,886,339 5,055,997 Claim and claim adjustment expenses - fronting arrangements $ 24,616,491 11,317,277 418,573
The amounts included in the Consolidated Balance Sheets for reinsurance ceded under fronting arrangements and reinsurance ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania were as follows:
1997 1996 1995 ---------------- -------------- -------------- Unearned premiums $ 1,552,654 2,149,286 2,836,492 Unearned premiums - fronting arrangements $ 17,160,782 13,625,619 2,544,837 Unpaid claims and claim adjustment expenses $ 9,431,814 11,012,699 9,842,815 Unpaid claims and claim adjustment expenses - fronting arrangements $ 8,623,890 4,321,085 266,720
52 53 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The Insurers remain directly liable to their policyholders for all policy obligations and the reinsuring companies are obligated to the Insurers to the extent of the reinsured portion of the risks. The Insurers, for years prior to 1993, utilized reinsurance arrangements with various non-affiliated admitted insurance companies, whereby the Insurers underwrote the coverage and assumed the policies 100% from the companies. During 1995, 1994 and 1993, the business generated from these arrangements was in a run-off position. These arrangements require that the Insurers maintain escrow accounts to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to risks insured through such arrangements and assumed by the Insurers. For the years ended December 31, 1997, 1996, and 1995, the balance in such escrow accounts totalled $0, $1,100,000 and $1,100,000, respectively. For 1997, 1996 and 1995, the premiums earned by assumption were $0, $0 and $(2,496), respectively and the assumed unpaid claims and claim adjustment expenses were $810,000, $1,845,000 and $4,427,000, respectively. The Company has not and does not intend to utilize retrospectively rated reinsurance contracts with indefinite renewal terms. This form of reinsurance is commonly known as a "funded cover". Under a funded cover reinsurance arrangement, an insurance company essentially deposits money with a reinsurer to help cover future losses and records the "deposit" as an expense instead of as an asset; or, the insurance company can borrow from a reinsurer recording the "loan" as income instead of as a liability with the future "loan" payments recorded as expense when the payments are made. (5) FEDERAL INCOME TAXES In the accompanying consolidated statements of operations, the provisions for Federal income tax as a percent of related pretax income differ from the Federal statutory income tax rate. A reconciliation of income tax expense using the Federal statutory rates to actual income tax expense follows:
1997 1996 1995 --------------- ------------ ------------ Income tax expense at 35% $ 5,166,625 7,384,371 8,392,950 Tax-exempt interest income (2,486,582) (2,308,364) (2,039,995) Building rehabilitation tax credit (41,984) (77,102) - Other, net 200,203 79,730 (951) ------------- ------------- ------------- Income tax expense $ 2,838,262 5,078,635 6,352,004 ============= ============= =============
The FASB issued Statement 109 "Accounting for Income Taxes" which changed the Company's method of accounting for income taxes. Under APB 11, the primary objective was to match the tax expense with pre-tax operating income on the statement of operations. Under Statement 109, the primary objective is to establish deferred tax assets and liabilities for the temporary differences 53 54 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. As a consequence, the portion of the tax expense which is a result of the change in the deferred tax asset or liability may not always be consistent with the income reported on the statement of operations. In the Company's opinion, there will be adequate earnings in future years to recover its deferred tax asset and as such, the Company has not established a valuation allowance. The following table represents the tax effect of temporary differences giving rise to the net deferred tax asset established under Statement 109.
As of December 31 -------------------------- 1997 1996 ----------- ----------- Deferred tax assets: Discounting of unpaid claims and claim adjustment expenses $ 4,375,152 4,475,305 Discounting of unearned premiums 3,158,477 3,463,159 Deferred service fee income 214,164 207,584 Other 34,026 41,640 ----------- ----------- Total deferred tax assets 7,781,819 8,187,688 ----------- ----------- Deferred tax liabilities: Deferred policy acquisition costs and deferred ceding commission income 4,086,944 4,452,344 Unrealized gains on investments 569,837 267,440 Depreciation and amortization 386,463 504,547 Capitalized software 56,248 4,631 Other 5,772 2,216 ----------- ----------- Total deferred tax liabilities 5,105,264 5,231,178 ----------- ----------- Net deferred tax asset $ 2,676,555 2,956,510 =========== ===========
(6) SHAREHOLDERS' EQUITY The Company has 250,000,000 shares of authorized $.10 par value common stock. Of the authorized shares, 21,701,118 and 21,670,369 were issued as of December 31, 1997 and 1996, respectively and 20,874,224 and 21,087,407 were outstanding as of December 31, 1997 and 1996, respectively. The Company also has 10,000,000 shares of preferred stock with $100 par value authorized of which no shares have been issued. The Board of Directors can designate the relative rights and preferences of the authorized preferred stock to be issued. In 1991, the Company adopted a policy to pay a quarterly cash dividend of $.01 per share on its common stock every quarter until further action by the Board of Directors. The Board of Directors increased the cash dividend to: $.0125 per share in November of 1995, $.015 per share in August of 1996, and $.0175 per share in November of 1997. In November of 1995, the Board of Directors announced the discontinuance of the semi-annual stock dividends. The Board of Directors granted 5% stock dividends to shareholders of record on March 31, 1995 and September 30, 1995. The market value of the stock dividends was charged to retained earnings, common stock was credited for 54 55 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 the par value, the excess of market value over par value was credited to additional paid-in capital and cash was paid in lieu of issuing fractional shares. The earnings per share computation and the number of stock options and their exercise price have been retroactively adjusted for the effect of the stock dividends. The amount of consolidated statutory shareholder's equity or policyholders' surplus of General Agents and MGAI was $76,495,883, $57,011,890 and $47,880,301 at December 31, 1997, 1996 and 1995, respectively, and the amount of consolidated statutory net income was $14,155,450, $15,829,108 and $15,167,151 for the years ended 1997, 1996, and 1995, respectively. The amount of policyholders' surplus of GCM was $2,000,000, $2,000,001 and $2,260,001 at December 31, 1997, 1996 and 1995, respectively, and the amount of statutory net income was $44,569, $115,563 and $369,356 for the years ended December 31, 1997, 1996 and 1995, respectively. The Company's statutory capital significantly exceeds the benchmark capital level under the Risk Based Capital formula for its major insurance companies. Statutes in Texas and Oklahoma restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds derived from their realized net profits. The maximum amount of cash dividends that each subsidiary may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. At December 31, 1997, General Agents, the Oklahoma subsidiary, had net income of $15,449,442 and policyholders' surplus of $76,495,883 and MGAI, the Texas subsidiary, had net income of $3,456,008 and policyholders' surplus of $21,026,541. In 1988, the Board of Directors declared, pursuant to a Rights Plan, a dividend distribution of one common share purchase right on each outstanding share of $.10 par value common stock. The dividend distribution was made on March 18, 1988, payable to shareholders of record on that date. In 1993, the Board of Directors amended the Rights Plan and extended the expiration date of these rights from March 18, 1998 to May 25, 2003. Each right, as amended during 1993, has an exercise price of $70. The rights are not exercisable until the Distribution Date (as defined in the Rights Plan). The Rights Plan provides, among other things, that if any person or group (other than the Company, one of its subsidiaries or an employee benefit plan of the Company or a subsidiary) acquires 20% or more of the Company's common stock (except pursuant to an offer for all outstanding common stock which the Continuing Directors (as defined in the Rights Plan) have determined to be in the best interests of the Company and its shareholders), if a 20% holder engages in certain self-dealing transactions or if a holder of 15% or more of the Company's common stock is declared an Adverse Person (as defined in the Rights Plan) by the Board of Directors, each holder of a right (other than the 20% holder or the Adverse Person, whose rights would become null and void) would have the right to receive, upon exercise of the right, common stock having a market value of two times the exercise price of the right. The Company is able to redeem rights under certain conditions set forth in the Rights Plan. If, following a public announcement that a person has acquired 20% or more of the common stock, the Company is acquired in a merger (other than a merger which follows an offer approved by the Continuing Directors as defined in the Rights Plan) or other business combination transaction or if 50% of the assets or earning power of the Company is sold, each right (except rights 55 56 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 which have previously become null and void as described above), will entitle its holder to purchase, at the right's then-current exercise price, shares of the acquiring Company's common stock having a market value of two times the exercise price of the right. (7) BENEFIT PLANS At December 31, 1997, the Company had two stock option plans, the 1990 Stock Option Plan (90 Plan) and the 1995 Stock Option Plan (95 Plan). Under the 90 Plan, all options available have been granted and are fully vested. Any unexercised options will expire in the year 2000. The 95 Plan approved by the shareholders on May 10, 1996, reserved 1,071,000 shares for issuance under this plan. Options granted under the 95 Plan have a maximum ten year term and are exercisable at the rate of 20% immediately upon grant and 20% on each of the first four anniversaries of the grant date. The exercise price of each option equals the market price of the Company's stock on the date of grant. A summary of the status of the Company's outstanding options as of December 31, 1997 and 1996, and changes during the years ended December 31, 1997 and 1996 is presented below:
1997 1996 ------------------------------------ ---------------------------------- Underlying Weighted Average Underlying Weighted Average Shares Exercise Price Shares Exercise Price ------ -------------- ---------- ---------------- Options --------------- Outstanding, beginning of period 1,352,786 $ 8.38 401,277 $ 2.60 Granted 158,425 $ 8.60 984,397 $ 10.57 Exercised (30,749) $ 2.94 (32,888) $ 2.14 Forfeited (127,749) $ 10.63 - ---------- ---------- Outstanding, end of period 1,352,713 $ 8.32 1,352,786 $ 8.38 ========== ========== Options exercisable at end of period 711,978 565,265 Weighted-average fair value of options granted during the period $ 4.82 $ 4.43
56 57 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 The following table summarizes information for the stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable --------------------------------------------------- --------------------------------- Number Weighted Average Weighted Number Weighted Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/97 Contractual Life Exercise Price at 12/31/97 Exercise Price --------------- ----------- ---------------- -------------- ----------- -------------- $ 2 to 9 461,449 4.57 years $ 4.08 362,401 $ 2.89 $ 9 to 11 891,264 8.45 years $ 10.51 349,577 $ 10.53 --------- --------- $ 2 to 11 1,352,713 6.91 years $ 8.32 711,978 $ 6.65 ========= =========
The Company applies APB 25 and related Intepretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost been determined consistent with Statement 123 for the options granted, the Company's net income and earnings per share would have been the pro forma amounts indicated below:
Year ended Year ended ----------------- ----------------- December 31, 1997 December 31, 1996 ----------------- ----------------- Net income As reported $ 11,923,526 16,019,567 Pro forma $ 11,368,790 15,504,676 Basic earnings per share As reported $ .57 .75 Pro forma $ .54 .72 Diluted earnings per share As reported $ .56 .74 Pro forma $ .54 .71
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for 1997 and 1996, respectively: expected volatility of 33.6% and 34.0%, risk free interest rates of 5.88% and 6.05%, expected dividend yields of .74% and .57% and an expected life of 7.5 years for both periods presented. The Company has a profit sharing and trust plan for the benefit of its eligible employees. Contributions are made in such amounts as the Company elects. The annual contributions amounted to $396,838, $578,107, and $605,935 for 1997, 1996 and 1995, respectively. The Company has an incentive compensation plan in which certain key officers of the Company participate and earn bonuses. The fund from which bonuses are paid is comprised of net income for 57 58 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 the current year that is in excess of ten percent (10%) of beginning shareholders' equity for the current year, with the fund not to exceed ten percent (10%) of net income for the current year. (8) CONTINGENCIES In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover possible liability from lawsuits which arise in the normal course of its insurance business. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of all claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company does not have any financial instruments where there is off-balance-sheet-risk of accounting loss due to credit or market risk. There is credit risk in the premiums receivable and reinsurance balances receivable of the Company. At December 31, 1997 and 1996 the Company did not have a premiums receivable balance nor a reinsurance balance receivable from any one entity that was material with regard to shareholders' equity. (9) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table contains selected unaudited consolidated financial data for each quarter (in thousands, except per share data):
1997 Quarter 1996 Quarter ------------------------------------- ----------------------------------- Fourth Third Second First Fourth Third Second First -------- ------- ------ ----- ------ ------ ------ ------ Gross premiums written $ 26,763 23,055 26,938 23,020 29,107 27,065 29,240 24,588 Total revenues 28,816 28,484 28,850 28,795 30,317 30,067 29,460 28,960 Total expenses 25,381 27,253 22,980 24,570 25,192 26,000 23,331 23,184 Net income 2,887 1,464 4,409 3,164 3,933 3,298 4,514 4,275 Earnings per share(a): Basic $ .14 .07 .21 .15 .19 .15 .21 .20 Diluted $ .14 .07 .21 .15 .18 .15 .21 .20 Common share prices (b) High 10 3/16 9 15/16 9 3/8 10 10 3/4 10 3/4 11 5/8 11 3/4 Low 8 8 1/2 8 1/8 8 3/4 8 3/4 9 3/8 9 7/8 9 3/4
(a) All periods have been restated to comply with FASB Statement 128, "Earnings Per Share". (b) As reported by the American Stock Exchange from January 1, 1996 to July 30, 1996. As reported by the New York Stock Exchange thereafter. 58 59 INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION The Board of Directors and Shareholders GAINSCO, INC: Under date of February 16, 1998, we reported on the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. 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 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP Dallas, Texas February 16, 1998 59 60 Schedule I GAINSCO, INC. AND SUBSIDIARIES Summary of Investments - Other Than Investments in Related Parties (Amounts in thousands)
As of December 31 ------------------------------------------------------------------------ 1997 1996 1995 -------------------- -------------------- --------------------- Amortized Fair Amortized Fair Amortized Fair Type of Investment Cost Value Cost Value Cost Value - ------------------ ---------- ----- --------- ----- --------- ----- Fixed Maturities: Bonds held to maturity: U.S. government securities $ 5,404 5,476 7,731 7,748 9,606 9,733 Tax exempt state and municipal bonds 84,330 85,052 97,199 97,977 87,696 88,689 Bonds available for sale: U.S. government securities 27,322 27,404 -- -- -- -- Tax exempt state and municipal bonds 94,700 96,246 76,880 77,644 77,478 79,130 Certificates of deposit 595 595 595 595 620 620 -------- -------- -------- -------- -------- -------- Total fixed maturities 212,351 214,773 182,405 183,964 175,400 178,172 -------- -------- -------- -------- -------- -------- Short-term investments 2,823 2,823 20,662 20,662 5,975 5,975 -------- -------- -------- -------- -------- -------- Total investments $215,174 217,596 203,067 204,626 181,375 184,147 ======== ======== ======== ======== ======== ========
See accompanying independent auditors' report on supplementary information. 60 61 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Balance Sheets December 31, 1997 and 1996
Assets 1997 1996 ------ ------------- ------------- Investments in subsidiaries $ 117,359,673 102,217,935 Cash 1,614 8,243 Net receivables from subsidiaries 1,308,015 7,289,111 Short-term investments 83,475 -- Other assets 191,716 159,492 ------------- ------------- Total assets $ 118,944,493 109,674,781 ============= ============= Liabilities and Shareholders' Equity Liabilities: Accounts payable $ 16,933 5,887 Dividends payable 365,300 316,312 ------------- ------------- Total liabilities 382,233 322,199 ------------- ------------- Shareholders' equity: Preferred stock ($100 par value, 10,000,000 shares authorized, none issued) -- -- Common stock ($.10 par value, 250,000,000 shares authorized, 21,701,118 issued at December 31, 1997 and 21,670,369 issued at December 31, 1996) 2,170,112 2,167,037 Additional paid-in capital 87,697,754 87,610,379 Net unrealized gains on fixed maturities 1,058,268 496,675 Retained earnings 35,188,460 24,517,265 Treasury stock, at cost (826,894 shares in 1997, 582,962 shares in 1996) (7,552,334) (5,438,774) ------------- ------------- Total shareholders' equity 118,562,260 109,352,582 ------------- ------------- Total liabilities and shareholders' equity $ 118,944,493 109,674,781 ============= =============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 61 62 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Operations Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Revenues - dividend income $ 3,700,000 9,900,000 3,115,000 Investment Income 3,779 -- -- Expenses - operating expenses (1,367,178) (1,191,222) (1,092,470) ------------ ------------ ------------ Operating income before Federal income tax benefit 2,336,601 8,708,778 2,022,530 Federal income tax benefit (455,679) (467,559) (366,716) ------------ ------------ ------------ Income before equity in undistributed income of subsidiaries 2,792,280 9,176,337 2,389,246 Equity in undistributed income of subsidiaries 9,131,246 6,843,230 15,238,609 ------------ ------------ ------------ Net income $ 11,923,526 16,019,567 17,627,855 ============ ============ ============ Earnings per share: Basic $ .57 .75 .82 ============ ============ ============ Diluted .56 .74 .81 ============ ============ ============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 62 63 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ----------- ----------- ----------- Common Stock: Balance at beginning of year $ 2,167,037 2,163,748 1,961,137 Issue of shares as stock dividends (2,009,797 in 1995) -- -- 200,980 Exercise of options to purchase shares (30,749 in 1997, 32,888 in 1996 and 16,316 in 1995) 3,075 3,289 1,631 ----------- ----------- ----------- Balance at end of year 2,170,112 2,167,037 2,163,748 ----------- ----------- ----------- Additional paid-in capital: Balance at beginning of year 87,610,379 87,543,175 69,671,214 Issue of shares as stock dividends (2,009,797 in 1995) -- -- 17,835,103 Exercise of options to purchase shares (30,749 in 1997, 32,888 in 1996 and 16,316 in 1995) 87,375 67,204 36,858 ----------- ----------- ----------- Balance at end of year $87,697,754 87,610,379 87,543,175 ----------- ----------- -----------
(continued) 63 64 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Net unrealized gains (losses) on fixed maturities: Balance at beginning of year $ 496,675 1,073,597 (55,686) Change during year 561,593 (576,922) 1,129,283 ------------ ------------ ------------ Balance at end of year 1,058,268 496,675 1,073,597 ------------ ------------ ------------ Retained earnings: Balance at beginning of year 24,517,265 9,673,968 10,982,494 Net income for year 11,923,526 16,019,567 17,627,855 Cash dividends (1,310,518) (1,176,270) (893,943) Tax benefit on non-qualified stock options exercised 58,187 -- -- Stock dividends -- -- (18,042,438) ------------ ------------ ------------ Balance at end of year 35,188,460 24,517,265 9,673,968 ------------ ------------ ------------ Treasury stock: Balance at beginning of year (5,438,774) (1,012,592) (1,012,592) Change during year (2,113,560) (4,426,182) -- ------------ ------------ ------------ Balance at end of year (7,552,334) (5,438,774) (1,012,592) ------------ ------------ ------------ Total shareholders' equity at end of year $118,562,260 109,352,582 99,441,896 ============ =========== ============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 64 65 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 11,923,526 16,019,567 17,627,855 Adjustments to reconcile net income to cash provided by operating activities: Change in investments in subsidiaries (5,390,712) -- -- Change in net receivable from subsidiaries 5,981,096 (3,593,152) (1,575,085) Change in other assets (32,224) (95,992) (6,750) Change in accounts payable 11,046 5,887 (18,798) Change in other liabilities -- (900) -- Equity in income of subsidiaries (9,131,246) (6,843,230) (15,238,609) ------------ ------------ ------------ Net cash provided by operating activities 3,361,486 5,492,180 788,613 ------------ ------------ ------------ Cash flows from investing activities: Net change in short-term investments (83,475) -- -- ------------ ------------ ------------ Net cash used for investing activities $ (83,475) -- -- ------------ ------------ ------------
(continued) 65 66 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ----------- ----------- ----------- Cash flows from financing activities: Cash dividends paid $(1,261,530) (1,129,024) (819,972) Payments for fractional shares resulting from stock dividends -- -- (6,358) Proceeds from exercise of common stock options 90,450 70,493 38,489 Treasury stock acquired (2,113,560) (4,426,182) -- ----------- ----------- ----------- Net cash used for financing activities (3,284,640) (5,484,713) (787,841) ----------- ----------- ----------- Net increase (decrease) in cash (6,629) 7,467 772 Cash at beginning of year 8,243 776 4 ----------- ----------- ----------- Cash at end of year $ 1,614 8,243 776 =========== =========== ===========
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 66 67 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Notes to Condensed Financial Statements December 31, 1997, 1996 and 1995 (1) GENERAL The accompanying condensed financial statements should be read in conjunction with the notes to the consolidated financial statements for the years ended December 31, 1997, 1996 and 1995 included elsewhere in this Annual Report. (2) RELATED PARTIES During 1997, the Company made a capital contribution to GAINSCO Service Corp. by forgiving an intercompany debt in the amount of $5,390,712. The following table presents the components of the Net receivables from subsidiaries at December 31, 1997 and 1996:
Name of Subsidiary 1997 1996 ------------------ ----------- ------------ Agents Processing Systems, Inc. $ 883,224 439,711 GAINSCO Service Corp. 218,287 5,677,163 General Agents Insurance Company of America, Inc. 206,504 1,172,237 ----------- --------- Net receivable from subsidiaries $ 1,308,015 7,289,111 =========== =========
See accompanying independent auditors' report on supplementary information. 67 68 Schedule III GAINSCO, INC. AND SUBSIDIARIES Supplementary Insurance Information Years ended December, 1997, 1996 and 1995 (Amounts in thousands)
Other Deferred Reserves policy policy for claims claims and Net acquisition and claim Unearned benefits premiums Segment costs expenses premiums payable earned - ------- ------- ---------- -------- --------- -------- Year ended December 31, 1997 Property and casualty insurance $ 11,618 113,227 64,005 9,393 102,256 -------- ------- ------ ----- ------- Total $ 11,618 113,227 64,005 9,393 102,256 ======== ======= ====== ===== ======= Year ended December 31, 1996 Property and casualty insurance $ 12,634 105,691 65,255 6,219 106,793 -------- ------- ------ ----- ------- Total $ 12,634 105,691 65,255 6,219 106,793 ======== ======= ====== ===== ======= Year ended December 31, 1995 Property and casualty insurance $ 12,115 95,011 53,525 2,569 97,255 -------- ------ ------ ----- ------ Total $ 12,115 95,011 53,525 2,569 97,255 ======== ====== ====== ===== ====== Amortization of deferred Other Net Claims policy operating Net investment & claim acquisition costs and premiums Segment income expenses costs (1) expenses written - ------- -------- -------- ----------- --------- -------- Year ended December 31, 1997 Property and casualty insurance 9,731 62,086 (26,179) 37,082 98,139 ----- ------ ------- ------ ------ Total 9,731 62,086 (26,179) 37,082 98,139 ===== ====== ====== ====== ====== Year ended December 31, 1996 Property and casualty insurance 9,161 58,379 (27,191) 39,847 108,251 ----- ------ ------ ------ ------- Total 9,161 58,379 (27,191) 39,847 108,251 ===== ====== ====== ====== ======= Year ended December 31, 1995 Property and casualty insurance 8,157 48,465 (24,546) 37,542 106,104 ----- ------ ------ ------ ------- Total 8,157 48,465 (24,546) 37,542 106,104 ===== ====== ====== ====== =======
(1) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 69 Schedule IV GAINSCO, INC. AND SUBSIDIARIES Reinsurance Years ended December 31, 1997, 1996 and 1995 (Amounts in thousands, except percentages)
Percentage Ceded to Assumed from of amount Direct other other Net assumed amount companies companies amount to net ------ --------- --------- ------ ------- Year ended December 31, 1997: Premiums earned: Property and casualty $ 137,071 -- -- 137,071 Reinsurance -- (34,815) -- (34,815) --------- ------ --------- ------- Total $ 137,071 (34,815) -- 102,256 -- % ========= ====== ========= ======= ==== Year ended December 31, 1996: Premiums earned: Property and casualty $ 125,112 -- -- 125,112 Reinsurance -- (18,319) -- (18,319) --------- ------ --------- ------- Total $ 125,112 (18,319) -- 106,793 -- % ========= ====== ========= ======= ==== Year ended December 31, 1995: Premiums earned: Property and casualty $ 102,779 -- -- 102,779 Reinsurance -- (5,522) (2) (5,524) --------- ----- --------- ------- Total $ 102,779 (5,522) (2) 97,255 -- % ========= ===== ========= ======= ====
See accompanying independent auditors' report on supplementary information. 69 70 Schedule VI GAINSCO, INC. AND SUBSIDIARIES Supplemental Information Years ended December 31, 1997, 1996 and 1995 (Amounts in thousands)
Column A Column B Column C Column D Column E Column F -------- -------- -------- -------- -------- -------- Reserves for unpaid Discount Deferred claims if any, Affiliation policy and claim deducted with acquisition adjustment in Unearned Net earned registrant costs expenses Column C premiums premiums ---------- ------- ---------- -------- -------- -------- Year ended December 31, 1997 Property and casualty insurance $ -- 11,618 113,227 -- 64,005 102,256 -- ------ ------- --- ------ ------- Total $ -- 11,618 113,227 -- 64,005 102,256 == ====== ======= === ====== ======= Year ended December 31, 1996 Property and casualty insurance $ -- 12,634 105,691 -- 65,255 106,793 -- ------ ------- --- ------ ------- Total $ -- 12,634 105,691 -- 65,255 106,793 == ====== ======= === ====== ======= Year ended December 31, 1995 Property and casualty insurance $ -- 12,115 95,011 -- 53,525 97,255 -- ------ ------ --- ------ ------ Total $ -- 12,115 95,011 -- 53,525 97,255 == ====== ====== === ====== ====== Column H Column I Column J Column K Column L -------- -------- -------- -------- -------- Claim and claim adjustment expenses Amortization Paid incurred of deferred claims Net related to: policy and claim Net investment Current Prior acquisition adjustment premium income year years costs (1) expenses written -------- ---- ----- ----------- ---------- ------- Year ended December 31, 1997 Property and casualty insurance 9,731 53,969 8,117 (26,179) 57,361 98,139 ----- ------ ----- ------ ------ ------ Total 9,731 53,969 8,117 (26,179) 57,361 98,139 ===== ====== ===== ====== ====== ====== Year ended December 31, 1996 Property and casualty insurance 9,161 53,037 5,342 (27,191) 49,762 108,251 ----- ------ ----- ------ ------ ------- Total 9,161 53,037 5,342 (27,191) 49,762 108,251 ===== ====== ===== ====== ====== ======= Year ended December 31, 1995 Property and casualty insurance 8,157 48,064 401 (24,546) 38,861 106,104 ----- ------ --- ------ ------ ------- Total 8,157 48,064 401 (24,546) 38,861 106,104 ===== ====== === ====== ====== =======
(1) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 71 EXHIBIT INDEX
Sequentially Exhibit No. Description No. Page ----------- ----------- -------- 3.1 Restated Articles of Incorporation of Registrant (Exhibit 3.1)(1) 3.2 Articles of Amendment to the Articles of Incorporation dated June 9, 1988 (Exhibit 3.2)(2) 3.6 Articles of Amendment to Articles of Incorporation effective August 13, 1993 (Exhibit 3.6)(7) 3.7 Bylaws of Registrant as restated on February 18, 1998 (11) 4.2 Rights Agreement, dated as of March 3, 1988, between the Registrant and Team Bank/Fort Worth, N.A. (incorporated by reference to Exhibit 1 to the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 15, 1988) (Exhibit 4.2)(3) 4.3 Amendment No. 1 dated as of March 5, 1990 to Rights Agreement dated as of March 3, 1988 between GAINSCO, INC. and Team Bank as Rights Agent (Exhibit 4.2)(5) 4.4 Amendment No. 2 dated as of May 25, 1993 to Rights Agreement between GAINSCO, INC. and Society National Bank (successor to Team Bank (formerly Texas American Bank/Fort Worth, N.A.)), as Rights Agent (Exhibit 4.4)(7) 4.6 Revised Form of Common Stock Certificate (Exhibit 4.6) (10) 10.2 (Restated) Incentive Compensation Plan of the Registrant (Exhibit 10.2)(2) 10.16 1990 Stock Option Plan of the Registrant (Exhibit 10.16)(4) 10.23 Surplus Debenture issued by GAINSCO County Mutual Insurance Company. (Exhibit 10.23)(6) 10.24 Management Contract between GAINSCO County Mutual Insurance Company and GAINSCO Service Corp. (Exhibit 10.24)(6) 10.25 Certificate of Authority and accompanying Commissioner's Order granting Certificate of Authority, allowing for charter amendments and extension of charter (Exhibit 10.25)(6) 10.27 Amendment to Surplus Debenture issued by GAINSCO County Mutual Insurance Company (Exhibit 10.27)(7) 10.28 Agreement dated August 26, 1994 appointing Continental Stock Transfer & Trust Company transfer agent and registrar (Exhibit 10.28)(8).
71 72
Sequentially Exhibit No. Description No. Page ----------- ----------- -------- 10.29 Amendment No. 3 to Rights Agreement and appointment of Continental Stock Transfer & Trust Company as Successor Rights Agent, made September 30, 1994 (Exhibit 10.29)(8). 10.31 1995 Stock Option Plan of the Registrant (Exhibit 10.31)(9) 10.32 Clarification to the GAINSCO, INC. Executive Incentive Compensation Plan (Exhibit 10.32)(9) 10.36 Form of Change of Control Agreements (11) 11 (Not required to be filed as an Exhibit. See footnote (1)(l) on page 48 of this 10-K Report for information called for by number 11 of the Exhibit Table to Item 601 of SK) 22.2 Subsidiaries of Registrant (11) 24.2 Consent of KPMG Peat Marwick to incorporation by reference (11) 25.1 Powers of Attorney (11) 27 Financial Data Schedule (11) (1) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration Statement No. 33-7846 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 6, 1986. (2) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration 33-25226 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 14, 1988. (3) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. (4) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. (5) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (6) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (7) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
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Sequentially Exhibit No. Description No. Page ----------- ----------- -------- (8) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (9) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (10) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. (11) Filed herewith.
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EX-3.7 2 BYLAWS OF THE COMPANY 1 EXHIBIT 3.7 BYLAWS OF GAINSCO, INC. As amended as of February 18, 1998 Contents ARTICLE 1: OFFICES 1.01 Registered Office and Agent 1.02 Other Offices ARTICLE 2: SHAREHOLDERS 2.01 Place of Meetings 2.02 Annual Meeting 2.03 Voting List 2.04 Special Meetings 2.05 Notice 2.06 Quorum 2.07 Majority Vote; Withdrawal of Quorum 2.08 Method of Voting 2.09 Record Date; Closing Transfer Books 2.10 Action Without Meeting 2.11 Order of Business at Meetings ARTICLE 3: DIRECTORS 3.01 Management 3.02 Number; Qualifications; Election; and Term 3.03 Change in Number 3.04 Removal 3.05 Vacancies 3.06 Election of Directors 3.07 Place of Meetings 3.08 First Meeting 3.09 Regular Meetings 3.10 Special Meetings 3.11 Quorum; Majority Vote 3.12 Compensation 3.13 Procedure 3.14 Interested Directors and Officers 3.15 Action Without Meeting 3.16 Advisory Directors ARTICLE 4: NOTICE AND ATTENDANCE THROUGH USE OF ELECTRONIC EQUIPMENT 4.01 Method 4.02 Waiver 4.03 Telephone and Similar Meetings i. 2 ARTICLE 5: OFFICERS AND AGENTS 5.01 Number; Qualification; Election; Term 5.02 Removal 5.03 Vacancies 5.04 Authority 5.05 Compensation 5.06 President 5.07 Vice Presidents 5.08 Secretary 5.09 Assistant Secretary 5.10 Treasurer 5.11 Assistant Treasurer 5.12 Chairman of the Board 5.13 Vice-Chairman of the Board 5.14 Second Vice Presidents ARTICLE 6: CERTIFICATES AND SHAREHOLDERS 6.01 Certificates 6.02 Issuance 6.03 Payment for Shares 6.04 Subscriptions 6.05 Lien 6.06 Lost, Stolen or Destroyed Certificates 6.07 Registration of Transfer 6.08 Registered Shareholders 6.09 Denial of Preemptive Rights ARTICLE 7: GENERAL PROVISIONS 7.01 Dividends and Reserves 7.02 Books and Records 7.03 Annual Statement 7.04 Checks and Notes 7.05 Fiscal Year 7.06 Seal 7.07 Indemnification; Insurance 7.08 Resignation 7.09 Amendment of Bylaws 7.10 Construction 7.11 Table of Contents; Headings 7.12 Relation to Articles of Incorporation ARTICLE 8: COMMITTEES 8.01 Designation 8.02 Number; Qualification; Term 8.03 Authority 8.04 Change in Number 8.05 Removal 8.06 Vacancies 8.07 Meetings 8.08 Quorum; Majority Vote 8.09 Compensation ii. 3 ARTICLE 1: OFFICES 1.01 Registered Office and Agent. The registered office of the corporation shall be at 500 Commerce Street, Fort Worth, Texas 76102. The name of the registered agent at such address is Joseph D. Macchia. Anything in these Bylaws to the contrary notwithstanding revision of the registered office or the registered agent of the corporation in accordance with the provisions of the Texas Business Corporation Act shall automatically and without further action amend this section to name such newly adopted office or registered agent. 1.02 Other Offices. The corporation may have offices at other places both within and without the State of Texas as the board of directors may determine or as the business of the corporation may require. ARTICLE 2: SHAREHOLDERS 2.01 Place of Meetings. All meetings of the shareholders shall be held at such time and place, in or out of the State of Texas, as shall be stated in the notice of the meeting or in a waiver of notice. 2.02 Annual Meeting. An annual meeting of the shareholders shall be held each year at a time and on a day during the month of May to be selected by the board of directors. At the meeting, the shareholders shall elect directors and transact such other business as may properly be brought before the meeting. In the event the annual meeting is omitted by oversight or otherwise and not held as provided herein, an annual meeting may be called in the manner provided for special meetings herein at a subsequent date and the business transacted at such meeting shall be valid as if transacted at the annual meeting held during the month of May. 2.03 Voting List. At least ten days before each meeting of shareholders, a complete list of the shareholders entitled to vote at the meeting, arranged in alphabetical order, with the address of each and the number of voting shares held by each, shall be prepared by the officer or agent having charge of the stock transfer books. The list, for a period of ten days prior to the meeting, shall be kept on file at the registered office of the corporation and shall be subject to inspection by any shareholder at any time during usual business hours. The list shall also be produced and kept open at the time and place of the meeting during the whole time thereof, and shall be subject to the inspection of any shareholder during the whole time of the meeting. 2.04 Special Meetings. Special meetings of the shareholders, for any purpose or purposes, unless otherwise prescribed by statute or by the articles of incorporation, may be called by the president, the Board of Directors, or the holders of not less than twenty-five percent of all of the shares entitled to vote at the meetings. Business transacted at a special meeting shall be confined to the objects stated in the notice of the meeting. 2.05 Notice. Written or printed notice stating the place, day and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than fifty days before the date of the meeting, either personally or by mail, by or at the direction of the president, the secretary, or the officer or person calling the meeting, to each shareholder of record entitled to vote at the meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail addressed to the shareholder at his address as it appears on the stock transfer books of the corporation, with postage thereon prepaid. 2.06 Quorum. At all meetings of the shareholders, the presence in person or by proxy of the holders of a majority of the shares issued and outstanding and entitled to vote will be necessary and sufficient 1 4 to constitute a quorum for the transaction of business except as otherwise provided by law, the articles of incorporation or these bylaws. If a quorum is not present or represented at a meeting of the shareholders, the shareholders entitled to vote, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice (other than announcement at the meeting of the time and place at which the meeting is to be reconvened) until a quorum is present or represented. At such adjourned meeting at which a quorum is present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. For purposes of determining the presence or absence of a quorum under this bylaw 2.06, abstentions and broker non-votes (as such terms are defined in bylaw 2.07) shall be treated as shares present and entitled to vote. 2.07 Majority Vote; Withdrawal of Quorum. When a quorum is present at any meeting of the shareholders, the vote of the holders of a majority of the shares entitled to vote, present in person or represented by proxy and voting "for" or "against" any question brought before the meeting shall decide such question, unless the question is one upon which, by express provision of law, the articles of incorporation or these bylaws, a different vote is required in which case such express provision shall govern and control the decision of such question but if such other express provision does not specify that the affirmative vote of a given percent of outstanding shares are required, the matter shall be approved or adopted if the required percent of the shares entitled to vote, present in person or represented by proxy and voting "for" or "against" such matter has voted "for". Abstentions and broker non-votes are not counted (even though such shares are considered present and entitled to vote for purposes of determining a quorum pursuant to bylaw 2.06). The term "abstentions" shall refer to shares which are not voted "for" or "against" a particular question by a holder or holders present in person or by proxy at a meeting and entitled to vote such shares on such question. The term "broker non-vote" shall refer to shares held by brokers or nominees as to which instructions have not been received from the beneficial owners or persons entitled to vote and that the broker or nominee does not have discretionary power to vote on the particular question on which the vote is being counted. Anything herein to the contrary notwithstanding, any alteration, amendment, or repeal of bylaws 2.07, 3.02, 3.03, 3.04, 3.05, 3.11 and 7.09, or adoption of any provision inconsistent therewith, by the shareholders shall require the vote of the holders of two-thirds (2/3) of the shares having voting power. The shareholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum. 2.08 Method of Voting. Each outstanding share shall be entitled to one vote on each matter submitted to a vote at a meeting of shareholders. At any meeting of the shareholders, every shareholder having the right to vote may vote either in person, or by proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact. No proxy shall be valid after seven months from the date of its execution, unless otherwise provided in the proxy. Each proxy shall be revocable unless expressly provided therein to be irrevocable and unless otherwise made irrevocable by law. Each proxy shall be filed with the secretary of the corporation prior to or at the time of the meeting. Voting for directors shall be in accordance with Section 3.06 of these bylaws. Any vote may be taken by voice or by show of hands unless someone entitled to vote objects, in which case, written ballots shall be used. 2.09 Record Date; Closing Transfer Books. The board of directors may fix in advance a record date for the purpose of determining shareholders entitled to notice of or to vote at a meeting of the shareholders, the record date to be not less than ten nor more than fifty days prior to the meeting; or the board of directors may close the stock transfer books for such purpose for a period of not less than ten nor more than fifty days prior to such meeting. In the absence of any action by the board of directors, the date upon which the notice of the meeting is mailed shall be the record date. 2 5 2.10 Action Without Meeting. Any action required by statute to be taken at a meeting of the shareholders, or any action which may be taken at a meeting of the shareholders, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the shareholders entitled to vote with respect to the subject matter thereof and such consent shall have the same force and effect as a unanimous vote of the shareholders. The consent may be in more than one counterpart so long as each shareholder signs one of the counterparts. The consent shall be placed in the Minute Book. 2.11 Order of Business at Meetings. The order of business at annual meetings and so far as practicable at other meetings of shareholders shall be as follows unless changed by the board of directors: (1) call to order (2) proof of due notice of meeting (3) determination of quorum and examination of proxies (4) announcement of availability of voting list (see Bylaw 2.03) (5) announcement of distribution of annual statement (see Bylaw 8.03) (6) reading and disposing of minutes of last meeting of shareholders (7) reports of officers and committees (8) appointment of voting inspectors (9) unfinished business (10) new business (11) nomination of directors (12) opening of polls for voting (13) recess (14) reconvening; closing of polls (15) report of voting inspectors (16) other business (17) adjournment ARTICLE 3: DIRECTORS 3.01 Management. The business and affairs of the corporation shall be managed by the board of directors who may exercise all such powers of the corporation and do all such lawful acts and things as are not (by statute or by the articles of incorporation or by these bylaws) directed or required to be exercised or done by the shareholder. 3.02 Number; Qualifications; Election; and Term. The board of directors shall consist of nine (9) directors until the annual meeting of shareholders to be held in May 1998 at which time the number of directors shall be reduced to eight (8) directors until thereafter changed by resolution adopted by the board of directors pursuant to Bylaw 3.03. None of the members of the board of directors need to be shareholders or residents of the State of Texas. The directors shall be elected at the annual meeting of the shareholders, except as provided in Bylaws 3.03 and 3.05. Each director shall hold office until his successor shall be elected and shall qualify. 3.03 Change in Number. The number of directors may be increased or decreased from time to time by resolution adopted by the Board of Directors but no decrease shall have the effect of shortening the term of any incumbent director. 3.04 Removal. Any director may be removed either for or without cause at any special or annual meeting of shareholders, by the affirmative vote of over two-thirds in number of shares of the shareholders 3 6 present in person or by proxy at such meeting and entitled to vote for the election of such director if notice of intention to act upon such matter shall have been given in the notice calling such meeting. 3.05 Vacancies. Any vacancy occurring in the board of directors (by death, resignation or removal) may be filled by an affirmative vote of a majority of the remaining directors though less than a quorum of the board of directors. A director elected to fill a vacancy shall be elected for the unexpired term of his predecessor in office. Any directorship to be filled by reason of an increase in the number of directors shall be filled either (i) by election at an annual meeting or at a special meeting of shareholders called for that purpose or (ii) by the Board, provided the Board may not fill more than two such directorships during the period between any two successive annual meetings of shareholders. 3.06 Election of Directors. Directors shall be elected by plurality vote. Cumulative voting shall not be permitted. 3.07 Place of Meetings. Meetings of the board of directors, regular or special, may be held either within or without the State of Texas. 3.08 First Meeting. The first meeting of each newly elected board shall be held without further notice immediately following the annual meeting of shareholders, and at the same place, unless (by unanimous consent of the directors then elected and serving) such time or place shall be changed. 3.09 Regular Meetings. Regular meetings of the board of directors may be held without notice at such time and place as shall from time to time be determined by the board. 3.10 Special Meetings. Special meetings of the board of directors may be called by the president on three days' notice to each director, either personally or by mail or by telegram. Special meetings shall be called by the president or secretary in like manner and on like notice on the written request of a majority of the directors. Except as otherwise expressly provided by statute, or by the articles of incorporation, or by these bylaws, neither the business to be transacted at, nor the purpose of, any special meeting need be specified in a notice or waiver of notice. 3.11 Quorum; Majority Vote. At all meetings of the board of directors, a majority of the board of directors fixed by these Bylaws shall constitute a quorum for the transaction of business. The act of a majority of the directors present at any meeting at which a quorum is present shall be the act by the board of directors, except as otherwise specifically provided by statute, by the Articles of Incorporation or by these Bylaws. Anything herein to the contrary not withstanding, any alteration, amendment, or repeal of Bylaws 2.07, 3.02, 3.03, 3.04, 3.05, 3.11 and 7.09, or adoption of any provision inconsistent therewith, by the board of directors shall require the affirmative vote of two-thirds (2/3) of the board of directors of the corporation. If a quorum is not present at a meeting of the board of directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present. 3.12 Compensation. By resolution of the board of directors, the directors may be paid their expenses, if any, of attendance at each meeting of the board of directors and may be paid a fixed sum for attendance at each meeting of the board of directors or a stated salary as director. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Members of the Executive Committee or of special or standing committees may, by resolution of the board of directors, be allowed like compensation for attending committee meetings. 4 7 3.13 Procedure. The board of director shall keep regular minutes of its proceedings. The minutes shall be placed in the minute book of the corporation. 3.14 Interested Directors and Officers . (a) No contract or transaction between the Corporation and one or more of its directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one or more of the directors or officers are directors or officers or have a financial interest, shall be void or voidable solely for this reason, solely because the director or officer is present at or participates in the meeting of the board or committee thereof which authorizes the contract or transaction, or solely because his or their votes are counted for such purposes, if: (1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative vote of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or (2) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or (3) The contract or transaction is fair as to the Corporation as of the time it is authorized, approved, or ratified by the board of directors, a committee thereof, or the shareholders. (b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors. 3.15 Action Without Meeting. Any action required or permitted to be taken at a meeting of the board of directors may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by all members of the board of directors. Such consent shall have the same force and effect as a unanimous vote at a meeting and may be stated as such in any document or instrument filed with the Secretary of State. 3.16 Advisory Directors. The board of directors, by resolution adopted by not less than a majority of the directors then in office, may from time to time appoint such number of individuals as it may deem appropriate to serve as advisory directors at the pleasure of the board of directors. Advisory directors may be given such designations (including without limitation "advisory director," "director emeritus" or "honorary director") as the board of directors may from time to time determine. Advisory directors are not, and shall not have the duties and responsibilities of, directors of the corporation, and the terms "director" or "member of the board of directors" as used in these Bylaws shall not be deemed to mean or include advisory directors. Without limiting the generality of the foregoing, advisory directors shall not be entitled (a) to receive any notice of any meeting of the board of directors, (b) to attend any meeting of the board of directors except at the invitation of the board of directors, (c) to vote on any matter presented for action by the board of directors or, except at the invitation of the board of directors, to participate in the consideration 5 8 of any such matter or the formulation or determination of corporate policy, (d) to receive any non-public information regarding the business or affairs of the corporation or any matters presented for action or consideration by the board of directors, or (e) to receive any compensation for serving as an advisory director except as the board of directors may otherwise determine by resolution. ARTICLE 4: NOTICE AND ATTENDANCE THROUGH USE OF ELECTRONIC EQUIPMENT 4.01 Method. Whenever by statute or the articles of incorporation or these bylaws, notice is required to be given to any director or shareholder, and no provision is made as to how the notice shall be given, it shall not be construed to mean personal notice, but any such notice may be given (a) in writing, by mail, postage prepaid, addressed to the director or shareholder at the address appearing on the books of the corporation, or (b) in any other method permitted by law. Any notice required or permitted to be given by mail shall be deemed given at the time when the same is thus deposited in the United States mails. 4.02 Waiver. Whenever, by statute or the articles of incorporation or these bylaws, notice is required to be given to any shareholder or director, a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time stated in such notice, shall be equivalent to the giving of such notice. Attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. 4.03 Telephone and Similar Meetings. Shareholders, directors and committee members may participate in and hold a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting shall constitute presence in person at the meeting, except where a person participates in the meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. ARTICLE 5: OFFICERS AND AGENTS 5.01 Number; Qualification; Election; Term. (a) The corporation shall have: (1) a president, a vice president, a secretary and a treasurer, and (2) such other officers (including a chairman of the board and additional vice presidents) and assistant officers and agents as the board of directors may think necessary. (b) No officer or agent need be a shareholder, a director or a resident of Texas. (c) Officers named in Section 5.01(a)(1) shall be elected by the board of directors on the expiration of an officer's term or whenever a vacancy exists. Officers and agents named in Section 5.01(a)(2) may be elected by the board at any meeting. (d) Unless otherwise specified by the board at the time of election or appointment, or in any employment contract approved by the board, each officer's and agent's term shall end at the first meeting of directors after the next annual meeting of shareholders. He shall serve until the end of his term or, if earlier, his death, resignation or removal. 6 9 (e) Any two or more offices may be held by the same person, except that the president and the secretary shall not be the same person. 5.02 Removal. Any officer or agent elected or appointed by the board of directors may be removed by the board of directors whenever in its judgment the best interests of the corporation will be served thereby. Such removal shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of an officer or agent shall not of itself create contract rights. 5.03 Vacancies. Any vacancy occurring in any office of the corporation (by death, resignation, removal or otherwise) maybe filled by the board of directors. 5.04 Authority. Officers and agents shall have such authority and perform such duties in the management of the corporation as are provided in these bylaws or as may be determined by resolution of the board of directors not inconsistent with these bylaws. 5.05 Compensation. The compensation of officers and agents shall be fixed from time to time by the board of directors. 5.06 President. The president shall be the chief executive officer of the corporation; he shall preside at all meetings of the shareholders and the board of directors, shall have general and active management of the business and affairs of the corporation, shall see that all orders and resolutions of the board are carried into effect. He shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe. 5.07 Vice Presidents. The vice presidents, in the order of their seniority unless otherwise determined by the board of directors, shall, in the absence or disability of the president, perform the duties and have the authority and exercise the powers of the president. They shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe or as the president may from time to time delegate. 5.08 Secretary. (a) The secretary shall attend all meetings of the board of directors and all meetings of the shareholders and record the minutes of all proceedings in a book to be kept for that purpose. (b) The secretary shall give, or cause to be given, notice of all meetings of the shareholders and special meetings of the board of directors. (c) The secretary shall keep in safe custody the seal of the corporation and, when authorized by the board of directors or the executive committee, affix the same to any instrument requiring it. (d) The secretary shall be under the supervision of the president and shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe or as the president may from time to time delegate. 5.09 Assistant Secretary. The assistant secretary shall, in the absence or disability of the secretary, perform the duties and have the authority and exercise the powers of the secretary. He shall 7 10 perform such other duties and have such other powers as the board of directors may from time to time prescribe or as the president may from time to time delegate. 5.10 Treasurer. (a) The treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements of the corporation and shall deposit all monies and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the board of directors. (b) He shall disburse the funds of the corporation as may be ordered by the board of directors, taking proper vouchers for such disbursements, and shall render to the president and directors, at the regular meetings of the board, or whenever they may require it, an account of all his transactions as treasurer and of the financial condition of the corporation. (c) If required by the board of directors, he shall give the corporation a bond in such form, in such sum, and with such surety or sureties as shall be satisfactory to the board for the faithful performance of the duties of his office and for the restoration to the corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the corporation. (d) He shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe or as the president may from time to time delegate. 5.11 Assistant Treasurer. The assistant treasurer shall, in the absence or disability of the treasurer, perform the duties and have the authority and exercise the powers of the treasurer. He shall perform such other duties and have such other powers as the board of directors may from time to time prescribe or the president may from time to time delegate. 5.12 Chairman of the Board. The chairman of the board shall have such duties as may be assigned to him from time to time by the board of directors. 5.13 Vice-Chairman of the Board. The vice chairman of the board shall act as a liaison between the board of directors and the shareholders of the corporation and shall keep the shareholders fully advised with regard to progress of the corporation and with regard to any major policy decisions made by the board of directors. 5.14 Second Vice Presidents. The board of directors may designate vice presidents to serve in the absence of the vice president in charge of any area of responsibility and, in such event, to perform the duties and have the authority of such absent vice president. Additionally, a second vice president shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe. ARTICLE 6: CERTIFICATES AND SHAREHOLDERS 6.01 Certificates. Certificates in the form determined by the board of directors shall be delivered representing all shares to which shareholders are entitled. Certificates shall be consecutively numbered and shall be entered in the books of the corporation or its agents as they are issued. Each certificate shall state on its face the holder's name, the number and class of shares, the par value of shares or a statement that such 8 11 shares are without par value, and such other matters as may be required by law. They shall be signed by the president or a vice president and such other officer or officers as the board of directors shall designate, and may be sealed with the seal of the corporation or a facsimile thereof. If any certificate is countersigned by a transfer agent or registered by a registrar (either of which is other than the corporation or an employee of the corporation), the signature of any such officer may be facsimile. In case any officer who has signed or whose facsimile signature has been placed upon such certificate shall have ceased to be such officer before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer at the date of its issuance. 6.02 Issuance. Shares (both treasury and authorized but unissued) may be issued for such consideration (not less than par value) and to such persons as the board of directors may determine from time to time. Shares may not be issued until the full amount of the consideration, fixed as provided by law, has been paid. 6.03 Payment for Shares. (a) Kind. The consideration for the issuance of shares shall consist of money paid, labor done (including services actually performed for the corporation) or property (tangible or intangible) actually received. Neither promissory notes nor the promise of future services shall constitute payment for shares. (b) Validation. In the absence of fraud in the transaction, the judgment of the board of directors as to the value of consideration received shall be conclusive. (c) Effect. When consideration, fixed as provided by law, has been paid, the shares shall be deemed to have been issued and shall be considered fully paid and nonassessable. (d) Allocation of Consideration. The consideration received for shares shall be allocated by the board of directors in accordance with law, between stated capital and capital surplus accounts. 6.04 Subscriptions. Unless otherwise provided in the subscription agreement, subscriptions for shares, whether made before or after organization of the corporation, shall be paid in full at such time or in such installments and at such times as shall be determined by the board of directors. Any call made by the board of directors for payment on subscriptions shall be uniform as to all shares of the same series. In case of default in the payment on any installment or call when payment is due, the corporation may proceed to collect the amount due in the same manner as any debt due to the corporation. 6.05 Lien. For any indebtedness of a shareholder to the corporation, the corporation shall have a first and prior lien on all shares of its stock owned by him and on all dividends or other distributions declared thereon. 6.06 Lost, Stolen or Destroyed Certificates. The corporation shall issue a new certificate in place of any certificate for shares previously issued if the registered owner of the certificate: (a) Claim. Makes proof in affidavit form that it has been lost, destroyed or wrongfully taken; and (b) Timely Request. Requests the issuance of a new certificate before the corporation has notice that the certificate has been acquired by a purchaser for value in good faith and without notice of an adverse claim; and 9 12 (c) Bond. Gives a bond in such form, and with such surety or sureties, with fixed or open penalty, as the corporation may direct, to indemnify the corporation (and its transfer agent and registrar, if any) against any claim that may be made on account of the alleged loss, destruction or theft of the certificate; and (d) Other Requirements. Satisfies any other reasonable requirements imposed by the corporation. When a certificate has been lost, apparently destroyed or wrongfully taken, and the holder of record fails to notify the corporation within a reasonable time after he has notice of it, and the corporation registers a transfer of the shares represented by the certificate before receiving such notification, the holder of record is precluded from making any claim against the corporation for the transfer or for a new certificate. 6.07 Registration of Transfer. The corporation shall register the transfer of a certificate for shares presented to it for transfer if: (a) Endorsement. The certificate is properly endorsed by the registered owner or by his duly authorized attorney; and (b) Guarantee and Effectiveness of Signature. The signature of such person has been guaranteed by a national banking association or member of the New York Stock Exchange, and reasonable assurance is given that such endorsements are effective; and (c) Adverse Claims. The corporation has no notice of an adverse claim or has discharged any duty to inquire into such a claim; and (d) Collection of Taxes. Any applicable law relating to the collection of taxes has been complied with. 6.08 Registered Shareholders. The corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it has express or other notice thereof, except as otherwise provided by law. 6.09 Denial of Preemptive Rights. No shareholder of corporation nor other person shall have any preemptive rights whatsoever. ARTICLE 7: GENERAL PROVISIONS 7.01 Dividends and Reserves. (a) Declaration and Payment. Subject to statute and the articles of incorporation, dividends may be declared by the board of directors at any regular or special meeting and may be paid in cash, in property or in shares of the corporation. The declaration and payment shall be at the discretion of the board of directors. (b) Record Date. The board of directors may fix in advance a record date for the purpose of determining shareholders entitled to receive payment of any dividend, the record date to be not more than fifty days prior to the payment date of such dividend, or the board of directors may close the stock 10 13 transfer books for such purpose for a period of not more than fifty days prior to the payment date of such dividend. In the absence of any action by the board of directors, the date upon which the board of directors adopts the resolution declaring the dividend shall be the record date. (c) Reserves. By resolution the board of directors may create such reserve or reserves out of the earned surplus of the corporation as the directors from time to time, in their discretion, think proper to provide for contingencies, or to equalize dividends, or to repair or maintain any property of the corporation, or for any other purpose they think beneficial to the corporation. The directors may modify or abolish any such reserve in the manner in which it was created. 7.02 Books and Records. The corporation shall keep correct and complete books and records of account and shall keep minutes of the proceedings of its shareholders and board of directors, and shall keep at its registered office or principal place of business, or at the office of its transfer agent or registrar, a record of its shareholders, giving the names and addresses of all shareholders and the number and class of the shares held by each. 7.03 Annual Statement. The board of directors shall present at each annual meeting of shareholders a full and clear statement of the business and condition of the corporation, including a reasonably detailed balance sheet, income statement and surplus statement. 7.04 Checks and Notes. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the board of directors may from time to time designate. 7.05 Fiscal Year. The fiscal year of the corporation shall be fixed by resolution of the board of directors. 7.06 Seal. The corporation seal (of which there may be one or more) shall contain the name of the corporation and the name of the state of incorporation. The seal may be used by impressing it or reproducing a facsimile of it, or otherwise. 7.07 Indemnification; Insurance. The corporation shall indemnify to the full extent permitted by law any person who is made a named defendant or respondent in any action, suit or proceeding, whether civil, criminal, administrative, arbitrative or investigative, or in any appeal in such action, suit or proceeding, by reason of the fact that he or she is or was a director or officer of the corporation, against all expenses (including attorney's fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such director or officer in connection with any such action, suit or proceeding. The corporation may indemnify other persons, as permitted by law. The corporation may advance expenses to directors, officers or other persons, as permitted by law. The corporation may purchase and maintain insurance on behalf of the directors, officers or other persons, against any liability asserted against such persons in their capacities as directors, officers or otherwise, of the corporation, whether or not the corporation would have the power to indemnify such directors, officers or other persons against such liability. 7.08 Resignation. Any director, officer or agent may resign by giving written notice to the president or the secretary. The resignation shall take effect at the time specified therein, or immediately if no time is specified therein. Unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. 11 14 7.09 Amendment of Bylaws. These Bylaws may be altered, amended or repealed or new Bylaws may be adopted by the board of directors (subject to the shareholders repealing or changing the action of the board of directors, or making new Bylaws, at an annual or special meeting called and held as provided in these Bylaws) at any meeting at which a quorum is present. 7.10 Construction. Whenever the context so requires, the masculine shall include the feminine and neuter, and the singular shall include the plural, and conversely. If any portion of these bylaws shall be invalid or inoperative, then, so far as is reasonable and possible: (a) The remainder of these bylaws shall be considered valid and operative, and (b) Effect shall be given to the intent manifested by the portion held invalid or inoperative. 7.11 Table of Contents; Headings. The table of contents and headings used in these bylaws have been inserted for convenience only and do not constitute matter to be construed in interpretation. 7.12 Relation to Articles of Incorporation. These bylaws are subject to and governed by the articles of incorporation. ARTICLE 8: COMMITTEES 8.01 Designation. The board of directors may, by resolution adopted by a majority of the whole board, designate from among its members an executive committee and one or more such other committees as it may determine necessary. 8.02 Number; Qualification; Term. The executive committee and any other designated committees shall consist of two or more directors, not less than a majority of whom in each case shall be directors who are not officers or employees of the Company. The committees shall serve at the pleasure of the board of directors. 8.03 Authority. Each committee, to the extent provided in such resolution, shall have and may exercise all of the authority of the board of directors in the management of the business and affairs of the corporation, except in the following matters and except where action of the full board of directors is required by statute or by the articles of incorporation: (a) Amending the articles of incorporation; (b) Amending, altering or repealing the bylaws of the corporation or adopting new bylaws; (c) Approving and/or recommending or submitting to shareholders: (1) merger (2) consolidation (3) sale, lease (as Lessor), exchange or other disposition of all or substantially all the property and assets of the corporation; (4) dissolution; 12 15 (d) Filling vacancies in the board of directors or any such committee; (e) Electing or removing officers of the corporation or members of any such committee; (f) Fixing compensation of any person who is a member of any such committee; (g) Declaring dividends; (h) Altering or repealing any resolution of the board of directors. 8.04 Change in Number. The number of committee members may be increased or decreased (but not below two) from time to time by resolution adopted by a majority of the whole board of directors. 8.05 Removal. Any committee member may be removed by the board of directors by the affirmative vote of a majority of the whole board, whenever in its judgment the best interests of the corporation will be served thereby. 8.06 Vacancies. A vacancy occurring in any committee (by death, resignation, removal or otherwise) may be filled by the board of directors in the manner provided for original designation in paragraph 8.01. 8.07 Meetings. Time, place and notice (if any) of all committee meetings shall be determined by the respective committee. (see also paragraph 4.03). 8.08 Quorum; Majority Vote. At meetings of any committee, a majority of the number of members designated by the board of directors shall constitute a quorum for the transaction of business. The act of a majority of the members present at any meeting at which a quorum is present shall be the act of the committee, except as otherwise specifically provided by statute or by the articles of incorporation or by these bylaws. If a quorum is not present at a meeting of the committee, the members present thereat may adjourn the meeting from time to time, without notice other than an announcement at the meeting until a quorum is present. 8.09 Compensation. Compensation of committee members shall be fixed pursuant to the provisions of paragraph 3.12 of these bylaws. 13 EX-10.36 3 FORM OF CHANGE OF CONTROL AGREEMENTS 1 EXHIBIT 10.36 ____________, 19__ - --------------------- - --------------------- - --------------------- Dear _________: GAINSCO Service Corp. (the "Company") considers it essential to the best interests of its stockholders to foster the continuous employment of key management personnel. In this connection, the Board of Directors of the Company (the "Board") recognizes that, as is the case with many publicly held corporations, the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its stockholders. The Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including yourself, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a change in control of the Company, although no such change is now contemplated. In order to induce you to remain in the employ of the Company and in consideration of your agreement set forth in Subsection 2(ii) hereof, the Company agrees that you shall receive the severance benefits set forth in this letter agreement ("Agreement") in the event your employment with the Company is terminated subsequent to a "change in control of the Company" (as defined in Section 2 hereof) under the circumstances described below. 1. Term of Agreement. This Agreement shall commence on its effective date and shall continue in effect through December 31, 19__; provided, however, that commencing on January 1, 19__ and each January thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than the September 30 preceding each such January 1, the Company shall have given notice that it does not wish to extend this Agreement; provided, further, if a change in control of the Company shall have occurred during the original or extended term of this Agreement, this Agreement shall continue in effect for the later of (i) the original or extended term or (ii) a period of twenty-four (24) months beyond the month in which such change in control occurred. Notwithstanding the foregoing, in no event shall the term of this Agreement extend beyond the date that you attain sixty-five years of age. 2 Page 2 2. Change in Control. (i) No benefits shall be payable hereunder unless there shall have been a change in control of the Company, as set forth below. For purposes of this Agreement, a "change in control of the Company" shall be deemed to have occurred if (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding securities; or (B) during any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clauses (A), (C) or (D) of this Subsection) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof; or (C) the shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (D) the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. (ii) For purposes of this Agreement, a "potential change in control of the Company" shall be deemed to have occurred if (A) the Company enters into an agreement, the consummation of which would result in the occurrence of a change in control of the Company, (B) any person (including the Company) publicly announces an intention to take or to consider taking actions which if consummated would constitute a change in control of the Company; (C) any person, other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, who is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 10% or more of the combined voting power of the Company's then outstanding securities, increases his beneficial ownership of such securities by 5% or more of the combined voting power of the Company's then outstanding securities on the date hereof; or (D) the Board adopts a resolution to the effect that, for purposes of this Agreement, a potential change in control of the Company has occurred. You agree that, subject to the terms and conditions of this Agreement, in the event of a potential change in control of the Company, you will remain in the employ of the Company until the earliest of (i) a date 3 Page 3 which is six (6) months from the occurrence of such potential change in control of the Company, (ii) the termination by you of your employment by reason of Disability or Retirement as defined in Subsection 3(i), or (iii) the occurrence of a change in control of the Company. 3. Termination Following Change in Control. If any of the events described in Subsection 2(i) hereof constituting a change in control of the Company shall have occurred, you shall be entitled to the benefits provided in Subsection 4(iii) hereof upon the subsequent termination of your employment during the term of this Agreement unless such termination is (A) because of your death, Disability or Retirement, (B) by the Company for Cause, or (C) by you other than for Good Reason. (i) Disability; Retirement. If, as a result of your incapacity due to physical or mental illness, you shall have been absent from the full-time performance of your duties with the Company for a period of six (6) consecutive months, and within thirty (30) days after written notice of termination is given you shall not have returned to the full-time performance of your duties, your employment may be terminated for "Disability." Termination by the Company or you of your employment based on "Retirement" shall mean termination with your consent in accordance with the Company's Pension Plan (as hereafter defined) including early retirement, generally applicable to its salaried employees, provided, however, that termination based on "Retirement" shall not include retirement in conjunction with termination by you for Good Reason. (ii) Cause. Termination by the Company of your employment for "Cause" shall mean termination upon (A) the willful and continued failure by you to substantially perform your duties with the Company (other than any such failure resulting from your incapacity due to physical or mental illness or any such actual or anticipated failure after the issuance of a Notice of Termination, by you for Good Reason as defined in Subsections 3(iv) and 3(iii), respectively) after a written demand for substantial performance is delivered to you by the Board, which demand specifically identifies the manner in which the Board believes that you have not substantially performed your duties, or (B) the willful engaging by you in conduct which is demonstrably and materially injurious to the Company, monetarily or otherwise. For purposes of this Subsection, no act, or failure to act, on your part shall be deemed "willful" unless done, or omitted to be done, by you not in good faith and without reasonable belief that your action or omission was in the best interest of the Company. Notwithstanding the foregoing, you shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to you a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3/4) of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice to you and an opportunity for you, together with your counsel, to be heard before the Board), finding that in the good faith opinion of the Board you were guilty of conduct set forth above in clauses (A) or (B) of the first sentence of this Subsection and specifying the particulars thereof in detail. (iii) Good Reason. You shall be entitled to terminate your employment for Good 4 Page 4 Reason. For purposes of this Agreement, "Good Reason" shall mean, without your express written consent, the occurrence after a change in control of the Company of any of the following circumstances unless, in the case of paragraphs (A), (E), (F), (G) or (H), such circumstances are fully corrected prior to the Date of Termination specified in the Notice of Termination, as defined in Subsections 3(v) and 3(iv), respectively, given in respect thereof: (A) the assignment to you of any duties inconsistent with your present status as Vice President of the Company (or such other title or titles as you may be holding immediately prior to the change in control of the Company) or a substantial adverse alteration in the nature or status of your responsibilities from those in effect immediately prior to the change in control of the Company; (B) a reduction by the Company in your annual base salary as in effect on the date of the change in control of the Company; (C) the relocation of the Company's principal executive offices to a location outside of Fort Worth, Texas (or, if different, the metropolitan area in which such offices are located immediately prior to the change in control of the Company) or the Company's requiring you to be based anywhere other than the Company's principal executive offices except for required travel on the Company's business to an extent substantially consistent with your present business travel obligations; (D) the failure by the Company, without your consent, to pay to you any portion of your current compensation, or to pay to you any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due; (E) except as provided below, the failure by the Company to continue in effect any compensation plan in which you participate immediately prior to the change in control of the Company which is material to your total compensation, including but not limited to the Company's 1995 Stock Option Plan and the Executive Incentive Compensation Plan or any substitute or additional plans adopted prior to the change in control, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue your participation therein (or in such substitute or additional plans) on a basis not materially less favorable, both in terms of the amount of benefits provided and the level of your participation relative to other participants, as existed at the time of the change in control; (F) except as provided below, the failure of GAINSCO, Inc. to continue to provide you with benefits substantially similar to those enjoyed by you under the Company's Profit Sharing Plan and Trust of GAINSCO, Inc. (the "Pension Plan") or under any of the 5 Page 5 Company's other deferred compensation plans, life insurance, medical, health and accident, or disability plans in which you were participating at the time of the change in control of the Company, the taking of any action by the Company which would directly or indirectly materially reduce any of such benefits or deprive you of any material fringe benefit enjoyed by you at the time of the change in control of the Company, or the failure by the Company to provide you with the number of paid vacation days to which you are entitled on the basis of years of service with the Company in accordance with the Company's normal vacation policy for officers in effect at the time of the change in control of the Company; (G) the failure of the Company to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement, as contemplated in Section 5 hereof; or (H) any purported termination of your employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Subsection (iv) below (and, if applicable, the requirements of Subsection (ii) above); for purposes of this Agreement, no such purported termination shall be effective. Your right to terminate your employment pursuant to this Subsection shall not be affected by your incapacity due to physical or mental illness. Your continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder. You may not terminate your employment for Good Reason pursuant to paragraphs (E) or (F) on account of the discontinuance of any plan or benefit (without an equitable substitution) which is part of a uniform, non-discriminatory, Company-wide reduction in benefits. (iv) Notice of Termination. Any purported termination of your employment by the Company or by you shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 6 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of your employment under the provision so indicated. (v) Date of Termination, Etc. "Date of Termination" shall mean (A) if your employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that you shall not have returned to the full-time performance of your duties during such thirty (30) day period), and (B) if your employment is terminated pursuant to Subsection (ii) or (iii) above or for any other reason (other than Disability), the date specified in the Notice of Termination (which, in the case of a termination pursuant to Subsection (ii) above shall not be less than thirty (30) days, and in the case of a termination pursuant to Subsection (iii) above shall not be less than fifteen (15) nor more than sixty (60) days, respectively, from the date such Notice of Termination is given); provided that if within fifteen (15) days after any Notice of Termination is given, or, if later, prior 6 Page 6 to the Date of Termination (as determined without regard to this proviso), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding arbitration award, or by a final judgment, order or decree of a court of competent jurisdiction (which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided further that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. Notwithstanding the pendency of any such dispute, the Company will continue to pay you your full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, base salary) and continue you as a participant in all compensation, benefit and insurance plans in which you were participating whether or not specifically referenced in this Agreement when the notice giving rise to the dispute was given, until the dispute is finally resolved in accordance with this Subsection. Amounts paid under this Subsection are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement, except as provided in Subsection 4(iii)(B) below. 4. Compensation Upon Termination or During Disability. Following a change in control of the Company, as defined by Subsection 2(i), upon termination of your employment or during a period of Disability you shall be entitled to the following benefits: (i) During any period that you fail to perform your full-time duties with the Company as a result of incapacity due to physical or mental illness, you shall continue to receive your salary at the rate in effect at the commencement of such period, together with all other compensation and benefits payable to you during such period, until this Agreement is terminated pursuant to Section 3(i) hereof. Thereafter, or in the event your employment shall be terminated by the Company or by you for Retirement, or by reason of your death, your benefits shall be determined under the Company's retirement, insurance and other compensation plans and programs then in effect in accordance with the terms of such programs. (ii) If your employment shall be terminated by the Company for Cause or by you other than for Good Reason, Disability, death or Retirement, the Company shall pay you your full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given, plus all other amounts to which you are entitled under any compensation or benefit plan of the Company at the time such payments are due, and the Company shall have no further obligations to you under this Agreement. (iii) If your employment by the Company shall be terminated (a) by the Company other than for Cause, Retirement or Disability or (b) by you for Good Reason, then you shall be entitled to the benefits provided below: 7 Page 7 (A) the Company shall pay you your full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given, plus all other amounts to which you are entitled under any compensation plan of the Company, at the time such payments are due, except as otherwise provided below; and (B) in lieu of any further salary payments to you for periods subsequent to the Date of Termination, the Company shall pay as severance pay to you a lump sum cash severance payment in an amount equal to two times your "base amount" (within the meaning of section 280G(b)(3) of the Internal Revenue Code of 1986, as amended (the "Code")), provided, however, that such severance payment shall be no less than 1.25 times the amount reported on your Form W-2 statement issued by the Company with respect to the year preceding that in which the Date of Termination occurs. Notwithstanding any other provision of this Agreement, in the event that any payment or benefit received or to be received by you in connection with a change in control or the termination of your employment (whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control or any person affiliated with (or which, as a result of the completion of the transactions causing a change in control, will become affiliated) the Company or such person within the meaning of section 1504 of the Code) (all such payments and benefits being hereinafter called the "Severance Payments") would not be deductible (in whole or in part), by the Company, an affiliate or any person making such payment or providing such benefit as a result of section 280G of the Code, then, to the extent necessary to make such portion of the Severance Payments deductible (and after taking into account any reduction in the Severance Payments provided by reason of section 280G of the Code in such other plan, arrangement or agreement), (A) the cash Severance Payments shall first be reduced (if necessary, to zero), and (B) all other non-cash Severance Payments shall next be reduced. For purposes of this limitation (i) no portion of the Severance Payments the receipt or enjoyment of which you shall have effectively waived in writing prior to the Date of Termination shall be taken into account, (ii) no portion of the Severance Payments shall be taken into account which in the opinion of tax counsel selected by the Company's independent auditors and reasonably acceptable to you does not constitute a "parachute payment" within the meaning of section 280G(b)(2) of the Code, including by reason of section 280G(b)(4)(A) of the Code, (iii) the Severance Payments shall be reduced only to the extent necessary so that the Severance Payments (other than those referred to in clauses (i) or (ii)) in their entirety constitute reasonable compensation for services actually rendered within the meaning of section 280G(b)(4)(B) of the Code or are otherwise not subject to disallowance as deductions, in the opinion of tax counsel referred to in clause (ii); and (iv) the value of any non-cash benefit or any deferred payment or benefit included in the Severance Payments shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(d)(3) and (4) of the Code. 8 Page 8 (C) the payment provided for in paragraph (B) above, shall be made not later than the fifth day following the Date of Termination, provided, however, that if the amount of such payment cannot be finally determined on or before such day, the Company shall pay to you on such day an estimate, as determined in good faith by the Company, of the minimum amount of such payment and shall pay the remainder of such payment (together with interest at the rate provided in section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined but in no event later the thirtieth day after the Date of Termination. In the event that the amount of the estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to you, payable on the fifth day after demand by the Company (together with interest at the rate provided in section 1274(b)(2)(B) of the Code). (D) the Company also shall pay to you all legal fees and expenses incurred by you as a result of such termination (including all such legal fees and legal expenses, if any, incurred in contesting or disputing any such termination or in seeking to obtain or enforce any right or benefit provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder). Such payments shall be made at the later of the times specified in paragraph (C) above, or within five (5) days after your request for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require. (iv) You shall not be required to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for in this Section 4 be reduced by any compensation earned by you as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by you to the Company, or otherwise. (v) In addition to all other amounts payable to you under this Section 4, you shall be entitled to receive all benefits payable to you, at the respective time or times such payments are due, under the Pension Plan[s], and any other plan or agreement relating to retirement benefits. 5. Successors; Binding Agreement. (i) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle you to compensation from the Company in the same amount and on the same terms as you would be entitled to hereunder if you terminate your employment for Good Reason following a change in control of the Company, except that for purposes of implementing the foregoing, the date 9 Page 9 on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. (ii) This Agreement shall inure to the benefit of and be enforceable by your personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If you should die while any amount would still be payable to you hereunder if you had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with terms of this Agreement to your devisee, legatee or other designee or, if there is no such designee, to your estate. 6. Notice. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage pre-paid, addressed as follows: If to the Company: GAINSCO Service Corp. Attn: President 500 Commerce Street Fort Worth, Texas 76102-5439 If to you: - --------------------- - --------------------- - --------------------- or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 7. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by you and such officer as may be duly authorized to act on the Company's behalf. No waiver by either party hereto at any time of any breach by the other party hereto of, or non-compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar of dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this 10 Page 10 Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Texas. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law. The obligations of the Company under Subsections 4(i), 4(ii), 4(iii)(D) and 4(v) shall survive the expiration of the term of this Agreement. 8. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 9. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 10. Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled, at the Company's expense, exclusively by arbitration in Tarrant County, Texas in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that you shall be entitled to seek specific performance of your right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. If this letter sets forth our agreement on the subject matter hereof, kindly signed and return to the Company the enclosed copy of this letter which will then constitute our agreement on this subject. Sincerely, GAINSCO Service Corp. By: ------------------------------ 11 Page 11 Agreed to effective the ____ day of _____________, ______ ____________________________ GUARANTEE GAINSCO, INC., a Texas corporation, unconditionally guarantees payment and performance in full of all obligations of GAINSCO Service Corp. ("Service Corp.") under the above and foregoing change in control agreement (the "Change in Control Agreement") between Service Corp. and _______________ and any renewals or extensions thereof whether or not the terms of the Change in Control Agreement are modified. This guarantee is a continuing guarantee and may not be revoked by the guarantor without the written consent of _______________ and shall expire only when the Change in Control Agreement and all renewals or extensions of it have terminated. GAINSCO, INC. By: ------------------------------ EX-22.2 4 SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 22.2 S U B S I D I A R I E S O F R E G I S T R A N T --------------- GAINSCO, INC. 75-1617013 (Texas) --------------- ---------------------------------------------------------------------------------------- -------------- ----------------- ---------------- -------------- -------------- GAINSCO Service Agents Processing General Agents General Agents Risk Retention Corp. Systems, Inc. Insurance Company Premium Finance Administrators of America, Inc. Company Inc. 75-2282846 75-1796560 75-1629914 75-1631637 75-2217958 (Texas) (Texas) (Oklahoma) (Texas) (Nevada) -------------- ----------------- ---------------- -------------- -------------- * -------------- ----------------- ---------------- GAINSCO County MGA Premium MGA Insurance Mutual Insurance Finance Company Company, Inc. Company 75-2447701 75-2371163 75-1767545 (Texas) (Texas) (Texas) -------------- ----------------- ---------------- ----------------- MGA Agency, Inc. 75-1622457 (Texas) -----------------
* GAINSCO Service Corp. owns the charter and management contract, thereby giving it 100% control of GAINSCO County Mutual Insurance Company.
EX-24.2 5 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 24.2 CONSENT OF INDEPENDENT AUDITORS TO INCORPORATION BY REFERENCE ----------------------------- The Board of Directors: GAINSCO, INC.: We consent to incorporation by reference in the registration statements (No. 33-48634 and No. 33-37070) on Form S-8 of GAINSCO, INC. of our reports dated February 16, 1998, relating to the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, and all related schedules, which reports appear in the December 31, 1997 annual report on Form 10-K of GAINSCO, INC. KPMG Peat Marwick L.L.P. Dallas, Texas March 30, 1998 EX-25.1 6 POWER OF ATTORNEY 1 EXHIBIT 25.1 SPECIAL POWER OF ATTORNEY THE STATE OF TEXAS ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF TARRANT ) THAT I, the undersigned, of Tarrant County, Texas, have made, constituted and appointed and by these presents do make, constitute and appoint JOSEPH D. MACCHIA, DANIEL J. COOTS and SAM ROSEN, and each of them severally, my true and lawful attorneys and agents to execute in my name, place and stead in my capacity as Director of GAINSCO, INC. the Annual Report on Form 10-K of GAINSCO, INC. ("Form 10-K") for the fiscal year ended December 31, 1997, each of said attorneys and agents to have power to act in the name of and on behalf of the undersigned on every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. WITNESS MY HAND this 24th day of March, 1998. /s/ Robert J. McGee ----------------------------- ROBERT J. McGEE 2 EXHIBIT 25.1 SPECIAL POWER OF ATTORNEY THE STATE OF MINNESOTA ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF HENNEPIN ) THAT I, the undersigned, of Hennepin County, Minnesota, have made, constituted and appointed and by these presents do make, constitute and appoint JOSEPH D. MACCHIA, DANIEL J. COOTS and SAM ROSEN, and each of them severally, my true and lawful attorneys and agents to execute in my name, place and stead in my capacity as Director of GAINSCO, INC. the Annual Report on Form 10-K of GAINSCO, INC. ("Form 10-K") for the fiscal year ended December 31, 1998, each of said attorneys and agents to have power to act in the name of and on behalf of the undersigned on every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. WITNESS MY HAND this 20th day of March, 1998. /s/ Joel C. Puckett --------------------------- JOEL C. PUCKETT 3 EXHIBIT 25.1 THE STATE OF TEXAS ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF TARRANT ) THAT I, the undersigned, of Dallas County, Texas, have made, constituted and appointed and by these presents do make, constitute and appoint JOSEPH D. MACCHIA, DANIEL J. COOTS and SAM ROSEN, and each of them severally, my true and lawful attorneys and agents to execute in my name, place and stead in my capacity as Director of GAINSCO, INC. the Annual Report on Form 10-K of GAINSCO, INC. ("Form 10-K") for the fiscal year ended December 31, 1997, each of said attorneys and agents to have power to act in the name of and on behalf of the undersigned on every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. WITNESS MY HAND this 20th day of March, 1998. /s/ Harden H. Wiedemann ----------------------------- HARDEN H. WIEDEMANN 4 EXHIBIT 25.1 SPECIAL POWER OF ATTORNEY THE STATE OF TEXAS ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF TARRANT ) THAT I, the undersigned, of Dallas County, Texas, have made, constituted and appointed and by these presents do make, constitute and appoint JOSEPH D. MACCHIA, DANIEL J. COOTS and SAM ROSEN, and each of them severally, my true and lawful attorneys and agents to execute in my name, place and stead in my capacity as Director of GAINSCO, INC. the Annual Report on Form 10-K of GAINSCO, INC. ("Form 10-K") for the fiscal year ended December 31, 1997, each of said attorneys and agents to have power to act in the name of and on behalf of the undersigned on every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. WITNESS MY HAND this 20th day of March, 1998. /s/ John H. Williams ----------------------------- JOHN H. WILLIAMS 5 SPECIAL POWER OF ATTORNEY THE STATE OF TEXAS ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF TARRANT ) THAT I, the undersigned, of Tarrant County, Texas, have made, constituted and appointed and by these presents do make, constitute and appoint JOSEPH D. MACCHIA, DANIEL J. COOTS and SAM ROSEN, and each of them severally, my true and lawful attorneys and agents to execute in my name, place and stead in my capacity as Director of GAINSCO, INC. the Annual Report on Form 10-K of GAINSCO, INC. ("Form 10-K") for the fiscal year ended December 31, 1997, each of said attorneys and agents to have power to act in the name of and on behalf of the undersigned on every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. WITNESS MY HAND this 24 day of March, 1998. /S/ John C. Goff -------------------------------- JOHN C. GOFF EX-27 7 FINANCIAL DATA SCHEDULE
7 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 123650289 89733503 90527669 0 0 0 216802185 696513 2604511 11618136 313685306 113227009 64004507 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 78,978 53,969 8,117 17807 39554 85703 (8117)
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