-----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, VShXgGzkVHr2UwINIymudvMuoiA2PNakt5jCdHuEfwd9RoM8Cz1/cOtfCCtP3nYc QTWgwhnbaxMdw4WYfWxImA== 0000891618-97-001496.txt : 19970401 0000891618-97-001496.hdr.sgml : 19970401 ACCESSION NUMBER: 0000891618-97-001496 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL INSURANCE GROUP /CA/ CENTRAL INDEX KEY: 0000815555 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE AGENTS BROKERS & SERVICES [6411] IRS NUMBER: 943031790 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16332 FILM NUMBER: 97568601 BUSINESS ADDRESS: STREET 1: 395 OYSTER POINT BLVD STE 500 CITY: SAN FRANCISCO STATE: CA ZIP: 94080 BUSINESS PHONE: 4158726772 MAIL ADDRESS: STREET 1: 395 OYSTER POINT BLVD STREET 2: SUITE 500 CITY: SAN FRANCISCO STATE: CA ZIP: 94080 10-K 1 FORM 10-K FOR THE FISCAL YEAR ENDED 12/31/96 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ------------------------ (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER: 0-16332 NATIONAL INSURANCE GROUP (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ CALIFORNIA 94-3031790 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 395 OYSTER POINT BLVD., SUITE 500 SO. SAN FRANCISCO, CALIFORNIA 94080 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (415) 872-6772 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (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 ninety (90) days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by nonaffiliates of the Registrant, based upon the average of the last closing bid and ask prices of the Common Stock on March 25, 1997 on the NASDAQ National Market System was approximately $9,039,417. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's Common Stock as of March 25, 1997 was 3,896,937. DOCUMENTS INCORPORATED BY REFERENCE Listed below are those documents incorporated by reference and the part of the Form 10-K into which the document is incorporated: None ================================================================================ 2 PART I The Business section and other parts of this Report contain forward-looking statements that involve risks and uncertainties. Such statements include, but are not limited to, forward looking statements made in this Report which are identified by the words "believe", "anticipates", "expects", "aware" or similar expressions as they relate to the Company, as defined below, or its management. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that may cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Future Operating Results". ITEM 1. BUSINESS INTRODUCTION National Insurance Group, a California corporation ("National"), and its wholly-owned subsidiaries, Pinnacle Data Corporation, a California corporation ("Pinnacle"), Great Pacific Insurance Company, a California corporation (the "Insurance Subsidiary") and Fastrac Systems, Inc. Insurance Agent & Broker, a California corporation (the "Agency") (which together with Fastrac Systems, Inc., a California corporation ("Fastrac") are referred to in this Report collectively as the "Subsidiaries") provide specialized information services and related insurance products to mortgage bankers, other financial institutions and others located throughout the United States. National and its Subsidiaries are referred to in this Report collectively as the "Company". Utilizing sophisticated computer applications, the Company has developed special-purpose, proprietary software and database systems which provide information services on an outsourced, remote computer or manual access basis, enabling these institutions and others to: - determine if the residential or commercial real estate is located within a federally-designated Special Flood Hazard Area ("SFHA"), which real estate is collateral for loans being financed or serviced by such institutions or for other purposes, (the "Flood Zone Determination Services"); and - monitor the insurance coverage on collateral securing residential mortgages (predominantly one-to-four unit family dwellings), automobile and other consumer loans and leases and, to a lesser extent, commercial mortgages (collectively, the "Tracking Services"). When the Tracking Services indicate that insurance coverage has lapsed, the financial institution may contract with the Company to provide specialized, short-term fire, allied peril or physical damage insurance (generally referred to as "force-place" insurance), which the Company provides through its wholly-owned subsidiary, Great Pacific Insurance Company, a California corporation (the "Insurance Subsidiary"), in 48 states and the District of Columbia and through nonaffiliated insurance companies in the remainder of the United States. In addition, the Company provides flood insurance, for which the risk is assumed by the U. S. Government under the National Flood Insurance Program ("NFIP"). The Insurance Subsidiary is rated "A+" ("Superior") by A.M. Best, a nationally recognized insurance statistical and rating service. The Company began operations in 1972 as an independent general insurance agency (which is currently operating as a subsidiary of National under the name Fastrac Systems, Inc. Insurance Agent & Broker, a California corporation (the "Agency")) selling to financial institutions short-term fire and related insurance products written by nonaffiliated companies. In 1977, the Company formed the Insurance Subsidiary to underwrite the business being generated by the Agency. During the mid-1980s, the Company developed computer software systems to provide financial institutions with an economic and efficient alternative to the time-consuming and labor-intensive processes traditionally associated with monitoring and obtaining insurance coverage on collateral securing mortgages, consumer loans and leases and foreclosed properties. In 1991, the Company acquired certain assets of Fastrac Systems, Inc., a California corporation ("Fastrac"), which expanded the Company's Tracking Services to provide outsourcing capabilities. Fastrac operates as a wholly owned subsidiary of the Agency. Beginning in the late 1980s, the Company developed and test-marketed its Flood Zone Determination Services which assist a financial institution that is financing improved real estate in meeting its obligation to advise potential borrowers if such improvement is located within an SFHA. Federal law and certain secondary 1 3 markets require: (i) that regulated real estate lenders and users of such markets determine and disclose to each mortgage loan applicant if the property securing such loan is located in a federally-designated flood zone; and (ii) that borrowers maintain flood insurance in force as long as the mortgaged property is included within an SFHA. To enhance its entry into and penetration of the flood zone determination market, in 1990, the Company purchased certain assets of a flood zone determination competitor. The Company's information services and insurance products are marketed nationwide by its direct sales force to mortgage bankers, other financial institutions (including mortgage origination/servicing companies, commercial banks, savings and loans, credit unions and automobile leasing firms and others). Additional sales are made, on an indirect basis, through independent sales representatives and insurance agents and brokers. MARKET OVERVIEW Flood Zone Determination Services Market The Company markets its Flood Zone Determination Services and, in certain cases, flood insurance, to mortgage lenders, including mortgage bankers, commercial banks, savings and loans, insurance companies, credit bureaus and others. In the late 1980s, the Company utilized its proprietary technology to develop a database which enables it to determine whether or not a specific property address is located in an SFHA as defined by the Federal Emergency Management Agency ("FEMA"). The Company's database was developed by merging about 65,000 of the approximately 90,000 flood maps which have been developed by FEMA under the NFIP, which do not contain address-specific information, with a geographic database which contains address-specific information. In addition, for those addresses not in the Company's database, the Company makes these determinations manually using the FEMA flood maps, census maps, parcel maps, subdivision maps, tract maps, as well as aerial photographs and other available information. The National Flood Insurance Reform Act of 1994 ("Flood Reform Act") affirmed existing requirements that borrowers must be informed prior to loan closing whether or not their property is located in an SFHA and, if so located, flood insurance must be purchased for all loans made by federally regulated institutions and loans purchased by Federal agencies, such as Fannie Mae and Freddie Mac. The Flood Reform Act expanded existing law by requiring borrowers to place in force flood insurance if their property is determined to be located in an SFHA. The Flood Reform Act further allows a lender to charge a borrower a reasonable fee for such flood zone determination services and requires that the provider of such services guarantee the accuracy of its flood zone determinations. Insurance Tracking Services Market The Company markets its Tracking Services to mortgage bankers and financial institutions that own or service loan and personal property lease portfolios ("Servicers"). In many cases, the Company also sells force-place insurance to customers that use its insurance tracking services. See "Business -- Market Overview -- Specialized Insurance Market". Servicers generally have a need to monitor whether insurance is maintained on the real property or collateral for the loan or lease. The Company has developed special-purpose, proprietary systems which track insurance information on all types of loan and personal property lease portfolios. The Company primarily focuses its marketing efforts on Servicers with mortgage loan, consumer loan (primarily automobile) or automobile lease portfolios. Specialized Insurance Market The Company markets its specialized insurance including force-place and, in certain cases, flood insurance, to mortgage bankers and financial institutions that own or service loan portfolios. Servicers generally monitor whether insurance is maintained on the real property or collateral for the loan. In the event a borrower allows insurance to lapse, Servicers may order force-place insurance from the Company. The Company sells force-place insurance to customers that use its Tracking Services and to customers which track their own loans and manually order such insurance. The Company primarily sells flood insurance to customers 2 4 that also use its Flood Zone Determination Services. See "Business -- Market Overview -- Flood Zone Determination Services Market" and "-- Insurance Tracking Services Market". INFORMATION SERVICES Flood Zone Determination Services The use of the Company's on-line computerized Flood Zone Determination Services system is offered nationwide to financial institutions and others through Pinnacle. The proprietary system is a database of digitized geographical information which determines whether or not a particular property address is located in an SFHA and enables users to access Pinnacle's database using computer time share, batch processing or electronic data interface services. Where it cannot be determined whether a particular property address is located in an SFHA through the database, Pinnacle manually renders the determination. In addition, customers may submit their determination requests by facsimile. The Flood Zone Determination Services system also prints flood zone certificates, certain disclosure notices, flood insurance policy rating information and, for some customers, flood insurance policies which policies are placed through the Agency and, in most cases, with the Insurance Subsidiary. In addition, Pinnacle introduced life of loan service in 1991, whereby Pinnacle will automatically notify financial institutions of changes in the SFHA status of properties in their mortgage loan portfolios for the period during which their agreement with Pinnacle is in effect, or throughout the term of the loan, depending upon the fee paid for the life of loan service. Tracking Services The Company, through Fastrac, provides its Tracking Services to financial institutions located throughout the United States. The system utilizes Company-developed special-purpose, proprietary software and database systems to provide multiple tracking features for mortgages, automobile and personal property loan and automobile lease portfolios, as well as for portfolios of properties which have been foreclosed upon by financial institutions ("Real Estate Owned" or "REO"). The Tracking Services may be customized to meet the specific needs of each customer and provide automated insurance tracking and data processing services, such as tracking of whether or not insurance is in force, processing correspondence, ordering and canceling insurance coverage, receiving and placing telephone calls on behalf of its customers, and accounting for multiple premium transactions. Where Fastrac processes a customer's insurance transactions at Fastrac's facilities, the customer may access Fastrac's database to determine the status of any particular matters. Such services provided by Fastrac are commonly known as "Outsourcing." Customers who process their own insurance transactions may access Fastrac's computer system to order force-place insurance or REO insurance. See "Business -- Insurance Products -- Force-Place Insurance". The Company believes its Tracking Services enable financial institutions to track insurance coverage more efficiently and accurately and to reduce their internal labor costs. Competition The flood zone determination business is highly competitive. The major competitors known to management include Transamerica Flood Hazard Certification, First American Flood Data Services, Inc., Geotrac, Palma-Lazar & Ulsh, Inc., Lereta Corporation, National Flood Certification Services, Inc., National Flood Information Services, Flood Zones, Inc. and numerous other providers. Management believes that the most significant factors affecting competition are speed and responsiveness of service, accuracy, breadth of geographical area covered, price and financial strength. The Company believes it competes favorably with respect to these factors. The insurance tracking industry is also highly competitive. The major competitors in the tracking industry include American Security Insurance Company, American Sterling Insurance Group, Balboa Life and Casualty, Insureco Inc. and numerous other providers. Management believes that the most significant factors affecting competition are speed, accuracy and responsiveness of service, price and financial strength. The Company believes it competes favorably with respect to these factors. 3 5 INSURANCE PRODUCTS The Company provides the following specialized insurance products to its Tracking Services and Flood Zone Determination Services customers, other financial institutions and insurance agents and brokers. Force-Place Insurance Force-place insurance is purchased by financial institutions when their borrowers, whose loans are secured by real property, fail to provide the financial institutions with adequate evidence of fire and certain allied perils insurance covering improvements to real property. The financial institutions pay insurance premiums directly to the Insurance Subsidiary and ordinarily are entitled to reimbursement of the premiums paid to the Insurance Subsidiary from their borrowers in accordance with the terms of their loans. In the Company's experience, approximately 53% of force-place insurance coverage terminates or is canceled within approximately sixty (60) days of the date the policy is issued, but some policies remain in force for periods of up to one (1) year or more. The Insurance Subsidiary also offers REO insurance to financial institutions for properties on which they have foreclosed. REO insurance is generally issued for thirty (30) day periods, and provides coverage similar to the coverage provided under force-place policies. REO insurance premiums may be higher than force-place premiums because of the higher risks involved in insuring REO property, which is often vacant. Financial institutions ordinarily require immediate coverage for force-place and REO insurance, but generally do not have readily available underwriting information. Due to the lack of underwriting information, the Insurance Subsidiary usually calculates its premiums on flat rates, and covers almost all improvements on real properties, vehicles or other personal property submitted by financial institutions within predesignated limits and territories. See "Business -- Insurance Operations -- Underwriting". This method, while commonly used by force-place insurers, is unusual in the insurance industry which traditionally underwrites each risk on an individual or class basis. The Insurance Subsidiary may terminate relationships with financial institutions and insurance agents and brokers which request coverage for properties, vehicles or other personal property that have significantly higher-than-average risks or for other reasons. When an insurance policy is canceled for any reason, the Insurance Subsidiary is required to refund, at a minimum, an unearned premium calculated pursuant to applicable statutes or regulations, unless a minimum earned premium has been established. The Insurance Subsidiary's primary customers for force-place and REO insurance are mortgage bankers and financial institutions which provide mortgages on one-to-four unit dwellings, apartment buildings and commercial buildings. The net premiums earned by the Insurance Subsidiary on one-to-four unit dwellings accounted for approximately 78% of the Insurance Subsidiary's force-place and REO insurance for fiscal years 1992 through 1996. The Insurance Subsidiary also offers force-place automobile and personal property physical damage insurance products to financial institutions with loans secured by automobiles or personal property. The insurance and service needs of such financial institutions are similar to the needs of financial institutions with loans secured by real property. These financial institutions are serviced primarily on an outsourcing basis. The Insurance Subsidiary recently began underwriting automobile physical damage insurance through a general insurance agent. These policies are sold to the general public through insurance agents and brokers. The rates charged for this type of insurance are higher than usually charged in the standard insurance market. The Insurance Subsidiary writes force-place and REO insurance on a direct basis in 48 states and the District of Columbia. The Insurance Subsidiary assumes some of the risk and premium on force-place and REO insurance in the other states by being the primary reinsurer on such business generated by the Agency. See "Business -- Insurance Operations -- Agency Operations". 4 6 Flood Insurance In 1987, the Company entered into an agreement with the Federal Insurance Administration of FEMA enabling the Insurance Subsidiary to issue flood insurance polices in the Write Your Own Program ("WYO Program"). Under the WYO Program, insurance companies are authorized by FEMA to write flood insurance, and 100% of each risk is ceded to FEMA. The Insurance Subsidiary receives a commission based upon a percentage of premium for each policy it writes under the WYO Program. The Insurance Subsidiary provides its flood insurance policies under the WYO Program to customers who utilize Pinnacle's Flood Zone Determination Services and Fastrac's Tracking Services and through insurance agents and brokers. Competition The Insurance Subsidiary's major competitors in the highly competitive force-place insurance industry include the major competitors Fastrac confronts in the insurance tracking industry. See "Business -- Information Services -- Competition". The flood insurance business is also very competitive and is serviced by approximately 100 WYO carriers and other carriers offering flood insurance products that are underwritten by private carriers, many of which competitors have greater financial, marketing and other resources than the Insurance Subsidiary. Management believes that the most significant factors affecting competition in the specialized insurance industry include speed and responsiveness of service, breadth of insurance coverage and services offered, amount of commissions paid, price and financial strength. The Company believes it competes favorably with respect to these factors. INSURANCE OPERATIONS Agency Operations The Agency is a general insurance agent for the Insurance Subsidiary and other insurance companies. The Agency has entered into agency agreements to sell force-place and REO insurance in the states where the Insurance Subsidiary does not write insurance on a direct basis. These other insurance companies are not affiliated with the Company. They are Empire Fire and Marine Insurance Company, covering New Hampshire, and Universal Underwriters Insurance Company, covering New York. Under the agency agreements, the unaffiliated insurance companies pay the Agency commissions for policies sold. These agency agreements allow the Agency to initiate and maintain relationships with customers and to continue these relationships following termination of the agency agreements. The Agency also markets flood insurance policies on behalf of the Insurance Subsidiary and other WYO Program insurance companies. The Agency is currently licensed and regulated as an insurance agent and broker in California and as a nonresident insurance agent and/or broker in 32 other states and the District of Columbia. See "Business -- Regulation". Underwriting Insurance companies traditionally underwrite risks individually or by class. Since financial institutions usually do not have the underwriting information traditionally required by many insurance companies to issue fire or personal property physical damage insurance at the time that financial institutions require insurance coverage, the Insurance Subsidiary, like many of its force-place insurance competitors, insures for a flat premium rate almost all property within predesignated limits and territories without the application of underwriting criteria to individual risks. The Insurance Subsidiary determines its flat premium rate based on its underwriting experience and knowledge of the industry in which it operates. The Insurance Subsidiary uses actuaries to determine such premium rates, only where mandated by law, regulations or by unaffiliated insurance companies it represents as an agent. Accordingly, the Insurance Subsidiary may be insuring individual risks that it might not have insured if it had information obtained in the traditional underwriting process. The automobile physical damage insurance written through an unaffiliated general agent is underwritten using more traditional methods of underwriting. 5 7 Policies and Endorsements For its force-place insurance products, the Insurance Subsidiary uses its own policy language, the policy language of companies it represents as an agent, and the policy language required by applicable law or regulation, together with forms extending coverage and lender loss-payable forms giving financial institutions certain rights. The Insurance Subsidiary customizes its policy language and forms to meet the specific needs of its customers. The Insurance Subsidiary has also developed some special endorsements, including one which provides that some force-place insurance is in excess of other insurance. In many states the policy forms and rates charged must be filed with the insurance regulatory agency of the state and such filing may be subject to approval or disapproval by that regulator before the form or rate can be used. For flood insurance, the Insurance Subsidiary uses policy language provided by FEMA. The maximum limit of the Insurance Subsidiary's insurance coverage overall is generally $3 million per property location for force-place insurance, $500,000 per location for REO insurance, $100,000 per vehicle for force-place physical damage insurance and $50,000 for the automobile physical damage written through an unaffiliated general agent. In certain cases, the Insurance Subsidiary grants customers a higher maximum limit and, additionally, the Insurance Subsidiary may underwrite risks outside of predesignated limits and, in some cases, may use underwriting information furnished by financial institutions, but, to date, such underwritten risks have not represented a material portion of the Insurance Subsidiary's net premiums earned. For flood insurance, the Insurance Subsidiary uses coverage limits and rates provided by FEMA. Insurance Operating Ratios The underwriting experience of insurance companies is traditionally measured by the statutory "combined ratio". The combined ratio, calculated on a SAP (Statutory Accounting Principles) basis, is the sum of: (i) the ratio of losses and LAE (loss adjustment expenses) incurred to net premiums earned (the "loss ratio"); and (ii) the ratio of the underwriting and operating expenses, exclusive of deferred acquisition costs, to net premiums written (the "expense ratio"). The approximate SAP underwriting profit (loss) is reflected by the extent to which the combined ratio is less (indicating profit) or greater (indicating loss) than 100%. The following table shows, for the periods indicated, the Insurance Subsidiary's loss ratio, expense ratio and combined ratio.
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------- 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- Loss ratio............................... 37.1% 38.5% 37.8% 35.5% 30.0% Expense ratio............................ 50.5% 53.4% 55.7% 66.6% 61.2% ------ ------ ------ ------ ------ Combined ratio........................... 87.6% 91.9% 93.5% 102.1% 91.2% ====== ====== ====== ====== ====== Property and casualty industry combined ratio(1)............................... 115.7% 106.9% 108.5% 106.5% 107.0% ====== ====== ====== ====== ======
- --------------- (1) Based on property and casualty insurance industry statistics published by A.M. Best as of December 31, 1995. Industry statistics for 1996 are preliminary estimates available from A.M. Best as of the date of this report. The Company does not currently write any casualty insurance. The premium-to-surplus ratio of an insurance company measures the relationship of net premiums written in a given period (direct premiums written plus reinsurance assumed less returned premiums and reinsurance ceded to other carriers) to surplus (admitted assets less liabilities), all determined on a SAP basis. There are no regulations in California requiring maintenance of any particular premium-to-surplus ratio. However, regulatory authorities regard this ratio as an important indication of an insurance company's ability to withstand abnormal loss experience and prefer to see a ratio of not more than a ratio of 3-to-1 of net written 6 8 premium to surplus. The Insurance Subsidiary's premium-to-surplus ratio for the periods indicated are shown in the following table.
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- Net premiums written to surplus ratio............ 1.2 1.0 0.8 0.6 0.5 Property and casualty industry average(1)........ 1.4 1.3 1.3 1.1 1.0
- --------------- (1) Based on property and casualty insurance industry statistics published by A.M. Best as of December 31, 1995. Industry statistics for 1996 are preliminary estimates available from A.M. Best as of the date of this report. The Company does not currently write any casualty insurance. Loss and LAE Reserves The Insurance Subsidiary is required to maintain adequate reserves for the payment of anticipated eventual losses arising from claims which have been reported to it and claims which have been incurred but not yet reported. A loss and LAE reserve is established in an amount estimated by the Insurance Subsidiary to be sufficient to cover its costs of settling claims. The amount of this reserve is usually based upon management's experience with similar losses and, when available, the report of an outside adjuster. In addition, a reserve account is established to cover claims for losses that have been incurred but are not yet reported in an amount estimated by the Insurance Subsidiary to be sufficient to cover its costs of unreported losses. The amount of this reserve is based upon statistical analyses and historical trends. Reserve amounts are necessarily based on management's informed estimates and judgments using data currently available to them. As additional experience and other data become available and are reviewed, estimates and judgments may be changed which result in adjustments in operating results for the period in which such changes are made. Unlike many other types of losses, such as liability losses, losses relating to force-place, REO, flood and automobile physical damage insurance are usually known and reported to an insurance carrier promptly; the amount of the loss is usually easier to determine promptly than other types of insurance losses; and, claims are usually settled without prolonged litigation, meaning that the risks are "short-tailed". As a result, more timely information is usually available to calculate and evaluate the adequacy of reserves on known and unreported claims than with many other lines of insurance. The Insurance Subsidiary's loss and loss adjustment expense reserves are reviewed on an annual basis by unaffiliated actuaries. The Insurance Subsidiary's most recent actuarial review of such reserves as of December 31, 1996, concluded that the reserves (i) met the requirements of the insurance laws of California, (ii) were computed in accordance with accepted loss reserving standards and principles and (iii) made a reasonable provision for all unpaid loss and loss expense obligations of the Company under the terms of its policies and agreements. There are no differences between reserves determined in accordance with generally accepted accounting principles and the reserves established by the Insurance Subsidiary based upon accounting principles and practices prescribed or permitted by insurance regulatory authorities. The Insurance Subsidiary's estimate of loss reserves includes an implicit provision for inflation. The Insurance Subsidiary does not discount loss reserves. For the Insurance Subsidiary's accounting policy see Note 2 of Notes to Consolidated Financial Statements. The Insurance Subsidiary's loss reserves include losses reinsured by other companies. The estimated recoveries from reinsurers are included in net premiums and accounts receivable. See "Business - Insurance Operations -Reinsurance" and Note 10 of Notes to Consolidated Financial Statements. 7 9 The following table provides the reconciliation of reserves for losses and LAE for the periods indicated (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1994 1995 1996 ------ ------ ------ Reserves for losses and LAE at beginning of year........................................... $5,628 $3,360 $3,055 ------ ------ ------ Losses and LAE: Provision for losses and LAE for claims occurring in current year................... 7,627 6,378 3,971 Increase (decrease) in estimated losses and LAE for claims occurring in prior years......... 246 (334) 31 ------ ------ ------ 7,873 6,044 4,002 ------ ------ ------ Losses and LAE payments for claims occurring during: Current year................................... 4,664 4,329 2,487 Prior years.................................... 5,477 2,020 2,372 ------ ------ ------ 10,141 6,349 4,859 ------ ------ ------ Reserves for losses and LAE at end of year....... $3,360 $3,055 $2,198 ====== ====== ======
The following table shows how reserves for losses and LAE may be re-estimated based on experience in subsequent years. The first line presents the reserves as originally reported at the end of the calendar year. Each calendar year end reserve includes the estimated liabilities for losses and LAE for that year and the re-estimated remaining liabilities for all prior years. The second section sets forth, as of the end of successive years, the cumulative amounts paid for those claims that as of the calendar year-end, were reported but unpaid, or incurred but not reported. The last line, cumulative redundancy (deficiency), compares the latest re-estimated reserve amount to the reserve amount as originally established. A redundancy indicates the original estimate was higher than the current estimate; a deficiency indicates the original estimate was lower than the current estimate.
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ (IN THOUSANDS) Balance sheet reserves for losses and LAE........... $1,579 $1,942 $2,195 $1,776 $4,702 $3,731 $5,628 $3,360 $3,055 $2,198 Cumulative amount paid as of: One year later........... $1,117 $1,697 $1,634 $1,336 $4,391 $2,448 $5,477 $2,020 $2,372 Two years later.......... 1,307 1,916 1,923 1,837 4,551 2,645 5,822 2,234 -- Three years later.......... 1,323 2,061 2,104 1,917 4,763 2,679 5,890 -- -- Four years later......... 1,339 2,191 2,157 2,013 4,826 2,686 -- -- -- Five years later......... 1,376 2,213 2,183 2,013 4,849 -- -- -- -- Six years later.......... 1,386 2,222 2,183 2,018 -- -- -- -- Seven years later........ 1,386 2,222 2,183 -- -- -- -- -- -- Eight years later........ 1,386 2,222 -- -- -- -- -- -- -- Nine years later......... 1,386 -- -- -- -- -- -- -- -- Reserves reestimated as of: One year later........... $1,482 $2,159 $1,807 $1,769 $4,817 $2,978 $5,781 $3,026 $3,086 Two years later.......... 1,447 2,033 2,060 1,897 4,660 2,652 5,844 3,390 -- Three years later........ 1,460 2,122 2,120 1,920 4,772 2,672 5,937 -- -- Four years later......... 1,352 2,191 2,158 2,013 4,838 2,705 -- -- -- Five years later......... 1,376 2,214 2,183 2,013 4,853 -- -- -- -- Six years later.......... 1,386 2,222 2,183 2,018 -- -- -- -- -- Seven years later........ 1,386 2,222 2,183 -- -- -- -- -- -- Eight years later........ 1,386 2,222 -- -- -- -- -- -- -- Nine years later......... 1,386 -- -- -- -- -- -- -- -- Cumulative redundancy (deficiency)........... $ 193 $ (280) $ 12 $ (242) $ (151) $1,026 $ (309) $ (30) $ 31
8 10 The cumulative redundancies (deficiencies) noted in the above table are a result of the reserving process which, as discussed above, is based upon management judgment and estimates that are subject to adjustment as additional information becomes known. The Company believes that the current reserves adequately represent management's best estimate of liability for foreseeable claims. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Operating Results -- Reserve Adequacy". Investments Insurance company investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, deposits in regulated banks, savings and loans and other federally insured institutions, real estate mortgages and real estate. As of December 31, 1996, the Company had $33 million of investment assets. The Insurance Subsidiary held approximately $29 million of those investments. The Company's investment policy is determined by the Company's Board of Directors and is reviewed on a quarterly basis. Pursuant to its investment policy, the Company concentrates, for the most part, its investments in certificates of deposit, treasury securities and state and municipal issued securities. The Insurance Subsidiary also maintains a large portion of its investments in short-term instruments in order to maintain the ability to fund large losses of the Insurance Subsidiary's insureds, should they occur. The following tables reflect the investments of the Company (dollars in thousands). The table set forth below reflects the average amount of investments, income earned and annualized yield thereon for the three (3) years ended December 31, 1996.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1994 1995 1996 ------- ------- ------- (IN THOUSANDS) Average investment............................ $40,982 $38,080 $34,888 Net investment income......................... 1,836 2,042 1,975 Average annualized yield...................... 4.5% 5.4% 5.7%
The following table summarizes by type, the investments of the Company as of December 31, 1996 (dollars in thousands). The Company's investments are either insured by the Federal Deposit Insurance Corporation or have one of the top two designations from the National Association of Insurance Commissioners ("NAIC"), which correspond to an "investment grade" rating.
PERCENT OF AMOUNT TOTAL ------- ---------- Short-term investments.................................. $ 5,021 15.4% Certificates of Deposit................................. 12,294 37.8% U.S. Government-backed securities....................... 2,609 8.0% Obligations of states and municipalities................ 10,517 32.3% Equity securities....................................... 2,051 6.3% Mortgage-backed securities.............................. 81 0.2% ------- ----- Total investments............................. $32,573 100.0% ======= =====
9 11 The table set forth below indicates the expected maturity distribution of the Insurance Subsidiary's fixed income securities and short-term investments as of December 31, 1996 (dollars in thousands).
PERCENT OF AMOUNT PORTFOLIO ------- ---------- One year or less...................................... $14,675 48.0% One year to five years................................ 10,523 34.4% Six years to ten years................................ 4,885 16.1% More than ten years................................... 439 1.5% ------- ----- Total fixed income securities and short-term investments............................... $30,522 100.0% ======= =====
Reinsurance In order to limit the maximum losses for which it might otherwise be solely responsible under its policies, the Insurance Subsidiary arranges for the payment of a portion of the premiums it receives to other insurance companies pursuant to a series of treaties of reinsurance in return for reinsurance to protect against losses in excess of certain limits. The amount of potential exposure which is not reinsured is referred to as the Insurance Subsidiary's "retention". The Insurance Subsidiary pays treaty reinsurers a percentage of net premiums written and/or earned to cover reinsurance costs. The Insurance Subsidiary, subject to certain limitations, for 1996 retained the first $750,000 of each risk and reinsured the rest up to a maximum $1.75 million per risk. This per risk excess reinsurance was provided in one layer and was subject to a maximum reinsurer's liability arising out of any one event of $3.5 million in the aggregate. The reinsurance contract had a one (1) year term. The Insurance Subsidiary also purchased catastrophic reinsurance, under which the Insurance Subsidiary was protected against an accumulation of losses arising out of any one event up to $11.75 million in excess of the initial $1.75 million of losses which the Insurance Subsidiary incurred. The first layer of catastrophic reinsurance covered 95% of the first $2.5 million in excess of $2.5 million for each occurrence, with a maximum of 95% of $5.0 million for all losses during the term of the contract. The second layer covered 95% of the next $5.0 million over $5.0 million for each loss occurrence, subject to a maximum of 95% of $10.0 million for all losses during the term. The third layer of catastrophic reinsurance covered 95% of the next $5.0 million in excess of $10.0 million for each loss occurrence, subject to a maximum of 95% of $10.0 million for all losses during the term. Each of the catastrophic reinsurance agreements has a one (1) year term. The Insurance Subsidiary, subject to certain limitations, currently retains the first $500,000 of each risk and reinsures the rest up to a maximum $2.0 million per risk. This per risk excess reinsurance is provided in one layer and is subject to a maximum reinsurer's liability arising out of any one event of $4 million in the aggregate. The reinsurance contract has a one (1) year term. The Insurance Subsidiary also purchases catastrophic reinsurance, under which the Insurance Subsidiary is protected against an accumulation of losses arising out of any one event up to $12.5 million in excess of the initial $2.5 million of losses which the Insurance Subsidiary incurs. The first layer of catastrophic reinsurance covers 95% of the first $2.5 million in excess of $2.5 million for each occurrence, with a maximum of 95% of $5.0 million for all losses during the term of the contract. The second layer covers 95% of the next $5.0 million over $5.0 million for each loss occurrence, subject to a maximum of 95% of $10.0 million for all losses during the term. The third layer of catastrophic reinsurance covers 95% of the next $5.0 million in excess of $10.0 million for each loss occurrence, subject to a maximum of 95% of $10.0 million for all losses during the term. Each of the catastrophic reinsurance agreements has a one (1) year term. The Insurance Subsidiary from time to time purchases another form of reinsurance called "facultative reinsurance" for an individual policy or group of policies to protect the Insurance Subsidiary and its treaty reinsurers from certain risks or when the amount of insurance exceeds the maximum amount covered under various reinsurance treaties. The Insurance Subsidiary negotiates the cost of facultative reinsurance on a case-by-case basis, and normally passes on such costs to the insured. 10 12 The purchase of reinsurance does not relieve the Insurance Subsidiary of liability for the full amount of loss in the event the reinsurer fails or refuses to pay the reinsured portion. To date, the Insurance Subsidiary has collected full reinsurance reimbursement on all claims submitted to its reinsurers. During 1992, 1993, 1994 and 1995, the Insurance Subsidiary ceded losses of $1,267,000, $423,000, $213,000 and $6,600 respectively, to reinsurers. In 1995 and 1996, the Insurance Subsidiary paid 5.3% and 4.9%, respectively, of its premiums earned for its excess and catastrophic reinsurance treaties. REGULATION Regulation in General Pinnacle's operations are generally not subject to regulation by any government agency. Certain rules relating to issuing flood zone determination certificates are contained in volume 44 of the Code of Federal Regulations. FEMA generally oversees the enforcement of such regulations, however, neither FEMA nor any other government agency directly regulates the activities of Pinnacle. The Insurance Subsidiary is subject to regulation by government agencies in California, its state of domicile, and in the remaining states in which it does business. The nature and extent of such regulation may vary from jurisdiction to jurisdiction, but typically, among other things, involves prior approval of the acquisition of "control" of an insurance company or of any company controlling an insurance company, regulation of certain transactions entered into by an insurance company with any of its affiliates, the payment of dividends by an insurance company, approval of premium rates for many lines of insurance, standards of solvency and minimum amounts of capital and surplus which must be maintained, limitations on types and amounts of investments, restrictions on the size of risk which may be insured by a single company, licensing of insurers and their agents, deposits of securities for the benefit of policyholders, approval of policy forms, methods of accounting, establishing reserves for losses and loss adjustment expenses and filing of annual report financial statements and other reports with respect to the financial condition of the insurer and other matters. In addition, state regulatory examiners perform periodic examinations of insurance companies. Such regulation is generally intended for the protection of policyholders rather than shareholders. The following represent the more significant insurance regulatory requirements which are or will be imposed on the Insurance Subsidiary and its affiliates. Licensing in Other Jurisdictions In order to issue policies on a direct basis in a state, the Insurance Subsidiary either: (i) must be licensed by such state and usually must have its rates and policy forms approved by such state's insurance regulator; or (ii) under certain circumstances, such as dealings initiated directly by citizens or placements through licensed surplus lines brokers, it may conduct business without being admitted and without being subject to rate and/or policy forms approval. The Insurance Subsidiary currently is licensed to write insurance in the following 46 states and the District of Columbia: Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Indiana Illinois Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Jersey New Mexico North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Utah Virginia West Virginia* Washington Wisconsin Wyoming - --------------- * Insurance Subsidiary has not had its rates and policy forms approved by the West Virginia Insurance Commissioner, however, application for policy form and rate approval has been made. 11 13 In addition, the Insurance Subsidiary is authorized to write insurance in Texas and Vermont on a surplus lines basis. The Insurance Subsidiary is in the process of obtaining requisite approvals to write insurance on a direct basis in New Hampshire. The Agency (or, as to some states, at least one of the Agency's officers) must be licensed in any state in which it operates. The Agency is currently licensed in California and as a nonresident insurance agent and broker in 32 other states and the District of Columbia. Timothy Dixon, Assistant Vice President and Assistant Secretary of the Company, is licensed as a broker and/or agent in 49 states and the District of Columbia. Restrictions on Dividends Payable by the Insurance Subsidiary to the Company As a nonoperating holding company, a principal source of National's liquidity is the cash dividends received from its subsidiaries, principally the Insurance Subsidiary. The Insurance Subsidiary is subject to laws and regulations which restrict its ability to pay dividends. Effective January 1, 1994, the Insurance Subsidiary must report to the California Department of Insurance (the "Department") all dividends and other distributions to shareholders within five business days following declaration. No dividend or other distribution to shareholders may be paid until at least ten business days after receipt by the California Insurance Commissioner (the "Commissioner") of such notice. Moreover, the Insurance Subsidiary may not pay any extraordinary dividend or make any other extraordinary distribution to its shareholders until thirty days after receipt by the Commissioner of a Notice of Declaration thereof and, within such period, the Commissioner has not disapproved such payment. The interim period will allow the Department to issue an order stopping payment of the dividend if, in the Department's opinion, the payment would in any way violate the California Insurance Code or be hazardous to the insurer's policyholders, creditors or the public. An extraordinary dividend or distribution, is any dividend or distribution which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of either: (i) 10 percent of the Insurance Subsidiary's policy holder surplus as of the previous December 31, or (ii) The net income of the Insurance Subsidiary, for the twelve month period ending the previous December 31. California law further prohibits the payment of dividends without prior approval of the Department unless the insurer has available "earned surplus". The term "earned surplus" is defined as unassigned funds (surplus) as reported on the insurer's annual statement. Dividends may not be declared out of: (i) earned surplus derived from the mere net appreciation in the value of the assets not yet realized; and (ii) an exchange of assets, unless such earned surplus has been realized or the assets received in exchange are currently realizable in cash. An exception to this prohibition is allowed where the insurer's surplus as regards policyholders is: (i) reasonable in relation to its outstanding liabilities; (ii) adequate to the insurer's financial needs; and (iii) the Department's prior approval is obtained. Restrictions on Transactions Among Affiliates of the Insurance Subsidiary In addition to the dividend payment restrictions set forth above, California law places further restrictions upon the ability of an insurance company to enter into certain transactions with its affiliates. In particular, insurers are generally required to disclose to the Department certain in force agreements, relationships subsisting, and transactions which are deemed "material". These include all sales, purchases, exchanges, loans, extensions of credit, investments or other payments made by or to the insurance company within the immediately preceding twelve (12) months provided such payments involve in the net aggregate one-half of one percent or more of the insurer's admitted assets or 5% or more of the insurer's surplus as to policyholders, determined by whichever is greater, as of December 31 of the preceding year. In addition, prior approval of the Department is necessary with respect to sales, purchases, exchanges, loans or extensions of credit, or investments or other payments made by or to the insurance company within the immediately preceding twelve (12) months, provided such payments involve in the net aggregate more than 5% of the insurer's admitted assets or 25% of the insurer's surplus as to policyholders, determined by whichever is less, as of December 31 12 14 of the preceding year. These restrictions will apply to all payments made by the Insurance Subsidiary to any of its affiliates, including National and the Agency, as well as all payments made by any of the affiliates to the Insurance Subsidiary. Risk-Based Capital Rules The National Association of Insurance Commissioners ("NAIC") has adopted a formula to calculate Risk Based Capital ("RBC") of property and casualty insurance companies and adopted an RBC model for property and casualty insurance companies. Although the final RBC model for property and casualty insurance companies cannot be predicted with certainty, such model can be expected to measure four major areas of risk facing property and casualty insurers: underwriting, credit, investment, and other off-balance sheet risks. Companies having statutory surplus less than that determined necessary by the RBC model will likely be required to adequately address these three risk factors and will be subject to varying degrees of regulatory intervention, depending upon their level of capital inadequacy. The RBC model for the 1996 annual statement did not indicate an impairment of the Insurance Subsidiary's measurement of capital adequacy. Rate Regulation Under Proposition 103 In November 1988, California voters approved Proposition 103. Proposition 103 requires, in part, a one (1) year 20% rate rollback for substantially all property and casualty insurance written in California with the exception of workers' compensation and reinsurance. In May 1989, the California Supreme Court held that insurers would not be obligated to pay the rate rollback mandated by Proposition 103 if they could demonstrate that application of the rollback would produce confiscatory rates which would deny a fair and reasonable rate of return. The California Supreme Court's decision allowed insurers to file and use rates after November 8, 1989, pending approval by the Department. On February 26, 1993, the trial court in 20th Century Insurance Company v. Garamendi, determined that the regulations which included the rollback formula for rate determination were unlawful. The Department appealed the trial court's determination and on August 25, 1994, the California Supreme Court unanimously held that the California Insurance Commissioner's rollback formula which includes a uniform rate of return was constitutional and complied with the intent of Proposition 103. The Department, by letter dated June 13, 1995, denied the Company's application for an adjustment to the Department's formula for determining the amount of the Company's Proposition 103 rollback liability and assessed the liability to be $4.5 million. In order to reserve for the $4.5 million, the Company accrued $4.1 million in the second quarter of 1995 in addition to the 1994 accrual of $433,000. This amount is included on the balance sheet as Reserve for Proposition 103 and on the income statement as Non-recurring Expenses. On October 25, 1995, the Insurance Subsidiary entered into a stipulation and consent order with the Department to resolve the Insurance Subsidiary's rollback obligation. Pursuant to that settlement, the Insurance Subsidiary agreed to pay the sum of approximately $4.1 million as a rollback refund to its policyholders for the rollback year. The Company made the refunds during the first quarter of 1996. The rollback refund was paid to each eligible policyholder in the proportion that the written premium for each policyholder bears to the Insurance Subsidiary's total written premiums in California for policies in Proposition 103 lines issued or renewed during the rollback year. Pursuant to the settlement, the rollback refund constitutes the Insurance Subsidiary's entire rollback obligation and fully discharges the Insurance Subsidiary and extinguishes all of its obligations to rollback rates, make rollback refunds to policyholders, or pay interest to rollback policyholders. The Department has agreed to seek no further rollbacks or interest against the Insurance Subsidiary for the rollback year. Also, the settlement approves all rate filings which received interim approvals for current rate levels made since 1989, and all rates and rate levels charged by the Insurance Subsidiary from time to time between November 8, 1989, and the date the settlements were approved. 13 15 The amount of any refund checks uncashed after a certain period will be escheated to the State of California in accordance with its laws. Although the Company will incur additional costs for processing the refunds, management believes that its existing reserves are adequate. Finally, Proposition 103 requires insurers to submit for prior approval all proposed California rate changes to the Department prior to implementation. The Department is authorized to assess the proposed rates to determine if they are excessive, inadequate or unfairly discriminatory. Rates which violate any of these standards cannot be implemented. These prior approval requirements could limit the ability of the Insurance Subsidiary to implement California rate changes on a going forward basis. Membership in Insolvency Funds and Associations Most states require property and casualty insurance companies to become members of insolvency funds or associations which generally protect policyholders against the insolvency of insurance companies writing business in the state. Members of the fund or association must contribute to the payment of certain claims made against insolvent insurance companies. The maximum contributions required by law in any one (1) year have varied between 1% and 2% of annual premiums written by a member in that state. Most of these payments are recoverable through future policy surcharges and premium tax reductions. The Insurance Subsidiary is required to participate in such insolvency funds and associations and contributed $0 in 1995 and $23,056 in 1996 to such funds and associations. The Insurance Subsidiary is also required to participate in various mandatory insurance facilities or to participate in funding mandatory pools. These include individual state facilities such as the state FAIR Plan Associations. The Insurance Subsidiary made certain significant contributions to the California FAIR Plan Association in 1995 and 1996. See "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations". Insurance Regulation Concerning a Change in or the Acquisition of Control of an Insurance Company The Insurance Subsidiary is a property and casualty insurance company organized under the laws of the State of California. The California Insurance Code provides that any acquisition or change in "control" of a domestic insurer or of any person that controls a domestic insurer cannot be consummated without the prior approval of the Commissioner of Insurance. Control is defined to mean the power to direct or cause the direction of the management and policies of the insurer through the ownership of voting securities or by contract. A presumption of "control" arises from the ownership, control, possession with the power to vote or possession of proxies with respect to 10% or more of the voting securities of a domestic insurer or of a person that controls a domestic insurer. Any person who purchases shares of the common stock of the Company which, when combined with all other voting securities owned or otherwise controlled by that person, total 10% or more of the voting securities of the Company, will be deemed to have become a controlling person of the Insurance Subsidiary. Any purchase resulting in such an acquisition of control of the Insurance Subsidiary would require prior action by the California Commissioner of Insurance. MARKETING The Company's information services and insurance products are marketed nationwide by its sales and marketing staff located in California, Florida, Georgia, Kansas, Oregon, Pennsylvania, Texas and Virginia. Additional sales are made, on an indirect basis, through independent sales representatives and insurance agents and brokers. Most of the Company's sales personnel sell and market the Company's full line of services and products, although most of the Company's sales efforts in recent years have focused on the marketing of the Flood Zone Determination Services. In addition to a base salary, the direct sales personnel are compensated by commissions based, for the most part, on a percentage of revenues generated. Management works closely with its sales personnel to customize its Tracking and Flood Zone Determination Services to meet the needs of its financial institution customers. The Company uses direct mail and select advertising to augment its sales efforts, and has recently established an Internet web site. 14 16 SIGNIFICANT CUSTOMERS During the year ended December 31, 1996, no customer accounted for 10% or more of the Company's consolidated revenues. EMPLOYEES As of December 31, 1996, the Company employed approximately 384 persons on a full-time basis, approximately 55 persons on a part-time basis and approximately 37 persons on a temporary basis. The Company has never experienced a work stoppage, and at present, no employee is known by management to be represented by a labor organization. The Company considers its employee relations to be good. FINANCIAL INFORMATION The principal industry segments in which the Company operates are Insurance Products and Information Services. Information on revenue, identifiable assets, capital expenditures, and depreciation and amortization by segment appears in Note 23 of Notes to Consolidated Financial Statements. ITEM 2. PROPERTIES The Company leases its principal offices, located at 395 Oyster Point Boulevard, South San Francisco, California 94080, pursuant to a lease agreement entered into in November 1992. The lease is for approximately 45,600 rentable square feet at lease payments ranging from approximately $49,400 per month in the first year to $66,500 per month in the seventh year. The Company leases approximately 22,000 square feet in Concord, California at approximately $25,500 per month. The Company relocated its loan tracking operations (excluding its computer operations) from Bellevue, Washington, to South San Francisco, California, during 1994. In order to accommodate the Company's computer-related operations remaining in Bellevue, Washington, the Company entered into a new 3-year lease commencing approximately May 1, 1995, for approximately 5,060 square feet at a rental of approximately $7,600 per month. In connection with the final move of the Bellevue, Washington, operations to South San Francisco, California, the Company anticipates an early termination of such lease. The Company also entered into a new lease for approximately 11,860 square feet of office facilities in Springfield, Ohio, at lease payments of approximately $9,920 per month for the period August 1, 1995, through April 30, 1999, which lease may be terminated by the Company on July 31, 1998, upon three months prior notice and payment of a $3,000 termination fee. Some of the leases require the Company to pay certain operating expenses in addition to the lease payment. ITEM 3. LEGAL PROCEEDINGS The Company is routinely a party to litigation incidental to its business, as well as other litigation. While the ultimate results of such litigation cannot presently be determined on the date of this Report, management believes that no individual item of litigation or group of similar items of litigation is likely to have a material adverse effect on the consolidated financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth fiscal quarter of 1996. 15 17 EXECUTIVE OFFICERS OF THE COMPANY The executive officers of the Company and their ages as of March 25, 1997, are set forth below. Except for Mr. Gauer and Mr. Padilla, the following hold the indicated office with respect to National and each of the Subsidiaries.
NAME AGE POSITION WITH NATIONAL - ---------------------- --- -------------------------------------------------------------- Mark A. Speizer 53 Chief Executive Officer Bruce A. Cole 49 President Robert P. Barbarowicz 50 Executive Vice President, General Counsel and Secretary Gregory S. Saunders 34 Executive Vice President, Treasurer and Chief Financial Officer Tyron Yun 42 Executive Vice President and Chief Information Officer C. Alan Paylor 51 Executive Vice President, Sales and Marketing Robert J. Lelieur 54 Vice President and Controller Gerry L. Gauer 32 Senior Vice President of Pinnacle Data Corporation Larry Padilla 47 Senior Vice President of Fastrac Systems, Inc., and of Fastrac Systems, Inc. Insurance Agent & Broker
MR. SPEIZER, a co-founder of the Company, has served on the Board of Directors of National since its inception. Since July 1996, Mr. Speizer has served as Chairman of the Board and Chief Executive Officer of National. Between November 1986 and October 1995, Mr. Speizer served as Chairman of the Board and Chief Executive Officer of National, and between June 1995 and October 1995 served as President of National. Between 1972 and October 1995, Mr. Speizer also served in various executive level capacities and as a director for National's subsidiaries, and since July, 1996, Mr. Speizer again serves in such capacity for National's subsidiaries. MR. COLE was elected President of the Company in July 1996. From March 1994 through July 1996, Mr. Cole was general counsel and executive vice president of JB Oxford Holdings, Inc. From January 1991 through March 1994, Mr. Cole was of counsel to the law firm Rubinstein & Perry, A Professional Corporation, and Rubinstein & Perry, LLP, with an emphasis on business and corporation law with extensive involvement in corporate restructuring and securities industries matters. Mr. Cole was a founding partner of the law firm of Hendrickson, Higbie & Cole and served as a partner of the firm from 1981 to 1991. MR. BARBAROWICZ was elected Executive Vice President, General Counsel and Secretary of the Company in August 1996. From 1993 to 1996, Mr. Barbarowicz was a shareholder in the law firm Rubinstein & Perry, A Professional Corporation. Mr. Barbarowicz was of counsel to Rubinstein & Perry, LLP from 1991 to 1993. From 1983 to 1990, Mr. Barbarowicz was First Vice President and Assistant General Counsel of H.F. Ahmanson & Company and was General Counsel for The Ahmanson Insurance Companies from 1982 to 1989. In 1995, Mr. Barbarowicz commenced voluntary proceedings under the provisions of Chapter 13 of the federal bankruptcy laws, which proceedings were voluntarily withdrawn by Mr. Barbarowicz within sixty days thereafter without any action taken or any debts discharged. MR. SAUNDERS joined the Company in March 1997 as Executive Vice President, Treasurer and Chief Financial Officer. From 1990 to 1997, Mr. Saunders held several senior management positions at Transcisco Industries, Inc., including Vice President and Chief Financial Officer. From 1985 through 1988, Mr. Saunders served in various financial management capacities at PLM International, Inc., including Controller of PLM Transportation Equipment Management, Inc. Prior to 1985, Mr. Saunders held finance and system analytical positions at American Express Company, Inc. and Control Data Business Advisors, Inc. Mr. Saunders earned his Masters in Business Administration from the Graduate School of Business at Harvard University. MR. YUN joined the Company in August 1995 as Executive Vice President and Chief Information Officer. He served, from 1991 to 1995, as Director of Applications and Components Engineering of DHL Systems, Inc., and held executive positions with Oracle Corporation from 1990 to 1991, and with Arthur Andersen & Company from 1977 to 1990. 16 18 MR. PAYLOR joined the Company in September 1996 as Executive Vice President, Sales. From October 1993 to September 1996, Mr. Paylor was Vice-President, Sales for First American Real Estate Information Services, Inc. Mr. Paylor served as Vice President, Sales for Computer Power, Inc. from January 1992 until October 1993. MR. LELIEUR joined the Company in November 1995 as Director of Finance and Controller. Mr. Lelieur currently serves as Vice President and Controller. From 1991 through October 1995 Mr. Lelieur served as Director of Finance for Advanced Computer Group Software where he was directly responsible for finance, accounting and human resources functions. MR. GAUER was elected Senior Vice President of Pinnacle Data Corporation in July 1996. From August 1995 through July 1996, Mr. Gauer was a consultant and temporary employee of Pinnacle Data Corporation. From 1994 through August 1995, Mr. Gauer was self employed as a financial consultant. Mr. Gauer was Operations Manager for Foster Ousley Conley, a nationwide appraisal firm, from 1992 until 1994, where he managed the sales, customer service, production and human resources functions as well as facilities management. In such capacity he managed a staff of approximately 120, including professional appraisers, productions managers, supervisors and processors. MR. PADILLA joined Fastrac Systems, Inc. and Fastrac Systems, Inc. Insurance Agent & Broker in June 1996 as Senior Vice President. From May 1994 until May 1996, Mr. Padilla was Senior Vice President and Director of Loan Administration at First Interstate Bank. Mr. Padilla was First Vice President at Great Western Bank from May 1990 to May 1994. The executive officers serve at the discretion of the Board of Directors of the Company. Mr. Speizer and Mr. Cole have each entered into employment agreements with the Company for a three year term commencing July 11, 1996. Mr. Speizer's and Mr. Cole's employment agreements each provide, among other things, that during the term of the employment agreements the Board of Directors may terminate Mr. Speizer's or Mr. Cole's employment only upon written notice for cause. Cause is defined as a conviction of a felony or a finding of liability based on intentional tortuous conduct consisting of a breach of fiduciary duty relating to his performance as an officer and/or director of the Company. In addition, Mr. Cole's employment agreement provides that if the Company terminates Mr. Cole for reasons other than for cause, the Company shall pay Mr. Cole, in a single payment payable upon termination, an amount equal to (i) his unpaid base salary for the remainder of the three year term, (ii) the undiscounted remaining costs to provide the benefits provided in the employment agreement for the remainder of the three year term, such as the cost of Mr. Cole's membership and participation in professional associations, a $1,000 per month automobile allowance and premiums for certain insurance, including a $1 million life insurance policy, and (iii) any unpaid bonus from the previous year plus any bonus payable pursuant to any bonus plan then in effect. 17 19 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS National's Common Stock trades on the NASDAQ stock market under the symbol "NAIG". The following table sets forth the high and low sale prices for the Common Stock and cash dividends declared for the periods indicated.
COMMON CASH STOCK PRICE DIVIDENDS -------------- DECLARED PER HIGH LOW SHARES ---- --- ------------ 1995 First Quarter.............................. 5 1/2 4 3/4 $ 0.00 Second Quarter............................. 7 3/4 6 1/8 $ 0.00 Third Quarter.............................. 6 3/4 5 3/4 $ 0.00 Fourth Quarter............................. 6 1/8 4 5/8 $ 0.00 1996 First Quarter.............................. 7 1/8 5 1/2 $ 0.00 Second Quarter............................. 7 1/4 5 1/4 $ 0.00 Third Quarter.............................. 7 3/8 5 5/8 $ 0.00 Fourth Quarter............................. 6 7/8 4 3/8 $ 0.00
The average of the last closing bid and ask prices of the Common Stock, as reported on the NASDAQ National Market on March 25, 1997, was $6.9375 per share. As of March 25, 1997, there were approximately 700 holders of the Common Stock. The Companies' Boards of Directors meet quarterly to consider the payment of cash dividends based upon, among other things, an analysis of each Companies' financial performance. As a non-operating holding company, a principal source of National's liquidity is the cash dividends received from its subsidiaries, including the Insurance Subsidiary. The Insurance Subsidiary, consistent with other insurance companies, is subject to laws and regulations which restrict its ability to pay dividends. Under California law, the maximum amount of dividends that the Insurance Subsidiary may pay National in any twelve (12) month period without prior regulatory approval is the greater of either: (i) the net income (excluding capital gains and losses) for the preceding calendar year; or (ii) 10% of policyholder surplus as of the previous December 31. For the year ended December 31, 1996, the maximum dividend permitted to be paid in 1997 by the Insurance Subsidiary to National is limited to approximately $2.7 million without prior consent of the Commissioner. See "Business -- Restrictions on Dividends by Insurance Subsidiary". In addition, insurers are required to report dividends within five (5) days of declaration and at least ten (10) days prior to payment. The interim period will allow the Commissioner to issue an order stopping payment of the dividend if, in the Commissioner's opinion, the payment would in any way violate the California Insurance Code or be hazardous to the insurer's policyholders, creditors or the public. California law further prohibits the payment of dividends without prior approval of the Commissioner unless the insurer has available "earned surplus". The term "earned surplus" is defined as unassigned funds (surplus) as reported on the insurer's annual statement, excluding earned surplus derived from: (i) unrealized net appreciation of assets; and (ii) an exchange of assets, unless such earned surplus has been realized or the assets received in exchange are currently realizable in cash. An exception to this prohibition is allowed where the insurer's surplus as regards policyholders: (i) is reasonable in relation to its outstanding liabilities; (ii) is adequate to the insurer's financial needs; and (iii) the prior approval of the Commissioner is obtained. The Company believes that the implementation of the modified restrictions on the payment of dividends in California will not significantly affect the Company's ability to pay dividends in accordance with its current dividend policy. In addition, the Company believes that the implementation of the restrictions will not have any significant effect on National's liquidity. 18 20 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth certain historical selected consolidated financial data of the Company which has been derived from the audited consolidated statements of the Company for and as of the end of each of the years ended December 31, 1992, 1993, 1994, 1995 and 1996. The following information should be read in conjunction with the financial statements and related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Report.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------- 1992 1993 1994 1995 1996 ------- ------- ------- ------- ------- (IN THOUSANDS) STATEMENT OF OPERATIONS DATA Net premiums written................... $21,317 $22,549 $20,036 $14,956 $12,636 ======= ======= ======= ======= ======= Net premiums earned.................... $24,100 $23,265 $20,858 $17,020 13,585 Flood inquiry fees..................... 6,767 11,693 7,978 10,593 18,499 Tracking fees.......................... 2,594 2,477 3,012 4,786 5,479 Net commission income.................. 1,526 462 1,103 1,502 1,145 Net investment income.................. 1,811 1,797 1,836 2,042 1,975 ------- ------- ------- ------- ------- Total revenues................. 36,798 39,694 34,787 35,943 40,683 ------- ------- ------- ------- ------- Loss and LAE........................... 8,951 8,952 7,873 6,044 4,002 Commissions paid to nonaffiliates...... 5,862 4,989 4,739 4,079 1,954 Personnel expenses..................... 10,069 12,890 13,677 16,891 18,948 All other expenses..................... 7,236 7,532 9,096 12,252 14,221 Non-recurring expense.................. 0 0 1,020 4,100 0 ------- ------- ------- ------- ------- Total expenses................. 32,118 34,363 36,405 43,366 39,125 ------- ------- ------- ------- ------- Income (loss) before provision for income taxes........................ 4,680 5,331 (1,618) (7,423) 1,558 Provision for (benefit from) income taxes............................... 1,514 1,687 (534) (2,559) 284 ------- ------- ------- ------- ------- Net income (loss)...................... $ 3,166 $ 3,644 $(1,084) $(4,864) 1,274 ======= ======= ======= ======= ======= Net income (loss) per share............ $ 0.75 $ 0.85 $ (0.23) $ (1.04) $ 0.33 Weighted average common and common equivalent shares outstanding....... 4,198 4,270 4,679 4,679 3,917 Dividends per share.................... $ 0.32 $ 0.32 $ 0.20 $ 0.00 $ 0.00 BALANCE SHEET DATA Total investments...................... $31,395 $43,008 $38,957 $37,202 $32,573 Total assets........................... $50,718 $63,699 $55,092 $52,096 $47,112 Total shareholders' equity............. $28,893 $41,949 $37,290 $32,881 $28,552
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL National Insurance Group provides specialized information services and related insurance products to mortgage bankers and financial institutions located throughout the United States. The Company's primary sources of revenues are premiums and commissions earned from its specialized insurance products, fees billed to customers who use Flood Zone Determination or Tracking Services and investment income. Net premiums written represent direct and assumed premiums generated by the Insurance Subsidiary, less premiums canceled or ceded to other insurers, and adjusted for changes in the reserve for return premiums. Net premiums earned represent net premiums written adjusted for changes in unearned premium reserves. Flood inquiry fees are generated by Flood Zone Determination Services and are based on the number of flood inquiries rendered. The Company provides either one-time flood determinations 19 21 or higher fee, life-of-loan services where the Company updates the flood determinations over the periods in which the loans are outstanding or over the term of the agreement with the particular customer. Revenues from flood zone determinations are generally related to the volume of mortgage loan originations, both new and refinanced. Tracking fees are generated by Tracking Services and are usually based on the number of loans and leases tracked. Net commission income represents commissions received from nonaffiliated insurance companies for force-place insurance produced by the Agency and from the Federal Emergency Management Agency ("FEMA") for flood insurance written by the Insurance Subsidiary. The Company's insurance products include force-place insurance policies which have stated terms of either up to ninety (90) days ("short-term policies") or six (6) months to one (1) year ("longer-term policies"), most of which are longer-term policies. Premiums for longer-term policies are recorded as revenues when earned. The Company's policies are canceled at a relatively high rate because they generally remain in effect only until financial institutions receive proof that borrowers have obtained their own insurance. At the time the policies are issued, a reserve is established to provide for return of premiums for anticipated cancellations, which has the effect of decreasing net premiums written. Since 1993, the reserve has been established at approximately 64% to 68% of premiums. Premiums are written directly by the Insurance Subsidiary or by third party insurance companies in certain states where the Insurance Subsidiary is not licensed or where its products are not approved. The following table summarizes premiums written net of cancellations during the periods indicated (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1994 1995 1996 ------- ------- ------- Direct Premiums Written....................... $23,984 $17,324 $15,623 Assumed Premiums.............................. (1,259) (197) (29) ------- ------- ------- Gross Premiums Written........................ 22,725 17,127 15,594 Gross Premiums Ceded.......................... (2,689) (2,171) (2,958) ------- ------- ------- Net Premiums Written.......................... $20,036 $14,956 $12,636 ======= ======= =======
The Company's strategy includes expanding its authorization to write premiums on a direct basis and to reduce premium ceded to reinsurers. At the present, the Company generally retains the first $500,000 of each risk and reinsures the rest up to a maximum of $2.0 million per risk, pursuant to reinsurance arrangements. The Company also purchases catastrophic reinsurance, under which the Company is protected against an accumulation of losses arising out of any one event up to 95% of $12.5 million in excess of the initial $2.5 million of losses which the Company incurs. See "Business -- Regulation -- Reinsurance" and Note 10 of Notes to Consolidated Financial Statements for a description of the Company's reinsurance arrangements. The Company remains primarily liable to its policyholders in the event any reinsurer is unable or will not fulfill the obligations assumed under reinsurance. As a result of the cost and availability of reinsurance, in the future the Company may elect to retain a higher portion of the risk historically ceded to reinsurers. If the Company were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by the Company. This increased exposure could have a material adverse effect on the Company's results of operations. During 1992, 1993, 1994 and 1995, the Company ceded losses of $1,267,000, $423,000, $213,000 and $6,600, respectively, to reinsurers, and for which it has been fully reimbursed. The Company seeks to limit its exposure with respect to any failure by a reinsurer to fulfill its obligations by evaluating the financial condition and rating of members of its reinsurance pool (the Company's policy is to only purchase reinsurance with U.S. insurers rated "A" or better by A.M. Best) at the time of such purchase and by diversifying the reinsurance pool. Loss and loss adjustment expenses ("LAE") represent losses paid related to force-place insurance underwritten or reinsured by the Insurance Subsidiary, adjusted for changes in reserves for losses that are in the course of settlement and losses that have been incurred but not yet reported. Commissions paid to nonaffiliates represent amounts paid to third party agents and brokers, and other producers related to sales of the Company's services and products. Personnel expenses represent salaries, wages, sales commissions and 20 22 bonuses paid to Company employees and related employee benefits. All other expenses primarily consist of occupancy costs, including office rent and utilities, equipment maintenance and depreciation, amortization of acquisition costs, sales and marketing expenses, professional services and expenses related to the delivery of products and services such as postage and printing. The Company has considered the potential impact of the year 2000 to its computer systems. Through normal, planned enhancements of existing systems, future development of new systems, and upgrades to operation systems and databases already covered by maintenance agreements, the Company believes that year 2000 compliance will be achieved over approximately the next 18 months. The Company does not anticipate any purchases of specific software or hardware, nor does it anticipate the need to engage outside consultants, to achieve compliance. While management expects some costs associated with compliance, it is anticipated that those costs will not be material. The accounting treatment of costs incurred in connection with year 2000 compliance will be treated as period costs and will be expensed as incurred. The Company's effective income tax rate was 33%, 34% and 18% for 1994, 1995 and 1996, respectively, reflecting the 35% federal statutory income tax rate and the net effect of state taxes, less the beneficial effect of tax-exempt investment income earned during the periods. See Note 7 of Notes to Consolidated Financial Statements. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128. SFAS No. 128 is designed to improve the earnings per share (EPS) information provided in the financial statements by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of EPS data on an international basis. SFAS No. 128 is effective for financial statements issued for periods ending after December 31, 1997, including interim periods. The Company will implement SFAS No. 128 in 1997. Management has not determined the impact that SFAS No. 128 may have on the financial statements. RESULTS OF OPERATIONS The following table sets forth certain items as a percentage of total revenues for the periods indicated.
FOR YEARS ENDED DECEMBER 31, ------------------------- 1994 1995 1996 ----- ----- ----- Net premiums earned................................. 60.0% 47.4% 33.4% Flood inquiry fees.................................. 22.9 29.5 45.4 Tracking fees....................................... 8.7 13.3 13.5 Net commission income............................... 3.2 4.2 2.8 Net investment income............................... 5.2 5.6 4.9 ----- ----- ----- Total revenue............................. 100.0 100.0 100.0 ----- ----- ----- Loss and LAE........................................ 22.6 16.8 9.8 Commissions paid to nonaffiliates................... 13.6 11.3 4.8 Personnel expenses.................................. 39.3 49.3 46.6 All other expenses.................................. 26.1 25.7 34.7 Restructuring charge................................ 2.9 17.5 0.3 ----- ----- ----- Total expenses............................ 104.5 120.6 96.2 ----- ----- ----- Income (loss) before provision for income taxes..... (4.5) (20.6) 3.8 Provision for income taxes.......................... (1 .5) (7.1) 0.7 ----- ----- ----- Net income (loss)................................... (3.0)% (13.5)% 3.1% ===== ===== =====
21 23 YEAR ENDED DECEMBER 31, 1995 VERSUS YEAR ENDED DECEMBER 31, 1996 Revenue Total revenue increased from $35.9 million in 1995 to $40.7 million in 1996, an increase of $4.8 million or 13.4%. Net premiums written decreased from $15.0 million in 1995 to $12.6 million in 1996, a decrease of $2.4 million or 16.0%. The decrease in net premiums was principally due to an increase in reserves to provide for return of premiums for anticipated policy cancellations and the run-off of certain accounts. Net premiums earned decreased from $17.0 million in 1995 to $13.6 million in 1996, a decrease of $3.4 million or 20.0%. The decrease was partially due to the increase in reserve for return premiums and also partially due to a decline in written premiums. Flood inquiry fees increased from $10.6 million in 1995 to $18.5 million in 1996, an increase of $7.9 million or 74.5%. The addition of new customers contributed approximately $6 million of the increase. A change in estimate of deferred revenue related to Pinnacle's future servicing obligations for its life of loan services contributed approximately $900,000 of the increase. Interest rates have remained generally favorable for real estate borrowers with loan origination volumes increasing with Pinnacle's existing customers. Tracking fees increased from $4.8 million in 1995 to $5.5 million in 1996, an increase of $700,000 or 14.6%. The increase was primarily due to new business from two new customers. Expenses Loss and LAE was $6.0 million in 1995 (35.5% of net premiums earned) and $4.0 million in 1996 (29.5% of net premiums earned), a decrease of $2.0 million or 33.3%. The decline in losses and LAE was a direct result of fewer losses and loss adjustment expenses incurred during 1996. The loss ratio for the fourth quarter of 1996 was very favorable and contributed approximately one-half of the decrease when compared to 1995. The average loss per new claim reported decreased from $6,316 in 1995 to $5,513 in 1996. The number of new claims decreased from 957 reported in 1995 to 726 reported in 1996. Commissions paid to nonaffiliates decreased from $4.1 million (24.1% of premiums earned) in 1995 to $2.0 million (14.4% of premiums earned) in 1996, a decrease of $2.1 million, or 51.2%, due primarily to the fact that a larger percentage of the insurance business has transferred to customers with lower commission rates. Personnel expenses increased from $16.9 million in 1995 to $18.9 million in 1996, an increase of $2.0 million or 11.8%. The increase in personnel expenses was due to staff additions and increased outside labor in response to the volume increases in the Flood Zone Determinations Services business. Personnel expenses as a percent of total revenue decreased from 47.0% in 1995 to 46.6% in 1996. All other expenses increased from $12.2 million in 1995 to $14.2 million in 1996, an increase of $2 million or 16.4%. In June 1996, the Company accrued $1.4 million of expense as a result of retention agreements entered into with certain executives. The purpose of the agreements was to ensure the availability and employment of those executives through the transition following the change of control of the Company which occurred in July 1996. As a result of the above factors, income before provision for income taxes increased from a loss of $7.4 million in 1995 to a profit of $1.6 million in 1996, an increase of $9.0 million. YEAR ENDED DECEMBER 31, 1994 VERSUS YEAR ENDED DECEMBER 31, 1995 Revenue Total revenue increased from $34.8 million in 1994 to $35.9 million in 1995, an increase of $1.1 million or 3.2%. Net premiums written decreased from $20.0 million in 1994 to $15.0 million in 1995, a decrease of $5.0 million or 25.0%. The decrease in net premiums was principally due to two factors: (1) approximately $4.3 million less business in 1995 from one customer which ceased writing premiums with the Company in early 1995, and; (2) 1994 premiums written included $1.4 million from a significant customer whose loan 22 24 servicing portfolio was sold by the Resolution Trust Corporation in late 1994 and therefore, the customer did not contribute to premiums in 1995. These decreases were partially offset by additional business from new customers. Net premiums earned decreased from $20.9 million in 1994 to $17.0 million in 1995, a decrease of $3.9 million or 18.7%. The decrease was primarily related to the same factors which caused the decline in net premiums written during the period. Flood inquiry fees increased from $8.0 million in 1994 to $10.6 million in 1995, an increase of $2.6 million or 32.5%. Flood determinations are performed as part of the mortgage loan origination process and the increase in flood inquiry fee revenues is primarily due to the decline in mortgage interest rates and the addition of new customers. Interest rates began to decline during the first quarter of 1995 contributing to increases in loan origination volumes. In addition, Pinnacle added new customers and converted many of its existing customers to the higher priced life-of-loan product as the industry complies with recent federal regulations. Tracking fees for the period increased from $3.0 million in 1994 to $4.8 million in 1995, an increase of $1.8 million or 60.0%. The increase was due to the addition of several new customers. Net investment income for the period increased from $1.8 million in 1994 to $2.0 million in 1995, an increase of $200,000 or 11.1%. The increase is due to a rise in interest rates during 1995 which increased the Company's rate of return on investments. Expenses Loss and LAE was $7.9 million in 1994 (37.7% of net premiums earned) and $6.0 million in 1995 (35.5% of net premiums earned), a decrease of $1.9 million or 24.1%. The decrease was due in part to fewer occurrences of catastrophic events in 1995 as compared to 1994. Commissions paid to nonaffiliates decreased from $4.7 million (22.7% of premiums earned) in 1994 to $4.1 million (24.1% of premiums earned) in 1995, a decrease of $600,000, or 12.8%, due primarily to lower commission rates and the loss of premiums from customers who did not renew with the Company. Personnel expenses increased from $13.7 million in 1994 to $16.9 million in 1995, an increase of $3.2 million or 23.4%. The increase in personnel expenses is due to staff additions in response to the volume increases in the Flood inquiry and Tracking fee based business and staff additions in the information systems departments in an effort to enhance the new systems technology. All other expenses increased from $9.1 million in 1994 to $12.3 million in 1995, an increase of $3.2 million or 35.2%. The Company incurred charges of $1.6 million in connection with the employment termination of Mark Speizer who was the Company's Chief Executive Officer and Howard L. Herman who was the Company's President. The Company also recorded $600,000 for the write-off of software used to provide its information services products. The Company incurred expenses of a non-recurring nature in the amount of $4.1 million during 1995. On June 13, 1995, the California Department of Insurance notified the Company that its application for adjustment of its Proposition 103 return premium liability had been denied and the Company accrued an additional $4.1 million for the constitutionally mandated roll-back of insurance premiums under the Proposition. This amount is included on the balance sheet as Reserve for Prop 103 and on the income statement as Non-recurring Expense. As a result of the above factors, loss before provision for income taxes increased from $1.6 million in 1994 to $7.4 million in 1995, an increase of $5.8 million. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of a company's ability to secure sufficient cash to meet its contractual obligations and operating needs. National is a holding company with no operations and no sources of income itself except 23 25 interest or investment income. The principal assets of National are the stock of its Subsidiaries. National is, and for the foreseeable future will continue to be, dependent on the dividends from its Subsidiaries to meet its liquidity requirements, including debt service obligations. Dividends payable to National by the Insurance Subsidiary are subject to certain regulatory restrictions which are described below. The Insurance Subsidiary collects and invests premiums written in advance of the payments for associated claims. In the absence of a catastrophic loss, this timing difference between premium collection and claims payment, combined with investment income, normally provides short-term funds in excess of normal operating demands for cash. As of December 31, 1996, the Company had cash and short-term investments aggregating $13.2 million. Of the Company's cash and short-term investments, $8.3 million is held by the Insurance Subsidiary. Insurance companies, including the Insurance Subsidiary, are subject to laws and regulations which restrict their ability to pay dividends to parent companies or other shareholders. Under California law, the maximum amount of dividends that the Insurance Subsidiary may pay the Company in any twelve (12) month period without prior regulatory approval is the greater of (i) net income for the preceding calendar year, or (ii) 10% of policyholders' surplus (shareholders' equity adjusted to a statutory basis) as of the previous December 31. For the year ended December 31, 1996, the Insurance Subsidiary had net income of $2.8 million and as of December 31, 1996, statutory policyholders' surplus of $26.8 million. For the year ended December 31, 1996, the maximum dividend permitted to be paid by the Insurance Subsidiary to National was approximately $2.8 million. See "Market for Registrant's Common Equity and Related Stockholder Matters" and Note 14 of Notes to Consolidated Financial Statements. In September 1996, the Company concluded a note agreement providing $2.0 million for the purpose of partially financing the repurchase of 705,300 shares of its common stock. The total purchase price of the stock was approximately $5.0 million. See Note 20 of Notes to Consolidated Financial Statements. A second repurchase of 100,000 shares was made on October 22, 1996. The shares were acquired through a private transaction at a price of $6.95 per share. The total purchase price of that stock was approximately $700,000. Consolidated stockholders' equity at December 31, 1996, totaled $28.6 million or $7.33 per share compared to $32.9 million or $7.03 per share at December 31, 1995. As a result of the repurchase of the Company's common shares of stock, stockholders' equity decreased approximately $5.0 million; however, the equity per share increased approximately $.30. See Note 22 to Notes to Consolidated Financial Statements. Industry and regulatory guidelines suggest that a property and casualty insurers' annual statutory net written premium should not exceed approximately three times its policyholders' surplus. The Company's surplus ratio is significantly lower than such guidelines. For the year ended December 31, 1996, the Company's net written premium to policyholder surplus ratio was .50 to 1. See "Business -- Insurance Operations -- Insurance Operating Ratios". The Company is not aware of any trends, requirements, commitments, or events that will or are reasonably likely to have a negative impact on the Company's liquidity during 1997. This paragraph contains forward-looking statements reflecting the Company's current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Investors should review the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - -- Factors Affecting Future Operating Results" for a discussion of factors that could affect future performance. Inflation generally affects the rate of investment return in the securities and financial markets, and increases and decreases in such investment return rates have a corresponding effect on the Company's investment income. 24 26 FACTORS AFFECTING FUTURE OPERATING RESULTS These factors, together with statements regarding certain risks and uncertainties contained in other parts of this Report, may affect the Company's operating results. Investors should read this section in connection with any forward-looking statement made in this Report, including statements preceded or followed by the words "believes", "anticipates", "expects", "aware" or similar expressions as they relate to the Company or its management. Flood Zone Determinations The Company derives a substantial portion of its total revenues from fees for Flood Zone Determination Services. These services are primarily provided to assist lenders in complying with federal laws which in many instances require lenders to determine whether property being financed is located in a federally-designated Special Flood Hazard Area ("SFHA") and require borrowers to obtain flood insurance. Any significant change in federal legislation or secondary market requirements limiting these requirements on lenders or borrowers, or the development by competitors of significantly enhanced service or delivery systems or an increase in interest rates or a reduction in real estate loan fundings could have a material adverse effect on the Company's business or operating results. Earnings Volatility The Company's financial results can be significantly affected by a number of factors, including, but not limited to, the volume of force-place insurance and the rate of cancellation of insurance policies, the addition or loss of significant customers, significant changes in the number of loans or personal property leases being tracked for major customers, increases or decreases in interest rates, and catastrophic loss events. For example, in 1992 the Insurance Subsidiary incurred net losses relating to the Los Angeles riots and Hurricane Andrew of $612,000 and $527,000, respectively. In November 1993, the Insurance Subsidiary received claims of approximately $650,000 from policyholders for losses arising out of the October and November 1993 series of fires in Southern California. The Company also received an assessment of $725,000 from the California Fair Plan Association, a mandatory insurance pool for certain California real estate, relating to losses from those fires. In addition, revenues from the Company's Flood Zone Determination Services are directly related to the volume of mortgage loan originations, both new and refinanced, and any change in the level of such activity could have a material impact on the Company's performance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Operating Results -- The Insurance Industry", and "Management's Discussion and Analysis of Financial Condition and Results of Operations". The Insurance Industry The Company derives a significant amount of its revenues from insurance premiums and investment income. In the event that, for whatever reason, the Insurance Subsidiary experiences abnormally high losses, purchases reinsurance from reinsurers who will not or cannot pay losses submitted, or other adverse developments occur, then any such event or combination of events could have a material adverse impact on the Company. In addition, insurance companies and others have often been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject the Insurance Subsidiary to liability in excess of policy limits. An adverse outcome of any such lawsuit could have a material negative impact on the Company. Reserve Adequacy The Insurance Subsidiary is required to maintain reserves to cover its estimated ultimate liability for loss and loss adjustment expenses with respect to reported losses and incurred but not reported claims. These reserves are estimates of what the Insurance Subsidiary expects the ultimate settlement and administration of claims will cost, and are based on known facts and circumstances, predictions of future events, estimates of future trends in claims severity and other variable, subjective factors. No assurances can be given that such estimates will be adequate to cover actual losses incurred by the Insurance Subsidiary. Any significant changes 25 27 in the Insurance Subsidiary's estimate of ultimate losses on reported claims may materially adversely affect the results of the Insurance Subsidiary's operations in the period reported. The Insurance Subsidiary has in the past experienced adverse developments in its loss reserves. The Insurance Subsidiary's loss and loss adjustment expense reserves are reviewed on an annual basis by unaffiliated actuaries. The Insurance Subsidiary's most recent actuarial review of such reserves as of December 31, 1996 concluded that the reserves (i) met the requirements of the insurance laws of California; (ii) were computed in accordance with accepted loss reserving standards and principles and (iii) make a reasonable provision for all unpaid loss and loss expense obligations of the Insurance Subsidiary under the terms of its policies and agreements. The Insurance Subsidiary also maintains a reserve for return premiums which is based upon the Insurance Subsidiary's historical experience. As is prevalent in the force-place insurance industry, a substantial amount of the Insurance Subsidiary's net premiums written are refunded to policyholders. The amount of such refunds can be affected by, among other things, inaccurate or untimely data submitted by customers, which the Insurance Subsidiary uses as a basis for recording written premiums or the loss of a significant customer. No assurance can be given that the reserve for return premiums will be adequate to cover actual refunded premiums paid by the Insurance Subsidiary in the future. See, "Business - Insurance Operations", and "Management's Discussion and Analysis of Financial Condition and Results of Operations". Underwriting Risks Traditional insurance companies underwrite risks individually or by class, following an in-depth analysis of such risks. Although the Insurance Subsidiary applies underwriting techniques to a small portion of insured risks, the immediate coverage required by purchasers of force-place insurance generally requires the Insurance Subsidiary to write specialized insurance within predesignated limits and geographic area, at a flat rate, without the application of traditional underwriting criteria to individual risks. Accordingly, the Insurance Subsidiary may be insuring individual risks that it might not have insured had it applied traditional analysis to such risks. In addition, the Insurance Subsidiary may not have adequate spread of risk in a particular geographic area. See "Insurance Operations -Underwriting". Reinsurance Considerations The Insurance Subsidiary's business is partially dependent upon its ability to cede to reinsurers risks insured by the Insurance Subsidiary. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of the Insurance Subsidiary, which can affect the Insurance Subsidiary's level of business and profitability. The Insurance Subsidiary is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay the Insurance Subsidiary for the losses of the insureds. As a result of the anticipated increased cost and more limited availability of reinsurance, in the future, the Insurance Subsidiary may elect to retain a higher portion of the risk historically ceded to reinsurers. If the Insurance Subsidiary were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by the Insurance Subsidiary. This increased exposure could have a material adverse effect on the Company's results of operation. See "Regulation - Reinsurance". Pinnacle and/or the Company also indemnifies its customers for certain losses resulting from erroneous flood inquiry determinations, where a borrower was not properly advised whether the collateral was located in or out of an SFHA. While to date Pinnacle has experienced no significant losses in this regard and maintains reserves equal to its estimate of incurred but unreported indemnification losses, there can be no assurance such reserves will prove adequate in the future. The Company does not maintain errors and omissions insurance coverage against losses. Rapid Technological Change and New Products; Product Delays The markets for the Company's information services are highly competitive and characterized by rapidly changing technology. The Company believes that its future success will depend, in part, on its ability to identify, develop, install and support new services in a timely fashion, and on market acceptance of such 26 28 services. No assurance can be given that the introduction of new technologies will enable the Company to gain market share, realize cost savings or increase revenues. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This information is incorporated hereby by reference to the financial statements listed in Item 14 of Part IV of this Report. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS
NAME AGE(1) PRINCIPAL OCCUPATION - ------------------------- ------ --------------------------------------------------------- Nuno Brandolini d'Adda 43 Chairman of the Board and Chief Executive Officer of Scorpion Holdings, Inc. Bruce A. Cole 49 President of National, the Agency, Fastrac, the Insurance Subsidiary, and Pinnacle. Saul B. Jodel 46 President and Chairman of the Board of The Original San Francisco Toymakers, Inc. Kevin R. McCarthy 36 President of Scorpion Holdings, Inc. Mark A. Speizer 53 Chief Executive Officer and Chairman of the Board of National, the Agency, Fastrac, the Insurance Subsidiary, and Pinnacle.
- --------------- (1) As of March 25, 1997. Except as set forth below, each of the directors has been engaged in his principal occupation set forth above during the past five years. There is no family relationship between any director or executive officer of the Company, except that Mr. Speizer and Mr. Cole are second cousins. MR. BRANDOLINI has been Chairman of the Board and Chief Executive Officer of Scorpion Holdings, Inc., a merchant bank, since May 1995. Prior to that he was affiliated with various merchant banks, serving as Managing Director of Rosecliff, Inc. from November 1993 to May 1995, as Vice President of Salomon Inc. from June 1992 to November 1993, and as President of Baltheus Group from May 1988 to June 1991. Mr. Brandolini serves on the Board of Directors of Sonex Research, a technology based company which has developed a product to favorably alter the internal combustion process; Arabella S.A., a holding company based in Luxembourg which invests in public and private securities; and Hariston Corporation, a Canadian holding corporation with interests in a Polish specialty retailer and a CD Rom based educational software developer. MR. COLE has served as President of the Company since July 1996. From March 1994 through July 1996, Mr. Cole was general counsel and executive vice president of JB Oxford Holdings, Inc. From 1991 through March 1994 Mr. Cole was of counsel to the law firm Rubinstein & Perry, A Professional Corporation, and Rubinstein & Perry, LLP, with an emphasis on business and corporation law with extensive involvement in corporate restructuring and securities industries matters. Mr. Cole was a founding partner of the law firm of Hendrickson, Higbie & Cole and served as a partner of the firm from 1981 to 1991. MR. JODEL has been President and Chairman of the Board of The Original San Francisco Toymakers, Inc., since January 1992. From 1984 to October 1991, he served in various executive capacities with Lewis Galoob Toys, most recently as President. 27 29 MR. MCCARTHY has been President of Scorpion Holdings, Inc., since November 1995. From October 1993 to October 1995, he was Chief Financial Officer of Rosecliff, Inc. From May 1988 to October 1993, he was with the accounting firm Ernst & Young, most recently as a partner. Mr. McCarthy serves on the Board of Directors of Hariston Corporation, a Canadian holding corporation with interests in a Polish specialty retailer and a CD Rom based educational software developer. MR. SPEIZER, a co-founder of the Company, has served on the Board of Directors of National since its inception. Since July 1996, Mr. Speizer has served as Chairman of the Board and Chief Executive Officer of National. Between November 1986 and October 1995, Mr. Speizer served as Chairman of the Board and Chief Executive Officer of National, and between June 1995 and October 1995, served as President of National. Between 1972 and October 1995, Mr. Speizer also served in various executive level capacities and as a director for National's subsidiaries, and since July 1996 Mr. Speizer again serves in such capacity for National's subsidiaries. COMPENSATION OF DIRECTORS Each non-employee director of the Company is paid at the rate of $1,000 per month. Employee directors are not compensated for their services on the Board of Directors or on committees of the Board. Non-employee directors also participate in the 1991 Director Option Plan (the "Director Plan"). The Director Plan provides for the automatic grant of a nonstatutory stock option to purchase 50,000 shares of Common Stock of the Company on the date such person first becomes a director (which number was increased from 25,000 shares at the May 1995 Annual Meeting of Shareholders). All options granted under the Director Plan vest at the rate of one-fourth of the shares subject to the option on the first anniversary of the date of grant, with one-forty-eighth of such shares vesting at the end of each month thereafter. The Director Plan further provides that if Mr. Speizer and Howard L. Herman, the Company's former President, shall sell or otherwise transfer beneficial ownership of more than 75% of the aggregate number of shares controlled by them as of May 23, 1995, the optionee (except for options granted under the Director Plan to Mr. Speizer and/or Mr. Herman) shall thereafter have the right to exercise such option as to all of the optioned stock, including shares as to which such option would not otherwise be exercisable. As of May 23, 1995, Mr. Speizer and Mr. Herman controlled an aggregate of 1,772,329 shares which number is subject to adjustment in accordance with the provision of the Directors Plan regarding adjustments upon changes in capitalization or merger. On May 31, 1996, Mr. Speizer purchased 788,795 shares from Mr. Herman and certain Herman family members and trusts. On June 18, 1996, Mr. Speizer purchased 35,500 shares from Mr. Herman and his spouse. Such purchases constituted the purchase of all shares owned and beneficially owned by Mr. Herman. During the fiscal year ended December 31, 1996, directors Brandolini, Jodel and McCarthy were each automatically granted an option to purchase 50,000 shares each at a per share exercise price of $5.875. EXECUTIVE OFFICERS Information regarding executive officers is included in Item 1 hereof under the caption "Executive Officers of the Company" and is hereby incorporated by reference into this Item 10. COMPLIANCE WITH SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires National's officers and directors and persons who own more than ten percent (10%) of a registered class of National's equity securities, to file certain reports regarding ownership of, and transactions in, National's securities with the SEC. Such officers, directors and ten percent (10%) shareholders are also required by SEC rules to furnish National with copies of all Section 16(a) forms that they file. Based solely on its review of such forms received by it, or written representations from certain reporting persons, National believes that during fiscal 1996 all Section 16(a) filing requirements applicable to its officers, directors and ten percent (10%) shareholders were complied with. 28 30 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth compensation received in the last three fiscal years by (i) each individual who served as National's Chief Executive Officer during the last fiscal year, (ii) each of the four other most highly compensated executive officers whose salary plus bonus exceeded $100,000 during the last fiscal year who served as executive officers at the end of the fiscal year ended December 31, 1996, and (iii) Paulette J. Taylor and Kevin C. Eichler, who would have qualified as executive officers pursuant to item (ii) but for the fact that they were not serving as executive officers as of the end of the fiscal year ended December 31, 1996 (collectively, the "Named Officers").
LONG TERM COMPENSATION ------------ ANNUAL COMPENSATION AWARDS ALL OTHER ---------------- ------------ COMPENSATION SALARY BONUS OPTIONS ------------ NAME AND PRINCIPAL POSITION YEAR ($) ($) (#) ($) - ---------------------------------------------- ----- ------- ------ ------------ ------------ Mark A. Speizer............................... 1996 134,601 60,000 75,000 23,828(1) Chairman of the Board and CEO 1995 565,212(2) 0 50,000 602,000(3) 1994 297,711 0 50,000(4) 0 John R. Gaulding(5)........................... 1996 104,319 0 50,000 743,200(6) Former President and CEO 1995 -- -- -- -- 1994 -- -- -- -- Melvyn D. Croner(7)........................... 1996 120,000 0 -- 3,000(8) Former Acting President, Acting 1995 75,000 0 50,000 6,000(9) CEO and Acting Chairman of the Board 1994 -- -- -- -- Bruce A. Cole(10)............................. 1996 124,923 40,000 75,000 23,490(11) President 1995 -- -- -- -- 1994 -- -- -- -- Tyron Yun..................................... 1996 129,288 20,000 0 0 Executive Vice President, Chief 1995 47,500 0 25,000 0 Information Officer 1994 -- -- -- -- Robert J. Lelieur............................. 1996 89,288 15,000 0 0 Vice President and Controller 1995 12,750 0 5,000 0 1994 -- -- -- -- Gerry L. Gauer................................ 1996 153,000 23,000 25,000 0 Senior Vice President, Pinnacle 1995 27,333 0 0 0 Data Corporation 1994 -- -- -- -- Paulette J. Taylor(12)........................ 1996 105,384 0 50,000 195,000(13) Former Executive Vice President, 1995 144,231 0 5,000 0 General Counsel and Secretary 1994 121,635 0 16,000(14) 0 Kevin C. Eichler(15).......................... 1996 96,154 0 50,000 195,000(16) Former Executive Vice President, 1995 62,308 0 25,000 0 Chief Financial Officer and Treasurer 1994 -- -- -- --
- --------------- (1) Represents $12,458 of premiums on a term life insurance policy paid by the Company for Mr. Speizer's benefit, an automobile allowance of $5,370 and $6,000 payable to non-employee directors of National. (2) Includes severance payment of $285,000 attributable to salary relating to Mr. Speizer's termination of employment with National in October 1995. (3) Represents severance payment of $600,000 and $2,000 payable to non-employee director of National. (4) Pursuant to National's February 1994 option repricing program (the "February Repricing"), this option was granted upon the simultaneous cancellation of an option to purchase a like number of shares granted in fiscal 1993. (5) Mr. Gaulding served as a consultant to the Company in February and March 1996. He served as President, Chief Executive Officer and Chairman of the Board from April 1996 until July 1996. 29 31 (6) Represents payments made upon a change of control of the Company pursuant to the terms of a the Second Amendment of John R. Gaulding At-Will Employment Agreement dated July 10, 1996. (7) Mr. Croner served as Acting President, Acting Chief Executive Officer and Acting Chairman of the Board until John R. Gaulding assumed such positions in April 1996. (8) Represents compensation payable to non-employee director of National. (9) Represents compensation payable to non-employee director of National. (10) Mr. Cole assumed the position of President in July, 1996. (11) Represents $18,120 of premiums on a term life insurance policy paid by the Company for Mr. Cole's benefit and an automobile allowance of $5,370. (12) Ms. Taylor terminated her employment with the Company effective July, 1996. (13) Represents payment made upon a change of control of the Company pursuant to the terms of that certain Change of Control Severance Agreement and Mutual Release dated July 10, 1996 between Ms. Taylor and National. (14) Pursuant to the National's November 1994 option repricing program (the "November Repricing"), options to purchase an aggregate of 11,000 shares were granted upon the simultaneous cancellation of options to purchase an aggregate of 11,000 shares granted in prior fiscal years. In addition, an option to purchase 5,000 shares was granted pursuant to the November Repricing upon the simultaneous cancellation of an option to purchase 5,000 shares granted pursuant to the February Repricing. (15) Mr. Eichler terminated his employment with the Company effective July, 1996. (16) Represents payment made upon a change of control of the Company pursuant to the terms of that certain Change of Control Severance Agreement and Mutual Release dated June 26, 1996 between Mr. Eichler and National. OPTION GRANTS IN LAST FISCAL YEAR The following tables set forth, as to the Named Officers, certain information relating to stock options granted during fiscal 1996.
INDIVIDUAL GRANTS POTENTIAL REALIZABLE ---------------------------------------------------------- VALUE AT ASSUMED NUMBER OF PERCENT ANNUAL RATES OF SECURITIES OF TOTAL STOCK PRICE UNDERLYING OPTIONS APPRECIATION OPTIONS GRANTED TO EXERCISE OR FOR OPTION TERM(3) GRANTED EMPLOYEES IN BASE PRICE EXPIRATION --------------------- NAME (#) FISCAL YEAR(1) ($/SH) DATE(2) 5% ($) 10% ($) - --------------------- ---------- -------------- ----------- -------- ------- ------- Mark A. Speizer...... 75,000 18.0% 5.875 07/11/06 277,125 702,375 John R. Gaulding..... 50,000 12.0% 6.500 02/25/06 204,500 518,000 Melvyn D. Croner..... 0 -- -- -- -- -- Bruce A. Cole........ 75,000 18.0% 5.875 07/11/06 277,125 702,375 Tyron Yun............ 0 -- -- -- -- -- Robert J. Lelieur.... 0 -- -- -- -- -- Gerry L. Gauer....... 25,000 6.0% 5.875 07/11/06 92,375 234,125 Paulette J. Taylor... 50,000 12.0% 7.000 07/11/98(4) 36,000 73,500 Kevin C. Eichler..... 50,000 12.0% 6.750 07/11/98(4) 34,500 83,500
- --------------- (1) The total number of shares subject to options granted to employees in fiscal 1996 was 416,000. (2) Options may terminate before their expiration upon the termination of optionee's status as an employee or consultant, the optionee's death or an acquisition of National. 30 32 (3) Potential realizable value assumes that the stock price increases from the date of grant until the end of the option term (10 years except in the cases of Ms. Taylor and Mr. Eichler whose option term ends effective July 11, 1998) at the annual rate specified (5% and 10%). Annual compounding results in total appreciation of 63% (at 5% per year) and 159% (at 10% per year). If the price of National's Common Stock were to increase at such rates from the price at 1996 fiscal year end ($4.375 per share) over the next 10 years, the resulting stock price at 5% and 10% appreciation would be $7.13 and $11.35, respectively. The assumed annual rates of appreciation are specified in SEC rules and do not represent National's estimate or projection of future stock price growth. National does not necessarily agree that this method can properly determine the value of an option. (4) The option term of the options granted to Ms. Taylor and to Mr. Eichler will end July 11, 1998 pursuant to the terms of their respective severance agreements with the company. See "Certain Relationships and Related Transactions" regarding the terms of such severance agreements. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES There were no option exercises in fiscal 1996 by the Named Officers. The following table provides information with respect to the value of unexercised options held by the Named Officers at the close of business on December 31, 1996.
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS OPTIONS AT FISCAL YEAR END (#) AT FISCAL YEAR END ($)(2) ---------------------------------- ----------------------------- NAME EXERCISABLE(1) UNEXERCISABLE EXERCISABLE UNEXERCISABLE - -------------------------------------- -------------- ------------- ----------- ------------- Mark A. Speizer....................... 70,000(3) 125,000(4) -- -- John R. Gaulding...................... 50,000(5) 0 -- -- Melvyn D. Croner...................... 13,542 0 -- -- Bruce A. Cole......................... 0 75,000 -- -- Tyron Yun............................. 8,333 16,667 -- -- Robert J. Lelieur..................... 1,354 3,646 -- -- Gerry L. Gauer........................ 0 25,000 -- -- Paulette J. Taylor.................... 72,250(5) 0 -- -- Kevin C. Eichler...................... 75,000(5) 0 -- --
- --------------- (1) Options granted under National's 1986 Stock Option Plan are fully exercisable from their date of grant, whether or not vested. Unvested shares purchased upon exercise of an option are subject to a repurchase option in favor of National, which repurchase option lapses over time. The options listed as Exercisable are those which could be exercised without being subject to a repurchase option in favor of National. (2) Market value of underlying securities based on the closing price of $4.375 of National's Common Stock on the NASDAQ National Market on December 31, 1996, minus the exercise price. None of the options held by the Named Officers were exercisable at a price of $4.375 or less. (3) Represents 55,417 under the 1986 Stock Option Plan and 14,583 under the 1991 Director Option Plan. (4) Represents 89,583 under the 1986 Stock Option Plan and 35,417 under the 1991 Director Option Plan. (5) At December 31, 1996 all of such shares were vested. COMPENSATION OF DIRECTORS See Part III, Item 10, "Directors and Executive Officers of the Registrant -- Compensation of Directors". EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS See Part III, Item 13, "Certain Relationships and Related Transactions", for a discussion of employment contracts and severance agreements with certain of the Named Officers. 31 33 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Company's Board of Directors is composed of two non-employee directors, Saul B. Jodel and Nuno Brandolini d'Adda. No interlocking relationship exists between the Company's Board of Directors and the compensation committee of any other company, nor has any such interlocking relationship existed in the past. Mr. Brandolini is the sole shareholder, a director and chief executive officer of Scorpion Holdings, Inc., a Delaware corporation ("Scorpion"). In September 1996, National entered into a one year consulting agreement with Scorpion pursuant to which Scorpion would render services relating to investments, acquisitions and other potential transactions in exchange for an annual fee of $300,000 plus reimbursement for costs and expenses. Mr. Brandolini is a director of National. For a more detailed description of such consulting agreement, see "Item 13 -- Certain Relationships and Related Transactions". Mr. Brandolini is a shareholder, director and officer of Hydrodynamics Corporation ("Hydrodynamics"). In October 1996, National entered into a bridge loan agreement with Hydrodynamics, pursuant to which National loaned to Hydrodynamics $300,000. In December 1996, Hydrodynamics commenced voluntary proceedings under Chapter 11 of the federal bankruptcy laws. In February 1997, Arabella, S.A. purchased from National the Convertible Promissory Note of Hydrodynamics issued to National for a purchase price of $300,000. National assigned its rights under the Convertible Promissory Note and the Stock Purchase Warrant to Arabella, S.A. Mr. Brandolini is also a director of Arabella, S.A. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Compensation Committee establishes the general compensation plans of the Company, including the Company's 1986 Stock Option Plan. The Committee reviews compensation, evaluates performance, and determines base salary levels for the Company's executives. The Chief Executive Officer ("CEO") of the Company is invited to attend and participate in Committee meetings, except when CEO compensation is being discussed. The CEO may designate the President, General Counsel, another Executive Vice President or the head of the Human Resources function to attend and participate in the CEO's stead. Final decisions regarding executive compensation (excluding stock options) are made by the full Board of Directors based on recommendations of the Committee and decisions regarding stock option grants to executives are made by the Committee. The Company's executive compensation programs are designed to attract and retain executives who will contribute to the Company's long-term success, to reward the achievement of both short-term and long-term strategic goals, and to link executive and shareholder interests through equity-based plans. The three components of the Company's executive compensation program for fiscal 1996 were base salary, short-term incentives in the form of a target bonus and long-term incentives represented by stock option grants. The Committee's policies in these areas are as follows: Base Salary The Committee reviews compensation surveys and the reports of compensation consultants to determine the recommended levels of basic salary. Salaries are established at levels that are competitive for the Company's size, type of industry, and the nature of the function to be performed. Incentive Bonus The payment of incentive bonuses is dependent on the performance of the Company and the achievement of objectives developed for each individual executive. Incentive bonuses were paid to certain executive officers of the Company during 1996. See "Executive Officer Compensation -- Summary Compensation Table" which is set forth in Item 11. 32 34 Stock Option Grants Under the Company's 1986 Stock Option Plan, stock options may be granted to officers, other employees and consultants of the Company. The size of the stock option awards is based primarily on the individual's responsibilities and performance, as well as on an assessment of competitive equity compensation structures. Options are designed to match the interests of officers, employees and consultants with those of the shareholders. Stock options are generally granted with an exercise price equal to the fair market value of the Company's Common Stock on the date of grant. Current grants generally vest over a period of four years. This approach is designed to encourage the growth and preservation of shareholder value and to secure the long-term commitment of officers, employees and consultants. COMPARATIVE STOCK PERFORMANCE The graph below compares the total shareholder return on the Common Stock of the Company for the last five fiscal years with the cumulative total return on the Index for NASDAQ Stock Market (U.S. Companies) and the Index for the NASDAQ Fire, Marine, and Casualty Insurance Group over the same period (assuming the investment of $100 in the Company's Company Stock, the Index for NASDAQ Stock Market (U.S. Companies) and the Index for NASDAQ Fire, Marine, and Casualty Insurance Group on January 1, 1992 and reinvestment of all dividends.) CUMULATIVE SHAREHOLDER RETURN: NATIONAL INSURANCE GROUP VS. INDICES FOR NASDAQ STOCK MARKET (U.S. COMPANIES) AND THE NASDAQ FIRE, MARINE, AND CASUALTY INSURANCE GROUP
'INDEX FOR THE NASDAQ FIRE, INDEX FOR NASDAQ MARINE, AND MEASUREMENT PERIOD NATIONAL STOCK MARKET CASUALTY (FISCAL YEAR COVERED) INSURANCE GROUP (U.S. COMPANIES) INSURANCE GROUP' 1991 100 100 100 1992 122.5 116.4 134.8 1993 132.6 133.6 138.8 1994 55.2 130.6 133.6 1995 59.1 184.7 187.4 1996 46 227.2 203.1
33 35 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the beneficial ownership of Common Stock of National as of March 25, 1997, by (i) each person or entity who is known by National to beneficially own more than 5% of National's Common Stock, (ii) the Named Officers, (iii) each of National's current directors, and (iv) all current directors and executive officers as a group. A total of 3,896,937 shares of National's Common Stock were issued and outstanding as of March 25, 1997. For the purposes of the following information any securities not outstanding which are subject to options or other right to acquire within 60 days of March 25, 1997 are deemed to be outstanding for the purposes of computing the percentage of outstanding securities owned by such individual, but are not deemed to be outstanding for the purpose of computing the percentage of outstanding securities owned by any other person.
NUMBER PERCENT NAME AND ADDRESS OF SHARES(1) OF TOTAL - --------------------------------------------------------------------- ------------ -------- Mark A. Speizer(2)................................................... 1,962,126 49.3% 395 Oyster Point Blvd., Suite 500 South San Francisco, CA 94080 Brinson Partners, Inc.(3) and its affiliated entities................ 509,399 13.1% 209 South LaSalle Street Chicago, IL 60604-1295 Bankers Insurance Company(4)......................................... 200,500 5.1% 360 Central Avenue St. Petersburg, FL 33701 Bruce A. Cole........................................................ 2,000 * Tyron Yun(5)......................................................... 11,288 * Robert J. Lelieur.................................................... 1,875 * Gerry L. Gauer....................................................... -- -- Nuno Brandolini d'Adda............................................... -- -- Kevin R. McCarthy.................................................... -- -- Saul B. Jodel........................................................ -- -- John R. Gaulding(6).................................................. 50,000 1.3% Melvyn D. Croner(7).................................................. 13,542 * Paulette J. Taylor(8)................................................ 72,250 1.8% Kevin C. Eichler(9).................................................. 75,000 1.9% All current directors and executive officers as a group (11 persons)(10)....................................................... 1,979,997 49.6%
- --------------- * Less than 1% (1) The number and percentage of shares beneficially owned is determined under rules of the Securities and Exchange Commission (the "SEC"), and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has sole or shared voting power or investment power and also any shares which the individual has the right to acquire within 60 days of March 25, 1997 through the exercise of any stock option or other right. Unless otherwise indicated in the footnotes, each person has sole voting and investment power (or shares such powers with his or her spouse) with respect to the shares shown as beneficially owned. (2) Includes: (i) 80,417 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997, (ii) 2,400 shares held by Mr. Speizer's spouse, Linda Speizer and (iii) 4,800 shares held by Mr. Speizer and his wife for the benefit of each of Mr. Speizer's two daughters (2,400 shares for the benefit of each daughter). (3) Based on Amendment No. 7 to Schedule 13G dated February 12, 1997, filed by Brinson Partners, Inc. ("BPI") with the SEC on behalf of itself, Brinson Trust Company ("BTC"), Brinson Holdings, Inc. ("BHI"), SBC Holding (USA), Inc. ("SBCUSA") and Swiss Bank Corporation ("SBC"). BTC is a wholly-owned subsidiary of BPI. BPI is a wholly-owned subsidiary of BHI. BHI is a wholly-owned 34 36 subsidiary of SBCUSA. SBCUSA is a wholly-owned subsidiary of SBC. BPI, BHI, SBCUSA and SBC share voting and dispositive power with respect to 509,399 shares, of which shares BTC shares voting and dispositive power with respect to 150,364 shares. (4) Based on Schedule 13D dated June 12, 1996, filed by Bankers Insurance Company with the SEC pursuant to which Bankers Insurance Company disclosed the acquisition of 300,500 shares. Based on information provided to National in connection with National's preparation of this Form 10-K, Bankers Insurance Company disposed of 100,000 shares. (5) Includes 10,938 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. (6) Represents 50,000 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. (7) Represents 13,542 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. (8) Represents 72,250 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. (9) Represents 75,000 shares of Common Stock issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. (10) Includes an aggregate of 95,938 shares issuable upon exercise of outstanding options exercisable within 60 days of March 25, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Pursuant to an Option and Stock Purchase Agreement entered into on May 1, 1996, as amended (the "Stock Purchase Agreement"), between Howard L. Herman and Marcia Herman, Bradley Herman, Barbara Herman, and the Joel Franklin Herman Trust (collectively, the "Sellers"), and Mr. Speizer, Mr. Speizer agreed to purchase from the Sellers a total of 824,295 shares of Common Stock of National (the "Herman Shares") for a purchase price of $10.50 per share. 788,795 of the Herman Shares were purchased on May 31, 1996 and the remaining 35,500 Herman Shares were purchased on June 18, 1996. The Herman Shares represent approximately 17.5% of the then outstanding stock of the Company. Mr. Speizer's agreement to purchase the Herman Shares pursuant to the Stock Purchase Agreement was expressly conditioned upon receipt of an approval from the Commissioner, or an exemption granted by the Commissioner from the full filing and prior approval requirements set by the Commissioner. On May 23, 1996, the Commissioner granted such exemption. Pursuant to the Stock Purchase Agreement, the purchase price for the Herman Shares was $8,655,098, of which $3,074,805 was paid in cash, and $5,580,293 was paid by promissory notes payable by Mr. Speizer to the Sellers (the "Speizer Notes"). The Speizer Notes were payable over fifteen years, shall bear interest at 9% per annum and are payable in monthly installments of principal and interest in the aggregate amount of $56,599 per month. As collateral for the Speizer Notes, Mr. Speizer pledged to the Sellers, pursuant to Security Agreements and Stock Pledges, the Herman Shares and 400,000 additional shares of the Company's Common Stock currently owned by Mr. Speizer (together the "Pledged Shares"). The Pledged Shares are to be held in escrow by City National Bank (of Beverly Hills, California) pursuant to the terms of an Escrow Agreement dated May 31, 1996 between Mr. Speizer, the Sellers and City National Bank as escrow agent. Mr. Speizer obtained from Arabella S.A. ("Arabella"), a Luxembourg company, a line of credit for up to $4.2 million. Advances under the line of credit from Arabella are evidenced by a one-year term note bearing interest at 10% per annum (the "Arabella Note"). The Arabella Note is unsecured and no principal or accrued interest is due and payable by Mr. Speizer until May 31, 1997, the end of the term. Such line of credit was available to fund the purchase of the Herman Shares and remains available to fund amounts necessary for Mr. Speizer to make any regularly scheduled payments of principal and interest on the Speizer Notes during the term of the Arabella Note and certain other expenses. 35 37 In February 1996, John R. Gaulding entered into a Consulting Agreement with the Company, pursuant to which he agreed to provide consulting services to the Company for the months of February and March 1996 at a rate of $25,000 per month. In February 1996, the Company entered into an At-Will Employment Agreement (the "Agreement") with Mr. Gaulding, pursuant to which Mr. Gaulding agreed to serve, commencing April 1, 1996, as Chief Executive Officer and President of National and each of its subsidiaries, and the Company agreed to pay Mr. Gaulding a signing bonus of $100,000, payable in installments of $50,000 on April 1, 1996 and $25,000 on each of October 1, 1996 and January 1, 1997 (the "Signing Bonus"), and an annual salary of $300,000. Pursuant to an incentive performance program recommended by the Compensation Committee of the Board of Directors and approved by the Board of Directors, which program was to set specific goals and performance criteria and targets for fiscal years 1996 and 1997 ("Incentive Plan Criteria and Targets"), Mr. Gaulding would have been eligible to receive an annual incentive award of (i) up to $150,000 for achieving the at target goal of the Incentive Plan Criteria and Targets, (ii) up to $90,000 for achieving an acceptable but not at target goal, and (iii) $300,000 for achieving an exceptional above target goal, provided that the incentive compensation for 1996 would have been pro rated based upon the months Mr. Gaulding was a full time employee and officer of the Company. New goals and incentives for calendar years subsequent to 1997 were to be defined by the Board of Directors; however, the at target incentive award was not to be less than $100,000, prorated for the year. Pursuant to the Agreement, Mr. Gaulding was granted an option to purchase 250,000 shares of Common Stock of National, all of which shares were to vest on March 31, 1998, subject to acceleration of vesting in the event of Mr. Gaulding's termination of employment in connection with a "change in control of the Company" or in the event of an "adverse change in the board of directors," as such terms were to be defined by June 30, 1996. The Company also agreed to provide Mr. Gaulding with a monthly automobile allowance of $1,000 and provided for participation by Mr. Gaulding and his immediate family in such group insurance plans and other employee benefits as the Company maintained. In addition, the Company agreed to reimburse the premium cost of $1.3 million life insurance policy for the period April 1, 1996 through March 31, 1998, up to a maximum premium amount of $10,000 per year. In addition, the Agreement provided that in the event of termination of employment by the Company without cause, Mr. Gaulding was to receive any installment of the Signing Bonus not yet paid and a severance payment ranging from (i) $150,000, in the event his employment was terminated more than 18 months but less than twenty-four months following the date of the Agreement, to (ii) $300,000, in the event his employment was terminated within nine months following the date of the Agreement. Minor modifications of the foregoing were made in a First Amendment to the foregoing Agreement. In July 1996, National entered into the Second Amendment of John R. Gaulding At-Will Employment Agreement with John R. Gaulding. The Second Amendment provided that upon a change of control (as defined therein) that Mr. Gaulding would receive a change of control payment of $350,000. For a period of twenty-four (24) months after a change of control, Gaulding would make himself available to provide consulting services to the Company. As compensation Gaulding was to receive a payment of $14,300 per month for such twenty four month period with the full amount which would be payable over such period to be paid upon a change of control into a rabbi trust. As additional compensation Mr. Gaulding was to receive a payment of up to $10,000 for life insurance, a payment of up to $25,000 for office rental and related expenses, and reimbursement of reasonable expenses incurred by Gaulding in providing such consulting services to National. The Second Amendment also provided that the option to purchase 250,000 shares of Common Stock of National, which Gaulding received in the Agreement, would be amended as of the date of a change of control so that it covered only 50,000 shares, which option would be fully exercisable and one hundred percent (100%) vested and would remain exercisable for a period of ten years following the date of grant. The grant with respect to the remaining 200,000 shares would become void upon a change of control. In July 1996, Mr. Gaulding resigned following a change of control thereby causing National to pay the foregoing amounts and his receipt of the indicated benefits. See "Item 11 -- Executive Compensation -- Summary Compensation Table". In order to provide an incentive for continued employment during any change of control, in July 1996 National entered into a Change of Control Severance Agreement and Mutual Release with each of (i) Paulette J. Taylor, then Executive Vice President, General Counsel and Secretary of National, (ii) Roger A. Conley, then Executive Vice President, Sales of National, and (iii) Kevin C. Eichler, then 36 38 Executive Vice President and Chief Financial Officer of National. Pursuant to such Agreements, National agreed that if the particular individual terminated employment at any time within twelve (12) months following a change of control of National, as defined in the Agreement, then National would provide the following benefits to such individual: (i) a cash payment equal to one year's salary, (ii) a cash payment of $10,000, in lieu of twelve (12) months of employer-paid COBRA benefits, (iii) a cash payment of $35,000, in lieu of outplacement counseling and assistance benefits, (iv) one hundred percent (100%) vesting of the unvested portion of any stock option held by the individual, and (v) stock options held by the individual would remain exercisable for a period of two years following the date of such individual's termination of employment with National. In July 1996, Ms. Taylor, Mr. Eichler and Mr. Conley resigned their positions with National following a change of control thereby causing National to pay the foregoing amounts to each of them and their receipt of the indicated benefits. See "Item 11 -- Executive Compensation -- Summary Compensation Table". In July 1996, National entered into an employment agreement with Mark A. Speizer pursuant to which Mr. Speizer was engaged as National's Chairman of the Board and Chief Executive Officer. The term of such employment agreement is three years. Mr. Speizer is paid a salary of $300,000 per year. Mr. Speizer was granted an option to purchase 75,000 shares of Common Stock of National, one-third of which options shall vest after one (1) year with the balance vesting monthly over the next 24 months. The employment agreement further provided for a waiver of the limitation of employment provisions contained in the Severance Agreement and Release of Claims entered into by Mr. Speizer and National on October 19, 1995 (the "Severance Agreement"). The Severance Agreement was entered into in connection with the termination of Mr. Speizer's employment in 1995. Pursuant to that agreement, Mr. Speizer was paid approximately $885,000. Section 7.3 of the Severance Agreement provided that "Speizer agrees that he will not seek nor accept employment with the Company in the future and that the Company is entitled to reject without cause any application for employment with the Company made by him, and not hire him, and that Speizer shall have no cause of action against the Company arising out of any such rejection. *** If Speizer in any other manner becomes an employee of the Company, Speizer shall be obligated to return all amounts paid to him pursuant to this Severance Agreement and Release unless otherwise agreed in writing by the parties hereto." The employment agreement provided that the provisions of the Severance Agreement limiting Mr. Speizer's right to accept future employment with National are null and void and that the obligation to repay any amounts paid to Mr. Speizer under the Severance Agreement are waived provided that Mr. Speizer remains employed by National for the three year term of his employment agreement. Section 8 of the employment agreement provides: "WAIVER OF LIMITATION ON REEMPLOYMENT. The parties agree that Section 7.3 of the Severance Agreement and Release of Claims entered into between Speizer and the Company on October 19, 1995, limiting Speizer's right to accept future employment with the Company shall be null and void, and the Company waives any right it may have or may have had under that provision to require Speizer to forfeit sums paid under the Severance and Release Agreement provided that Speizer remains employed by the Company during the Term of this Agreement. Notwithstanding the foregoing, in the event of Speizer's death or disability, Speizer or his estate will not be obligated to forfeit said sums." In July 1996 National entered into an employment agreement with Bruce A. Cole pursuant to which Mr. Cole was engaged as National's President. The term of such employment agreement is three years. Mr. Cole is paid a salary of $290,000 per year. Mr. Cole was granted an option to purchase 75,000 shares of Common Stock of National one-third of which options shall vest after one (1) year with the balance vesting monthly over the next 24 months. Mr. Cole's employment agreement provides, among other things, that during the term of the employment agreement the Board of Directors may terminate Mr. Cole's employment only upon written notice for cause. Cause is defined as a conviction of a felony or a finding of liability based on intentional tortuous conduct consisting of a breach of fiduciary duty relating to his performance as an officer and/or director of the Company. In addition, Mr. Cole's employment agreement provides that if the Company terminates Mr. Cole for reasons other than for cause, the Company shall pay Mr. Cole, in a single payment payable upon termination, an amount equal to (i) his unpaid base salary for the remainder of the three year term, (ii) the undiscounted remaining costs to provide the benefits provided in the employment agreement for the remainder of the three year term, such as the cost of Mr. Cole's membership and participation in 37 39 professional associations, a $1,000 per month automobile allowance and premiums for certain insurance, including a $1 million life insurance policy, and (iii) any unpaid bonus from the previous year plus any bonus payable pursuant to any bonus plan then in effect. In August 1996, National entered into an employment agreement with C. Alan Paylor pursuant to which Mr. Paylor was engaged as National's Executive Vice President, Sales. The agreement is an at-will employment agreement. Mr. Paylor is paid a salary of $130,000 per year plus certain incentive compensation calculated based on the performance of the Company. In September 1996 National entered into a consulting agreement with Scorpion Holdings, Inc., a Delaware corporation ("Scorpion") pursuant to which Scorpion agreed to provide certain consulting services in connection with (i) management and strategic planning, (ii) the identification of financing, acquisitions and divestiture opportunities for National, and (iii) other matters relating to the day-to-day business and operation of National or any of its subsidiaries or affiliated companies, as the Board of Directors of National may from time to time reasonably request. In addition, if National engages in any (i) merger, consolidation or sale of any of its assets (other than in the ordinary course of its business) or outstanding securities or (ii) acquisition of assets or stock of another company, Scorpion has the right to act as a financial advisor to National pursuant to an engagement agreement, the terms and conditions of which shall be mutually agreed upon by National and Scorpion. The term of the consulting agreement is for one year; provided, however, the term is extended for an additional period of one year unless written notice of termination is given by either party not less than sixty (60) days prior to the first anniversary date of the consulting agreement. Pursuant to the consulting agreement, Scorpion receives an annual fee of $300,000 plus reimbursement for reasonable out-of-pocket costs and expenses. Mr. Brandolini is the sole shareholder, a director and chief executive officer of Scorpion. Mr. McCarthy is a director and president of Scorpion. Mr. Brandolini and Mr. McCarthy are directors of National. In October 1996, National entered into a bridge loan agreement with Hydrodynamics Corporation ("Hydrodynamics"), pursuant to which National loaned to Hydrodynamics $300,000. The bridge loan is evidenced by a Convertible Promissory Note, in the principal amount of $300,000, which note bears interest at the rate of 10% per annum and matures on October 28, 1997. Mr. Brandolini and Mr. McCarthy, who are directors of National are also directors, officers and shareholders of Hydrodynamics. In December 1996, Hydrodynamics commenced voluntary proceedings under Chapter 11 of the federal bankruptcy laws. In February 1997, Arabella, S.A. purchased from National the Convertible Promissory Note of Hydrodynamics issued to National for a purchase price of $300,000. National assigned its rights under the Convertible Promissory Note and the Stock Purchase Warrant to Arabella, S.A. Mr. Brandolini is also a director of Arabella S.A. In March 1997 National entered into an employment agreement with Gregory S. Saunders pursuant to which Mr. Saunders was engaged as National's Executive Vice President, Treasurer and Chief Financial Officer. The agreement is an at-will employment agreement. Mr. Saunders is paid a salary of $150,000 per year. National entered into an employment agreement with Robert P. Barbarowicz, effective as of August 1996, pursuant to which Mr. Barbarowicz was engaged as National's Executive Vice President, General Counsel and Secretary. The agreement is an at-will employment agreement. Mr. Barbarowicz is paid a salary of $150,000 per year of which, for the first year, $25,000 was paid upon commencement of employment. 38 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Report:
ITEM(S) PAGE(S) ---- ------- (1) FINANCIAL STATEMENTS: Report of Independent Accountants....................................... 40 Consolidated Balance Sheets, December 31, 1996 and 1995................. 41 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994..................................................... 42 Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994.................................. 43 Consolidated Statement of Cash Flows for the years ended December 31, 1996, 1995 and 1994..................................................... 44 Notes to Consolidated Financial Statements.............................. 45 (2) FINANCIAL STATEMENT SCHEDULES: Report of Independent Accountants on Financial Statement Schedules...... 59 I Summary of Investments Other than Investments in Related Parties..... 60 II Condensed Financial Information of Registrant (Parent Company)...... 61 III Supplementary Insurance Information Concerning Property Casualty Operations......................................................... 64 VI Reinsurance......................................................... 65 All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. (3) EXHIBITS The Exhibits listed on the accompanying index immediately following the signature page are filed as part of this Report.
(b) REPORTS ON FORM 8-K National filed a Form 8-K on October 23, 1996 which filed as Exhibits, an Employment Contract with C. Alan Paylor dated August 26, 1996, a Consulting Agreement with Scorpion Holdings, Inc. dated September 11, 1996, and a press release dated October 22, 1996. (c) EXHIBITS See Item 14 (a)(3) above. (d) FINANCIAL STATEMENT SCHEDULES See Item 14 (a)(2) above. 39 41 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors National Insurance Group: We have audited the accompanying consolidated balance sheets of National Insurance Group and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, retained earnings, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Insurance Group and Subsidiaries as of December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. San Francisco, California February 7, 1997 40 42 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
AS OF DECEMBER 31, ------------------- 1995 1996 ------- ------- ASSETS Investments: Fixed maturities for 1995 at market (amortized cost: $20,718) and 1996 at market (amortized cost: $18,293)................................. $21,130 $18,538 Equity securities at market............................................ 2,271 2,051 Short-term investments, at cost (which approximates market)............ 13,801 11,984 ------- ------- Total investments.............................................. 37,202 32,573 Cash..................................................................... 133 1,204 Net premiums and accounts receivable..................................... 4,875 5,181 Accrued interest receivable.............................................. 344 377 Net property and equipment............................................... 4,068 3,484 Deferred acquisition costs............................................... 2,624 2,186 Deferred federal income taxes............................................ 1,590 421 Other assets............................................................. 1,260 1,686 ------- ------- Total assets................................................... $52,096 $47,112 ======= ======= LIABILITIES Reserve for losses and LAE............................................... $ 3,055 $ 2,198 Unearned premiums........................................................ 5,703 4,753 Commissions payable...................................................... 742 584 Accrued expenses and other liabilities................................... 2,442 4,247 Drafts payable........................................................... 421 295 Notes payable............................................................ 0 1,333 Reserve for return premiums.............................................. 1,216 2,382 Reserve for Proposition 103.............................................. 4,534 2,268 Deferred Revenue......................................................... 1,102 500 ------- ------- Total liabilities.............................................. $19,215 $18,560 ======= ======= Commitments (Note 8) SHAREHOLDERS' EQUITY Preferred Stock, 5,000,000 shares authorized with no par value; none issued and outstanding................................................. -- -- Common stock: 15,000,000 shares authorized with no par value; issued and outstanding, 4,679,697 and 3,896,937 in 1995 and 1996, respectively.............. $23,071 $17,592 Retained earnings........................................................ 9,810 10,960 ------- ------- Total shareholders' equity..................................... 32,881 28,552 ------- ------- Total liabilities and shareholders' equity............................... $52,096 $47,112 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 41 43 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------- 1994 1995 1996 --------- --------- --------- Net premiums written...................................... $ 20,036 $ 14,956 $ 12,636 Change in unearned premiums............................... 822 2,064 949 --------- --------- --------- Net premiums earned....................................... 20,858 17,020 13,585 Flood inquiry fees........................................ 7,978 10,593 18,499 Tracking fees............................................. 3,012 4,786 5,479 Net commissions income.................................... 1,103 1,502 1,145 Net investment income..................................... 1,836 2,042 1,975 --------- --------- --------- Total revenues.................................. 34,787 35,943 40,683 --------- --------- --------- Loss and LAE.............................................. 7,873 6,044 4,002 Commissions paid to nonaffiliates......................... 4,739 4,079 1,954 Personnel expenses........................................ 13,677 16,891 18,948 All other expenses........................................ 9,096 12,252 14,221 Non-recurring expenses.................................... 1,020 4,100 0 --------- --------- --------- Total expenses.................................. 36,405 43,366 39,125 --------- --------- --------- Income (loss) before provision for (benefit from) income taxes................................................... (1,618) (7,423) 1,558 Provision for (benefit from) income taxes................. (534) (2,559) 284 --------- --------- --------- Net income (loss)......................................... $ (1,084) $ (4,864) $ 1,274 ========= ========= ========= Weighted average common and common equivalent shares outstanding............................................. 4,679,000 4,679,000 3,917,000 ========= ========= ========= Net income (loss) per share..................... $ (0.23) $ (1.04) $ 0.33 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 42 44 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK TOTAL ---------------- RETAINED SHAREHOLDERS' SHARES AMOUNT EARNINGS EQUITY ------ ------- -------- ------------- Balance, January 1, 1994................................. 5,064 $25,267 $ 16,682 $41,949 Shares issued under public offering...................... 115 1,408 -- 1,408 Shares repurchased....................................... (500) (3,610) -- (3,610) Net unrealized loss on fixed maturities and equity securities, net of deferred tax........................ -- -- (171) (171) Dividend paid............................................ -- -- (1,202) (1,202) Net loss................................................. -- -- (1,084) (1,084) ----- ------- ------- ------- Balance, December 31, 1994............................... 4,679 23,065 14,225 37,290 Net unrealized gain on fixed maturities and equity securities, net of deferred tax........................ -- -- 449 449 Options exercised........................................ 1 6 -- 6 Net loss................................................. -- -- (4,864) (4,864) ----- ------- ------- ------- Balance, December 31, 1995............................... 4,680 23,071 9,810 32,881 Net unrealized loss on fixed maturities and equity securities, net of deferred tax........................ -- -- (124) (124) Options exercised........................................ 22 188 -- 188 Shares repurchased....................................... (805) (5,667) -- (5,667) Net income............................................... -- -- 1,274 1,274 ----- ------- ------- ------- Balance, December 31, 1996............................... 3,897 $17,592 $ 10,960 $28,552 ===== ======= ======= =======
Dividends declared per share were $0.20 for the year ended December 31, 1994. There were no dividends declared for the years ended December 31, 1995 and 1996. The accompanying notes are an integral part of these consolidated financial statements. 43 45 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1994 1995 1996 -------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss)....................................... $ (1,084) $ (4,864) $ 1,274 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization........................ 2,099 2,193 1,758 Loss on sale of equipment............................ -- 1,040 288 Change in assets and liabilities: (Increase) decrease in net premiums and accounts receivable, and accrued interest receivable..... 4,015 (89) 339 Decrease in deferred acquisition costs............. 378 949 438 Increase in insurance liabilities.................. (4,573) (3,179) (767) Increase (decrease) in reserve for Prop. 103....... 434 4,100 (2,266) (Increase) decrease in tax assets.................. (160) (1,292) 1,169 Other, net......................................... 317 709 (200) -------- -------- --------- Net cash provided (used) by operating activities.................................... 1,426 (433) 2,033 -------- -------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments................................. (88,947) (43,518) (123,509) Maturity of investments................................. 92,998 45,273 128,138 Purchase of equipment................................... (2,620) (1,350) (1,445) -------- -------- --------- Net cash provided by investing activities....... 1,431 405 3,184 -------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of notes......................... -- -- 2,000 Principal payments on notes payable..................... -- -- (667) Issuance of common stock................................ 1,408 -- -- Repurchase of common stock.............................. (3,610) -- (5,667) Stock options exercised................................. -- 6 188 Dividends to shareholders............................... (1,202) -- -------- -------- --------- Net cash provided (used) by financing activities.................................... (3,404) 6 (4,146) -------- -------- --------- Net increase (decrease) in cash........................... (547) (22) 1,071 Cash at beginning of year................................. 702 155 133 -------- -------- --------- Cash at end of year....................................... $ 155 $ 133 $ 1,204 ======== ======== =========
The accompanying notes are an integral part of these consolidated financial statements. 44 46 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) 1. BASIS OF PRESENTATION AND NATURE OF OPERATIONS The accompanying consolidated financial statements of the Company include the accounts of National Insurance Group ("National") and its subsidiaries ("Subsidiaries"), Great Pacific Insurance Company (the "Insurance Subsidiary"), Pinnacle Data Corporation ("Pinnacle"), and Fastrac Systems, Inc. Insurance Agent & Broker (the "Agency"). The Agency has a wholly-owned subsidiary, Fastrac Systems, Inc. ("Fastrac"). The Subsidiaries have transactions with each other in the ordinary course of business. The Agency receives a commission for business it writes which is insured or reinsured by the Insurance Subsidiary. Certain expenses are shared between the Subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company provides specialized information services and related insurance products to mortgage bankers, other financial institutions and others located throughout the United States. Utilizing sophisticated computer applications, the Company has developed special-purpose, proprietary software and database systems which provide information services on an outsourced, remote computer or manual access basis, enabling these institutions to: - determine if the residential or commercial real estate, which is collateral for loans being financed or serviced by such institutions and for other purposes, is located within a federally-designated Special Flood Hazard Area ("SFHA"), and - monitor the insurance coverage on collateral securing residential mortgages (predominantly one-to-four unit family dwellings), automobile and other consumer loans and leases and, to a lesser extent, commercial mortgages. When the Tracking Services indicate that insurance coverage has lapsed, the financial institution may contract with the Company to provide specialized, short-term fire, allied peril or physical damage insurance (generally referred to as "force-place" insurance), which the Company provides through its wholly-owned subsidiary, Great Pacific Insurance Company (the "Insurance Subsidiary") in 48 states and through nonaffiliated insurance companies in the remainder of the United States. In addition, the Company provides flood insurance, for which the risk is assumed by the U.S. Government under the National Flood Insurance Program ("NFIP") and underwrites automobile physical damage insurance. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the significant accounting policies adopted by National and Subsidiaries in the accompanying financial statements: Data processing equipment and purchased software and office furniture and equipment are depreciated over five (5) years, and automobiles are depreciated over three (3) to five (5) years, all using a modified straight-line method. Upon retirement or sale of an asset, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in operations. Maintenance and repairs are charged to income as incurred. Goodwill is the excess of cost over fair market value of the Company's acquired entities. It is amortized on a straight-line basis over a period of twenty years. Costs associated with the research and development of the Company's flood determination products have been expensed as incurred. Commission income is recorded when earned, net of an estimated reserve for cancellation. 45 47 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Premiums written are earned on a pro rata basis over the periods covered by the policies. Policyholders have the right to cancel a policy at any time and receive a minimum refund as defined by law or regulation. In certain circumstances, the Company grants refunds in excess of the minimum amounts required by regulation. The Company received acceptance from the California Department of Insurance to establish a reserve for return premiums, based upon historical experience, to provide for anticipated cancellations net of written premiums. Actual cancellations could differ from management's estimates. Changes in estimates of cancellations resulting from the continuous review process and differences between estimates and actual cancellations are included in income of the period in which the estimates are changed or cancellations occur. Fee income is recognized when earned. Certain contractual agreements for Flood Zone Determination Services provide for some future services by the Company. In these cases the majority of the revenue is recognized at the inception of the service and the balance of the revenue is recognized over the estimated period the services are performed. Policy acquisition costs, principally commissions, premium taxes, and variable underwriting and policy issuance expenses, have been deferred. Such costs are recognized on a pro rata basis over the periods covered by the policies. Costs are deferred to the extent that they are recoverable from premium income after providing for all loss-related and maintenance expenses. Anticipated investment income is not considered in the determination of recoverability of this asset. The reserve for unpaid losses and LAE is based on the estimated ultimate cost of settling claims, using past experience adjusted for current trends and any other factors which, in management's judgment, would modify this experience. Changes in estimates of losses resulting from the continuous review process and differences between estimates and payments for claims are included in income of the period in which the estimates are changed or payments are made. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of certain revenues and certain expenses during the reporting period. Actual results could differ from those estimates. Investments in fixed maturities include bonds, U.S. Treasury notes, federal discount notes, mortgage-backed securities and certificates of deposit. Investments in equity securities are preferred stock. Short-term investments consist of certificates of deposits, commercial paper and money market accounts at certain financial institutions and are carried at cost which approximates market. Investment income is recognized as earned. Realized gains or losses on sale of investments are determined on the basis of specific identification and are included in income. The Company's fixed maturity and equity security investments are categorized as available-for-sale and as a result are carried at market value. Market value is determined using published quotes as of the close of business. Unrealized gains and losses are excluded from earnings and reported net of tax as a separate component of stockholders' equity until realized. On December 29, 1995, the Company transferred securities with an amortized cost basis of $20,718,000 and net unrealized gains of $412,000 from its held-to-maturity portfolio to the available-for-sale portfolio in accordance with the special report issued by the Financial Accounting Standards Board ("FASB") titled "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The FASB special report included special transition provisions for the one-time reassessment and reclassification of securities from the held-to-maturity portfolio during the period from November 15, 1995 to December 31, 1995. Prior to December 29, 1995, the Company 46 48 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) classified its fixed maturity and equity security investments as held-to-maturity. Held-to-maturity investments were carried at amortized costs. The Company's investment policies limit concentration of credit risk by diversifying its investment portfolio and by, among other things, limiting its investments in certificates of deposit to balances insured by the Federal Deposit Insurance Corporation. The Company maintains deposit balances, other than certificates of deposit, with some financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. A significant portion of the Company's receivables are from mortgage bankers and financial institutions. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128. SFAS No. 128 is designed to improve the earnings per share (EPS) information provided in the financial statements by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of EPS data on an international basis. SFAS No. 128 is effective for financial statements issued for periods ending after December 31, 1997, including interim periods. The Company will implement SFAS No. 128 in 1997. Management has not determined the impact that SFAS No. 128 may have on the financial statements. For comparative purposes, certain prior year amounts have been reclassified to conform to the current year presentation. Such reclassifications had no impact on net income (loss) or Shareholder's equity. 3. INVESTMENTS (a) Fixed-maturity investments available for sale (in thousands):
AS OF DECEMBER 31, 1995 AS OF DECEMBER 31, 1996 ----------------------------------------------- ----------------------------------------------- ESTIMATED ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET COST GAIN LOSS VALUE COST GAIN LOSS VALUE --------- ---------- ---------- --------- --------- ---------- ---------- --------- U.S. Government securities........ $ 4,886 $ 57 $ -- $ 4,943 $ 2,599 $ 10 $ -- $ 2,609 State and municipal bonds............. 12,380 365 10 12,735 10,282 235 -- 10,517 Certificates of deposit........... 3,362 -- -- 3,362 5,331 -- -- 5,331 Mortgage-backed securities........ 90 -- -- 90 81 -- -- 81 -- ------- ---- --- ------- ------- ---- ------- Total...... $20,718 $422 $ 10 $21,130 $18,293 $245 $ 0 $18,538 ======= ==== === ======= ======= ==== == =======
At December 31, 1996, investment securities, at amortized cost and estimated market value, have contractual maturities as presented in the table below; however, other contract terms may allow actual maturities to differ from contractual maturities.
AMORTIZED COST ESTIMATED MARKET VALUE ------------------------------------------- ------------------------------------------- STATE AND CERTIFICATES U.S. GOVT. STATE AND CERTIFICATES U.S. GOVT. MUNICIPAL BONDS OF DEPOSIT SECURITIES MUNICIPAL BONDS OF DEPOSIT SECURITIES --------------- ------------ ---------- --------------- ------------ ---------- Within one year................ $ 645 $ -- $1,900 $ 646 $ -- $ 1,905 One through five years......... 5,848 5,331 699 5,951 5,331 704 Six through ten years.......... 3,695 -- -- 3,817 -- -- More than ten years............ 94 -- -- 103 -- -- Mortgage-backed securities..... -- -- 81 -- -- 81 ------- ------ ------ ------- ------ ------ Total................. $10,282 $5,331 $2,680 $10,517 $5,331 $ 2,690 ======= ====== ====== ======= ====== ======
47 49 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) There were no sales of fixed-maturity investments in 1995 or 1996. (b) Equity Securities Available for Sale: At December 31, 1995 the Company had market rate preferred stock with a cost of $2,210,000, an unrealized gain of $61,000 and a market value of $2,271,000. At December 31, 1996 the Company had market rate preferred stock with a cost of $2,010,000 an unrealized gain of $41,000, and a market value of $2,051,000. 4. PROPERTY AND EQUIPMENT The components of property and equipment are as follows (in thousands):
AS OF DECEMBER 31, --------------------- 1995 1996 -------- -------- Office furniture and equipment......................... $ 3,237 $ 3,240 Data processing equipment.............................. 6,273 6,618 Software............................................... 4,172 4,579 Leasehold improvements................................. 998 1,023 ------ ------ 14,680 15,460 Less accumulated depreciation and amortization......... (10,612) (11,976) ------ ------ Total........................................ $ 4,068 $ 3,484 ====== ======
Depreciation and amortization expense was $2,042,000, $2,160,000 and $1,758,000, in 1994, 1995 and 1996, respectively. 5. DEFERRED ACQUISITION COSTS Changes in deferred acquisition costs are summarized as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1994 1995 1996 ------- ------- ------- Deferred acquisition costs, beginning of period.................................... $ 3,951 $ 3,573 $ 2,624 Additions................................... 10,669 8,648 5,859 Amortization expense........................ (11,047) (9,597) (6,297) ------- ------ ------ Deferred acquisition costs, end of period... $ 3,573 $ 2,624 $ 2,186 ======= ====== ======
The net change in deferred acquisition costs is included in the consolidated statements of income as a component of commissions paid to nonaffiliates, personnel expenses and all other expenses. 48 50 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSE (LAE) Activity in the reserve for loss and loss adjustment expenses is summarized as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1994 1995 1996 ------ ------ ------ Reserves for losses and LAE at beginning of year......... $5,628 $3,360 $3,055 ------ ------ ------ Losses and LAE: Provision for losses and LAE for claims occurring in current year........................................ 7,627 6,378 3,971 Increase (decrease) in estimated losses and LAE for claims occurring in prior years..................... 246 (334) 31 ------ ------ ------ 7,873 6,044 4,002 ------ ------ ------ Losses and LAE payments for claims occurring during: Current year........................................... 4,664 4,329 2,487 Prior years............................................ 5,477 2,020 2,372 ------ ------ ------ 10,141 6,349 4,859 ------ ------ ------ Reserves for losses and LAE at end of year............... $3,360 $3,055 $2,198 ====== ====== ======
During 1994, and 1995, the Company ceded losses of $213,000, and $6,600 respectively, to reinsurers for losses occurring in 1992. There were no losses ceded to reinsurers in 1996. 7. INCOME TAX The components of income tax expense are as follows (in thousands):
AS OF DECEMBER 31, --------------------------- 1994 1995 1996 ----- ------- ----- Federal Current...................................... $ (87) $(1,508) $(829) Deferred..................................... (447) (1,142) 1,091 ----- ------- ----- (534) (2,650) 262 State Current...................................... -- 91 22 ----- ------- ----- Total........................................ $(534) $(2,559) $ 284 ===== ======= =====
The actual tax expense differs from expected tax expense computed by applying the federal statutory tax rate to operating income before provision for income taxes as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1994 1995 1996 ----- ----- ----- Tax at federal statutory rate................ 34% 35% 35% Tax-Exempt investment income................. (7) (9) (13) Other........................................ 6 8 (4) -- - --- --- Total.............................. 33% 34% 18% === === ===
49 51 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The components of the net deferred tax balance as of December 31, 1994, 1995 and 1996 are as follows (in thousands):
ASSET (LIABILITY) ----------------------------- 1994 1995 1996 ------- ------- ----- Unearned premium reserve........................ $ 528 $ 388 $ 323 Deferred acquisition costs...................... (1,215) (892) (743) Write-down of carrying value of equity securities.................................... 78 0 0 Loss reserve discounting........................ 62 39 90 Prepaid expenses................................ 45 (95) (134) Deferred revenue................................ 201 335 170 Proposition 103 reserve......................... 147 1,541 0 Accrued liabilities............................. 338 181 613 Other........................................... 114 93 102 ------ ------ ---- Total................................. $ 298 $ 1,590 $ 421 ====== ====== ====
The Company has not established a valuation reserve at December 31, 1996. Realization of deferred tax assets is dependent on the ability to carry back losses to previous years, the likelihood of future income, and the timing of realization of deferred tax assets. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced or the timing of realization of deferred tax assets changes. Deferred income taxes were provided on temporary differences in the recognition of income for income tax and financial statement purposes. The source and tax effect of these temporary differences in the provision are as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1994 1995 1996 ----- ------- ------ Unearned premium reserve..................... $ 56 $ 140 $ 65 Deferred acquisition costs................... (128) (323) (149) Write-down of carrying value of equity securities................................. (19) 78 0 Loss reserve discounting..................... 54 23 (51) Prepaid expenses............................. 73 140 39 Deferred revenue............................. (81) (134) 165 Prop. 103 reserve............................ -- (1,394) 1,541 Accrued liabilities.......................... (478) 307 (432) Other........................................ 76 21 (87) ------ -------- ------ Total...................................... $(447) $(1,142) $1,091 ====== ======== ======
Taxes paid in 1994, 1995 and 1996 were $195,000, $91,000 and $22,000 respectively. Tax refunds received for 1994, 1995 and 1996 were $675,000, $627,000 and $798,000 respectively. 8. COMMITMENTS National's subsidiaries have entered into operating leases. The operating leases are for office space for National and Subsidiaries' home office, Fastrac branch offices in Bellevue, Washington and Springfield, Ohio and Pinnacle offices in Concord, California. Rental expense under operating leases was $1,222,000, $1,134,000 and $1,175,000 in 1994, 1995 and 1996, respectively. National has entered into employment contracts with some key employees. Base compensation expense (not including bonus or commission) under employment contracts was $425,000, $264,108 and $259,254 in 50 52 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1994, 1995 and 1996, respectively. In addition, in 1996 National paid $1,328,200 to certain individuals upon a change of control of the Company. As of December 31, 1996, National had commitments for such future compensation with respect to employment contracts with Mark Speizer and Bruce Cole, and future commissions payable for amounts that cannot now be determined for 1997 pursuant to the Employment contract with C. Alan Paylor and pursuant to the Agreement of Employment Termination between National and Douglas H. Helm. The future minimum payments due under commitments at December 31, 1996 are as follows (in thousands):
OPERATING EMPLOYMENT LEASES AGREEMENTS --------- ---------- For the Year Ending December 31, 1997............................................. $ 1,242 $ 590 1998............................................. $ 1,158 590 1999............................................. $ 838 306 2000............................................. $ 0 0 --------- ---------- Total minimum payments............................. $ 3,238 $1,486
9. PROPOSITION 103 On October 25, 1995, the Insurance Subsidiary entered into a stipulation and consent order with the California Insurance Department to resolve the Insurance Subsidiary's rollback obligation related to California Proposition 103. Pursuant to that settlement, the Insurance Subsidiary agreed to pay the sum of approximately $4.1 million as a rollback refund to its policyholders for the rollback year. The Company issued the refund checks during the first quarter of 1996. The rollback refund was paid to each eligible policyholder in the proportion that the written premium for each policyholder bears to the Insurance Subsidiary's total written premiums in California for policies in Proposition 103 lines issued or renewed during the rollback year. Pursuant to the settlement, the rollback refund constitutes the Insurance Subsidiary's entire rollback obligation and fully discharges the Insurance Subsidiary and extinguishes all of its obligations to rollback rates, make refunds to policyholders, or pay interest to policyholders. The Department has agreed to seek no further rollbacks or interest against the Insurance Subsidiary for the rollback year. Also, the settlement approves all rate filings which received interim approvals for current rate levels made since 1989, and all rates and rate levels charged by the Insurance Subsidiary from time to time between November 8, 1989 and the date the settlements were approved. The amount of any refund checks uncashed after a certain period will be escheated to the State of California in accordance with its laws. Although the Company will incur additional costs for processing the refunds, management believes that its existing reserves are adequate. 10. REINSURANCE The Insurance Subsidiary, in the ordinary course of its business, seeks to reduce the loss that may arise from catastrophes or other events that may cause unfavorable underwriting results by reinsuring certain levels of risk with other insurance companies. Recoverables under the reinsurance agreements are estimated in a manner consistent with the claim liability associated with the reinsured policy. Risks reinsured would become a liability of the Insurance Subsidiary in the event any reinsurer is unable or will not fulfill the obligations assumed under the agreements. The Insurance Subsidiary limits its credit risk associated with reinsurance recoverables by evaluating the financial condition of members of the reinsurance pool, and diversifying the pool participants. As of December 31, 1994, $11,000, was recorded as a receivable under reinsurance treaties. For the years ended December 31, 1995 and 1996, there were no receivables recorded under reinsurance treaties. 51 53 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) For the years ended December 31, 1994, 1995, and 1996, ceded reinsurance premiums were $1,170,000, $933,000 and $691,000, respectively, and there were no ceded reinsurance losses for the respective years. The Insurance Subsidiary is also a "Write Your Own" ("WYO") carrier under the National Flood Insurance Program. The premiums written and the insurance risks under the WYO program are ceded to the Federal Emergency Management Agency ("FEMA"). The form of this treaty is the actual assumption of liability by FEMA and, accordingly, amounts are excluded from net premiums and accounts receivable and reserve for losses and LAE. For the years ended December 31, 1994, 1995, and 1996, ceded reinsurance premiums for this program were $1,520,000, $1,234,000 and $2,268,000, respectively. The Insurance Subsidiary assumes a proportional share of the premiums written and the insurance risks from other insurance companies for force-place insurance policies produced through the Agency. In accordance with industry practice, reinsurance assumed is presented as an addition to net premiums written in the financial statements. The Insurance Subsidiary assumed net written premiums of $(1,259,000), $(197,000)and $(29,511) in 1994, 1995, and 1996, respectively. As of December 31, 1994, 1995 and 1996, assumed unearned premiums were $39,000, $0, and $0 respectively. 11. INVESTMENT INCOME The components of investment income are as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1994 1995 1996 ------ ------ ------ Fixed maturities................................. $1,165 $1,181 $1,246 Short-term investments........................... 802 947 739 Net realized gains (losses)...................... -- (3) 17 Investment expenses.............................. (131) (83) (27) ------ ------ ------ Net investment income............................ $1,836 $2,042 $1,975 ====== ====== ======
12. MAJOR CUSTOMERS During 1994, National and Subsidiaries derived 22% of total revenues from one customer, of which 20% was for insurance services and 2% for fee-based services. During 1995, National and Subsidiaries derived 13% of total revenues from one customer, of which all was for insurance services. During 1996, National and Subsidiaries derived 9% of total revenues from one customer, of which all was for insurance services. In the same year another customer represented 9% of total revenues, of which 7% was for insurance services and 2% for fee-based services. 13. EARNINGS PER SHARE The number of shares used in the earnings per share computation is calculated as follows:
1994 1995 1996 --------- --------- --------- Weighted average common shares......................... 4,678,729 4,679,697 3,885,740 Common shares issuable under outstanding stock options.............................................. -- -- 31,686 ---------- ---------- ---------- Total........................................ 4,678,729 4,679,697 3,917,426 ========== ========== ========== Net income (loss) (in thousands)....................... $ (1,084) $ (4,864) $ 1,274 Per share results: Net income (loss)............................ $ (0.23) $ (1.04) $ 0.33
52 54 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The number of shares issuable upon exercise of outstanding options has been calculated using the treasury stock method based on the average market price during the year. In 1994 and 1995, the Company had a loss per share which is calculated based upon the number of common shares outstanding. There are no differences between primary and fully diluted earnings per share. 14. DIVIDEND RESTRICTION California law limits the payment of dividends to National by the Insurance Subsidiary. The maximum dividend that may be paid without prior approval of the Insurance Commissioner is limited to the greater of 10% of policyholders' surplus (shareholders' equity adjusted to a statutory basis) as of the preceding December 31, or the net income of the preceding calendar year. In 1997, the maximum dividend would be limited to the net income of the Insurance Subsidiary at December 31, 1996. Statutory policyholders' surplus and net income of the Insurance Subsidiary is as follows (in thousands):
1994 1995 1996 ------- ------- ------- Statutory policyholders' surplus.............. $25,209 $23,687 $26,765 Net income (loss)............................. $ 2,575 $(1,892) $ 2,758
California law further prohibits the payment of dividends without prior approval of the California Department of Insurance unless the insurer has available "earned surplus". The term "earned surplus" is defined as unassigned funds (surplus) as reported on the insurer's annual statement, excluding earned surplus derived from: (i) unrealized net appreciation of assets; and (ii) an exchange of assets, unless such earned surplus has been realized or the assets received in exchange are currently realizable in cash. An exception to this prohibition is allowed where the insurer's surplus as regards policyholders is: (i) reasonable in relation to its outstanding liabilities; (ii) adequate to the insurer's financial needs; and (iii) the Department's prior approval is obtained. There were no cash dividends paid by the Insurance Subsidiary in 1994, 1995 or 1996. 15. STOCK OPTION PLANS Under the 1986 Stock Option Plan, as amended, participants may be awarded options for shares of National's common stock subject to various restrictions which limit the sale or other transfer of the shares until the expiration of a specified time period. A maximum of 1,006,820 shares may be issued under the plan. The exercise price of options granted under the plan may not be less than 100% of the fair value on the date of the grant. In 1992 and prior years, the exercise price was limited to 110% of the fair value on the date of the grant for shareholders owning more than 10% of the voting power of all shares of stock. Under the 1991 Director Option Plan, as amended, participants may be awarded options for shares of National's common stock subject to various restrictions which limit the sale or other transfer of the shares until the expiration of a specified time period. A maximum of 325,000 shares may be issued under the plan. The exercise price of options granted under the plan may not be less than 100% of the fair value on the date of the grant. For both stock option plans, the shares subject to option vest 25% at the end of the first twelve (12) calendar months following the date of grant, and the remainder vest ratably in each month over the next three (3) years. The maximum term of options granted is ten (10) years from the date of grant. Options issued to date have not resulted in any material compensation expense to the Company. However, the Company did receive tax deductions related to the exercise of stock options which reduced taxes payable by $0, $1,000 and $14,235 during 1994, 1995, and 1996, respectively. This amount has been credited directly to common stock. 53 55 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Director Plan provides that if Mr. Speizer and Howard L. Herman, the Company's former President, shall sell or otherwise transfer beneficial ownership of more than 75% of the aggregate number of shares controlled by them as of May 23, 1995, the optionee (except for options granted under the Director Plan to Mr. Speizer and/or Mr. Herman) shall thereafter have the right to exercise such option as to all of the optioned stock, including shares as to which such option would not otherwise be exercisable. As of May 23, 1995, Mr. Speizer and Mr. Herman controlled an aggregate of 1,772,329 shares which number is subject to adjustment in accordance with the provision of the Directors Plan regarding adjustments upon changes in capitalization or merger. On May 31, 1996, Mr. Speizer purchased 788,795 shares from Mr. Herman and certain Herman family members and trusts. On June 18, 1996, Mr. Speizer purchased 35,500 shares from Mr. Herman and his spouse. Such purchases constituted the purchase of all shares owned and beneficially owned by Mr. Herman. The Company applies Accounting Principals Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock option plans. Had compensation expense for the Company's stock options plans been determined based upon the fair value at the grant date for awards under these plans consistent with the optional expense measurement method described in SFAS No. 123 "Accounting for Stock-Based Compensation", the Company's net income would have been reduced by approximately $584,000 for 1996 and $0 for 1995, and earnings per share would have decreased to $0.23 for 1996 with no effect for the 1995 year. The pro forma effect on net income for 1996 and 1995 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. The weighted average fair value on the date of the grant, of options granted during 1996 and 1995, is estimated at $2.88 and $2.79, respectively. Fair value is determined using the modified Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1996 and 1995:
1995 1996 ----------- ----------- Dividend yield.......................... 0% 0% Expected volatility..................... 42.41% 42.41% Risk-free interest rates................ 5.66%-7.74% 5.11%-6.77% Expected life........................... 5 years 5 years
The following table summarizes option activity during 1995 and 1996 for the 1986 Stock Option Plan, as amended, and 1991 Director Option Plan, as amended.
1995 1996 --------------------------- ---------------------------- WEIGHTED AVERAGE WEIGHTED AVERAGE EXERCISE PRICE EXERCISE PRICE PER PER OPTIONS SHARE OPTIONS SHARE ------- ----------------- -------- ----------------- Shares issuable under outstanding options at January 1............... 503,748 $ 10.59 771,830 $6.66 Options granted...................... 363,000 $ 5.96 566,000 $6.14 Options exercised.................... (968) $ 3.75 (22,540) $6.64 Options canceled or forfeited........ (93,950) $ 8.27 (170,507) $5.64 ------- -------- Shares issuable under outstanding options at December 31............. 771,830 $ 6.66 1,144,783 $6.65 ======= ======== Options exercisable at December 31... 546,830 $ 6.79 836,970 $6.84 ======= ========
Options may be exercised in whole or part at any time as to shares which have not yet vested under the provisions of the 1986 Stock Option Plan, as amended, provided that the Optionee execute, as a condition to 54 56 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) the option, a Restricted Stock Purchase Agreement which gives the Company the right to repurchase at cost the unvested shares in the event of a termination of the optionee's employment with the Company prior to the date upon which they would have vested under the Option agreement. The following table summarizes information about options outstanding at December 31, 1996.
WEIGHTED NUMBER OF AVERAGE WEIGHTED AVERAGE RANGE OF OUTSTANDING REMAINING LIFE EXERCISE PRICE PER EXERCISE PRICES OPTIONS (YEARS) SHARE ----------------------------- ------------------ -------------- ------------------ $3.75-$5.25.................. 195,744 8.24 $ 5.13 $5.88-$8.00.................. 854,789 8.30 $ 6.29 $9.75-$15.25................. 94,250 6.37 $13.01 --------- Total: 1,144,783 8.13 $ 6.65 =========
Options exercisable:
WEIGHTED AVERAGE RANGE OF NUMBER EXERCISABLE AT EXERCISE PRICE PER EXERCISE PRICES DECEMBER 31, 1996 SHARE ------------------------------------------ --------------------- ------------------ $3.75-$5.25............................... 195,744 $ 5.13 $5.88-$8.00............................... 546,976 $ 6.38 $9.75-$15.25.............................. 94,250 $13.01 ------- Total: 836,970 $ 6.84 =======
16. NON-RECURRING EXPENSES On June 13, 1995, the Commissioner notified the Company that its application for adjustment of its Proposition 103 return premium liability had been denied and the Company accrued an additional $4.1 million for the constitutionally mandated roll-back of insurance premiums under the Proposition. This amount is included on the balance sheet as Reserve for Prop 103 and on the income statement as non-recurring expense. In the second quarter of 1994, the Company accrued $1.0 million for restructuring charges in connection with the relocation of the Company's loan tracking and customer service operations from Bellevue, Washington, to its South San Francisco, California, headquarters. 17. RELATED PARTY TRANSACTIONS The former President of the Company owns a controlling interest in, and the Chief Executive Officer of the Company previously owned a controlling interest in, another entity which ceased doing business in 1994. The Company assumed, in 1993, a lease of such entity's principal office located at 395 Oyster Point Boulevard, South San Francisco, California (which the Company used to expand its corporate headquarters), requiring lease payments of $21,000 per month. In September 1996 National entered into a consulting agreement with Scorpion Holdings, Inc., a Delaware corporation ("Scorpion") pursuant to which Scorpion agreed to provide certain consulting services in connection with (i) management and strategic planning, (ii) the identification of financing, acquisitions and divestiture opportunities for National, and (iii) other matters relating to the day-to-day business and operation of National or any of its subsidiaries or affiliated companies, as the Board of Directors of National may from time to time reasonably request. In addition, if National engages in any (i) merger, consolidation or sale of any of its assets (other than in the ordinary course of its business) or outstanding securities or (ii) acquisition of assets or stock of another company, Scorpion has the right to act as a financial advisor to National pursuant to an engagement agreement, the terms and conditions of which shall be mutually agreed upon by National and Scorpion. The term of the consulting agreement is for one year; provided, however, the term is extended 55 57 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) for an additional period of one year unless written notice of termination is given by either party not less than sixty (60) days prior to the first anniversary date of the consulting agreement. Pursuant to the consulting agreement, Scorpion receives an annual fee of $300,000 plus reimbursement for reasonable out-of-pocket costs and expenses. Mr. Brandolini is the sole shareholder, a director and chief executive officer of Scorpion. Mr. McCarthy is a director and president of Scorpion. Mr. Brandolini and Mr. McCarthy are directors of National. In October 1996, National entered into a bridge loan agreement with Hydrodynamics Corporation ("Hydrodynamics"), pursuant to which National loaned to Hydrodynamics $300,000. The bridge loan is evidenced by a Convertible Promissory Note, in the principal amount of $300,000, which note bears interest at the rate of 10% per annum and matures on October 28, 1997. Mr. Brandolini and Mr. McCarthy, who are directors of National are also directors, officers and shareholders of Hydrodynamics. In December 1996, Hydrodynamics commenced voluntary proceedings under Chapter 11 of the federal bankruptcy laws. In February 1997, Arabella, S.A. purchased from National the Convertible Promissory Note of Hydrodynamics issued to National for a purchase price of $300,000. National assigned its rights under the Convertible Promissory Note and the Stock Purchase Warrant to Arabella, S.A. Mr. Brandolini is also a director of Arabella S.A. 18. CHANGE OF CONTROL Pursuant to an Option and Stock Purchase Agreement entered into on May 1, 1996, between Howard L. Herman, a founder and former director of the Company, and certain of Mr. Herman's relatives, and Mark A. Speizer, it was agreed that 824,295 shares of Common Stock of the Company (the "Herman shares") would be sold to Mr. Speizer. 788,795 of the Herman Shares were purchased on May 31, 1996 and the remaining shares were purchased on June 18, 1996. At the annual meeting of shareholders held on July 11, 1996, the slate of directors nominated by the Board of Directors was elected. Following the annual meeting, Mr. Speizer was elected Chairman of the Board and Chief Executive Officer of the Company and each of Great Pacific Insurance Company, Fastrac Systems, Inc. Insurance Agent & Broker, Fastrac Systems, Inc., and Pinnacle Data Corporation, the Company's wholly owned subsidiaries through which the Company carries out its business activities. In June 1996, the Company accrued $1.4 million of expense as a result of retention agreements entered into with certain executives. The purpose of the agreements was to ensure the availability and employment of those executives through the transition following the change of control of the Company which occurred in July 1996. 19. PENSION PLANS The Company adopted a defined contribution 401(k) plan on July 1, 1996. All full time employees are eligible to participate in the plan at the beginning of a calendar quarter following completion of ninety days of continuous full time employment. The Company matches 25% of the employee's contributions up to and including the first 4% of the employee's salary. The Company's contribution was $34,569 for 1996. 20. NOTES PAYABLE In September 1996, a note agreement for $2,000,000 was entered into with a financial institution. The note is to be repaid monthly over a two year period with final payment due in October 1998. Interest is at the rate of 1% per year in excess of the rate of interest which the financial institution has announced as its prime lending rate or $250 per month whichever is greater. Collateral for the note is the outstanding capital stock of Pinnacle Data Corporation (a wholly owned subsidiary of the Company) which consists of 1,000 shares. 56 58 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 21. LITIGATION The Company is involved in various routine legal proceedings incident to its business and other litigation. While the ultimate disposition of each proceeding is not determinable, the Company does not believe that any of such proceedings is likely to have a materially adverse effect on the consolidated financial position of the Company. 22. COMMON STOCK REPURCHASE On September 17, 1996, the Company repurchased 705,300 shares of its common stock for $4.9 million. The shares were acquired through a private transaction with institutional investors at a price of $7 per share. This repurchase represents a reduction of approximately 15% of the Company's outstanding stock. A second repurchase of 100,000 shares was made on October 22, 1996. The shares were acquired through a private transaction at a price of $6.95 per share. The repurchases were funded by cash flows from operations and from proceeds of a bank credit facility. See Note 20 to Notes to Consolidated Financial Statements. 23. SEGMENT REPORTING The principal sources of the Company's business are the following. Insurance Products...... The Company provides force-place insurance for financial institutions when their borrowers fail to maintain adequate insurance in force, provides fire insurance on foreclosed real estate and provides automobile physical damage insurance. Information Services.... The Company provides contract services, including insurance tracking, outsourcing, and flood zone determinations for financial institutions and others.
Revenues and income from operations for each of these segments are presented below. Segment revenues and operating income are based upon transactions directly traceable to the segment and after elimination of intersegment revenues and expenses. General corporate expenses benefitting more than one segment, which include compensation of general corporate officers, certain occupancy costs, shareholder reporting expenses, general insurance, legal, sales and marketing and other corporate expenses and fees, are not allocated to segments (in thousands):
CONSOLIDATED REVENUES FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------- 1994 1995 1996 ----------------- ----------------- ----------------- AMOUNT % AMOUNT % AMOUNT % ------- ----- ------- ----- ------- ----- Insurance products......... $24,553 70.5% $20,564 57.2% $16,705 41.1% Information services....... 10,234 29.5% 15,379 42.8% 23,978 58.9% ------- ----- ------- ----- ------- ----- $34,787 100.0% $35,943 100.0% $40,683 100.0% ======= ===== ======= ===== ======= =====
CONSOLIDATED PRE-TAX INCOME (LOSS) FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1994 1995 1996 ------- ------- ------- Insurance products................................ $ 8,590 $ 5,559 $ 7,820 Information services.............................. (448) 13 3,545 General corporate expenses........................ (8,740) (8,895) (9,807) Non-recurring charges............................. (1,020) (4,100) -- ------- ------- ------- $(1,618) $(7,423) $ 1,558 ======= ======= =======
57 59 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Identifiable assets, capital expenditures, and depreciation and amortization by segment for the years ended as of December 31,1995 and 1996 are as follows (in thousands):
DECEMBER 31, 1995 DECEMBER 31, 1996 ------------------------------------- ------------------------------------- DEPRECIATION DEPRECIATION CAPITAL AND CAPITAL AND ASSETS EXPENDITURES AMORTIZATION ASSETS EXPENDITURES AMORTIZATION ------- ------------ ------------ ------- ------------ ------------ Insurance Products........... $45,052 $ 282 $ 605 $32,321 $ 239 $ 467 Information Services......... 597 1,069 1,588 15,338 1,206 1,291 Holding Company.............. 6,447 0 0 (547) 0 0 ------- ------ ------ ------- ------ ------ $52,096 $1,351 $2,193 $47,112 $1,445 $1,758
24. RESULTS BY QUARTER (UNAUDITED)
QUARTER ENDED ------------------------------------------------------------------------------- MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE SEPTEMBER DECEMBER 31, 30, 30, 31, 31, 30, 30, 31, 1995 1995 1995 1995 1996 1996 1996 1996 ------ ------ --------- -------- ------ ------ --------- -------- (IN THOUSANDS) Net premiums earned, fee income and commission income.................. $7,382 $7,928 $ 8,880 $9,711 $9,911 $9,642 $ 9,627 $9,528 Income before provision for income taxes........ (337) (6,376) 105 (815) 234 (1,350) 1,371 1,303 Net income (loss)......... (229) (4,336) 71 (370) 149 (857) 870 1,112 Net income per share...... $(0.05) $(0.93) $ 0.02 $(0.08) $ 0.03 $(0.18) $ 0.22 $ 0.29
58 60 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES Our report on the consolidated financial statements of National Insurance Group and Subsidiaries is included in this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index of this Form 10-K. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. San Francisco, California February 7, 1997 59 61 SCHEDULE I NATIONAL INSURANCE GROUP AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1996
AMOUNT AT WHICH SHOWN NUMBER OF IN THE SHARES OR MARKET BALANCE PRINCIPAL COST VALUE SHEET --------- ----------- ----------- ----------- Fixed Maturities: Bonds and notes: U.S. Government securities............... $ 2,599,225 $ 2,609,750 $ 2,609,750 Municipalities........................... 7,593,811 7,779,241 7,779,241 States................................... 2,688,727 2,737,932 2,737,932 Certificates of deposit.................. 5,330,914 5,330,914 5,330,914 Mortgage-backed securities............... 80,570 80,570 80,570 ----------- ----------- ----------- Total Fixed Maturities.............. 18,293,247 18,538,407 18,538,407 ----------- ----------- ----------- Equity Securities: Preferred stock Financial institution.................... 32,000 796,750 804,250 804,250 Public Utilities......................... 24,000 711,095 738,125 738,125 Industrial............................... 20,000 501,950 508,750 508,750 Common stock Financial institution.................... 27,701 228,405 0 0 ----------- ----------- ----------- Total Equity Securities............. 2,238,200 2,051,125 2,051,125 ----------- ----------- ----------- Short-term Investments...................... 11,983,619 11,983,619 11,983,619 ----------- ----------- ----------- Total Investments................... $32,515,066 $32,573,151 $32,573,151 =========== =========== ===========
60 62 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) BALANCE SHEETS DECEMBER 31, 1995 AND 1996 ASSETS
1995 1996 ----------- ----------- Short-term investments and cash................................... $ 142,732 $ (42,845) Investments in subsidiaries....................................... 25,298,919 27,397,827 Other assets...................................................... 8,889,193 4,267,506 ----------- ----------- Total assets............................................ $34,330,844 $31,622,488 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Federal and state income taxes payable............................ $ 267,774 $ 316,817 Accrued Liabilities............................................... 527,352 1,054,814 Deferred federal income taxes..................................... 655,551 365,448 Notes payable..................................................... -- 1,333,333 ----------- ----------- Total liabilities....................................... 1,450,677 3,070,412 ----------- ----------- Shareholders' equity Common stock.................................................... 23,070,551 17,591,787 Retained earnings............................................... 9,809,616 10,960,289 ----------- ----------- Total shareholders' equity.............................. 32,880,167 28,552,076 ----------- ----------- Total liabilities and shareholders' equity.............. $34,330,844 $31,622,488 =========== ===========
61 63 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
1994 1995 1996 ----------- ----------- ---------- Net investment income................................ $ 225,119 $ 67,979 $ 14,495 Operating expenses................................... (404,690) (1,141,735) 29,229 Provision for income taxes........................... (14,512) (116,145) (991,959) Equity in net income of subsidiaries................. (889,457) (3,674,831) 2,221,737 ----------- ----------- ---------- Net income (loss).......................... $(1,083,540) $(4,864,732) $1,273,502 =========== =========== ==========
62 64 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 INCREASE (DECREASE) IN CASH
1994 1995 1996 ------------ ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income......................................... $ (1,083,540) $(4,864,732) $ 1,273,502 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed equity in net income of subsidiaries.................................. 889,457 3,674,831 (2,221,737) Increase (decrease) in taxes payable............. 1,158,488 (322,198) (241,060) Other.............................................. (3,655,455) (1,875,270) 5,149,149 ------------ ----------- ----------- Net cash provided (used) by operating activities... $ (2,691,050) $(3,387,369) $ 3,959,854 ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments............................ $(68,599,619) $ 0 $ 0 Maturity of investments............................ 74,877,514 3,220,857 143,000 ------------ ----------- ----------- Net cash provided by investing activities.......... $ 6,277,895 $ 3,220,857 $ 143,000 ------------ ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from capital contributions................ $ 1,408,483 $ 0 $ 0 Dividends paid..................................... (1,202,894) 0 0 Proceeds from stock options exercised.............. 0 4,992 188,601 Repurchase of common stock......................... (3,610,000) 0 (5,667,365) Proceeds from notes payable........................ 0 0 1,333,333 ------------ ----------- ----------- Net cash provided (used) by financing activities... (3,404,411) 4,992 (4,145,431) ------------ ----------- ----------- Net increase (decrease) in cash.................... 182,434 (161,520) (42,577) Cash at beginning of year.......................... (21,182) 161,252 (268) ------------ ----------- ----------- Cash at end of year................................ $ 161,252 $ (268) $ (42,845) ============ =========== ===========
63 65 SCHEDULE III NATIONAL INSURANCE GROUP AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION CONCERNING PROPERTY CASUALTY OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
1994 1995 1996 ----------- ----------- ----------- Deferred Policy Acquisition Costs................... $ 3,573,248 $ 2,623,562 $ 2,186,586 Reserves for Unpaid Claims and Claims Adjustment Expenses.......................................... 3,360,438 3,054,710 2,198,478 Less Reserve Discount............................... -- -- -- Unearned Premiums................................... 7,767,930 6,674,877 6,098,435 Earned Premiums..................................... 20,857,424 17,020,440 13,585,007 Net Investment Income............................... 1,836,000 2,042,225 1,974,925 Claims and Claim Adjustment Expenses Incurred Related to: Current Year...................................... 7,627,000 6,378,000 3,971,000 Prior Year........................................ 246,000 (334,000) 31,000 Amortization of Deferred Policy Acquisition Costs... 11,046,985 9,597,252 6,296,010 Paid Claims and Claim Adjustment Expense............ 10,141,100 6,349,000 4,859,000 Net Premiums Written................................ 20,035,560 14,955,906 12,635,058
64 66 SCHEDULE VI NATIONAL INSURANCE GROUP AND SUBSIDIARIES REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER ASSUMED AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET ----------- ---------- ----------- ----------- ---------- Fire and Allied Lines Insurance Premiums: Year ended December 31, 1996..... $13,005,117 $ 691,208 $ (29,511) $12,284,398 (0.2)% =========== ========== =========== =========== ==== Year ended December 31, 1995..... $15,834,991 $ 922,579 $ (196,996) $14,715,416 (1.3)% =========== ========== =========== =========== ==== Year ended December 31, 1994..... $21,442,240 $1,124,481 $(1,270,716) $19,047,043 (6.7)% =========== ========== =========== =========== ==== Auto Physical Damage Insurance Premiums: Year ended December 31, 1996..... $ (18,430) $ 0 $ 0 $ (18,430) 0% =========== ========== =========== =========== ==== Year ended December 31, 1995..... $ 254,462 $ 10,810 $ (11) $ 243,652 0% =========== ========== =========== =========== ==== Year ended December 31, 1994..... $ 1,022,689 $ 45,235 $ 11,063 $ 988,517 1.1% =========== ========== =========== =========== ==== Flood Insurance Premiums: Year ended December 31, 1996..... $ 2,267,703 $2,267,703 0 0 0% =========== ========== =========== =========== ==== Year ended December 31, 1995..... $ 1,234,443 $1,234,443 0 0 0% =========== ========== =========== =========== ==== Year ended December 31, 1994..... $ 1,519,063 $1,519,063 0 0 0% =========== ========== =========== =========== ====
65 67 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 on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of South San Francisco, State of California. NATIONAL INSURANCE GROUP, a California corporation Date: March 28, 1997 By: /s/ ROBERT P. BARBAROWICZ ------------------------------------ Robert P. Barbarowicz, Executive Vice President, General Counsel and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------------------------------------------- ------------------------------- --------------- /s/ MARK A. SPEIZER Director, Chief Executive March 28, 1997 - --------------------------------------------- Officer and Chairman of the Mark A. Speizer Board /s/ BRUCE A. COLE Director and President March 28, 1997 - --------------------------------------------- Bruce A. Cole /s/ GREGORY S. SAUNDERS Executive Vice President, March 28, 1997 - --------------------------------------------- Treasurer and Chief Financial Gregory S. Saunders Officer (Principal Financial Officer) /s/ ROBERT J. LELIEUR Vice President and Controller March 28, 1997 - --------------------------------------------- (Principal Accounting Robert J. Lelieur Officer) /s/ NUNO BRANDOLINI D'ADDA Director March 28, 1997 - --------------------------------------------- Nuno Brandolini d'Adda /s/ KEVIN R. MCCARTHY Director March 28, 1997 - --------------------------------------------- Kevin R. McCarthy /s/ SAUL B. JODEL Director March 28, 1997 - --------------------------------------------- Saul B. Jodel
66 68 INDEX TO EXHIBITS
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE ------ ----------------------------------------------------------------------- ------------ 3.1 Articles of Incorporation of Company, as Amended (2)................... 3.2 Bylaws of Company(1)................................................... 10.1 1986 Stock Option Plan, as amended through July 11, 1996............... 10.2 1991 Director Option Plan, as amended through May 23, 1995(6).......... 10.4 Memoranda of Reinsurance as to First and Second Property Per Risk Excess of Loss......................................................... Reinsurance Agreements and the First, Second and Third Property Catastrophe Excess Reinsurance Agreements (1995)(5).................... 10.5 Memoranda of Reinsurance as to First and Second Property Per Risk Excess of Loss Reinsurance Agreements and the First, Second and Third Property Catastrophe Excess Reinsurance Agreements (1996)(6)........... 10.6 Memoranda of Reinsurance as to First and Second Property Per Risk Excess of Loss Reinsurance Agreements and the First, Second and Third Property Catastrophe Excess Reinsurance Agreements (1997).............. 10.7 Agreement of Employment Termination and Release dated July 2, 1995 between National Insurance Group, Fastrac Systems, Inc., Fastrac Systems, Inc. Insurance Agent & Broker, Great Pacific Insurance Company, Pinnacle Data Corporation and Douglas Harold Helm(6).......... 10.8 Severance Agreement and Full Release of All Claims dated May 23, 1995 by and among Howard L. Herman, National Insurance Group and future subsidiaries(6)........................................................ 10.9 Severance Agreement and Release of Claims dated October 19, 1995 by and among Mark A. Speizer, National Insurance Group and future subsidiaries(6)........................................................ 10.10 Consulting Agreement dated February 1, 1996 between National Insurance Group and John R. Gaulding(6).......................................... 10.11 John R. Gaulding At-Will Employment Agreement dated February 25, 1996 by and among John R. Gaulding, National Insurance Group and future subsidiaries(6)........................................................ 10.12 Second Amendment of John R. Gaulding At-Will Employment Agreement dated July 10, 1996 by and John R. Gaulding, National Insurance Group, its current and future subsidiaries(7)..................................... 10.13 Lease Agreement dated March 20, 1995 between Thomas H. Lagos, James H. Lagos and Fastrac Systems, Inc., Insurance Agent and Broker for the premises located at One South Limestone Street, Springfield, Ohio(6)... 10.14 Lease Agreement dated June 3, 1992 between the Company and Tomoe Investment & Development, Inc. for the premises located at 395 Oyster Point Boulevard, Suite 500, South San Francisco, California(3)......... 10.15 Form of First Amendment of Oyster Point Marina Business Park Office Lease (Suite 500) dated September 29, 1993 between Tomoe Investment & Development, Inc. and National Insurance Group(4)...................... 10.16 Assignment and Assumption of Lease dated August 1, 1993 between San Mateo Financial Corporation and National Insurance Group for the premises located at 395 Oyster Point Boulevard, Suite 550, South San Francisco, California(4)............................................... 10.17 Form of First Amendment of Oyster Point Marina Business Park Office Lease (Suite 550) dated September 29, 1993 between Tomoe Investment & Development, Inc. and National Insurance Group(4)......................
69
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE ------ ----------------------------------------------------------------------- ------------ 10.18 Sublease Agreement dated March 24, 1994 between the Company and PHH Homequity Corporation for the premises located at 1855 Gateway Boulevard, Concord, California(5)...................................... 10.19 Form of Indemnification Agreement between Registrant and its officers and directors(4)....................................................... 10.20 Form of Change of Control Severance Agreement and Mutual Release entered into between National and Paulette J. Taylor (July 10, 1996), Kevin C. Eichler (June 26, 1996) and Roger Conley (July 10, 1996)(7)... 10.21 Form of Donation Agreement entered into between National and Roger Conley (July 11, 1996), Kevin C. Eichler (July 11, 1996), John R. Gaulding (July 11, 1996), and Paulette J. Taylor (July 11, 1996)(7).... 10.22 Mark A. Speizer Employment Agreement dated July 11, 1996 by and between National and Mark A. Speizer (7)....................................... 10.23 Bruce A. Cole Employment Agreement dated July 11, 1996 by and between National and Bruce A. Cole(7).......................................... 10.24 Employment Agreement effective August 12, 1996 by and between National and Robert P. Barbarowicz.............................................. 10.25 Employment Agreement dated August 26, 1996 by and between National and C. Alan Paylor(8)...................................................... 10.26 Consulting Agreement dated September 11, 1996 by and between National and Scorpion Holdings, Inc.(8)......................................... 10.27 Employment Agreement dated March 10, 1997 by and between National and Gregory S. Saunders.................................................... 10.28 401(k) Plan, First Amendment to 401(k) Plan and Participation Agreements............................................................. 11.1 Computation of Weighted Average Shares Outstanding and Earnings per Share.................................................................. 21.1 Subsidiaries of Company(5)............................................. 24.1 Power of Attorney...................................................... 27 Financial Data Schedule................................................
- --------------- (1) Incorporated by reference to exhibits filed with the Company's Registration Statement on Form S-1 (No. 33-14940) which became effective July 21, 1987. (2) Incorporated by reference to exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1990. (3) Incorporated by reference to exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1992. (4) Incorporated by reference to exhibits filed with the Company's Registration Statement on Form S-2 (No. 33-71290) which became effective December 16, 1993. (5) Incorporated by reference to exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1994. (6) Incorporated by reference to exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1995. (7) Incorporated by reference to exhibits filed with the Company's Form 10-Q/A for the quarter ended June 30, 1996. (8) Incorporated by reference to exhibits filed with the Company's Form 8-K dated October 23, 1996. EX-10.1 2 1986 STOCK OPTION PLAN, AMENDED THROUGH 7/11/96 1 Exhibit 10.1 NATIONAL INSURANCE GROUP 1986 STOCK OPTION PLAN (AS AMENDED THROUGH JULY 11, 1996) 1. Purposes of the Plan. The purpose of this Stock Option Plan is to provide additional incentive to Employees and Consultants to work to maximize shareholder value. This Stock Option Plan also utilizes vesting periods to encourage key Employees and Consultants to continue in the employ of or service to the Company. The Plan and/or the granting of any option under the Plan to any employee shall not be construed to be any form of employment contract or guarantee of future employment or compensation. Options granted hereunder shall be "nonstatutory stock options." 2. Definitions. As used herein, the following definitions shall apply: (a) "Board" shall mean the Committee, if one has been appointed, or the Board of Directors of the Company, if no Committee is appointed. (b) "Common Stock" shall mean the Common Stock of the Company. (c) "Company" shall mean National Insurance Group, a California corporation. (d) "Committee" shall mean the Committee appointed by the Board of Directors in accordance with paragraph (a) of Section 4 of the Plan, if one is appointed. (e) "Employee" shall mean any person, including officers and directors, employed by the Company or any parent or subsidiary of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (f) "Consultant" shall mean any person who is engaged by the Company or any subsidiary to render consulting services and is -1- 2 compensated for such consulting services, and any director of the Company whether compensated for such services or not; provided that if and in the event the Company registers any class of any equity security pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the term Consultant shall thereafter not include directors who are not compensated for their services or are paid only a director's fee by the Company. (g) "Option" shall mean a stock option granted pursuant to the Plan. (h) "Optioned Stock" shall mean the Common Stock subject to an Option. (i) "Optionee" shall mean an Employee or Consultant who receives an Option. (j) "Plan" shall mean this 1986 Stock Option Plan. (k) "Share" shall mean a share of the Common Stock, as adjusted in accordance with Section 11 of the Plan. 3. Stock Subject to the Plan. Subject to the provisions of Section 11 of the Plan, the maximum aggregate number of shares which may be optioned and sold under the Plan is 1,006,820 shares of Common Stock. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option should expire or become unexercisable for any reason without having been exercised in full, the unpurchased Shares which were subject thereto shall, unless the Plan shall have been terminated, become available for future grant under the Plan. 4. Administration of the Plan. (a) Procedure. (i) Multiple Administrative Bodies. If permitted by Rule 16b-3 of the Exchange Act, the Plan may be administered by different bodies with respect to members of the Board of Directors of the Company ("Directors"), officers of the Company, within the meaning of Section 16 of the Exchange Act and the rules and -2- 3 regulations promulgated thereunder ("Officers"), who are not Directors, and Employees who are neither Directors nor Officers. (ii) Administration With Respect to Directors and Officers Subject to Section 16(b). With respect to Option grants made to Employees who are also Officers or Directors subject to Section 16(b) of the Exchange Act, the Plan shall be administered by (A) the Board of Directors, if the Board of Directors may administer the Plan in compliance with the rules governing a plan intended to qualify as a discretionary plan under Rule 16b-3, or (B) a committee designated by the Board of Directors to administer the Plan, which committee shall be constituted to comply with the rules governing a plan intended to qualify as a discretionary plan under Rule 16b-3 (the "Committee"). Once appointed, such Committee shall continue to serve in its designated capacity until otherwise directed by the Board of Directors. From time to time the Board of Directors may increase the size of the Committee and appoint additional members, remove members (with or without cause) and substitute new members, fill vacancies (however caused), and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by the rules governing a plan intended to qualify as a discretionary plan under Rule 16b-3. (ii) Administration With Respect to Other Persons. With respect to Option grants made to Employees or Consultants who are neither Directors nor Officers of the Company, the Plan shall be administered by (A) the Board of Directors or (B) a committee designated by the Board of Directors, which committee shall be constituted to satisfy the legal requirements relating to the administration of stock option plans under state corporate and securities laws and the Internal Revenue Code of 1986, as amended (the "Applicable Laws"). Once appointed, such Committee shall serve in its designated capacity until otherwise directed by the Board of Directors. The Board of Directors may increase the size of the Committee and appoint additional members, remove members (with or without cause) and substitute new members, fill vacancies (however caused), and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by Applicable Laws. (b) Powers of the Board. Subject to the provisions of the Plan, the Board shall have the authority, in its discretion: -3- 4 (i) to grant "nonstatutory stock options"; (ii) to determine, upon review of relevant information and in accordance with Section 8(b) of the Plan, the fair market value of the Common Stock; (iii) to determine the exercise price per share of Options to be granted, which exercise price shall be determined in accordance with Section 8(a) of the Plan; (iv) to determine the Employees or Consultants to whom, and the time or times at which, Options shall be granted and the number of shares to be represented by each Option; (v) to interpret the Plan; (vi) to prescribe, amend and rescind rules and regulations relating to the Plan; (vii) to deter mine the terms and provisions of each Option granted (which need not be identical) and, with the consent of the holder thereof, modify or amend each Option; (viii) to accelerate or defer (with the consent of the Optionee) the exercise date of any Option, consistent with the provisions of Section 5 of the Plan; (ix) to authorize any person to execute on behalf of the Company any instrument required to effectuate the grant of an Option previously granted by the Board; and (x) to make all other determinations deemed necessary or advisable for the administration of the Plan. (c) Effect of Board's Decision. All decisions, determinations and interpretations of the Board shall be final and binding on all Optionees and any other holders of any Options granted under the Plan. 5. Eligibility. (a) Options may be granted only to Employees and Consultants. An Employee or Consultant who has been granted an Option may, if he is otherwise eligible, be granted an additional Option or Options. (b) The Plan shall not confer upon any Optionee any right with respect to continuation of employment, compensation or consulting relationship with the Company, nor shall it interfere in any way with his right or the Company's right to terminate his employment or consulting relationship at any time. (c) The following limitations shall apply to grants of Options to Employees: -4- 5 (i) No Employee shall be granted, in any fiscal year of the Company, Options to purchase more than 150,000 Shares. (ii) The foregoing limitations shall be adjusted proportionately in connection with any change in the Company's capitalization as described in Section 11. (iii) If an Option is canceled in the same fiscal year of the Company in which it was granted (other than in connection with a transaction described in Section 11), the cancelled Option will be counted against the limit set forth in Section 5(c). For this purpose, if the exercise price of an Option is reduced, the transaction will be treated as a cancellation of the Option and the grant of a new Option. 6. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the shareholders of the Company as described in Section 17 of the Plan. It shall continue in effect for a term of twenty (20) years unless sooner terminated under Section 13 of the Plan. 7. Term of Option. The term of each Option shall be ten (10) years from the date of grant thereof or such shorter term as may be provided in the Stock Option Agreement. 8. Exercise Price and Consideration. (a) The per Share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Board, but shall be no less than 100% of the fair market value per Share on the date of grant. (b) The fair market value shall be determined by the Board in its discretion; provided, however, that where there is a public market for the Common Stock, the fair market value per Share shall be the mean of the bid and asked prices of the Common Stock for the date of grant, as reported in the Wall Street Journal (or, if not so reported, as otherwise reported by the National Association of Securities Dealers Automated Quotation (NASDAQ) System) or, in the event the Common Stock is listed on a stock exchange, the fair market value per Share shall be the closing -5- 6 price on such exchange on the date of grant of the Option, as reported in the Wall Street Journal. (c) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Board and may consist entirely of either cash or check in United States currency. 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Shareholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Board, consist of any consideration and method of payment allowable under Section 8(c) of the Plan. Until the Company receives written notice of such exercise and full payment for the Shares, no right to vote or receive dividends or any other rights as a shareholder shall exist with respect to Optioned Stock. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 11 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Status as an Employee or Consultant. If an Employee or Consultant ceases to serve as an Employee or Consultant, he may, but only within thirty (30) days (or such longer period of time as is determined by the Board, but in no event later -6- 7 than the expiration date of the term of such Option as set forth in the Option Agreement) after the date he ceases to be an Employee or Consultant of the Company, exercise his Option to the extent that he was entitled to exercise it at the date of such termination. To the extent that he was not entitled to exercise the Option at the date of such termination, or if he does not exercise such Option (which he was entitled to exercise) within the time specified herein, the Option shall terminate. (c) Disability of Optionee. Notwithstanding the provisions of Section 9(b) above, in the event an Employee or Consultant is unable to continue his employment or consulting relationship (as the case may be) with the Company as a result of his total and permanent disability (as defined in section 22(e)(3) of the Internal Revenue Code), he may, but only within six (6) months (or such longer period of time as is determined by the Board, but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement) from the date of termination, exercise his Option to the extent he was entitled to exercise it at the date of such termination. To the extent that he was not entitled to exercise the Option at the date of termination, or if he does not exercise such Option (which he was entitled to exercise) within the time specified herein, the Option shall terminate. (d) Death of Optionee. In the event of the death of an Optionee: (i) during the term of the Option who is at the time of his death an Employee or Consultant of the Company and who shall have been in continuous status as an Employee or Consultant since the date of grant of the Option, the Option may be exercised, at any time within twelve (12) months following the date of death (or such longer period of time as is determined by the Board, but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of the Optionee's death; or -7- 8 (ii) within thirty (30) days (or such longer period of time as is determined by the Board, but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement) after the termination of continuous status as an employee or Consultant, the Option may be exercised, at any time within six (6) months following the date of death (or such longer period of time as is determined by the Board, but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. 10. Non-Transferability of Options. The Option may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee. 11. Adjustments Upon Changes in Capitalization or Merger. Subject to any required action by the shareholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no -8- 9 adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. In the event of the proposed dissolution or liquidation of the Company, the Option will terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Board. The Board may, in the exercise of its sole discretion in such instances, declare that any Option shall terminate as of a date fixed by the Board and give each Optionee the right to exercise his Option as to all or any part of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Board determines, in the exercise of its sole discretion and in lieu of such assumption or substitution, that the Optionee shall have the right to exercise the Option as to all of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. If the Board makes an Option fully exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Board shall notify the Optionee that the Option shall be fully exercisable for a period of thirty (30) days from the date of such notice, and the Option will terminate upon the expiration of such period. 12. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date on which the Board makes the determination granting such Option. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. 13. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may amend or terminate the Plan from time to time in such respects as the Board may deem advisable; provided, however, that a following revision or amendment shall require approval of the Shareholders of the Company in the manner described in Section 17 of the Plan: -9- 10 (i) if the Company has a class of equity security registered under Section 12 of the Exchange Act at the time of such revision or amendment, any material increase in the benefits accruing to participants under the Plan. (b) Shareholder Approval. If any amendment requiring shareholder approval under Section 13(a) of the Plan is made subsequent to the first registration of any class of equity security by the Company under Section 12 of the Exchange Act, such shareholder approval shall be solicited as described in Section 17(a) of the Plan. (c) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 14. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the Shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the afore mentioned relevant provisions of law. 15. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. -10- 11 Inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 16. Option Agreement. Options shall be evidenced by written option agreements in such form as the Board shall approve. 17. Shareholder Approval. If and in the event that the Company registers any class of any equity security pursuant to Section 12 of the Exchange Act, the approval of such shareholders of the Company shall be: (a) (1) solicited substantially in accordance with Section 14(a) of the Exchange Act and the rules and regulations promulgated thereunder, or (2) solicited after the Company has furnished in writing to the holders entitled to vote substantially the same information concerning the Plan as that which would be required by the rules and regulations in effect under Section 14(a) of the Exchange Act at the time such information is furnished; and (b) obtained at or prior to the first annual meeting of shareholders held subsequent to the first registration of any class of equity securities of the Company under Section 12 of the Exchange Act. If such shareholder approval is obtained by written con sent, it must be obtained by the unanimous written consent of all shareholders of the Company. 18. Information to Optionees. The Company shall provide to each Optionee, during the period for which such Optionee has one or more Options outstanding, copies of all annual reports and other information which are provided to all shareholders of the Company. The Company shall not be required to provide such information if the issuance of Options under the Plan is limited to key employees whose duties in connection with the Company assure their access to equivalent information. -11- EX-10.6 3 MEMORANDA OF REINSURANCE (1997) 1 Exhibit 10.6 Number: C-97-01332 Renewal of: C-96-01332 REASSURED: NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY South San Francisco, California CONTRACT: FIRST PROPERTY PER RISK EXCESS OF LOSS REINSURANCE CONTRACT Effective January 1, 1997 BUSINESS COVERED: Business produced by Fastrac Systems, Inc. of Bellevue, Washington, and produced by M.A. Speizer & Co., Inc. or any other of the National Insurance Group Companies of South San Francisco, California on behalf of the Reassured and classified as: Coverage A: Dwelling Fire, Fire, Extended Perils, Special Form on Interim Coverage policies, Forced Order policies, Real-Estate Owned (REO) policies, Personal Article Floaters, Personal Lines, Watercraft and Private Passenger Planes, Force Placed Property and/or Blanket Mortgage Security Insurance. Coverage B: Comprehensive Personal Liability (Section II Liability), including, but not limited to, General Bodily Injury and Property Damage Liability, Medical Payments and Third Party Liability Coverages which may be written in conjunction with the Reassured's Coverage A Policies. TERM AND CANCELLATION: The term of this Contract shall be from January 1, 1997 to January 1, 1998, both days at 12:01 a.m., Local Standard Time (Local Standard Time being that time which applies in the area where the risk is located) for losses occurring on new, renewal and in force policies. In the event of cancellation, all cessions with an effective date prior to the date of termination of this Contract shall remain in full force and shall continue to be covered hereunder for a period of up to one year subsequent to the date of termination. The Reassured shall have the option to waive the run-off provision and the reinsurance premium shall be adjusted on the gross earned premium income as of the date and time of cancellation. In such event, the Reinsurer shall not be liable as respects losses occurring subsequent to the effective date and time of cancellation. TERRITORY: This reinsurance shall cover wherever the Reassured's policies apply. Page 1 of 8 2 Number: C-97-01332 Renewal of: C-96-01332 RETENTION AND LIMIT: Coverage A: 100% of $2,000,000 excess of $500,000 on any one risk, in any one loss occurrence, subject to a maximum recovery of 100% of $4,000,000 any one loss occurrence. Limits include affiliated coverages. Affiliated coverages shall mean appurtenant structures, living expenses and shrubbery. Coverage B: 100% of $90,000 excess of $10,000 each occurrence. Allocated loss adjustment expenses pro rata in addition. REINSTATEMENTS: Unlimited reinstatements without charge. REINSURANCE RATE: 0.83% of Gross Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $175,000 payable in advance in equal quarterly installments. Annual minimum premium of $157,500. Subject to annual adjustment. EXCLUSIONS: A. Business classified as Ocean Marine except for personal lines watercraft physical damage not to exceed $100,000 any one risk; B. Personal Accident, Health, Surety and Fidelity, Workers' Compensation, and all classes of Casualty; C. Financial and Insolvency guarantees; D. Aviation business except for physical damage on private planes not to exceed $100,000 any one risk; E. Automobile business; F. Inland Marine policies covering railroad rolling stock, streamlined trains, negative films, registered mail, jewelers block, animal mortality, offshore drilling rigs; Page 2 of 8 3 Number: C-97-01332 Renewal of: C-96-01332 G. Excess of Loss Reinsurance and reinsurance accepted under obligatory reinsurance treaties except for business produced by Fastrac Systems, Inc. of Bellevue, Washington, and by M.A. Speizer & Co., Inc. or any other of the National Insurance Group companies of South San Francisco, California; H. Hail damage to growing/standing crops; I. Flood insurance when written as such; J. Pools, Associations or Syndicates as per Exclusion Clause attached (amended to include coverage for the California Fair Plan); K. Insolvency Funds as per Exclusion Clause attached; L. Loss or damage occasioned by invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, martial law or confiscation by order of any government or public authority, as excluded under a standard policy containing a Standard War Exclusion Clause; M. Nuclear Incident as per Nuclear Incident Exclusion Clause Physical Damage - Reinsurance - (USA & Canada) attached; N. Nuclear Incident as per Nuclear Incident Exclusion Clause - Liability - Reinsurance - (USA & Canada) attached; O. See page and Pollution as per ISO wording, or so deemed; P. Transmission and Distribution Lines. GENERAL CONDITIONS: Definition of Loss Occurrence Clause (Property and Casualty Business) as per the attached Exhibit A Extra Contractual Obligations (100%) Excess of Policy Limits (100%) Definition of Net Loss Clause Net Retained Lines Clause (All recoveries received from the Florida Hurricane Fund will be retained net by the Reassured, down to a net occurrence loss to the Reassured of $250,000, after which any additional recoveries will inure to this Contract by reducing the gross loss subject to this program.) Notice of Loss and Loss Settlement Currency Clause Tax Provisions Clause Access to Records Clause Page 3 of 8 4 Number: C-97-01332 Renewal of: C-96-01332 Errors and Omissions Clause Insolvency Clause Arbitration Clause Service of Suit Clause Towers Perrin Reinsurance Reserves Clause which complies with requirements of New York, California, and other states Towers Perrin Reinsurance Intermediary Clause WORDING: As per the expiring Contract. REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. Note: 1. The financial statements of participating Reinsurers will be furnished upon request. 2. Towers Perrin Reinsurance has no ownership interest in or control of: - any Reinsurer subscribing to this reinsurance. - any underwriting agent or correspondent intermediary involved in this reinsurance. 3. Towers Perrin Reinsurance has on file written evidence from any Reinsurer whose participation in this reinsurance was authorized by a representative other than an employee. This written evidence states the representative's authority to bind the participation of such Reinsurer. Page 4 of 8 5 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01332 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA FIRST PROPERTY PER RISK EXCESS OF LOSS REINSURANCE CONTRACT Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- Constitution Reinsurance Corporation 20.00% New York, New York FEIN# 13-5009848 NAIC# 21032 Continental Casualty Company 7.00% Chicago, Illinois FEIN# 36-2114545 NAIC# 20443 Employers Mutual Casualty Company 1.50% Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 5.00% Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Folksamerica Reinsurance Company 5.00% New York, New York FEIN# 13-2997499 NAIC# 38776 Page 5 of 8 6 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01332 Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- The Hanover Insurance Company 5.00% Bedford, New Hampshire FEIN# 13-5129825 NAIC# 22292 through Allmerica Re, a division of The Hanover Insurance Company Florham Park, New Jersey Hartford Fire Insurance Company 7.00% Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut PMA Reinsurance Corporation 6.00% Philadelphia, Pennsylvania FEIN# 23-2153760 NAIC# 39675 Republic Western Insurance Company 3.00% Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 10.00% St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Reinsurance Management Corporation New York, New York Sumitomo Marine & Fire Insurance Company Ltd. (U.S.) 2.00% New York, New York FEIN# 13-2758523 NAIC# 20362 through Sumitomo Marine Re Management, Inc. New York, New York Page 6 of 8 7 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01332 Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- Sydney Reinsurance Corporation 10.00% Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 USF Re Insurance Company 8.50% Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 10.00% Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Total Placement 100.00% Page 7 of 8 8 REINSURANCE COVER NOTE NO. C-97-01332 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA FIRST PROPERTY PER RISK EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1997 The Reassured hereby confirms its approval of the terms and conditions of the reinsurance set forth in this Reinsurance Cover Note and the Reinsurers participating hereon. A copy of Towers Perrin Reinsurance's Market Security Policy and Procedures has been attached to this Cover Note and the Reassured has been advised as to the status of all Reinsurers participating herein as regards this market security criteria. By: /s/ Robert P. Barbarowicz ------------------------------------- Title: Executive Vice President -------------------------------------- Date: February 15, 1997 --------------------------------------- Page 8 of 8 9 EXHIBIT A DEFINITION OF LOSS OCCURRENCE (PROPERTY) 1. As respects Property coverages under Coverage A of the Business Covered provision, the term "Loss Occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States of America or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "Loss Occurrence" shall be limited to all individual losses sustained by the Reassured occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event except that the term "Loss Occurrence" shall be further defined as follows: a. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Reassured occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. b. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Reassured, occurring during any period of 120 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 120 consecutive hours may be extended in respect of individual losses which occur beyond such 120 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. c. As regards earthquake (the epicenter of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Reassured's "Loss Occurrence." d. As regards "Freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Reassured's "Loss Occurrence." 2. Except for those "Loss Occurrences" referred to in Paragraphs a. and b. the Reassured may choose the date and time when any such period of consecutive hours commences provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss and provided that only one such period of 168 consecutive hours shall apply with respect to one event. 3. However, as respects those "Loss Occurrences" referred to in Paragraphs a. and b., if the disaster, accident or loss occasioned by the event is of greater duration than 120 consecutive hours then the Reassured may divide the disaster, accident or loss into two or more "Loss Occurrences" provided no two periods overlap and no individual loss is included in more than one such period and provided that no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss. Page 1 of 2 10 4. No individual losses occasioned by an event that would be covered by 72 or 120 hours clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. DEFINITION OF OCCURRENCE (CASUALTY) 5. As respects Section II Liability coverage under Coverage B of the Business Covered provision, the term "occurrence", except as otherwise provided herein, shall mean any one accident, disaster, casualty, or happening, or series of accidents, disasters, casualties, or happenings arising out of or caused by one event, regardless of the number of interests insured or the number of policies responding. Furthermore, all losses having a common origin or traceable to the same act, omission, mistake, or happening shall be considered an accident, disaster, casualty, or happening. The term "loss occurrence" shall otherwise follow the definitions of the Reassured's original policies. Page 2 of 2 11 Number: C-97-01371 Renewal of: C-96-01371 REASSURED: NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY South San Francisco, California CONTRACT: FIRST PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Effective January 1, 1997 BUSINESS COVERED: Business classified as Dwelling Fire, Fire, Extended Perils, Special Form on Interim Coverage policies, Forced Order policies, Real-Estate Owned (REO) policies, Personal Article Floaters, Personal Lines; Watercraft and Private Passenger Planes, Force Placed Property and/or Blanket Mortgage Security Insurance produced by Fastrac Systems, Inc. of Bellevue, Washington, and produced by M.A. Speizer & Co., Inc. or any other of the National Insurance Group Companies of South San Francisco, California on behalf of the Reassured. TERM AND CANCELLATION: The term of this Contract shall be from January 1, 1997 to January 1, 1998, both days at 12:01 a.m., Local Standard Time (Local Standard Time being that time which applies in the area where the risk is located) for losses occurring on new, renewal and in force policies. Should this Contract terminate while a loss occurrence is in progress, the Reinsurers shall nevertheless be liable, to the extent of their interest and subject to the other conditions of this Contract, for all losses resulting from such loss occurrence, whether such losses occur before or after such termination. TERRITORY: This reinsurance shall cover wherever the Reassured's policies apply. RETENTION AND LIMIT: The Reinsurers shall be liable in each and every loss occurrence irrespective of the number and kinds of risks and perils involved, for 95% of $2,500,000 Net Loss each loss occurrence excess of $2,500,000 Net Loss each loss occurrence, not to exceed 95% of $5,000,000 Net Loss for all loss occurrences during the term of this Contract. All recoveries received from the Florida Hurricane Fund will be retained net by the Reassured, down to a net occurrence loss to the Reassured of $250,000 after which any additional recoveries will inure to the Catastrophe Excess Program by reducing the gross loss subject to the Catastrophe program. Recoveries from all underlying reinsurance greater than $2,500,000 shall inure to the sole benefit of the Reinsurers hereunder; subject to a minimum net retention by the Reassured any one loss of no less than $250,000. Page 1 of 6 12 Number: C-97-01371 Renewal of: C-96-01371 The reassured agrees to carry at its own risk and not reinsured in any way the remaining 5% of each excess net loss for which claim is made hereunder. REINSTATEMENT: One full reinstatement at pro rata additional premium with respect to amount and a minimum of 100% with respect to time. (Refer to Exhibit A for further details). WARRANTY: It is hereby warranted that any recovery under this Contract shall involve two or more risks in each loss occurrence. REINSURANCE RATE: 1.03% of Gross Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $215,000 payable in advance in equal quarterly installments. Annual minimum premium of $172,000. Subject to annual adjustment. EXCLUSIONS: A. Business classified as Ocean Marine except for personal lines watercraft physical damage not to exceed $100,000 any one risk; B. Personal Accident, Health, Surety and Fidelity, Workers' Compensation, and all classes of Casualty; C. Financial and Insolvency guarantees; D. Aviation business except for physical damage on private planes not to exceed $100,000 any one risk; E. Automobile; F. Inland Marine policies covering railroad rolling stock, streamlined trains, negative films, registered mail, jewelers block, animal mortality, offshore drilling rigs; G. Excess of Loss Reinsurance and reinsurance accepted under obligatory reinsurance treaties except for business produced by Fastrac Systems, Inc. of Bellevue, Washington, and by M.A. Speizer & Co., Inc. or any other of the National Insurance Group companies of South San Francisco, California; H. Hail damage to growing/standing crops; I. Flood insurance when written as such; J. Pools, Associations or Syndicates as per Exclusion Clause attached; K. Insolvency Funds as per Exclusion Clause attached; Page 2 of 6 13 Number: C-97-01371 Renewal of: C-96-01371 L. Loss or damage occasioned by invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, martial law or confiscation by order of any government or public authority, as excluded under a standard policy containing a Standard War Exclusion Clause; M. Nuclear Incident as per Nuclear Incident Exclusion Clause Physical Damage - Reinsurance - (USA & Canada) attached; N. Seepage and Pollution as per ISO wording, or so deemed; O. Transmission and Distribution Lines. GENERAL CONDITIONS: Definition of Loss Occurrence Clause to include definition of hours clause as attached, and as follows (no reinstatement for wind): - 72 hours clause tornado, cyclone, hurricane, windstorm and hail - 120 hours clause riots and civil commotion/vandalism and malicious mischief within the area of one municipality or county and the municipalities or counties contiguous thereto - 168 hours Freeze - 168 hours Earthquake and Ensuing Loss - 168 hours All Other Perils Extra Contractual Obligations (100%) Excess of Policy Limits (100%) (ECO/XPL subject to a maximum of 25% of original catastrophe loss) Definition of Net Loss Clause (which shall include defense costs but not limited to expenses incurred in determination of coverage) Net Retained Lines Clause Notice of Loss and Loss Settlement Clause Currency Clause Tax Provisions Clause Access to Records Clause Errors and Omissions Clause Insolvency Clause Arbitration Clause Service of Suit Clause Towers Perrin Reinsurance Reserves Clause which complies with requirements of New York, California, and other states Towers Perrin Reinsurance Intermediary Clause WORDING: As per the expiring Contract. Page 3 of 6 14 Number: C-97-01371 Renewal of: C-96-01371 REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. Note: 1. The financial statements of participating Reinsurers will be furnished upon request. 2. Towers Perrin Reinsurance has no ownership interest in or control of: - any Reinsurer subscribing to this reinsurance. - any underwriting agent or correspondent intermediary involved in this reinsurance. 3. Towers Perrin Reinsurance has on file written evidence from any Reinsurer whose participation in this reinsurance was authorized by a representative other than an employee. This written evidence states the representative's authority to bind the participation of such Reinsurer. Page 4 of 6 15 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01371 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA FIRST PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Direct Placement through Towers Perrin Reinsurance Share Constitution Reinsurance Corporation 8.50% New York, New York FEIN# 13-5009848 NAIC# 21032 Folksamerica Reinsurance Company 8.00% New York, New York FEIN# 13-2997499 NAIC# 38776 The Hanover Insurance Company 5.00% Bedford, New Hampshire FEIN# 13-5129825 NAIC# 22292 through Allmerica Re, a division of The Hanover Insurance Company Florham Park, New Jersey Hartford Fire Insurance Company 10.00% Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut Page 5 of 6 16 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01371 Direct Placement through Towers Perrin Reinsurance Share Nationwide Mutual Insurance Company 7.50% Columbus, Ohio FEIN# 31-4177100 NAIC# 23787 Republic Western Insurance Company 5.00% Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 8.00% St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Reinsurance Management Corporation New York, New York Sydney Reinsurance Corporation 10.00% Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 USF Re Insurance Company 5.00% Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 25.00% Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Winterthur Reinsurance Corporation of America 8.00% New York, New York FEIN# 13-3531373 NAIC# 10006 Total Placement 100.00% Page 6 of 6 17 REINSURANCE COVER NOTE NO. C-97-01371 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA FIRST PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1997 The Reassured hereby confirms its approval of the terms and conditions of the reinsurance set forth in this Reinsurance Cover Note and the Reinsurers participating hereon. A copy of Towers Perrin Reinsurance's Market Security Policy and Procedures has been attached to this Cover Note and the Reassured has been advised as to the status of all Reinsurers participating herein as regards this market security criteria. By: /s/ Robert P. Barbarowicz Title: Executive Vice President Date: February 15, 1997 Page 7 of 6 18 EXHIBIT A DEFINITION OF LOSS OCCURRENCE 1. The term "Loss Occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States of America or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "Loss Occurrence" shall be limited to all individual losses sustained by the Reassured occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event except that the term "Loss Occurrence" shall be further defined as follows: a. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Reassured occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. b. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Reassured, occurring during any period of 120 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 120 consecutive hours may be extended in respect of individual losses which occur beyond such 120 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. c. As regards earthquake (the epicenter of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Reassured's "Loss Occurrence." d. As regards "Freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Reassured's "Loss Occurrence." 2. Except for those "Loss Occurrences" referred to in Paragraphs a. and b. the Reassured may choose the date and time when any such period of consecutive hours commences provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss and provided that only one such period of 168 consecutive hours shall apply with respect to one event. 3. However, as respects those "Loss Occurrences" referred to in Paragraphs a. and b., if the disaster, accident or loss occasioned by the event is of greater duration than 120 consecutive hours then the Reassured may divide the disaster, accident or loss into two or more "Loss Occurrences" provided no two periods overlap and no individual loss is included in more than one such period and provided that no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss. 19 4. No individual losses occasioned by an event that would be covered by 72 or 120 hours clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. Page 2 of 2 20 Number: C-97-01402 Renewal of: C-96-01402 REASSURED: NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY South San Francisco, California CONTRACT: SECOND PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Effective January 1, 1997 BUSINESS COVERED: Business classified as Dwelling Fire, Fire, Extended Perils, Special Form on Interim Coverage policies, Forced Order policies, Real-Estate Owned (REO) policies, Personal Article Floaters, Personal Lines; Watercraft and Private Passenger Planes, Force Placed Property and/or Blanket Mortgage Security Insurance produced by Fastrac Systems, Inc. of Bellevue, Washington, and produced by M.A. Speizer & Co., Inc. or any other of the National Insurance Group Companies of South San Francisco, California on behalf of the Reassured. TERM AND CANCELLATION: The term of this Contract shall be from January 1, 1997 to January 1, 1998, both days at 12:01 a.m., Local Standard Time (Local Standard Time being that time which applies in the area where the risk is located) for losses occurring on new, renewal and in force policies. Should this Contract terminate while a loss occurrence is in progress, the Reinsurers shall nevertheless be liable, to the extent of their interest and subject to the other conditions of this Contract, for all losses resulting from such loss occurrence, whether such losses occur before or after such termination. TERRITORY: This reinsurance shall cover wherever the Reassured's policies apply. RETENTION AND LIMIT: The Reinsurers shall be liable in each and every loss occurrence irrespective of the number and kinds of risks and perils involved, for 95% of $5,000,000 Net Loss each loss occurrence excess of $5,000,000 Net Loss each loss occurrence, not to exceed 95% of $10,000,000 Net Loss for all loss occurrences during the term of this Contract. All recoveries received from the Florida Hurricane Fund will be retained net by the Reassured, down to a net occurrence loss to the Reassured of $250,000 after which any additional recoveries will inure to the Catastrophe Excess Program by reducing the gross loss subject to the Catastrophe program. Recoveries from all underlying reinsurance greater than $2,500,000 shall inure to the sole benefit of the Reinsurers hereunder; subject to a minimum net retention by the Reassured any one loss of no less than $250,000. Page 1 of 8 21 Number: C-97-01402 Renewal of: C-96-01402 The reassured agrees to carry at its own risk and not reinsured in any way the remaining 5% of each excess net loss for which claim is made hereunder. REINSTATEMENT: One full reinstatement at pro rata additional premium with respect to amount and a minimum of 100% with respect to time. (Refer to Exhibit A for further details). WARRANTY: It is hereby warranted that any recovery under this Contract shall involve two or more risks in each loss occurrence. REINSURANCE RATE: 1.43% of Gross Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $300,000 payable in advance in equal quarterly installments. Annual minimum premium of $240,000. Subject to annual adjustment. EXCLUSIONS: A. Business classified as Ocean Marine except for personal lines watercraft physical damage not to exceed $100,000 any one risk; B. Personal Accident, Health, Surety and Fidelity, Workers' Compensation, and all classes of Casualty; C. Financial and Insolvency guarantees; D. Aviation business except for physical damage on private planes not to exceed $100,000 any one risk; E. Automobile business; F. Inland Marine policies covering railroad rolling stock, streamlined trains, negative films, registered mail, jewelers block, animal mortality, offshore drilling rigs; G. Excess of Loss Reinsurance and reinsurance accepted under obligatory reinsurance treaties except for business produced by Fastrac Systems, Inc. of Bellevue, Washington, and by M.A. Speizer & Co., Inc. or any other of the National Insurance Group companies of South San Francisco, California; H. Hail damage to growing/standing crops; I. Flood insurance when written as such; J. Pools, Associations or Syndicates as per Exclusion Clause attached; Page 2 of 8 22 Number: C-97-01402 Renewal of: C-96-01402 K. Insolvency Funds as per Exclusion Clause attached; L. Loss or damage occasioned by invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, martial law or confiscation by order of any government or public authority, as excluded under a standard policy containing a Standard War Exclusion Clause; M. Nuclear Incident as per Nuclear Incident Exclusion Clause Physical Damage - Reinsurance - (USA & Canada) attached; N. Seepage and Pollution as per ISO wording, or so deemed; O. Transmission and Distribution Lines. GENERAL CONDITIONS: Definition of Loss Occurrence Clause to include definition of hours clause as attached, and as follows (no reinstatement for wind): - 72 hours clause tornado, cyclone, hurricane, windstorm and hail - 120 hours clause riots and civil commotion/vandalism and malicious mischief within the area of one municipality or county and the municipalities or counties contiguous thereto - 168 hours Freeze - 168 hours Earthquake and Ensuing Loss - 168 hours All Other Perils Extra Contractual Obligations (100%) Excess of Policy Limits (100%) (ECO/XPL subject to a maximum of 25% of original catastrophe loss) Definition of Net Loss Clause (which shall include defense costs but not limited to expenses incurred in determination of coverage) Net Retained Lines Clause Notice of Loss and Loss Settlement Clause Currency Clause Tax Provisions Clause Access to Records Clause Errors and Omissions Clause Insolvency Clause Arbitration Clause Service of Suit Clause Towers Perrin Reinsurance Reserves Clause which complies with requirements of New York, California, and other states Towers Perrin Reinsurance Intermediary Clause WORDING: As per the expiring Contract. Page 3 of 8 23 Number: C-97-01402 Renewal of: C-96-01402 REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. Note: 1. The financial statements of participating Reinsurers will be furnished upon request. 2. Towers Perrin Reinsurance has no ownership interest in or control of: - any Reinsurer subscribing to this reinsurance. - any underwriting agent or correspondent intermediary involved in this reinsurance. 3. Towers Perrin Reinsurance has on file written evidence from any Reinsurer whose participation in this reinsurance was authorized by a representative other than an employee. This written evidence states the representative's authority to bind the participation of such Reinsurer. Page 4 of 8 24 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01402 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA SECOND PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Direct Placement through Towers Perrin Reinsurance Share Constitution Reinsurance Corporation 5.00% New York, New York FEIN# 13-5009848 NAIC# 21032 Continental Casualty Company 14.50% Chicago, Illinois FEIN# 36-2114545 NAIC# 20443 Employers Mutual Casualty Company 2.25% Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 7.50% Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Folksamerica Reinsurance Company 8.00% New York, New York FEIN# 13-2997499 NAIC# 38776 Page 5 of 8 25 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01402 Direct Placement through Towers Perrin Reinsurance Share The Hanover Insurance Company 5.00% Bedford, New Hampshire FEIN# 13-5129825 NAIC# 22292 through Allmerica Re, a division of The Hanover Insurance Company Florham Park, New Jersey Insurance Company of the West 8.00% San Diego, California FEIN# 95-2769232 NAIC# 27847 Nationwide Mutual Insurance Company 7.50% Columbus, Ohio FEIN# 31-4177100 NAIC# 23787 Reliance Insurance Company 2.10% Philadelphia, Pennsylvania FEIN# 23-0580680 NAIC# 24457 through Reliance Reinsurance Corporation Philadelphia, Pennsylvania St. Paul Fire and Marine Insurance Company 8.00% St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Reinsurance Management Corporation New York, New York United Fire & Casualty Company 0.50% Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 Page 6 of 8 26 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01402 Direct Placement through Towers Perrin Reinsurance Share USF Re Insurance Company 3.15% Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 25.00% Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Winterthur Reinsurance Corporation of America 3.50% New York, New York FEIN# 13-3531373 NAIC# 10006 Total Placement 100.00% Page 7 of 8 27 REINSURANCE COVER NOTE NO. C-97-01402 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA SECOND PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1997 The Reassured hereby confirms its approval of the terms and conditions of the reinsurance set forth in this Reinsurance Cover Note and the Reinsurers participating hereon. A copy of Towers Perrin Reinsurance's Market Security Policy and Procedures has been attached to this Cover Note and the Reassured has been advised as to the status of all Reinsurers participating herein as regards this market security criteria. By: /s/ Robert P. Barbarowicz Title: Executive Vice President Date: February 15, 1997 Page 8 of 8 28 EXHIBIT A DEFINITION OF LOSS OCCURRENCE 1. The term "Loss Occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States of America or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "Loss Occurrence" shall be limited to all individual losses sustained by the Reassured occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event except that the term "Loss Occurrence" shall be further defined as follows: a. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Reassured occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. b. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Reassured, occurring during any period of 120 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 120 consecutive hours may be extended in respect of individual losses which occur beyond such 120 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. c. As regards earthquake (the epicenter of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Reassured's "Loss Occurrence." d. As regards "Freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Reassured's "Loss Occurrence." 2. Except for those "Loss Occurrences" referred to in Paragraphs a. and b. the Reassured may choose the date and time when any such period of consecutive hours commences provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss and provided that only one such period of 168 consecutive hours shall apply with respect to one event. 3. However, as respects those "Loss Occurrences" referred to in Paragraphs a. and b., if the disaster, accident or loss occasioned by the event is of greater duration than 120 consecutive hours then the Reassured may divide the disaster, accident or loss into two or more "Loss Occurrences" provided no two periods overlap and no individual loss is included in more than one such period and provided that Page 1 of 2 29 no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss. 4. No individual losses occasioned by an event that would be covered by 72 or 120 hours clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. Page 2 of 2 30 Number: C-97-01493 Renewal of: C-96-01493 REASSURED: NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY South San Francisco, California CONTRACT: THIRD PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Effective January 1, 1997 BUSINESS COVERED: Business classified as Dwelling Fire, Fire, Extended Perils, Special Form on Interim Coverage policies, Forced Order policies, Real-Estate Owned (REO) policies, Personal Article Floaters, Personal Lines; Watercraft and Private Passenger Planes, Force Placed Property and/or Blanket Mortgage Security Insurance produced by Fastrac Systems, Inc. of Bellevue, Washington, and produced by M.A. Speizer & Co., Inc. or any other of the National Insurance Group Companies of South San Francisco, California on behalf of the Reassured. TERM AND CANCELLATION: The term of this Contract shall be from January 1, 1997 to January 1, 1998, both days at 12:01 a.m., Local Standard Time (Local Standard Time being that time which applies in the area where the risk is located) for losses occurring on new, renewal and in force policies. Should this Contract terminate while a loss occurrence is in progress, the Reinsurers shall nevertheless be liable, to the extent of their interest and subject to the other conditions of this Contract, for all losses resulting from such loss occurrence, whether such losses occur before or after such termination. TERRITORY: This reinsurance shall cover wherever the Reassured's policies apply. RETENTION AND LIMIT: The Reinsurers shall be liable in each and every loss occurrence irrespective of the number and kinds of risks and perils involved, for 95% of $5,000,000 Net Loss each loss occurrence excess of $10,000,000 Net Loss each loss occurrence, not to exceed 95% of $10,000,000 Net Loss for all loss occurrences during the term of this Contract. All recoveries received from the Florida Hurricane Fund will be retained net by the Reassured, down to a net occurrence loss to the Reassured of $250,000 after which any additional recoveries will inure to the Catastrophe Excess Program by reducing the gross loss subject to the Catastrophe program. Recoveries from all underlying reinsurance greater than $2,500,000 shall inure to the sole benefit of the Reinsurers hereunder; subject to a minimum net retention by the Reassured any one loss of no less than $250,000. 31 Number: C-97-01493 Renewal of: C-96-01493 The reassured agrees to carry at its own risk and not reinsured in any way the remaining 5% of each excess net loss for which claim is made hereunder. REINSTATEMENT: One full reinstatement at pro rata additional premium with respect to amount and a minimum of 100% with respect to time. (Refer to Exhibit A for further details). WARRANTY: It is hereby warranted that any recovery under this Contract shall involve two or more risks in each loss occurrence. REINSURANCE RATE: .72% of Gross Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $150,000 payable in advance in equal quarterly installments. Annual minimum premium of $120,000. Subject to annual adjustment. EXCLUSIONS: A. Business classified as Ocean Marine except for personal lines watercraft physical damage not to exceed $100,000 any one risk; B. Personal Accident, Health, Surety and Fidelity, Workers' Compensation, and all classes of Casualty; C. Financial and Insolvency guarantees; D. Aviation business except for physical damage on private planes not to exceed $100,000 any one risk; E. Automobile business; F. Inland Marine policies covering railroad rolling stock, streamlined trains, negative films, registered mail, jewelers block, animal mortality, offshore drilling rigs; G. Excess of Loss Reinsurance and reinsurance accepted under obligatory reinsurance treaties except for business produced by Fastrac Systems, Inc. of Bellevue, Washington, and by M.A. Speizer & Co., Inc. or any other of the National Insurance Group companies of South San Francisco, California; H. Hail damage to growing/standing crops; I. Flood insurance when written as such; J. Pools, Associations or Syndicates as per Exclusion Clause attached; K. Insolvency Funds as per Exclusion Clause attached; Page 2 of 8 32 Number: C-97-01493 Renewal of: C-96-01493 L. Loss or damage occasioned by invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, martial law or confiscation by order of any government or public authority, as excluded under a standard policy containing a Standard War Exclusion Clause; M. Nuclear Incident as per Nuclear Incident Exclusion Clause Physical Damage - Reinsurance - (USA & Canada) attached; N. Seepage and Pollution as per ISO wording, or so deemed; O. Transmission and Distribution Lines. GENERAL CONDITIONS: Definition of Loss Occurrence Clause to include definition of hours clause as attached, and as follows (no reinstatement for wind): - 72 hours clause tornado, cyclone, hurricane, windstorm and hail - 120 hours clause riots and civil commotion/vandalism and malicious mischief within the area of one municipality or county and the municipalities or counties contiguous thereto - 168 hours Freeze - 168 hours Earthquake and Ensuing Loss - 168 hours All Other Perils Extra Contractual Obligations (100%) Excess of Policy Limits (100%) (ECO/XPL subject to a maximum of 25% of original catastrophe loss) Definition of Net Loss Clause (which shall include defense costs but not limited to expenses incurred in determination of coverage) Net Retained Lines Clause Notice of Loss and Loss Settlement Clause Currency Clause Tax Provisions Clause Access to Records Clause Errors and Omissions Clause Insolvency Clause Arbitration Clause Service of Suit Clause Towers Perrin Reinsurance Reserves Clause which complies with requirements of New York, California, and other states Towers Perrin Reinsurance Intermediary Clause WORDING: As per the expiring Contract. Page 3 of 8 33 Number: C-97-01493 Renewal of: C-96-01493 REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. Note: 1. The financial statements of participating Reinsurers will be furnished upon request. 2. Towers Perrin Reinsurance has no ownership interest in or control of: - any Reinsurer subscribing to this reinsurance. - any underwriting agent or correspondent intermediary involved in this reinsurance. 3. Towers Perrin Reinsurance has on file written evidence from any Reinsurer whose participation in this reinsurance was authorized by a representative other than an employee. This written evidence states the representative's authority to bind the participation of such Reinsurer. Page 4 of 8 34 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01493 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA THIRD PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT Direct Placement through Towers Perrin Reinsurance Share Constitution Reinsurance Corporation 5.00% New York, New York FEIN# 13-5009848 NAIC# 21032 Employers Mutual Casualty Company 2.25% Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 5.50% Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Hartford Fire Insurance Company 7.00% Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Company Hartford, Connecticut The Hanover Insurance Company 7.50% Bedford, New Hampshire FEIN# 13-5129825 NAIC# 22292 through Allmerica Re, a division of The Hanover Insurance Company Florham Park, New Jersey Page 5 of 8 35 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01493 Direct Placement through Towers Perrin Reinsurance Share Insurance Company of the West 8.00% San Diego, California FEIN# 95-2769232 NAIC# 27847 Nationwide Mutual Insurance Company 7.50% Columbus, Ohio FEIN# 31-4177100 NAIC# 23787 PMA Reinsurance Corporation 7.00% Philadelphia, Pennsylvania FEIN# 23-2153760 NAIC# 39675 Republic Western Insurance Company 5.00% Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 8.00% St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Reinsurance Management Corporation New York, New York The Sumitomo Marine & Fire Insurance Company Ltd. 3.25% New York, New York FEIN# 13-2758523 NAIC# 20362 through Sumitomo Marine Re Management, Inc. New York, New York Sydney Reinsurance Corporation 15.00% Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 Page 6 of 8 36 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-97-01493 Direct Placement through Towers Perrin Reinsurance Share United Fire & Casualty Company 3.00% Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 Vesta Fire Insurance Corporation 16.00% Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Total Placement 100.00% Page 7 of 8 37 REINSURANCE COVER NOTE NO. C-97-01493 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA THIRD PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1997 The Reassured hereby confirms its approval of the terms and conditions of the reinsurance set forth in this Reinsurance Cover Note and the Reinsurers participating hereon. A copy of Towers Perrin Reinsurance's Market Security Policy and Procedures has been attached to this Cover Note and the Reassured has been advised as to the status of all Reinsurers participating herein as regards this market security criteria. By: /s/ Robert P. Barbarowicz Title: Executive Vice President Date: February 15, 1997 Page 8 of 8 38 EXHIBIT A DEFINITION OF LOSS OCCURRENCE 1. The term "Loss Occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States of America or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "Loss Occurrence" shall be limited to all individual losses sustained by the Reassured occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event except that the term "Loss Occurrence" shall be further defined as follows: a. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Reassured occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. b. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Reassured, occurring during any period of 120 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 120 consecutive hours may be extended in respect of individual losses which occur beyond such 120 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. c. As regards earthquake (the epicenter of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Reassured's "Loss Occurrence." d. As regards "Freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Reassured's "Loss Occurrence." 2. Except for those "Loss Occurrences" referred to in Paragraphs a. and b. the Reassured may choose the date and time when any such period of consecutive hours commences provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss and provided that only one such period of 168 consecutive hours shall apply with respect to one event. 3. However, as respects those "Loss Occurrences" referred to in Paragraphs a. and b., if the disaster, accident or loss occasioned by the event is of greater duration than 120 consecutive hours then the Reassured may divide the disaster, accident or loss into two or more "Loss Occurrences" provided no two periods overlap and no individual loss is included in more than one such period and provided that Page 1 of 2 39 no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Reassured arising out of that disaster, accident or loss. 4. No individual losses occasioned by an event that would be covered by 72 or 120 hours clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. Page 2 of 2 EX-10.24 4 EMPLOYMENT AGREEMENT EFFECTIVE AUGUST 12, 1996 1 Exhibit 10.24 As of August 12, 1996 National Insurance Group 395 Oyster Point Blvd., Suite 500 South San Francisco, CA 94080 Attention: Mr. Mark A. Speizer Chairman and Chief Executive Officer Dear People: This letter agreement (the "Agreement") confirms my understanding and agreement that (i) the following terms and conditions were discussed with me prior to being offered employment, and (ii) I agreed to them at that time and I accept them as terms and conditions of my employment as an employee of National Insurance Group, or any of its subsidiaries which currently exist or may exist in the future. The current subsidiaries of the Company are Fastrac(R) Systems, Inc., Fastrac(R) Systems Inc. Insurance Agent & Broker, Pinnacle Data Corporation, and Great Pacific Insurance Company. Any references in this Agreement to the Company shall mean National Insurance Group and its subsidiaries collectively. I understand and agree that this Agreement supersedes any prior understanding, agreement, discussions or negotiations and that any such prior understanding, agreement, discussion or negotiation does not constitute an agreement between the Company and me and is void as being any such agreement. My employment by the Company shall be as an employee of the Company ("Employment") and is subject to the terms and conditions set forth in this Agreement, together with all written rules, policies and procedures of the Company that may be in effect from time to time during my employment ("Policies and Procedures"). 1 2 1. Compensation. 1.1 Salary Compensation. I shall be paid $25,000 on the first day of my Employment. Thereafter, my bi-weekly salary shall be $4,807.69 ("Salary Compensation"), which shall be paid to me in accordance with payroll practices and procedures of the Company, less any applicable withholdings, taxes and deductions as required by law and any deductions authorized by me. My Salary Compensation shall accrue from the first day of my Employment, which shall be August 12, 1996. My Salary Compensation may be adjusted, to be increased or decreased on or after the first anniversary of my Employment if I am an employee of the Company at such time. 1.2 Eligibility to Participate in Bonus Plans for Senior Management. In addition to my Salary Compensation, I understand that I shall be eligible to participate in and may receive awards made by the Company under a bonus plan for senior management of the Company as the same may be adopted by the Company. I further understand that any such participation in any such plan shall commence with calender year 1997. I understand that there is no guarantee or assurance that I will be granted any award under any such bonus plan or that any award granted to me would be equal to those granted to other employees of the Company, including but not limited to, officers who hold the same or similar titles or offices or who perform the same or similar duties as me. 1.3 Reimbursement for Reasonable Business Expenses. I further understand that the Company will reimburse me for any reasonable business related expenses incurred by me for travel, entertainment or other business expenses in accordance with the Policies and Procedures of the Company. All requests for reimbursements or any advances by the Company for expenses shall be on such forms as the Company may require with documentation or substantiation of any such expenses. All requests for reimbursement of expenses or advances shall be approved by one of the following officers of the Company (i) the Chairman of the Board and Chief Executive Officer, (ii) the President; or (iii) any Executive Vice President as may be designated by the Chairman or the President. I understand that I may be issued one or more credit cards issued to me on the account of the Company. I agree that I will use any such charge only for business purposes or, in the event that I use any such credit cards for personal purposes, 2 3 I will identify any such expense as personal in nature and pay to the Company the amount of any such charges at the time the account is rendered to the Company for payment by the credit card entity. The Company may revoke, modify or suspend its issuance of credit cards to its employees, including me. 2. Position and Title. My position shall be Executive Vice President, General Counsel and Secretary of the Company and I understand that I will be elected as an officer of the Company and may be elected as an officer of one of more of the subsidiaries of the Company. I shall have such duties as may be assigned to me by the Chairman of the Board and Chief Executive Officer or the President of the Company at any time or from time to time. I shall report to the Chairman of the Board and Chief Executive Officer or to the President of the Company if the Chairman so designates. 3. Work Hours; Exempt Employee Status. I agree that I will work at least forty hours per week, during the normal business hours of the Company, prevailing local time, however. I understand that I will not receive any additional compensation for any hours that I work in excess of eight hours per day and forty hours per week. As an executive officer of the Company with my duties as Executive Vice President, General Counsel, I understand and agree that my duties may require my services in excess of the services performed by other employees of the Company. I agree that I will devote my full time and attention to the performance of my duties during normal business hours. I further agree that I will not engage in any civic or other activities that would materially interfere with the performance of my duties under this Agreement or as an employee of the Company. I will not engage in any other business or commercial activity. 4. At Will Employment. I understand and agree that my Employment will be "at-will". This means that the Company has the right to and can terminate my Employment at any time, with or without cause, and without notice, and I can terminate my Employment at any time, with or without cause, and without notice. There is no promise that my Employment will continue for a specific period of time, duration or term and there is no promise that my employment will be terminated only under particular circumstances. NO POSITION WITHIN THE COMPANY IS 3 4 CONSIDERED PERMANENT. This Section 4 constitutes the entire agreement between me and the Company regarding the term of my Employment. 5. Vacations. The following is the vacation policy of the Company applicable to me. a. My paid vacation time ("Vacation Time") will accrue on the following basis: (i) .0625 of a vacation day for each full working day worked at the Company during each Working Year until such Vacation Time is modified by the Company. A "Working Year" begins on the first day of my Employment and ends 365 continuous days thereafter. b. If I do not take any Vacation Time within 180 days from the end of each Working Year of my Employment, the Company will require that I take my accrued Vacation Time and will assign me Vacation Time that must be used by me. I am required to take Vacation Time within the 180 day period described in Section 5.b because a stacking of accrued Vacation Time beyond one Working Year into an extended vacation may be a hardship on the Company. c. I will give advance written notice of the dates my Vacation Time is to begin and end by completing the Company's Vacation Request Form then in effect ("Vacation Request") and submitting it to my supervisor, no less than 60 days before my proposed Vacation Time will begin. I will be given a written receipt for the Vacation Request and my supervisor will review my Vacation Request with the Company's payroll supervisor. If my supervisor and the payroll supervisor are unable to agree mutually to approve the Vacation Request, my Vacation Request shall be forwarded to the Chief Executive Officer or President of the Company for review (my supervisor, the payroll supervisor, and/or the Chief Executive Officer or President shall be referred to herein as the "Designated Persons"). The Designated Persons can, in their discretion, turn down my request for the proposed dates of Vacation Time in my Vacation Request, but the Designated Persons must provide me with alternative dates which I must use instead. The Designated Persons will provide me with a written acceptance or rejection of the Vacation Request no more than 30 days after I present it to my supervisor. 6. Health/Life/Welfare Plans. 4 5 a. I will be eligible for coverage under the Company's health/life/welfare plans ("plans"), as may be amended from time-to-time, on the thirty-first consecutive day of my Employment. Even though I will be eligible for the plans on the thirty-first consecutive day of my Employment, the actual date coverage would go into effect on the plans, as respects me or my dependents eligible for coverage, is at the sole discretion of the plans' provider(s) (i.e., the insurance company or plans' trust). b. Once I am covered by the plans I will be covered until the earlier of the following: i. The date my Employment ceases, subject to Federal and State laws and regulations regarding the termination date of such coverage, or ii. Coverage for me or the Companies under the plans is terminated by the insurance company or other organization providing these benefits, or iii. The insurance company or other organization providing these benefits refuses to cover me under any of the plans. 7. Sick Time. a. If I do not work because of illness, sickness, disease, accident or disability, at option of the Company, the Company, in its sole discretion, may require me to bring a written notice from my physician, addressed to the Company, on the day I return to work (i) indicating the reason I was unable to work on the days that I missed work and stating "I have determined that (my name) was too ill, sick, diseased, injured or disabled to report to work and perform his duties from (insert date) to (insert date)", and (ii) stating that I am now able to resume the duties I performed and work the number of hours I was employed to work prior to such absence. I consent to the disclosure by my physician to the Company of such medical information as the Company may be legally entitled to obtain regarding my ability to perform my job. 5 6 b. If sick time pay ("Sick Time") is provided by the Company, it is only payable to me for the times when I am too ill, sick, diseased, injured or disabled to do the work which I was then employed by the Company to do. c. Currently, the Company provides me with six (6) Sick Time days during my Working Year. The Sick Time accrues at one-half day per each two consecutive pay periods. At the end of any Working Year, all accrued unused Sick Time is transferred to the next concurrent Working Year. No more than six (6) Sick Time days may be used in any Working Year. If unused Sick Time days are carried over from one Working Year to the next concurrent Working Year, then the amount of Sick Time days I can accrue in that next concurrent Working Year shall be limited to the difference between the unused Sick Time days carried forward to the next concurrent Working Year and six (6) days. d. The Company reserve the right to eliminate Sick Time upon 30 days' notice to its employees. d. Normal visits to my doctor or dentist, which are not due to illness, sickness, disease, accident or disability of a nature which prevented me from performing the work which I was then employed by the Company to do, shall not be considered Sick Time and I shall prearrange such visit with my supervisor. 8. Unpaid Absences. Any absence from work for any reason that is not expressly compensated pursuant to this Agreement will result in a deduction from my salary compensation, for the appropriate pay period, of an amount equal to the salary compensation I would have been paid for the time of such absence and, in the Company's discretion, I may not be allowed to make up time in this regard. Nothing herein shall operate to authorize an unpaid absence. 9. Cellular Telephone, Travel Expectations. 9.1 Cellular Telephone Expenses. I shall be reimbursed for cellular telephone expenses related to the business of the Company. 9.2 Travel Required in Connection with Duties. I understand that my duties as an employee shall require that I 6 7 travel during the term of my employment with the Company. The areas to which I shall travel and the frequency of my travel to perform my duties as an employee may be changed from time to time in the sole discretion of the Company. 10. Proprietary Information. I agree to be bound by the terms of the Proprietary Information Agreement and exhibits thereto, which are attached as Exhibit "A" and incorporated by this reference ("Proprietary Agreement"), and, by the rules of confidentiality promulgated by the Company from time to time and applicable to employees of the Company. 11. Outside Activities. Unless I receive official notification to the contrary in writing from either the Chairman of the Board and Chief Executive Officer of the Board or President of the Company ("Official Notice"), the Company does not now nor will it in the future sponsor any kind of event or activity for employees or others, including, without limitation any athletic events. Any participation in an activity by any officer, manager or director of the Company does not in any way signify or imply a change to the foregoing. I assume personal risk for any injury or loss associated with any activity or event, whether I, or my dependents are participants or spectators, unless I have received Official Notice that such activity or event is sponsored by the Company, in which case the activity or event shall be subject to the terms and conditions of that Official Notice. 12. No Promises or Representations With Respect to Career, Advancement, Stock Ownership and other Employment Issues. a. No promises of a career opportunity at the Company have been made to me. b. No promises of future increases in Salary Compensation, or other compensation payable by the Company have been made to me. c. No promises of being able to obtain ownership in the Company have been made to me. d. No promises of sharing the profits of the Company have been made to me. 7 8 e. No promises of advancement in the Company have been made to me. f. No promises of a review of my work and/or performance at the Company have been made to me, but the Company reserve the right to do so at any time. 13. Constitutional Rights and Offensive Conduct. The Company has advised me that it does not condone or approve any matter or thing, written or oral: a. that denigrates any person, creed, color, sex, race, religion, national origin, personal persuasion, derivation or political belief; b. or anything else that, to the reasonable employer or employee, would be considered offensive. 14. Consequences of Breach by Employee. Any breach by me of the terms and/or conditions of employment set forth in this Agreement or the Policies and Procedures, may result in discipline up to and including termination of my Employment. Timely performance of my duties of Employment is very important to the Company. 15. References. If and when the Company is asked for references of any kind on prior or current employees, including me, the Company may withhold any references for any reason. 16. Conditions of Offer. This Agreement and the terms and conditions described in it are subject to (i) my first completing, signing and submitting an Application for Employment to the Company, and (ii) the receipt of the following, which the Company may then deem acceptable: my references and background information received from any present or past employer or supervisor, educational institution, law enforcement agency, state and/or federal administrator, credit bureau, collection agency, military branch, the National Personnel Records Center and/or for the purpose of obtaining my motor vehicle history, credit history and/or criminal history. I hereby release any person and/or entity from any and all liability relating to their furnishing any such information to the Company; provided, that such information relating to me is factually correct. 8 9 17. Modifications to this Agreement. a. No promises or changes in my Employment status or concerning any of the terms and conditions of this Agreement or any other matter affecting or relating to my relationship with the Company have been be made to me and I agree that no such promises, or changes are valid unless they are made to me in writing and signed by the Chairman of the Board and Chief Executive Officer or President of the Company, or the person designated in writing by either of them to make such promises or changes. b. This Agreement and the terms and conditions described in it cannot be changed orally or by any conduct of either me or the Company or any course of dealings between me or another and the Company. Oral agreements are not binding on the Company. This Agreement is a fully-integrated agreement that stands on its own and requires no other document to interpret its meaning, and is binding by itself and covers all the issues raised within it. 18. Worker's Compensation Insurance. I have been informed that the Company carries Workers' Compensation Insurance, as required by law. 19. Miscellaneous. If my Employment changes from the Company to any subsidiary of the Company, then all of the above terms and conditions remain in force with respect to my Employment by the entity for whom I previously worked and by the entity for whom I am then working. If any term or condition, or any part of a term or condition, of this Agreement or the Policies and Procedures shall prove to be invalid, void or illegal, it shall in no way affect, impair or invalidate any of the other terms or conditions of this Agreement or the Policies and Procedures, which shall remain in full force and effect. The captions to this Agreement are for purposes of reference only and will be ignored in interpreting or construing the meaning of this Agreement. Any waiver by the Company of any breach by me of any term or condition of this Agreement or the Policies and Procedures shall not be construed as a waiver of any subsequent breach by me of this Agreement or the Policies and Procedures. I acknowledge that I have received a copy of this Agreement. 9 10 20. Arbitration. Any dispute between me and the Company relating to this Agreement, the Policies and Procedures or my Employment shall be resolved by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association, except as otherwise mandated by law or governmental regulation. Any such arbitration shall occur in San Francisco, California. The fees and expenses of the arbitrator for any arbitration under this Agreement shall be paid by the Company. 21. Governing Law. This Agreement shall be governed by the laws of the State of California. 22. Severability. If any provision of this Agreement is held to be illegal, invalid, or unenforceable, such provision shall be full, severable, and this Agreement shall be construed and enforced as if such illegal, invalid, or unenforceable provision were never a part of this Agreement; and the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance. In lieu of any such provision that is illegal, invalid or unenforceable, there shall be added automatically as part of this Agreement, a provision as similar in its terms to such illegal, invalid or unenforceable provision as may be possible and be legal, valid and enforceable. 23. Headings. The headings for the various sections and provisions of this Agreement are solely for the purpose of ease of reference for the parties and will not be considered in any manner as affecting the construction or interpretation of this Agreement. 24. Effective Date. This Agreement shall be effective as of the first day of my Employment by the Company notwithstanding any subsequent date of execution or acceptance by the Company. 10 11 I have read the foregoing provisions of this Agreement, including Exhibit "A" to this Agreement, consisting of this and the preceding eight pages and I fully understand and agree to the terms and conditions of this Agreement, and those of Exhibit "A", as a condition to my employment by the Company. /s/ Robert P. Barbarowicz Dated: March 21,1997 - -------------------------- Robert P. Barbarowicz ACCEPTED and AGREED NATIONAL INSURANCE GROUP By: /s/ Mark A. Speizer Dated: March 21, 1997 ---------------------- Mark A. Speizer Chairman and Chief Executive Officer 11 EX-10.27 5 EMPLOYMENT AGREEMENT DATED MARCH 10, 1997 1 Exhibit 10.27 March 10 ,1997 National Insurance Group 395 Oyster Point Blvd., Suite 500 South San Francisco, CA 94080 Attention: Mark A. Speizer, Chairman and Chief Executive Officer Dear Mr. Speizer: This letter agreement (the "Agreement") confirms my understanding and agreement that (i) the following terms and conditions were discussed with me prior to being offered employment, and (ii) I agreed to them at that time and I accept them as terms and conditions of my employment as an employee of National Insurance Group, or any of its subsidiaries which currently exist or may exist in the future. The current subsidiaries of the Company are Fastrac Systems, Inc., Fastrac Systems Inc. Insurance Agent & Broker, Pinnacle Data Corporation; and Great Pacific Insurance Company. Any references in this Agreement to the Company shall mean National Insurance Group and its subsidiaries collectively. I understand and agree that this Agreement supersedes any prior understanding, agreement, discussions or negotiations and that any such prior understanding, agreement, discussion or negotiation does not constitute an agreement between the Company and me and is void as being any such agreement. My employment by the Company shall be as an employee of the Company ("Employment") and is subject to the terms and conditions set forth in this Agreement, together with all written rules, policies and procedures of the Company that may be in effect from time to time during my employment ("Policies and Procedures"). 1. Compensation. 1.1 Salary Compensation. My bi-weekly salary shall be $5,769.23 ("Salary Compensation"), which shall be paid to me in accordance with payroll practices and procedures of the Company, Initials GS MAS 1 2 less any applicable withholdings, taxes as required by law and any deductions authorized by me. My Salary Compensation shall accrue from the first day of my Employment, which shall be March 10, 1997. My Salary Compensation may be adjusted, to be increased or decreased on or after the first anniversary of my Employment if I am an employee of the Company at such time. 1.2 Eligibility to Participate in Bonus Plans for Senior Management. In addition to my Salary Compensation, I understand that I shall be eligible to participate in and may receive awards made by the Company under a bonus plan for senior management of the Company as the same may be adopted by the Company. I further understand that any such participation in any such plan shall commence with calender year 1997. I understand that there is no guarantee or assurance that I will be granted any award under any such bonus plan or that any award granted to me would be equal to those granted to other employees of the Company, including but not limited to, officers who hold the same or similar titles or offices or who perform the same or similar duties as me. 1.3 Reimbursement for Reasonable Business Expenses. I further understand that the Company will reimburse me for any reasonable business related expenses incurred by me for travel, entertainment or other business expenses in accordance with the Policies and Procedures of the Company. All requests for reimbursements or any advances by the Company for expenses shall be on such forms as the Company may require with documentation or substantiation of any such expenses. All requests for reimbursement of expenses or advances shall be approved by one of the following officers of the Company (i) the Chairman of the Board and Chief Executive Officer, (ii) the President; or (iii) any Executive Vice President as may be designated by the Chairman or the President. I understand that I may be issued one or more credit cards issued to me on the account of the Company. I agree that I will use any such charge only for business purposes or, in the event that I use any such credit cards for personal purposes, I will identify any such expense as personal in nature and pay to the Company the amount of any such charges at the time the account is rendered to the Company for payment by the credit card entity. The Company may revoke, modify or suspend its issuance of credit cards to its employees, including me. Initials GS MAS 2 3 1.4 Recommendation for Stock Option Grant. I understand that a recommendation will be made to the Board of Directors of the Company that I be granted a stock option award under the Company's 1986 Stock Option Plan, as amended, to purchase 25,000 shares of the Company's stock, at a price equal to the fair market value per share on the date of such grant and subject to the terms and conditions generally imposed by the Company or its Board of Directors with respects to grants made under such plan. 2. Position and Title. My position shall be an Executive Vice President, Treasurer and Chief Financial Officer of the Company and I understand that I will be elected as an officer of the Company and may be elected as an officer of one of more of the subsidiaries of the Company. I shall have such duties as may be assigned to me by the Chairman of the Board and Chief Executive Officer or the President of the Company at any time or from time to time. I shall report to the Chairman of the Board and Chief Executive Officer or to the President of the Company if the Chairman so designates. 3. Work Hours; Exempt Employee Status. I agree that I will work at least forty hours per week, during the normal business hours of the Company, prevailing local time, however. I understand that I will not receive any additional compensation for any hours that I work in excess of eight hours per day and forty hours per week. As an executive officer of the Company with my duties as Chief Financial Officer, I understand and agree that my duties may require my services in excess of the services performed by other employees of the Company. I agree that I will devote my full time and attention to the performance of my duties during business hours. I further agree that I will not engage in any civic or other activities that would materially interfere with the performance of my duties under this Agreement or as an employee of the Company. I will not engage in any other business or commercial activity. 4. At Will Employment. I understand and agree that my Employment will be "at-will". This means that the Company has the right to and can terminate my Employment at any time, with or without cause, and without notice, and I can terminate my Employment at any time, with or without cause, and without notice. There is no promise that my Employment will continue for a specific period of time, Initials GS MAS 3 4 duration or term and there is no promise that my employment will be terminated only under particular circumstances. NO POSITION WITHIN THE COMPANY IS CONSIDERED PERMANENT. This Section 4 constitutes the entire agreement between me and the Company regarding the term of my Employment. 5. Vacations. The following is the vacation policy of the Company applicable to me. a. My paid vacation time ("Vacation Time") will accrue on the following basis: (i) .0625 of a vacation day for each full working day worked at the Company during each Working Year until such Vacation Time is modified by the Company. A "Working Year" begins on the first day of my Employment and ends 365 continuous days thereafter. b. If I do not take any Vacation Time within 180 days from the end of each Working Year of my Employment, the Company will require that I take my accrued Vacation Time and will assign me Vacation Time that must be used by me. I am required to take Vacation Time within the 180 day period described in Section 5.b because a stacking of accrued Vacation Time beyond one Working Year into an extended vacation may be a hardship on the Company. c. I will give advance written notice of the dates my Vacation Time is to begin and end by completing the Company's Vacation Request Form then in effect ("Vacation Request") and submitting it to my supervisor, no less than 60 days before my proposed Vacation Time will begin. I will be given a written receipt for the Vacation Request and my supervisor will review my Vacation Request with the Company's payroll supervisor. If my supervisor and the payroll supervisor are unable to agree mutually to approve the Vacation Request, my Vacation Request shall be forwarded to the Chief Executive Officer or President of the Company for review (my supervisor, the payroll supervisor, and/or the Chief Executive Officer or President shall be referred to herein as the "Designated Persons"). The Designated Persons can, in their discretion, turn down my request for the proposed dates of Vacation Time in my Vacation Request, but the Designated Persons must provide me with alternative dates which I must use instead. Initials GS MAS 4 5 The Designated Persons will provide me with a written acceptance or rejection of the Vacation Request no more than 30 days after I present it to my supervisor. 6. Health/Life/Welfare Plans. a. I will be eligible for coverage under the Company's health/life/welfare plans ("plans"), as may be amended from time-to-time, on the thirty-first consecutive day of my Employment. Even though I will be eligible for the plans on the thirty-first consecutive day of my Employment, the actual date coverage would go into effect on the plans, as respects me or my dependents eligible for coverage, is at the sole discretion of the plans' provider(s) (i.e., the insurance company or plans' trust). b. Once I am covered by the plans I will be covered until the earlier of the following: i. The date my Employment ceases, subject to Federal and State laws and regulations regarding the termination date of such coverage, or ii. Coverage for me or the Companies under the plans is terminated by the insurance company or other organization providing these benefits, or iii. The insurance company or other organization providing these benefits refuses to cover me under any of the plans. 6.3 The Company will reimburse me for the cost of premiums for continuation of benefits for health insurance coverage for me under a health insurance policy issued under which I am currently insured for a period of two months commencing for the month of March, 1997. I will not receive any reimbursement for the costs of premiums for continuation of benefits for health insurance coverage for my dependents Initials GS MAS 5 6 7. Sick Time. a. If I do not work because of illness, sickness, disease, accident or disability, at option of the Company, the Company, in its sole discretion, may require me to bring a written notice from my physician, addressed to the Company, on the day I return to work (i) indicating the reason I was unable to work on the days that I missed work and stating "I have determined that (my name) was too ill, sick, diseased, injured or disabled to report to work and perform his duties from (insert date) to (insert date)", and (ii) stating that I am now able to resume the duties I performed and work the number of hours I was employed to work prior to such absence. I consent to the disclosure by my physician to the Company of such medical information as the Company may be legally entitled to obtain regarding my ability to perform my job. b. If sick time pay ("Sick Time") is provided by the Company, it is only payable to me for the times when I am too ill, sick, diseased, injured or disabled to do the work which I was then employed by the Company to do. c. Currently, the Company provides me with six (6) Sick Time days during my Working Year. The Sick Time accrues at one-half day per each two consecutive pay periods. At the end of any Working Year, all accrued unused Sick Time is transferred to the next concurrent Working Year. No more than six (6) Sick Time days may be used in any Working Year. If unused Sick Time days are carried over from one Working Year to the next concurrent Working Year, then the amount of Sick Time days I can accrue in that next concurrent Working Year shall be limited to the difference between the unused Sick Time days carried forward to the next concurrent Working Year and six (6) days. d. The Company reserve the right to eliminate Sick Time upon 30 days' notice to its employees. d. Normal visits to my doctor or dentist, which are not due to illness, sickness, disease, accident or disability of a nature which prevented me from performing the work which I was then Initials GS MAS 6 7 employed by the Company to do, shall not be considered Sick Time and I shall prearrange such visit with my supervisor. 8. Unpaid Absences. Any absence from work for any reason that is not expressly compensated pursuant to this Agreement will result in a deduction from my salary compensation, for the appropriate pay period, of an amount equal to the salary compensation I would have been paid for the time of such absence and, in the Company's discretion, I may not be allowed to make up time in this regard. Nothing herein shall operate to authorize an unpaid absence. 9. Cellular Telephone, Travel Expectations. 9.1 Cellular Telephone Expenses. I shall be reimbursed for cellular telephone expenses related to the business of the Company. 9.2 Travel Required in Connection with Duties. I understand that my duties as an employee shall require that I travel during the term of my employment with the Company. The areas in which I may travel and the frequency of my travel to perform my duties as an employee may be changed from time to time in the sole discretion of the Company. 10. Proprietary Information. I agree to be bound by the terms of the Proprietary Information Agreement and exhibits thereto, which are attached as Exhibit "A" and incorporated by this reference ("Proprietary Agreement"), and, by the rules of confidentiality promulgated by the Company from time to time and applicable to employees of the Company. 11. Outside Activities. Unless I receive official notification to the contrary in writing from either the Chairman of the Board and Chief Executive Officer of the Board or President of the Company ("Official Notice"), the Company does not now nor will it in the future sponsor any kind of event or activity for employees or others, including, without limitation any athletic events. Any participation in an activity by any officer, manager or director of the Company does not in any way signify or imply a change to the foregoing. I assume personal risk for any injury or loss associated with any activity or event, whether I, or my dependents Initials GS MAS 7 8 are participants or spectators, unless I have received Official Notice that such activity or event is sponsored by the Company, in which case the activity or event shall be subject to the terms and conditions of that Official Notice. 12. No Promises or Representations With Respect to Career, Advancement, Stock Ownership and other Employment Issues. a. No promises of a career opportunity at the Company have been made to me. b. No promises of future increases in Salary Compensation, or other compensation payable by the Company have been made to me. c. No promises of being able to obtain ownership in the Company have been made to me. d. No promises of sharing the profits of the Company have been made to me. e. No promises of advancement in the Company have been made to me. f. No promises of a review of my work and/or performance at the Company have been made to me, but the Company reserve the right to do so at any time. 13. Constitutional Rights and Offensive Conduct. The Company has advised me that it does not condone or approve any matter or thing, written or oral: a. that denigrates any person, creed, color, sex, race, religion, national origin, personal persuasion, derivation or political belief; b. or anything else that, to the reasonable employer or employee, would be considered offensive. 14. Consequences of Breach by Employee. Any breach by me of the terms and/or conditions of employment set forth in this Agreement Initials GS MAS 8 9 or the Policies and Procedures, may result in discipline up to and including termination of my Employment. Timely performance of my duties of Employment is very important to the Company. 15. References. If and when the Company is asked for references of any kind on prior or current employees, including me, the Company may withhold any references for any reason. 16. Conditions of Offer. This Agreement and the terms and conditions described in it are subject to (i) my first completing, signing and submitting an Application for Employment to the Company, and (ii) the receipt of the following, which the Company may then deem acceptable: my references and background information received from any present or past employer or supervisor, educational institution, law enforcement agency, state and/or federal administrator, credit bureau, collection agency, military branch, the National Personnel Records Center and/or for the purpose of obtaining my motor vehicle history, credit history and/or criminal history. I hereby release any person and/or entity from any and all liability relating to their furnishing any such information to the Company; provided, that such information relating to me is factually correct. 17. Modifications to this Agreement. a. No promises or changes in my Employment status or concerning any of the terms and conditions of this Agreement or any other matter affecting or relating to my relationship with the Company have been be made to me and I agree that no such promises, or changes are valid unless they are made to me in writing and signed by the Chairman of the Board and Chief Executive Officer or President of the Company, or the person designated in writing by either of them to make such promises or changes. b. This Agreement and the terms and conditions described in it cannot be changed orally or by any conduct of either me or the Company or any course of dealings between me or another and the Company. Oral agreements are not binding on the Company. This Agreement is a fully-integrated agreement that stands on its own and requires no other document to interpret its meaning, and is binding by itself and covers all the issues raised within it. Initials GS MAS 9 10 18. Worker's Compensation Insurance. I have been informed that the Company carries Workers' Compensation Insurance, as required by law. 19. Miscellaneous. If my Employment changes from the Company to any subsidiary of the Company, then all of the above terms and conditions remain in force with respect to my Employment by the entity for whom I previously worked and by the entity for whom I am then working. If any term or condition, or any part of a term or condition, of this Agreement or the Policies and Procedures shall prove to be invalid, void or illegal, it shall in no way affect, impair or invalidate any of the other terms or conditions of this Agreement or the Policies and Procedures, which shall remain in full force and effect. The captions to this Agreement are for purposes of reference only and will be ignored in interpreting or construing the meaning of this Agreement. Any waiver by the Company of any breach by me of any term or condition of this Agreement or the Policies and Procedures shall not be construed as a waiver of any subsequent breach by me of this Agreement or the Policies and Procedures. I acknowledge that I have received a copy of this Agreement. 20. Arbitration. Any dispute between me and the Company relating to this Agreement, the Policies and Procedures or my Employment shall be resolved by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association, except as otherwise mandated by law or governmental regulation. Any such arbitration shall occur in San Francisco, California. The fees and expenses of the arbitrator for any arbitration under this Agreement shall be paid by the Company. 21. Governing Law. This Agreement shall be governed by the laws of the State of California. 22. Severability. If any provision of this Agreement is held to be illegal, invalid, or unenforceable, such provision shall be full, severable, and this Agreement shall be construed and enforced as if such illegal, invalid, or unenforceable provision were never a part of this Agreement; and the remaining provisions of this Agreement shall remain in full force and effect and shall not be Initials GS MAS 10 11 affected by the illegal, invalid, or unenforceable provision or by its severance. In lieu of any such provision that is illegal, invalid or unenforceable, there shall be added automatically as part of this Agreement, a provision as similar in its terms to such illegal, invalid or unenforceable provision as may be possible and be legal, valid and enforceable. 23. Headings. The headings for the various sections and provisions of this Agreement are solely for the purpose of ease of reference for the parties and will not be considered in any manner as affecting the construction or interpretation of this Agreement. I have read the foregoing provisions of this Agreement, consisting of this and the preceding nine pages and I fully understand and agree to the terms and conditions of this Agreement as a condition to my employment by the Company. /s/ Greg Saunders Dated: March 10,1997 - ------------------------------ Gregory S. Saunders ACCEPTED and AGREED NATIONAL INSURANCE GROUP By: /s/ Mark A. Speizer Dated: March 10, 1997 --------------------------- Mark A. Speizer Chairman and Chief Executive Officer Initials GS MAS 11 EX-10.28 6 401(K) PLAN, AMENDMENT & PARTICIPATION AGREEMENTS 1 Exhibit 10.28 NATIONAL INSURANCE GROUP 401(k) PLAN BY: /s/ ROBERT P. BARBAROWICZ -------------------------- (SIGNATURE) ROBERT P. BARBAROWICZ -------------------------- (NAME PRINTED OR TYPED) TITLE: EXECUTIVE VICE PRESIDENT, SECRETARY ----------------------- AND GENERAL COUNSEL DATE ADOPTED: August 28, 1996, Effective as of July 1, 1996 -------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- ARTICLE I STATEMENT OF PURPOSE AND INTENTIONS 1.1 Purpose........................................................................1 1.2 Intent to Qualify..............................................................1 ARTICLE II DEFINITIONS 2.1 Anniversary Date...............................................................2 2.2 Annuity Starting Date..........................................................2 2.3 Beneficiary....................................................................2 2.4 Break in Service Year..........................................................2 2.5 Code...........................................................................2 2.6 Company........................................................................2 2.7 Compensation...................................................................2 2.8 Date of Employment.............................................................3 2.9 Date of Re-employment..........................................................3 2.10 Earned Income..................................................................3 2.11 Effective Date.................................................................3 2.12 Elective Compensation..........................................................4 2.13 Employee.......................................................................4 2.14 Employer.......................................................................5 2.15 Hour of Service................................................................6 2.16 Individual Accounts............................................................7 2.17 Insurance Company..............................................................7 2.18 Limitation Year................................................................7 2.19 Normal Retirement Age and Normal Retirement Date...............................8 2.20 Owner-Employee.................................................................8 2.21 Participant....................................................................8 2.22 Plan...........................................................................8 2.23 Plan Administrator.............................................................8 2.24 Plan Year......................................................................8 2.25 Preliminary Service............................................................8 2.26 Qualified Matching Contributions ("QMAC")......................................8 Qualified Nonelective Contributions ("QNC")....................................8 2.27 Required Beginning Date........................................................8 2.28 Retirement and Retirement Date.................................................9 2.29 Self-Employed Individual.......................................................9 2.30 Service........................................................................9 2.31 Total and Permanent Disability.................................................9 2.32 Trustees.......................................................................9 2.33 Vested Benefit.................................................................9 2.34 Years of Service..............................................................10 ARTICLE III PARTICIPATION 3.1 Commencement of Participation.................................................11 3.2 Minimum Participation Standards...............................................11
3 3.3 Preliminary Service...........................................................11 3.4 Active Participation; Inactive Participation..................................12 3.5 Cessation of Participation....................................................12 3.6 Participation on Resumption of Employment.....................................12 ARTICLE IV CONTRIBUTIONS 4.1.1 Basic Contributions: Amount..................................................13 4.1.2 Basic Contribution Accounts...................................................13 4.1.3 Basic Contributions: Allocations.............................................14 4.1.4 Basic Contributions: Vesting.................................................14 4.1.5 Forfeitures...................................................................15 4.2.1 Elective Contributions: Amount...............................................15 4.2.2 Elective Contribution Account.................................................18 4.2.3 Elective Contributions: Allocations..........................................18 4.2.4 Elective Contributions: Vesting..............................................18 4.2.5 Elective Contributions: Withdrawals..........................................18 4.3.1 Supplemental Contributions: Amount...........................................20 4.3.2 Supplemental Contribution Accounts............................................20 4.3.3 Supplemental Contributions: Allocations......................................21 4.3.4 Supplemental Contributions: Vesting..........................................21 4.4.1 Rollover Contribution: Amount................................................21 4.4.2 Rollover Contribution Account.................................................21 4.4.3 Rollover Contributions: Allocation...........................................22 4.4.4 Rollover Contributions: Vesting..............................................22 ARTICLE V REQUIRED NON-DISCRIMINATION TESTING 5.1.1 Limitation on Additions.......................................................23 5.1.2 Suspense Account..............................................................26 5.2.1 Top-Heavy Provisions: Application............................................26 5.2.2 Top-Heavy Determination.......................................................27 5.2.3 Special Rules for Top-Heavy Plans.............................................29 5.3 Actual Deferral Percentage Test...............................................30 5.4 Average Contribution Percentage Test..........................................33 5.5 Multiple Use of Alternative Limitation........................................37 ARTICLE VI ADMINISTRATION OF PLAN ASSETS 6.1.1 The Investment Fund...........................................................38 6.1.2 Employee Directed Investments.................................................38 6.2 Account Adjustments...........................................................39 6.3 Distribution Adjustments......................................................39 6.4 Expenses......................................................................39 ARTICLE VII DISTRIBUTIONS 7.1 Termination of Employment (Including Disability) Before Retirement............40 7.2 Death Benefits................................................................40 7.3 Retirement....................................................................43 7.4 Form of Retirement Benefit....................................................43
4 7.5 Retirement Benefits: Election of Forms and Commencement of Payments .........44 7.6 Loans to Participants.........................................................48 ARTICLE VIII GENERAL PROVISIONS 8.1.1 Plan Modification: Authority.................................................52 8.1.2 Plan Modification: Merger....................................................52 8.1.3 Plan Modification: Termination...............................................52 8.2.1 Duties: Plan Administrator...................................................52 8.2.2 Duties: Employer.............................................................53 8.3 Benefit Claims Procedure......................................................53 8.4 Review Procedure..............................................................53 8.5 Qualification of the Plan and Conditions of Contributions.....................54 8.6 Beneficiaries.................................................................54 8.7 Spendthrift Clause............................................................55 8.8 Owner-Employees: Other Trades or Businesses..................................55 8.9 Annuities.....................................................................56 8.10 Limitations of the Employer's Liability.......................................56 8.11 Non-Guarantee of Employment...................................................56 8.12 Applicable Law................................................................56 ARTICLE IX DIRECT ROLLOVERS 9.1 General Rule..................................................................57 9.2 Definitions...................................................................57
5 ARTICLE I STATEMENT OF PURPOSE AND INTENTIONS 1.1 Purpose The EMPLOYER adopts this PLAN as a defined contribution retirement plan of the profit sharing type with a cash or deferred arrangement to provide retirement benefits and incidental benefits to certain EMPLOYEES who qualify for such benefits as more particularly provided herein. 1.2 Intent to Qualify It is the EMPLOYER'S intent that this PLAN be a qualified plan in the meaning of sec. 401 of the Internal Revenue Code of 1986, as amended, that any trust that may become part hereof be exempt from tax under sec. 501(a) of the CODE, and that contributions made by the EMPLOYER be deductible under sec. 404 of the CODE. This PLAN shall be interpreted, applied and administered in a manner consistent with this intent to qualify. All amounts contributed to, accumulated and/or held pursuant to this PLAN shall not be diverted to or used for other than the exclusive benefit of the PARTICIPANTS or their beneficiaries until after such amounts have been distributed from this PLAN. In the event that the portion of this PLAN comprising the qualified cash or deferred arrangement fails to qualify under the provisions of sec. 401(k) of the CODE, the PLAN as a whole shall nonetheless be interpreted so as to qualify under sec. 401(a) of the CODE. Art. I 1 6 ARTICLE II DEFINITIONS For the purposes of this Plan, when the following terms appear in this Plan in BOLDFACE type, they shall have the meanings indicated in this Article unless a different meaning is clearly required by the context. Whenever required by the context, masculine pronouns shall include the feminine, and singular the plural. 2.1 ANNIVERSARY DATE means each January 1. 2.2 ANNUITY STARTING DATE means the first day of the first period for which an amount is payable as an annuity or any other form. 2.3 BENEFICIARY is defined in Section 8.6, except as specifically provided to the contrary elsewhere in this PLAN. 2.4 BREAK IN SERVICE YEAR means a twelve-consecutive-month period commencing on an ANNIVERSARY DATE (or, for the purposes of determining an EMPLOYEE'S PRELIMINARY SERVICE, each Preliminary Computation Period, as described in Article III) and during which an EMPLOYEE (or former EMPLOYEE) is credited with not more than 500 HOURS OF SERVICE. 2.5 CODE means the Internal Revenue Code of 1986, as amended, and all regulations promulgated thereunder. 2.6 COMPANY means National Insurance Group, a California corporation. 2.7 COMPENSATION means wages, salary, and/or other remuneration that is receivable by an individual during a PLAN YEAR in exchange for SERVICE and that is required to be reported as income on the individual's Form W-2 for federal income tax withholding purposes under CODE sec. 3401(a). COMPENSATION also means an individual's EARNED INCOME, if any, attributable to SERVICE performed during the PLAN YEAR. In addition, COMPENSATION shall include the following amounts: (a) all elective deferrals (as defined by CODE sec. 402(g)(3)) made by the PARTICIPANT during the PLAN YEAR pursuant to a salary reduction agreement with the EMPLOYER, including those described by Section 4.2.1 of this PLAN; and (b) all COMPENSATION accrued by the PARTICIPANT during the PLAN YEAR but which is not then included as taxable income of the PARTICIPANT pursuant to a "cafeteria" or other such plan maintained by the EMPLOYER according to CODE sec. 125. In addition to other applicable limitations set forth in the PLAN, and notwithstanding any other provision of the PLAN to the contrary, for PLAN YEARS beginning on or after January 1, 1994, the annual COMPENSATION of each EMPLOYEE taken into account under the PLAN shall not exceed the OBRA '93 annual compensation limit. The OBRA '93 Art. II 2 7 annual compensation limit is $150,000, as adjusted by the Commissioner for increases in the cost of living in accordance with section 401(a)(17)(B) of the Internal Revenue Code. The cost-of-living adjustment in effect for a calendar year applies to any period, not exceeding 12 months, over which COMPENSATION is determined (determination period) beginning in such calendar year. If a determination period consists of fewer than 12 months, the OBRA '93 annual compensation limit will be multiplied by a fraction, the numerator of which is the number of months in the determination period, and the denominator of which is 12. For PLAN YEARS beginning on or after January 1, 1994, any reference in this PLAN to the limitation under section 401(a)(17) of the CODE shall mean the OBRA '93 annual compensation limit set forth in this provision. If COMPENSATION for any prior determination period is taken into account in determining an EMPLOYEE'S benefits accruing in the current PLAN YEAR, the COMPENSATION for the prior determination period is subject to the OBRA '93 annual compensation limit in effect for that prior determination period. For this purpose, for determination periods beginning before the first day of the first PLAN YEAR beginning on or after January 1, 1994, the OBRA '93 annual compensation limit is $150,000. In applying this limit, the family aggregation rules of CODE sec. 414(q)(6) shall apply, except that in applying such rules, the term "family" shall include only the spouse of the EMPLOYEE and any lineal descendants of the EMPLOYEE who have not attained age 19 before the close of the PLAN YEAR. In addition, if this limit applies to a family unit, then for the purposes of this PLAN, each affected family member shall be credited with an amount of COMPENSATION on a pro rata basis, so that such credited amount, when compared to the adjusted compensation limit, shall have the same direct proportion that exists in comparing that person's actual COMPENSATION to the sum of all that family's affected members' COMPENSATION. 2.8 DATE OF EMPLOYMENT means the date on which an EMPLOYEE has his first HOUR OF SERVICE. 2.9 DATE OF RE-EMPLOYMENT means the first date as of which an EMPLOYEE has an HOUR OF SERVICE after his most recent termination of SERVICE, EXCEPT that for the purposes of determining PRELIMINARY SERVICE, DATE OF RE-EMPLOYMENT means the first date as of which an EMPLOYEE is credited with an HOUR OF SERVICE after he most recently has accrued a BREAK IN SERVICE YEAR which permits his prior PRELIMINARY SERVICE to be disregarded. 2.10 EARNED INCOME means the net earnings from self-employment in the trade or business with respect to which the PLAN is established, and for which the personal services of the individual are a material income-producing factor. For the purposes of defining EARNED INCOME, net earnings will be determined without regard to items not included in gross income and the deductions allocable to such items, and net earnings will be reduced by contributions by the EMPLOYER to a qualified plan to the extent that such contributions are deductible under CODE sec. 404. In addition, net earnings shall be determined with regard to the deduction allowed to the EMPLOYER by CODE sec. 164(f) for taxable years beginning after December 31, 1989. 2.11 EFFECTIVE DATE means July 1, 1996. Art. II 3 8 2.12 ELECTIVE COMPENSATION means that portion of a PARTICIPANT'S COMPENSATION that is attributable to SERVICE performed while the PARTICIPANT had in effect an election to have Elective Contributions made on his behalf, pursuant to Article IV. 2.13 EMPLOYEE means a natural person who performs SERVICE for the EMPLOYER in exchange for COMPENSATION, including any LEASED EMPLOYEE (as described below) but excluding any independent contractor who is not a LEASED EMPLOYEE. For the purposes of this PLAN, EMPLOYEE shall be further described as follows. (a) HIGHLY COMPENSATED EMPLOYEE ("HCE") means: (1) The group of HCES includes any EMPLOYEE who during the PLAN YEAR performs services for the EMPLOYER and who (i) is a 5-percent owner, (ii) receives compensation for the PLAN YEAR in excess of the sec. 414(q)(1)(B) amount for the PLAN YEAR, (iii) receives compensation for the PLAN YEAR in excess of the sec. 414(q)(1)(C) amount for the PLAN YEAR and is a member of the top paid group of EMPLOYEES within the meaning of sec. 414(q)(4), or (iv) is an officer and receives compensation during the PLAN YEAR that is greater than 50 percent of the dollar limitation in effect under sec. 415(b)(1)(A). If no officer satisfies the compensation require ment during the PLAN YEAR, the highest paid officer for such year shall be treated as an HCE. For purposes of determining who is an HCE, compensation means wages, salary, and/or other remuneration that is required to be reported as income on the individual's W-2 for federal income tax withholding purposes under CODE sec. 3401(a), plus all elective deferrals as defined in CODE sec. 402(g)(3) and benefits pursuant to a plan under CODE sec. 125 that are not currently taxable. (2) If an EMPLOYEE is a family member of either a 5-percent owner (whether active or former) or an HCE who is one of the 10 most HCES ranked on the basis of compensation paid by the EMPLOYER during such year, then the family member and the 5-percent owner or top-ten HCE shall be aggregated. In such case, the family member and 5-percent owner or top- ten HCE shall be treated as a single EMPLOYEE receiving compensation and plan contributions or benefits equal to the sum of the compensation and benefits of the family member and 5-percent owner or top-ten HCE. For purposes of this section, family member includes the spouse, lineal ascendants and descendants of the EMPLOYEE or former EMPLOYEE, and the spouses of such lineal ascendants and descendants. (3) The determination of who is an HCE, including the determination of the number and identity of EMPLOYEES in the top paid group, the number of EMPLOYEES treated as officers and the compensation that is taken into account, shall be made in accordance with the sec. 414(q) and sec. 1.414(q)-1T of the temporary Income Tax Regulations to the extent they are not inconsistent with the method established above.] Art. II 4 9 (b) KEY EMPLOYEE means (solely for the purposes of Section 5.2) an EMPLOYEE who, at any time during the PLAN YEAR or 4 preceding PLAN YEARS, was: (1) an officer of the EMPLOYER having an annual "compensation" greater than 50% of the amount in effect under CODE sec. 415(b)(1)(A) for any such PLAN YEAR; or (2) one of the ten EMPLOYEES having annual "compensation" greater than the limitation in effect under CODE sec. 415(c)(1)(A) and owning (or considered as owning within the meaning of CODE sec. 318) the largest interests of the EMPLOYER; or (3) a 5 percent owner of the EMPLOYER; or (4) a 1 percent owner of the EMPLOYER having an annual "compensation" of more than $150,000. For the purposes of this PLAN, KEY EMPLOYEE shall be described more particularly by CODE sec. 416(i)(l). "Compensation" is defined under HIGHLY COMPENSATED EMPLOYEE, above. (c) LEASED EMPLOYEE means a person who is employed (either as a common law employee or an independent contractor) by a leasing organization (but not by the EMPLOYER) and who performs services for the EMPLOYER on a substantially full- time basis for a period of at least one year, where such services are of a type historically performed by EMPLOYEES within the business field of the EMPLOYER, and where such services are provided pursuant to a contract between the leasing organization and the EMPLOYER, EXCEPT that if such person is covered under a money purchase pension plan maintained by the leasing organization and which provides (1) a nonintegrated employer contribution rate of at least 7 1/2% of compensation for services performed prior to January 1, 1987, and at least 10% of compensation for services performed after December 31, 1986, with compensation being determined according to CODE sec. 415(c)(3), but including amounts contributed by the EMPLOYER pursuant to a salary reduction agreement which are excludable from the EMPLOYEE'S gross income under CODE sec. 125, 402(e)(3), 402(h), or 403(b); (2) immediate participation; and (3) full and immediate vesting, AND if the sum of all such persons is not more than 20% of the EMPLOYER'S "nonhighly compensated workforce" (as defined in 26 CFR 1.414(n)-2(f)(3)(ii)), then for the purposes of this PLAN such person is not a LEASED EMPLOYEE, and is at that time ineligible for a benefit or any vested interest in this PLAN. Any provisions of this Section and this PLAN to the contrary notwithstanding, the term "LEASED EMPLOYEE" shall be more specifically defined by, and LEASED EMPLOYEES shall be treated under this PLAN consistent with, CODE sec. 414(n) and 26 CFR 1.414(n)-2. 2.14 EMPLOYER means the COMPANY, and any other person or business organization which has adopted and maintains this PLAN on behalf of its employees with the consent of the COMPANY. Art. II 5 10 In addition, to the extent required for this PLAN'S qualification for special tax treatment under the CODE, and to the extent otherwise required by applicable law, including for example the determination of a PARTICIPANT'S PRELIMINARY SERVICE and YEARS OF SERVICE, EMPLOYER also means any predecessor organization which previously maintained this PLAN on behalf of its employees (but only with regard to that period of time during which the PLAN was maintained by such organization(s)), and any employer which, together with the EMPLOYER (as otherwise defined in this Section ), is a member of a controlled group of corporations in the meaning of CODE sec. 414(b), or is a member of a group of trades or business (whether or not incorporated) under common control in the meaning of CODE sec. 414(c), or is a member of an affiliated service group in the meaning of CODE sec. 414(m), or is otherwise required to be aggregated by CODE sec. 414(o). 2.15 HOUR OF SERVICE means: (a) each hour for which an EMPLOYEE is paid, or entitled to payment, by the EMPLOYER for the performance of duties; (b) each hour for which an EMPLOYEE is directly or indirectly paid, or entitled to payment, by the EMPLOYER on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence except with respect to payments made or due under a plan maintained solely for the purpose of complying with applicable workers' compensation or unemployment compensation or disability insurance laws or which are solely in reimbursement to the EMPLOYEE for medical or medically-related expenses incurred by the EMPLOYEE; however, no more than 501 HOURS OF SERVICE shall be credited pursuant to this paragraph to an EMPLOYEE on account of any single continuous period during which the EMPLOYEE performs no duties (whether or not such period occurs in a single PLAN YEAR); and (c) each hour for which back pay, irrespective of mitigation of damages, is either awarded or agreed to by the EMPLOYER; however, an HOUR OF SERVICE shall not be credited under both this paragraph and paragraph (a) or (b), above. HOURS OF SERVICE credited under paragraphs (b) and (c), above, shall be credited in accordance with Department of Labor Regulations found at 29CFR sec. 2530.200b-2(b). HOURS OF SERVICE shall be credited to the appropriate PLAN YEAR in accordance with 29CFR sec. 2530.200b-2(c). HOURS OF SERVICE included pursuant to paragraph (a) shall be determined according to records of employment maintained by the EMPLOYER. If such records do not provide an adequate basis for determining the actual number of HOURS OF SERVICE accrued by a particular EMPLOYEE (e.g. a salaried EMPLOYEE), then HOURS OF SERVICE under paragraph (a) shall be credited to the EMPLOYEE on a weekly basis and the EMPLOYEE shall be credited with 45 HOURS OF SERVICE for every week in which he has accrued at least one HOUR OF SERVICE as otherwise described in paragraph (a). Special Rule for Maternity or Paternity Absences Art. II 6 11 If an EMPLOYEE is absent from work due to (a) the pregnancy of the EMPLOYEE, (b) the birth of a child to the EMPLOYEE, (c) the placement of a child with the EMPLOYEE pursuant to the EMPLOYEE'S adoption of the child, or (d) the care of such child described in (b) or (c) above immediately following its birth or placement, the EMPLOYEE shall nonetheless be credited with the number of HOURS OF SERVICE which normally would have been credited to the EMPLOYEE but for said absence (or, if the PLAN ADMINISTRATOR is unable to determine said number, with eight (8) HOURS OF SERVICE for each regularly scheduled workday the EMPLOYEE is absent), to a maximum of 501 HOURS OF SERVICE, PROVIDED that this special crediting of HOURS OF SERVICE occurs during only one PLAN YEAR, and PROVIDED that the PLAN YEAR in which such HOURS OF SERVICE are credited is the PLAN YEAR in which the absence begins, unless such crediting would not be necessary to avoid a BREAK IN SERVICE YEAR in said PLAN YEAR, in which case such HOURS OF SERVICE shall be credited as they accrue in the PLAN YEAR immediately following the PLAN YEAR in which the absence begins, and PROVIDED that the crediting of such HOURS OF SERVICE shall be solely for the purpose of avoiding a BREAK IN SERVICE YEAR, and shall not operate to increase any EMPLOYEE'S or former EMPLOYEE'S vested percentage or retirement benefit, nor shall the crediting have any other operative effect regarding this PLAN, and PROVIDED that, under rules established by the PLAN ADMINISTRATOR, the EMPLOYEE may be required to provide to the PLAN ADMINISTRATOR written certification from the EMPLOYEE'S attending doctor or other professional attendant at birth or representative of the relevant adoption agency to establish that the absence from work is for the reasons referred to above. 2.16 INDIVIDUAL ACCOUNTS means, for any PARTICIPANT, those accounts which are both listed below and maintained pursuant to this PLAN on his behalf. (a) Basic Contribution Account (b) Elective Contribution Account (c) Rollover Contribution Account (d) Supplemental Contribution Account Art. II 7 12 2.17 INSURANCE COMPANY means a legal reserve life insurance company, licensed to do business in the state of California, with which the TRUSTEES have entered into a contract to provide benefits under the PLAN. 2.18 LIMITATION YEAR, for purposes of determining the limitation on certain additions to the PLAN for the benefit of an EMPLOYEE as described in Section 5.1.1, means a twelve- consecutive-month period beginning on an ANNIVERSARY DATE. 2.19 NORMAL RETIREMENT AGE and NORMAL RETIREMENT DATE are defined in Article VII under "RETIREMENT". 2.20 OWNER-EMPLOYEE means an EMPLOYEE who is the sole proprietor of the business employing the EMPLOYEES, or who is a partner owning more than 10% of the capital interest and/or the profits interest in the partnership employing the EMPLOYEES. 2.21 PARTICIPANT means an EMPLOYEE or former EMPLOYEE who has become a PARTICIPANT or resumed participation pursuant to Section 3.1 or 3.6 and who has not subsequently ceased to participate as provided in Section 3.5. A PARTICIPANT may be Active or Inactive as provided in Section 3.4. 2.22 PLAN means this National Insurance Group 401(k) Plan. 2.23 PLAN ADMINISTRATOR means one or more persons appointed by the TRUSTEES to control and manage the operation and administration of the PLAN. The person or persons so appointed shall constitute a named fiduciary or fiduciaries for purposes of the Employee Retirement Income Security Act of 1974. If no PLAN ADMINISTRATOR is appointed, then the EMPLOYER (or the TRUSTEE(S) if the PLAN is trusteed) shall be the PLAN ADMINISTRATOR. 2.24 PLAN YEAR means a period of time commencing on an ANNIVERSARY DATE and ending with the day immediately preceding the next ANNIVERSARY DATE. 2.25 PRELIMINARY SERVICE is defined in Article III. 2.26 QUALIFIED MATCHING CONTRIBUTIONS ("QMAC") means Employer Contributions (other than Elective Contributions) made to a plan for a PARTICIPANT on account of any EMPLOYEE Contributions or Elective Contributions made to a plan by or on behalf of the PARTICIPANT, PROVIDED that the amounts of the Employer Contributions are subject to the nonforfeitability and distribution limitations of Income Tax Reg. 26 CFR 1.401(k)-1(c) & (d) the same as Elective Contributions. QUALIFIED NONELECTIVE CONTRIBUTIONS ("QNC")means EMPLOYER Contributions made to a plan which are not Matching Contributions (i.e. not made on account of any employee or Elective Contribution) or Elective Contributions, but which are subject to the nonforfeitability and distribution limitations of Income Tax Reg. 26 CFR 1.401(k)-1(c) & (d) the same as Elective Contributions. 2.27 REQUIRED BEGINNING DATE (a) General Rule. REQUIRED BEGINNING DATE means, for any PARTICIPANT, April 1 of the calendar year following the calendar year in which the PARTICIPANT attains age 70 1/2. Art. II 8 13 (b) Transition Rules: The REQUIRED BEGINNING DATE of any PARTICIPANT who attained age 70 1/2 before January 1, 1988, shall be determined according to (1) or (2) below: (1) The REQUIRED BEGINNING DATE of a PARTICIPANT who is not a 5% owner is April 1 of the calendar year following the later of: (A) the calendar year in which the PARTICIPANT attained age 70 1/2, or (B) the calendar year in which the PARTICIPANT retires. (2) The REQUIRED BEGINNING DATE of any PARTICIPANT who is a 5% owner during any year beginning after December 31, 1979, is April 1 of the calendar year following the later of: (A) the calendar year in which the PARTICIPANT attained age 70 1/2, or (B) the earlier of (i) the calendar year with or within which ends the PLAN YEAR in which the PARTICIPANT becomes a 5% owner, or (ii) the calendar year in which the PARTICIPANT retires. (c) The REQUIRED BEGINNING DATE of any PARTICIPANT who is not a 5% owner, who attained age 70 1/2 during 1988, and who did not retire as of January 1, 1989, is April 1, 1990. (d) 5% owner, for purposes of this Section , means a PARTICIPANT who is a 5% owner within the meaning of CODE sec. 416(i) (except without regard to whether the PLAN is actually top-heavy) at any time during the PLAN YEAR ending with or within the calendar year in which the PARTICIPANT attains age 66 1/2, or any subsequent PLAN YEAR. 2.28 RETIREMENT and RETIREMENT DATE are defined in Article VII under "RETIREMENT". 2.29 SELF-EMPLOYED INDIVIDUAL means, with respect to any taxable year, an individual who has EARNED INCOME attributable to SERVICE performed during that taxable year, and also means an individual who would have had such EARNED INCOME but for the fact that the trade or business of the EMPLOYER and with regard to which the PLAN is maintained had no net profits for the taxable year. 2.30 SERVICE means employment of the EMPLOYEE by the EMPLOYER for the performance of labor or duties by the EMPLOYEE on behalf of the EMPLOYER and for which the EMPLOYEE is to be compensated by the EMPLOYER. 2.31 TOTAL AND PERMANENT DISABILITY means a physical or mental condition that in the opinion of the PLAN ADMINISTRATOR precludes a person from employment for which he is qualified because of his experience, training, and education, and that is expected to continue for not less than 12 months. The PLAN ADMINISTRATOR'S opinion regarding the degree and permanence of the disability shall be supported by medical evidence. Art. II 9 14 2.32 TRUSTEES means those persons or the organization with which the EMPLOYER has entered into a trust agreement to provide benefits under the PLAN. However, at any time that the PLAN is not trusteed, "TRUSTEES" shall mean the COMPANY. 2.33 VESTED BENEFIT means, at any time, the sum of the PARTICIPANT'S vested INDIVIDUAL ACCOUNT balances. 2.34 YEARS OF SERVICE (a) General Rule Subject to the exclusions set forth in (b) below, a PARTICIPANT'S period of employment taken into account to determine his YEARS OF SERVICE for the purposes of this PLAN shall be measured as follows. A PARTICIPANT shall be credited with one YEAR OF SERVICE for each twelve-consecutive-month period which commenced on an ANNIVERSARY DATE on or after the EFFECTIVE DATE and during which the PARTICIPANT accrued at least 1,000 HOURS OF SERVICE. In addition, if the PARTICIPANT was an EMPLOYEE on the EFFECTIVE DATE, he shall also be credited with one YEAR OF SERVICE for each twelve-consecutive-month period which commenced on an ANNIVERSARY DATE prior to the EFFECTIVE DATE and during which the PARTICIPANT accrued at least 1,000 HOURS OF SERVICE. (b) Exclusions If a PARTICIPANT or former PARTICIPANT accrues a BREAK IN SERVICE YEAR, all YEARS OF SERVICE attributable to his employment prior to that BREAK IN SERVICE YEAR shall thereafter be disregarded unless either (1) his Vested Percentage is greater than zero at the time the BREAK IN SERVICE YEAR has accrued, or (2) the number of his consecutive BREAK IN SERVICE YEARS is less than (A) or (B), whichever is greater, where (A) equals 5, and (B) equals the aggregate number of his YEARS OF SERVICE before the BREAK IN SERVICE YEARS, not taking into account YEARS OF SERVICE previously disregarded because of prior BREAK IN SERVICE YEARS. In addition, if a PARTICIPANT or former PARTICIPANT has at least five consecutive BREAK IN SERVICE YEARS, all YEARS OF SERVICE attributable to his employment subsequent to said five consecutive BREAK IN SERVICE YEARS shall thereafter be disregarded for purposes of determining his vested interest in the amount which had been allocated to his Basic Contribution Account (pursuant to Section 4.1.3) prior to the period of such five consecutive BREAK IN SERVICE YEARS. Art. II 10 15 ARTICLE III PARTICIPATION 3.1 Commencement of Participation An EMPLOYEE shall commence participation in the PLAN on the first Entry Date on which he meets the PLAN'S Minimum Participation Standards. The Entry Dates shall be the EFFECTIVE DATE, and thereafter the first day of each calendar quarter (i.e. each January 1, April 1, July 1, and October 1). Notwithstanding the above, the PRELIMINARY SERVICE requirement set forth in Section 3.2(b) herein shall be waived with respect to each EMPLOYEE employed on July 1, 1996, and each such EMPLOYEE shall commence participation in the PLAN on July 1, 1996. 3.2 Minimum Participation Standards An EMPLOYEE meets the PLAN'S Minimum Participation Standards at any time when he satisfies the following conditions: (a) He is an EMPLOYEE. (b) He is credited with at least three (3) months of PRELIMINARY SERVICE. (c) He is at least twenty-one (21) years of age. 3.3 PRELIMINARY SERVICE An EMPLOYEE shall be credited with at least three (3) months of PRELIMINARY SERVICE for any three-consecutive-month period during which he was continuously employed as an EMPLOYEE. However, in any event, an EMPLOYEE shall be credited with a year of PRELIMINARY SERVICE for each complete Preliminary Computation Period in which he has not less than 1,000 HOURS OF SERVICE, whether or not he was continuously employed during the Preliminary Computation Period. Preliminary Computation Periods shall have a duration of twelve consecutive months. Each EMPLOYEE'S initial Preliminary Computation Period shall commence as of his DATE OF EMPLOYMENT (or, after a BREAK IN SERVICE YEAR that permits his prior PRELIMINARY SERVICE to be disregarded, his DATE OF RE-EMPLOYMENT). Thereafter, the Preliminary Computation Periods shall commence as of each ANNIVERSARY DATE, beginning with the first ANNIVERSARY DATE following the EMPLOYEE'S DATE OF EMPLOYMENT (or DATE OF REEMPLOYMENT, if applicable). If an EMPLOYEE accrues a BREAK IN SERVICE YEAR, then his PRELIMINARY SERVICE attributable to his employment prior to that BREAK IN SERVICE YEAR shall thereafter be disregarded unless either Art. III 11 16 (a) his Vested Percentage is greater than zero at the time the BREAK IN SERVICE YEAR accrues, or (b) the number of his consecutive BREAK IN SERVICE YEARS is less than (1) or (2), whichever is greater, where (1) equals 5, and (2) equals the aggregate number of his Years of PRELIMINARY SERVICE before the BREAK IN SERVICE YEARS, not taking into account Years of PRELIMINARY SERVICE previously disregarded because of prior BREAK IN SERVICE YEARS. 3.4 Active Participation; Inactive Participation Once an EMPLOYEE has commenced participation (or if he subsequently ceased to participate, once he has resumed participation), he shall be an Active PARTICIPANT with respect to each HOUR OF SERVICE accrued while he is an EMPLOYEE. At any time thereafter at which he is not an EMPLOYEE, but before his participation has ceased, he shall be an Inactive PARTICIPANT. 3.5 Cessation of Participation A PARTICIPANT shall cease to participate in this PLAN (without regard to his status as an EMPLOYEE) as of the first date on which he has most recently terminated his employment as an EMPLOYEE and also has no rights (present or contingent) to any benefit under this PLAN. 3.6 Participation on Resumption of Employment A former EMPLOYEE who participated during the period of his prior employment and who does not have BREAK IN SERVICE YEARS which permit his PRELIMINARY SERVICE earned during his prior employment to be disregarded shall resume participation as of his first HOUR OF SERVICE upon resumption of employment as an EMPLOYEE. Any other former EMPLOYEE shall commence participation as of the first Entry Date which occurs on or after the date of his resumption of employment as an EMPLOYEE and as of which he has satisfied the Minimum Participation Standards described in Section 3.2. Art. III 12 17 ARTICLE IV CONTRIBUTIONS 4.1.1 Basic Contributions: Amount For each PLAN YEAR, the EMPLOYER may contribute amounts to the PLAN. These amounts shall be called Basic Contributions, and shall be determined according to the following provisions. (a) Basic Matching Contribution The EMPLOYER may contribute amounts as a match of Elective Contributions for the PLAN YEAR. The amount of the match will equal such amount as the EMPLOYER deems appropriate EXCEPT that a PARTICIPANT'S Elective Contributions in excess of four percent (4%) of the PARTICIPANT'S ELECTIVE COMPENSATION for each calendar quarter shall not be taken into account. For the purposes of this Section , the amount of Elective Contributions to be matched shall be determined without regard to any withdrawals of Elective Contributions that were made during that PLAN YEAR (see Section 4.2.5). (b) Basic Top-Heavy Contribution If a PARTICIPANT is to be credited with some additional amount pursuant to the "top-heavy" provisions of Section 5.2 of this PLAN, such additional amount shall be contributed and credited as an additional portion of the Basic Contribution for that PLAN YEAR. Any of the provisions of this Section to the contrary notwithstanding, no amounts may be contributed to the PLAN as Basic Contributions in excess of the maximum amount that the EMPLOYER may deduct from its net income subject to federal income taxation for the EMPLOYER'S taxable year on account of which such contributions have been made plus any amount which may be currently contributed and "carried over" for succeeding taxable years pursuant to CODE sec. 404(a)(3)(A)(ii) (assuming that the EMPLOYER is subject to federal income taxation), nor shall such amounts exceed the maximum amount which may be allocated consistently with the limitations stated in Section 5.1.1. Basic Contributions shall be allocated among the PLAN'S PARTICIPANTS pursuant to Section .1.3 in a uniform and nondiscriminatory manner. 4.1.2 Basic Contribution Accounts Each PARTICIPANT shall have maintained on his behalf a Basic Contribution Account, which shall be adjusted as provided in Article VI and which shall be closed when the PARTICIPANT is entitled to no further benefits under the terms of the PLAN. Art. IV 13 18 4.1.3 Basic Contributions: Allocations (a) Basic Matching Contributions: Allocations As of the date it is received by the PLAN and all necessary information to complete the allocation is available, a portion of the Basic Contribution for the calendar quarter, if any, shall be allocated to the Basic Contribution Account of each PARTICIPANT who is allocated an Elective Contribution for that calendar quarter. Each such PARTICIPANT shall be allocated a portion of that Basic Contribution, which portion shall equal a uniform percentage (for example, 10%) of his Elective Contributions for the calendar quarter, EXCEPT that a PARTICIPANT'S Elective Contributions in excess of four percent (4%) of the PARTICIPANT'S ELECTIVE COMPENSATION for the calendar quarter shall not be taken into account. (b) Also, as of the date the contribution is received by the PLAN, each PARTICIPANT who is entitled to be credited with an additional amount of Basic Contribution pursuant to Section 5.2 of this PLAN shall have such amount credited to his Basic Contribution Account. 4.1.4 Basic Contributions: Vesting (a) At any time, each PARTICIPANT'S interest in his Basic Contribution Account balance (EXCEPT in Basic Matching Contributions that are forfeited because they relate to excess deferrals, excess contributions, or excess aggregate contributions) shall be stated in terms of his Vested Percentage, which shall be determined from the following schedule according to his YEARS OF SERVICE (unless the PLAN'S Top-Heavy Provisions (Section 5.2) become effective, in which case the vesting schedule stated therein shall control):
YEARS OF SERVICE Vested Percentage ==================================== =================================== Less than 4 0% 4 or more 100% ==================================== ===================================
(b) Subsection (a) above notwithstanding, any PARTICIPANT'S Vested Percentage automatically shall be 100% upon the occurrence of any of the following events: (1) his death while an EMPLOYEE; (2) his termination of employment as an EMPLOYEE due to his having incurred TOTAL AND PERMANENT DISABILITY while an EMPLOYEE; or (3) his attainment of NORMAL RETIREMENT AGE. (c) Under no circumstances shall any amendment of this PLAN reduce any PARTICIPANT'S Vested Percentage regarding any benefits accrued under this PLAN as of the adoption date (or effective date, if later) of such amendment. With regard to the effect of such an amendment on subsequently accrued benefits, for each PARTICIPANT whose Vested Percentage under the PLAN as amended would at any Art. IV 14 19 future time be less than it would be if determined without regard to such amendment, then provided that the PARTICIPANT had completed at least three YEARS OF SERVICE as of the adoption date (or effective date, if later) of the amend- ment, such PARTICIPANT may irrevocably elect in a writing delivered to the PLAN ADMINISTRATOR during the election period described below to have his Vested Percentage in his subsequently accrued benefits under this PLAN determined without regard to such amendment. For the purpose of this Section , the election period within which such election may be delivered to the PLAN ADMINISTRATOR shall begin as of the adoption date of the amendment, and shall end on the sixtieth day after the latest of: (1) the adoption date of the amendment; (2) the effective date of the amendment; or (3) the date on which the PARTICIPANT received written notice of the amendment from the EMPLOYER or PLAN ADMINISTRATOR. 4.1.5 Forfeitures (a) On the date as of which a PARTICIPANT accrues the fifth of five (5) consecutive BREAK IN SERVICE YEARS, if the balance credited to his Basic Contribution Account exceeds his vested interest in that Account, then his rights (under this PLAN) to such excess shall be immediately forfeited, with the amount of such excess becoming a Forfeiture. Basic Matching Contributions that relate to excess deferrals, excess contributions, or excess aggregate contributions shall be treated as Forfeitures. Forfeitures may also result from the distribution of a PARTICIPANT'S entire VESTED BENEFIT due to his termination of employment as an EMPLOYEE, as further described in Section 7.1. (b) All Forfeitures which occur pursuant to this PLAN shall be applied to offset expenses and Basic Contributions as such obligations accrue. 4.2.1 Elective Contributions: Amount (a) Elective Deferral Each PARTICIPANT may elect to defer his receipt of COMPENSATION that has not yet become available to him. For each PLAN YEAR, the total amount of COMPENSATION that may be deferred may equal not less than one percent (1%) and not more than fifteen percent (15%) of his ELECTIVE COMPENSATION for the PLAN YEAR. For each PLAN YEAR, on behalf of each PARTICIPANT who has made such an elective deferral, the EMPLOYER shall contribute an amount to the PLAN equal to the amount of the PARTICIPANT'S elective deferral of COMPENSATION for the PLAN YEAR. This contribution shall be called an Elective Contribution. Art. IV 15 20 Each Elective Contribution shall be paid to the PLAN by the EMPLOYER as soon as reasonably practicable (in no event later than 90 days) after it is withheld by or otherwise paid to the EMPLOYER. In addition, each Elective Contribution shall be paid to the PLAN by the EMPLOYER no later than the last day of the twelve-month period immediately following the PLAN YEAR with respect to which the contribution is made. (b) Election A PARTICIPANT may elect to change the amount of his elective deferrals, and therefore the amount of the Elective Contributions made on his behalf, within the limits prescribed in subsection (a) above. A PARTICIPANT may also elect to cease his elective deferrals and Elective Contributions altogether, or, having done so, may elect to recommence them. A PARTICIPANT'S election to commence elective deferrals may become effective only as of the first day of any prospective calendar quarter. A PARTICIPANT'S election to recommence or to change the amount of his elective deferrals may become effective only as of the first day of any prospective month. A PARTICIPANT'S election to cease his elective deferrals altogether may become effective only as of the first day of any prospective payroll period. Any of the provisions of this subparagraph (b) to the contrary notwithstanding, any election described by this subparagraph (b) regarding elective deferrals may become effective only after written notice delivered to the PLAN ADMINISTRATOR within a reasonable time prior to the effective date of the election. (c) Limit on Amount The total sum of any PARTICIPANT'S elective deferrals for any taxable year of the PARTICIPANT may not exceed the limit prescribed by IRC Reg. 1.402(g)-1(c). (Generally, for taxable years beginning in 1996, that limit equals $9,500, except for adjustments made to take into account elective deferrals made to annuity contracts under CODE sec. 403(b)). For the purposes of this subsection (c), "elective deferrals" has the meaning defined in IRC Reg. 1.402(g)-1(b), including (but not limited to) Elective Contributions received by this PLAN on the PARTICIPANT'S behalf. For any PARTICIPANT, if this limit on elective deferrals is exceeded, then the following corrective measures are permitted. (1) The PARTICIPANT may notify the PLAN ADMINISTRATOR of the excess deferral, and may request that the PLAN ADMINISTRATOR distribute to the PARTICIPANT an amount not exceeding the lesser of: (A) the amount of the excess deferral, plus all income allocable to the excess deferral; Art. IV 16 21 (B) the sum of all amounts deferred by the PARTICIPANT and contributed to the PLAN as Elective Contributions on behalf of the PARTICIPANT with regard to the affected taxable year, net of any allocable earnings, gains or losses attributable to such amounts; or (C) the balance of the PARTICIPANT'S Elective Contribution Account as of the date of distribution, minus any amounts of withholding that are legally required. In addition, the amount that may be included in a corrective distribution shall be reduced by any excess contributions previously distributed to the PARTICIPANT for the PLAN YEAR that began with or within the affected taxable year of the PARTICIPANT. To be effective for the purposes of this PLAN, the PARTICIPANT'S notice and request must be in writing and delivered to the PLAN ADMINISTRATOR prior to the first April 15 following the close of the affected taxable year of the PARTICIPANT. To the extent that the PARTICIPANT has excess deferrals for the taxable year calculated by taking into account only elective deferrals under this PLAN and other plans of the EMPLOYER, and absent actual notification by the PARTICIPANT, the PARTICIPANT shall be deemed to have provided the notice described above in this subsection. (2) A corrective distribution of excess deferrals and allocable income may be made during the affected taxable year of the PARTICIPANT only if all of the following conditions are satisfied. (A) The PARTICIPANT has designated the amount of the distribution as being attributable to an excess deferral. (Because subsection (1) above limits the amount of the corrective distribution to not more than the amount of excess deferrals calculated by taking into account only elective deferrals under this PLAN and other plans of the EMPLOYER, and absent an actual designation by the PARTICIPANT, the PARTICIPANT shall be deemed to have provided the designation described above in this subsection.) (B) The corrective distribution is made after the date on which the PLAN received the excess deferral. (C) The PLAN has designated the amount of the distribution as being attributable to an excess deferral. (3) Not later than the first April 15 following the close of the affected taxable year of the PARTICIPANT, and after receipt of the PARTICIPANT'S written notice and request, the PLAN ADMINISTRATOR may make the appropriate corrective distribution, consistent with the provisions of this subparagraph (c). Art. IV 17 22 The PLAN ADMINISTRATOR may require that before the corrective distribution is made, the PARTICIPANT must provide to the PLAN ADMINISTRATOR additional documentation evidencing the PARTICIPANT'S representations regarding the excess deferrals. The income allocable to excess deferrals for the affected taxable year of the PARTICIPANT shall be determined according to the IRC Reg. 1.402(g)-1(c)(5). In the event of a corrective distribution of excess deferrals and allocable income, the balance of the PARTICIPANT'S Elective Contribution Account shall be reduced accordingly. 4.2.2 Elective Contribution Account On behalf of each PARTICIPANT who has elected to defer some portion of his COMPENSATION pursuant to this Article IV, there shall be maintained an Elective Contribution Account, which shall be adjusted as provided in Article VI and which shall be closed when the PARTICIPANT is entitled to no further benefits under the terms of this PLAN. 4.2.3 Elective Contributions: Allocations Any Elective Contribution received by the PLAN on behalf of a PARTICIPANT shall be credited to the Elective Contribution Account of that PARTICIPANT as of the date on which the contribution was received by the PLAN. 4.2.4 Elective Contributions: Vesting The Elective Contributions received by the PLAN on behalf of any PARTICIPANT shall be fully vested in such PARTICIPANT and not subject to forfeiture prior to the time they are withdrawn or distributed pursuant to this PLAN. 4.2.5 Elective Contributions: Withdrawals (a) At any time before his RETIREMENT DATE, a PARTICIPANT may apply to withdraw an amount from his Elective Contribution Account. The application must be in writing and received by the PLAN ADMINISTRATOR. If the PARTICIPANT has attained age 59 1/2 or is not an EMPLOYEE as of the date of distribution, the PARTICIPANT may withdraw up to the entire balance of his Elective Contribution Account, including interest or other earnings. Subject to the additional restrictions of this section, any other PARTICIPANT may withdraw an amount that does not exceed the balance of the account attributable to Elective Contributions made on his behalf, excluding any interest or other earnings. (b) If the PARTICIPANT is an EMPLOYEE on the date as of which the withdrawal is to be distributed, and if the PARTICIPANT has not yet attained age 59 1/2 as of the date of distribution, the PLAN ADMINISTRATOR may permit the distribution only to the extent that the PLAN ADMINISTRATOR reasonably believes that the distribution is necessary to satisfy an immediate and heavy financial need of the PARTICIPANT, taking into account all relevant facts and circumstances. Art. IV 18 23 (1) Any of the following facts and circumstances shall automatically be deemed by the PLAN ADMINISTRATOR to constitute an immediate and heavy financial need of the PARTICIPANT: (A) expenses for medical care (as defined in CODE sec. 213(d)) that were either previously incurred by the PARTICIPANT, the PARTICIPANT'S spouse, or any dependents of the PARTICIPANT (with "dependents" being as defined by CODE sec. 152) or that are necessary for these persons to obtain such medical care; (B) costs directly related to the purchase of a principal residence for the PARTICIPANT (excluding mortgage payments); (C) payment of tuition and related educational fees for the next 12 months of post-secondary education for the PARTICIPANT, or the PARTICIPANT'S spouse, children, or dependents (as defined in CODE sec. 152); (D) payments necessary to prevent the eviction of the PARTICIPANT from the PARTICIPANT'S principal residence, or foreclosure on the mortgage on that residence; or (E) any other facts and circumstances that the Commissioner of the Internal Revenue Service has included through the publication of revenue rulings, notices, or other documents of general applicability. A financial need shall not fail to qualify as immediate and heavy merely because such need was reasonably foreseeable or voluntarily incurred by the PARTICIPANT. (2) In requesting a withdrawal due to financial need, the PARTICIPANT shall specifically identify the facts and circumstances which have caused the financial need and shall state the amount needed to satisfy the need, which may include amounts necessary to pay any income taxes or penalties reasonably anticipated to result from the distribution. The PARTICIPANT shall further state that, to the extent of the amount requested, the financial need cannot otherwise be satisfied by: (A) reimbursement or compensation by insurance or otherwise; (B) reasonable liquidation of the PARTICIPANT'S assets, but only to the extent that such liquidation would not in itself cause an immediate and heavy financial need; (C) cessation of elective deferrals or any PARTICIPANT contributions permitted by the PLAN; (D) other distributions or nontaxable (at the time of the loan) loans from this PLAN or any other plan maintained by the EMPLOYER or any other employer; and/or (E) borrowing from commercial sources on reasonable commercial terms. Art. IV 19 24 For the purposes of this subsection, the PARTICIPANT'S resources shall be deemed to include those assets of the PARTICIPANT'S spouse and minor children to the extent that such assets are reasonably available to the PARTICIPANT. (3) Before the withdrawal may be permitted, the PLAN ADMINISTRATOR shall receive from the PARTICIPANT any documentation that the PLAN ADMINISTRATOR requires in the performance of his fiduciary duty to substantiate that the withdrawal is necessary to satisfy the financial need identified by the PARTICIPANT. Under no circumstances shall the PLAN ADMINISTRATOR distribute more than the PLAN ADMINISTRATOR reasonably believes is necessary to satisfy the financial need identified by the Participant. (c) The PLAN ADMINISTRATOR shall approve or deny the PARTICIPANT'S application for such a withdrawal within a reasonable amount of time after receipt of such application. If approved, payment shall be made by the PLAN ADMINISTRATOR as soon as administratively practicable, but in any event within ninety (90) days after the PLAN ADMINISTRATOR'S receipt of the PARTICIPANT'S application. The PLAN ADMINISTRATOR shall also issue any denial of such an application as soon as administratively practicable. Such a denial shall be delivered in writing and shall state specifically the reasons for such denial. (d) The PLAN ADMINISTRATOR may limit the frequency of withdrawals. Such limit shall apply uniformly to all PARTICIPANTS. (e) The amount of any withdrawal from an Elective Contribution Account pursuant to this Section shall be charged against that Account as of the date that the withdrawal is distributed from the PLAN. Absent written directions from the PARTICIPANT to the contrary, a withdrawal shall be taken pro rata from the PARTICIPANT'S balances in the PLAN'S investment options (described in Section 6.1.2) as of the date of withdrawal. 4.3.1 Supplemental Contributions: Amount For any PLAN YEAR in which the PLAN ADMINISTRATOR determines that the average of the actual deferral ratios and/or the actual contribution ratios of PARTICIPANTS who are HCE'S exceeds the limit determined pursuant to Section 5.3(b) or 5.4(b), as applicable, the EMPLOYER may make Supplemental Contributions that meet the requirements for QUALIFIED NONELECTIVE CONTRIBUTIONS or QUALIFIED MATCHING CONTRIBUTIONS described in Article II. Supplemental Contributions shall be made solely for the purpose of complying with the limitations of the applicable Section , and shall not exceed the amount necessary to satisfy the test described therein, subject to the limits of Section 5.1.1. 4.3.2 Supplemental Contribution Accounts A Supplemental Contribution Account shall be maintained on behalf of each PARTICIPANT who will be allocated a portion of the Supplemental Contribution. The account shall be Art. IV 20 25 adjusted as provided in Article VI and shall be closed when the PARTICIPANT is entitled to no further benefits under the terms of the PLAN. 4.3.3 Supplemental Contributions: Allocations As of the date on which it is received by the PLAN and all necessary information to complete the allocation is available, a portion of the Supplemental Contribution for the PLAN YEAR, if any, shall be allocated to the Supplemental Contribution Account of each PARTICIPANT who is not an HCE and who (1) is allocated an Elective Contribution for PLAN YEAR and (2) is an EMPLOYEE on the last day of the PLAN YEAR. Each such PARTICIPANT shall be allocated a portion of that Supplemental Contribution so that such portion, when compared with the entire amount of Supplemental Contribution that is allocated to all such PARTICIPANTS for the PLAN YEAR, shall bear the same direct proportion that the PARTICIPANT'S COMPENSATION for that PLAN YEAR bears to the aggregate COMPENSATION of all such PARTICIPANTS for that PLAN YEAR. 4.3.4 Supplemental Contributions: Vesting At any time, a PARTICIPANT'S interest in his Supplemental Contribution Account shall be fully vested and not subject to forfeiture prior to the withdrawal or distribution of such balance pursuant to this PLAN. 4.4.1 Rollover Contribution: Amount The PLAN ADMINISTRATOR may accept Rollover Contributions from or on behalf of a PARTICIPANT. As used herein, Rollover Contribution means all or a portion of an "eligible rollover distribution" described in CODE sec. 402(c), or an amount paid or distributed out of an individual retirement account or individual retirement annuity described in CODE sec. 408(d)(3)(A)(ii). The PLAN ADMINISTRATOR may require such assurance and proofs of fact from the PARTICIPANT as may be necessary to determine whether an amount the PARTICIPANT desires to contribute is a Rollover Contribution as defined herein. He may further require the PARTICIPANT to agree to indemnify the PLAN for any adverse consequences which may follow if a contribution proves not to have been a Rollover Contribution. An EMPLOYEE on whose behalf a transfer described in this Section is made shall agree to cooperate fully with the PLAN ADMINISTRATOR in effecting any and all corrective measures which may be required by an agency of the federal government to prevent the PLAN'S disqualification as a result of the transfer. 4.4.2 Rollover Contribution Account For the benefit of any PARTICIPANT on whose behalf the PLAN has accepted any Rollover Contribution, there shall be maintained a Rollover Account. Rollover Accounts shall be adjusted as provided in Article VI, and shall be closed when the balances of such accounts, including allocable earnings, gains and losses, have been distributed pursuant to this PLAN. Art. IV 21 26 4.4.3 Rollover Contributions: Allocation Any Rollover Contribution received by the PLAN pursuant to this Article IV shall be credited as it is received to the Rollover Account(s) of the PARTICIPANT on whose behalf it was received. 4.4.4 Rollover Contributions: Vesting The Rollover Contributions received by the PLAN on behalf of any PARTICIPANT shall be fully vested in such PARTICIPANT and not subject to forfeiture prior to the time they are distributed pursuant to this PLAN. Art. IV 22 27 ARTICLE V REQUIRED NON-DISCRIMINATION TESTING 5.1.1 Limitation on Additions (a) The Annual Additions to this PLAN for the benefit of a PARTICIPANT in a LIMITATION YEAR are the sum of: (1) Allocations to his Elective Contribution Account for the LIMITATION YEAR, directly or indirectly, of the Elective Contributions to the PLAN; and (2) Allocations to his Basic Contribution Account for the LIMITATION YEAR, directly or indirectly, of the Basic Contributions to the PLAN; and (3) Allocations to his Supplemental Contribution Account for the LIMITATION YEAR, directly or indirectly, of any Supplemental Contributions to the PLAN; and (4) Allocations to any individual medical account maintained on behalf of the PARTICIPANT by the EMPLOYER pursuant to a pension or annuity plan, as described in Sections 415(l)(1) and 419A(d)(2) of the CODE. Contributions shall not fail to be Annual Additions to this PLAN merely because such contributions are excess contributions or excess aggregate contributions, or merely because such excess contributions or excess aggregate contributions are distributed. Excess deferrals are Annual Additions only if they are not distributed as provided in Article IV. (b) A PARTICIPANT'S Maximum Annual Addition for a LIMITATION YEAR is the lesser of: (1) 25% of the PARTICIPANT'S compensation for the LIMITATION YEAR; or (2) the greater of: (A) $30,000; or (B) 25% of the defined benefit dollar limitation set forth in Section 415(b)(1)(A) of the CODE as in effect for the LIMITATION YEAR or such other amount as the Secretary of the Treasury or his delegate may from time to time authorize pursuant to Section 415(d) of the CODE. (c) Any provisions of this PLAN to the contrary notwithstanding, the Annual Additions to this PLAN for the benefit of a PARTICIPANT in a LIMITATION YEAR shall in no event exceed the PARTICIPANT'S Maximum Annual Addition for that LIMITATION YEAR. If allocations pursuant to Article IV would otherwise result in the limitation in the preceding sentence being exceeded for a PARTICIPANT in a LIMITATION YEAR because of the allocation of Forfeitures, if any, or because of a reasonable error Art. V 23 28 in estimating a PARTICIPANT'S annual compensation, or because of a reasonable error in determining the amount of elective deferrals (within the meaning of CODE sec. 402(g)(3), or because of any other facts and circumstances which the Internal Revenue Service finds to be appropriate consistent with sec. 415 of the CODE and regulations promulgated thereunder, then the PLAN ADMINISTRATOR shall reduce that PARTICIPANT'S Annual Additions, but only to the extent that the sum of such Additions no longer exceeds his Maximum Annual Additions. This reduction of the PARTICIPANT'S Annual Additions shall be accomplished by reducing the allocation (if any) to the PARTICIPANT'S INDIVIDUAL ACCOUNTS of each of the allocated amounts described below according to the order in which they are listed. Each such amount shall be completely exhausted before the next listed allocation is reduced. The allocations to be reduced (and the order in which they shall be reduced) shall be as follows: (1) Elective Contributions and, if the PARTICIPANT is an HCE, related Basic Matching Contributions (2) Basic Matching Contributions not described above (3) Supplemental Contributions The amount by which an Elective Contribution is reduced shall be distributed to the PARTICIPANT on whose behalf it was received as soon as administratively practicable, and shall include any earnings and gains that have been allocated and which are attributable to that returned amount. The remaining surplus amounts created by the reductions described above shall be held in a Suspense Account established and administered pursuant to Section 5.1.2. (d) For purposes of this Section, compensation means a PARTICIPANT'S wages, salary, and/or other remuneration that is required to be reported as income on the individual's Form W-2 for federal income tax withholding purposes under CODE sec. 3401(a). For any SELF-EMPLOYED INDIVIDUAL, compensation means EARNED INCOME. For the purposes of this Section, the total amount of compensation that is actually paid or made available to a PARTICIPANT within a LIMITATION YEAR shall be the amount of that PARTICIPANT'S compensation taken into account regarding that LIMITATION YEAR. (e) Additional Limitation in the Case of Defined Benefit PLAN and Defined Contribution PLAN for Same EMPLOYEE (1) In any case where a PARTICIPANT has at any time participated in a defined benefit plan maintained by the EMPLOYER, the limitation imposed by this Section (without regard to this Additional Limitation) shall be reduced to the Art. V 24 29 extent necessary to prevent the PARTICIPANT'S Combination Ratio from exceeding 1.0 in any LIMITATION YEAR. A PARTICIPANT'S Combination Ratio is the sum of his Defined Benefit Fraction and his Defined Contribution Fraction. (2) A PARTICIPANT'S Defined Benefit Fraction for a LIMITATION YEAR is a fraction - (A) the numerator of which is his projected annual benefit (as defined in sec. 415(e) of the CODE and regulations thereunder) to which the PARTICIPANT would be entitled under the defined benefit plan as of the close of the LIMITATION YEAR; (B) the denominator of which is the lesser of: (i) the product of 1.25 (or, if the PLAN is top-heavy as determined under the provisions of Section 5.2, 1.0) multiplied by the dollar limitation in effect under sec. 415(b)(1)(A) of the CODE for such LIMITATION YEAR, or (ii) the product of 1.4 multiplied by the amount which may be taken into account under sec. 415(b)(1)(B) of the CODE with respect to such PARTICIPANT for such LIMITATION YEAR. (3) A PARTICIPANT'S Defined Contribution Fraction for a LIMITATION YEAR is a fraction - (A) the numerator of which is the sum of the Annual Additions (as defined in this Section ) to the PARTICIPANT'S account for the PARTICIPANT'S benefit as of the close of the LIMITATION YEAR and for all prior LIMITATION YEARS; and (B) the denominator of which is the sum of the lesser of the following amounts determined for such LIMITATION YEAR and for each prior LIMITATION YEAR of service with the EMPLOYER: (i) the product of 1.25 (or, if the PLAN is top-heavy as determined under the provisions of Section 5.2, 1.0) multiplied by the dollar limitation in effect under sec. 415(c)(1)(A) of the CODE for such LIMITATION YEAR (determined without regard to sec. 415(c)(6) of the CODE), or (ii) the product of 1.4 multiplied by the amount which may be taken into account under sec. 415(c)(1)(B) of the CODE (or subsection (c)(7) or (8), if applicable) with respect to such PARTICIPANT for such LIMITATION YEAR. (4) For purposes of this Additional Limitation, EMPLOYEE contributions to any defined benefit plan maintained by the EMPLOYER, whether mandatory or voluntary, shall be treated as a separate defined contribution plan maintained by the EMPLOYER. Art. V 25 30 (5) If an additional limitation is applicable, it shall be imposed in this PLAN before any reduction in the limitation on benefits payable under any defined benefit plan, unless the applicable defined benefit plan provides expressly to the contrary. (f) Aggregation of PLANS For purposes of this Section, all qualified defined contribution plans (without regard to whether a plan has been terminated) ever maintained by the EMPLOYER will be treated as part of this PLAN, and all qualified defined benefit plans (without regard to whether a plan has been terminated) ever maintained by the EMPLOYER will be treated as one defined benefit plan. EMPLOYEE contributions (whether mandatory or voluntary) to a qualified defined benefit plan maintained by the EMPLOYER shall be treated as a defined contribu tion plan maintained by the EMPLOYER. Any qualified defined benefit or defined contribution plan maintained by any member of a controlled group of corporations or group of trades or businesses (whether or not incorporated) under common control (within the meaning of sec. 414(b) and (c) of the CODE as modified by sec. 415(h)) of which the EMPLOYER is a member shall be treated as a plan maintained by the EMPLOYER. 5.1.2 Suspense Account For any PLAN YEAR, any surplus amounts created by reductions described in Section 5.1.1(c) and not returned to a PARTICIPANT shall be held unallocated in a Suspense Account. Any provisions of this PLAN to the contrary notwithstanding, any amounts held in a Suspense Account shall be applied toward EMPLOYER contributions and PLAN expenses as such obligations accrue, with the EMPLOYER making no further contributions to the PLAN until such time as the Suspense Account balance has been exhausted. No amounts held in a Suspense Account may be distributed to any PARTICIPANT at any time prior to termination of the PLAN. If there are amounts held in a Suspense Account at a time when the PLAN is terminated, such amounts shall be reallocated to PARTICIPANTS in proportion to their COMPENSATION for that PLAN YEAR but not in excess of each PARTICIPANT'S Maximum Annual Addition for the PLAN YEAR. Any amounts that cannot be reallocated may revert to the EMPLOYER according to Section 8.1.3. 5.2.1 Top-Heavy Provisions: Application The provisions of Sections 5.2.1 - 5.2.3 shall become effective only if, as of the first day of the applicable PLAN YEAR, the PLAN is top-heavy pursuant to the Test described in Section 5.2.2. Art. V 26 31 5.2.2 Top-Heavy Determination (a) Definitions (1) Aggregation Group. (A) Required Aggregation Group means (i) each and every plan of the EMPLOYER in which a KEY EMPLOYEE is a PARTICIPANT during the PLAN YEAR containing the Determination Date or any of the four preceding PLAN YEARS, including any plan that has subsequently terminated, and (ii) each other plan of the EMPLOYER which enables any plan described in subsection (i) above to meet the participation and nondiscrimination requirements of the CODE, including (but not limited to) the requirements of CODE sections 401(a)(4) and 410. (B) Permissive Aggregation Group means a Required Aggregation Group or a plan described in subsection (A)(i) above together with any other plan of the EMPLOYER which is not required to be included in an Aggregation Group under subsection (A)(ii) above but which may be so included if such group would continue to meet the participation and nondiscrimination requirements of the Internal Revenue CODE. (C) Top-Heavy Group means any Required Aggregation Group found to be top-heavy pursuant to subsection (b) of this Section 5.2.2. (2) Compensation means compensation as defined in Section 5.1.1(d). (3) Determination Date means (A) in the case of the first PLAN YEAR, the last day of such PLAN YEAR; (B) in all other cases, the last day of the preceding PLAN YEAR. (4) Non-KEY EMPLOYEE means any EMPLOYEE who is not a KEY EMPLOYEE. (5) Present Value of Accrued Benefits means, for this PLAN, the sum of (A) the account balances attributable to Basic and Elective Contributions and Supplemental Contributions as of the most recent Valuation Date occurring within a twelve-month period ending on the Determination Date, and (B) an adjustment for certain contibutions due as of the Determination Date, as required by CODE sec. 416. If this PLAN is a member of an Aggregation Group, Present Value of Accrued Benefits shall mean the sum of the account balances of all EMPLOYER and nondeductible EMPLOYEE Contribution Accounts maintained for the PARTICI- Art. V 27 32 PANT pursuant to all defined contribution plans that belong to the group and of which he is a member and also the sum of the present values of the vested accrued benefits due the PARTICIPANT pursuant to all defined benefit plans that belong to the group and of which the PARTICIPANT is a member. (6) Valuation Date means the last date in each PLAN YEAR on which account balances are valued. (b) Top-Heavy Test The PLAN (or Aggregation Group) shall be top-heavy for each PLAN YEAR if, as of the Determination Date, the PLAN'S (or Aggregation Group's) top-heavy ratio for the PLAN YEAR exceeds sixty percent (60%). The top-heavy ratio is the Present Value of Accrued Benefits of all KEY EMPLOYEES over the Present Value of Accrued Benefits of all EMPLOYEES, excluding former Key EMPLOYEES. Calculation of the top-heavy ratio shall be made in accordance with sec. 416 of the CODE (with specific reference to CODE sec. 416(g)(3)) and shall take into account the following amounts: (1) Present Value of Accrued Benefits as described in subsection (a)(5) above; and (2) The amount of all distributions to PARTICIPANTS or their BENEFICIARIES during the PLAN YEAR that includes the Determination Date and also during the four preceding PLAN YEARS pursuant to this PLAN or pursuant to a terminated plan which if it had not been terminated would have been required to be included in an Aggregation Group, EXCEPT (A) any rollover to this PLAN initiated by the EMPLOYEE; and (B) any transfer to this PLAN from a qualified plan maintained by an unrelated employer; and (C) any distribution which occurred after the Valuation Date but prior to the Determination Date to the extent that such a distribution has been included in the calculation of the Present Value of Accrued Benefits. However, calculation of the top-heavy ratio for any PLAN YEAR shall not take into account the Present Value of Accrued Benefits or the amount of all distributions made to any individual who has not performed services for the EMPLOYER at any time during the 5-year period ending on such PLAN YEAR'S Determination Date. For an Aggregation Group, each plan shall initially be tested separately, and then the plans shall be aggregated by adding together the results for each plan as of the Determination Dates that fall within the same calendar year. If the Aggregation Group includes two or more defined benefit plans, the same actuarial assumptions will be specified within and used by such plans for the purposes of this Section 5.2. Also, in such defined benefit plans proportional subsidies shall be ignored and non-proportional subsidies considered for the purposes of this Section 5.2.2(b). Art. V 28 33 For a Required Aggregation Group, each PLAN shall be tested by determining the Present Value of Accrued Benefits for non-Key EMPLOYEES (1) pursuant to the method, if any, that uniformly applies for accrual purposes under all plans maintained by the affiliated EMPLOYERS; or (2) if there is no such method, as if such Accrued Benefits accrued not more rapidly than the slowest accrual rate permitted under the fractional accrual rates of Section 411(b)(1)(C) of the CODE. 5.2.3 Special Rules for Top-Heavy PLANS (a) Application of Special Rules (1) If, after application of the top-heavy test described in Section 5.2.2(b), this PLAN is found not to be top-heavy, then the special rules set forth below shall not apply to this PLAN. In that event, the other applicable provisions in this PLAN will govern. (2) If, after application of the top-heavy test in Section 5.2.2(b), this PLAN is found to be top-heavy, then the following special rules shall govern. (b) Vesting Schedule (1) At any time, a PARTICIPANT'S vested interest in his Basic Contribution Account balance shall be stated in terms of his Vested Percentage, which shall be determined from the following schedule, according to his YEARS OF SERVICE: YEARS OF SERVICE Vested Percentage ==================================== =================================== Less than 3 0% 3 or more 100% ==================================== =================================== However, this Vesting Schedule shall not apply to the Basic Contribution Account balance of any PARTICIPANT who does not have an HOUR OF SERVICE after the PLAN became top-heavy. (2) If this Vesting Schedule becomes applicable, then it shall apply to each PARTICIPANT'S entire Basic Contribution Account balance under this PLAN. In addition, such Vesting Schedule shall remain in effect in all future PLAN YEARS, even those in which the PLAN is not top-heavy. (c) Minimum Contribution (1) For each PLAN YEAR in which the PLAN is top-heavy, each non-KEY EMPLOYEE who is a PARTICIPANT and who has not separated from SERVICE at the end of the PLAN YEAR, including any PARTICIPANT who failed to complete 1,000 HOURS OF SERVICE, and any who did not make an Elective Contribution pursuant to Section 4.2.1, shall accrue not less than the minimum contribution described below. Art. V 29 34 (2) The sum of the EMPLOYER'S contributions and any forfeitures allocated to the INDIVIDUAL ACCOUNTS of each such PARTICIPANT for each PLAN YEAR in which the PLAN is top-heavy must equal not less than (A) at least three percent (3%) of each such PARTICIPANT'S compensation for that PLAN YEAR; or (B) if the highest percentage of compensation provided on behalf of KEY EMPLOYEES who are PARTICIPANTS for that PLAN YEAR is less than three percent (3%), then not less than the same percentage of such compensation for that PLAN YEAR for each non-KEY EMPLOYEE PARTICIPANT as the largest percentage of such compensation provided on behalf of KEY EMPLOYEE PARTICIPANTS for that PLAN YEAR. (3) Any provisions of subsection (2) above to the contrary notwithstanding, for each PLAN YEAR in which the EMPLOYER maintains both a defined benefit plan and a defined contribution plan and both plans are top-heavy, each non-KEY EMPLOYEE who is a PARTICIPANT in both such PLANS shall be credited with not less than a portion of the sum of the EMPLOYER'S contribu- tions and forfeitures made under the terms of this PLAN for that PLAN YEAR equal to five percent (5%) of his compensation. In determining the minimum contribution or benefit that is required for non-KEY EMPLOYEES by this Section , Elective Contributions and matching contributions, if any, that are allocated to KEY EMPLOYEES shall be taken into account. However, to the extent that matching contributions made on behalf of non-KEY EMPLOYEES are taken into account in meeting the Actual Deferral Percentage Test and/or the Actual Contribution Percentage Test described in Article V, such contributions may not additionally be credited as part of any minimum contribution or benefit required by this Section . Elective Contributions made on behalf of non- KEY EMPLOYEES may not be credited as part of any minimum contribution or benefit required by this Section . If the EMPLOYER is required to contribute an additional amount to the PLAN on behalf of a PARTICIPANT as a result of the operation of this Article, that amount shall be credited to a Basic Contribution Account established and maintained on his behalf. 5.3 Actual Deferral Percentage Test (a) For each PLAN YEAR, the PLAN ADMINISTRATOR shall perform (or have performed) an Actual Deferral Percentage Test in order to ensure that the PLAN'S cash or deferred arrangement satisfies the requirements of CODE sec. 401(k)(3) and does not impermissibly discriminate in favor of PARTICIPANTS who are HIGHLY COMPENSATED EMPLOYEES ("HCE'S"). The Actual Deferral Percentage ("ADP") Test shall compare the ADP of those PARTICIPANTS who are HCE'S with the ADP of those PARTICIPANTS who are not HCE'S. Art. V 30 35 For any group of PARTICIPANTS, the group's ADP equals the average (expressed as a percentage) of the actual deferral ratios of that group's PARTICIPANTS, with each PARTICIPANT'S actual deferral ratio calculated separately. For any PLAN YEAR, a PARTICIPANT'S actual deferral ratio consists of the amount of the PARTICIPANT'S Elective Contribution for the PLAN YEAR (subject to the limitations of the following paragraph) plus, at the discretion of the PLAN ADMINISTRATOR, the amount of any QUALIFIED MATCHING CONTRIBUTIONS ("QMAC'S") and QUALIFIED NONELECTIVE CONTRIBUTIONS ("QNC'S") that are treated as Elective Contributions and included in the ADP testing by the PLAN ADMINISTRATOR, with such sum expressed as a percentage of his COMPENSATION. For purposes of this Section 5.3, in any PLAN YEAR, the PLAN ADMINISTRATOR may elect to use compensation as described in Section 5.1.1(d) or "compensation" as described in the definition of HCE in Article II, instead of COMPENSATION, for every PARTICIPANT. Also, the PLAN ADMINISTRATOR may elect to limit COMPENSATION (or the applicable alternative) for every PARTICIPANT to COMPENSATION received while participating in the PLAN. However, the PLAN ADMINISTRATOR'S discretion in choosing to include any QMAC'S or QNC'S is limited to the extent that such inclusion satisfies the conditions and requirements set forth in 26 CFR 1.401(k)-1(b)(5). In determining a PARTICIPANT'S actual deferral ratio, the PARTICIPANT'S Elective Contributions may be taken into account only to the extent that they satisfy the following conditions. (1) The Elective Contribution must be allocated to an account maintained on behalf of the PARTICIPANT as of a day within the plan year being considered. For the purpose of this provision, an Elective Contribution shall be considered allocated as of a date within a plan year only if both: (A) the allocation is not contingent upon the PARTICIPANT'S participation in a plan or performance of service on any date subsequent to the date of allocation; and (B) the amount of the Elective Contribution is actually paid to the plan pursuant to which the Elective Contribution is made no later than the end of the twelve-consecutive-month period immediately following the plan year to which the contribution relates. (2) The Elective Contribution relates to COMPENSATION that either: (A) would have been received by the PARTICIPANT in the plan year but for the PARTICIPANT'S election to defer that COMPENSATION, or (B) is attributable to service performed by the PARTICIPANT in the plan year and, but for the PARTICIPANT'S election to defer, would have been received by the PARTICIPANT within two and one-half months after the close of the plan year. Art. V 31 36 In addition, if with reference to a PLAN YEAR the PARTICIPANT was an HCE and also participated in more than one cash or deferred arrangement sponsored by the EMPLOYER, then all such cash or deferred arrangements shall be aggregated and treated as one arrangement for the purposes of determining the PARTICIPANT'S actual deferral ratio for that PLAN YEAR. If these arrangements have different plan years, these arrangements' plan years that end with or within the same calendar year shall be aggregated and treated for ADP purposes as a single arrangement and single plan year. However, the preceding provisions to the contrary notwithstanding, contributions and allocations under plans described by CODE sec. 4975(e)(7) (i.e. "ESOP's") shall not be aggregated. (b) For each PLAN YEAR, the ADP for the group of Eligible PARTICIPANTS who are HCES for that PLAN YEAR shall not exceed the greater of (1) or (2), where (1) equals 125% of the ADP for the group of Eligible PARTICIPANTS who are non-HCES for that PLAN YEAR; and (2) equals the lesser of (A) and (B), where (A) equals 200% of the ADP for the group of Eligible PARTICIPANTS who are non-HCES for that PLAN YEAR; and (B) equals the ADP for the group of Eligible PARTICIPANTS who are non- HCES for that PLAN YEAR, plus 2 percentage points (or such other amount as may be prescribed by the Secretary of the Treasury). For the purposes of this subsection, "Eligible PARTICIPANTS" means those PARTICIPANTS who during the PLAN YEAR were eligible to have elected to defer some portion of their COMPENSATION for that PLAN YEAR so as to receive an Elective Contribution, regardless of whether such an election was actually made. (c) If for a PLAN YEAR the ADP limits of subsection (b) above are exceeded, the amount of excess contributions to be attributed to each HCE shall be determined by the following leveling method. The PLAN ADMINISTRATOR shall reduce the amount of Elective Contributions that are allocated pursuant to the PLAN for that PLAN YEAR on behalf of the HCE with the highest actual deferral ratio. This reduction shall be made only to the extent required to (1) enable the PLAN to meet the ADP limits, or (2) cause the HCE'S actual deferral ratio to equal the actual deferral ratio of the HCE with the next highest actual deferral ratio, whichever occurs first. This process shall be repeated by the PLAN ADMINISTRATOR until the ADP test limits of subsection (b) above have been met. For each PLAN YEAR, the amount of excess contributions, if any, for each HCE shall equal the sum of the HCE'S Elective Contributions, plus any QUALIFIED NONELECTIVE CONTRIBUTIONS and QUALIFIED MATCHING CONTRIBUTIONS that are treated as Elective Contributions (determined prior to the application of this subsection) in determining the HCE'S actual deferral ratio, minus the product of Art. V 32 37 the HCE'S actual deferral ratio (determined after application of this subsection) multiplied by the HCE'S COMPENSATION. (d) After the close of the PLAN YEAR to which the excess contributions are attributable, but within twelve months after such PLAN YEAR'S close, the PLAN ADMINISTRATOR shall designate as such and distribute to each HCE the amount (if any) of excess contributions (plus any earnings, gains, or losses described in Section 6.2 attributable to such contributions) that were made on that HCE'S behalf, minus the sum of any excess deferrals previously distributed to the HCE for the HCE'S taxable year ending with or within that PLAN YEAR. (e) Any of the provisions of this Section to the contrary notwithstanding, in determining the actual deferral ratio of a PARTICIPANT who is an HCE, the family aggregation rules described in paragraph (4) of the definition in Article II of Highly Compensated EMPLOYEE shall apply, and the actual deferral ratio of any such family aggregate shall equal the actual deferral ratio determined by combining the contributions received by the PLAN on behalf of and COMPENSATION paid to all eligible family members. After the actual deferral ratio of such a family aggregate has been determined, the amount of excess contributions (if any) that were allocated on behalf of the family aggregate shall be determined and corrected according to the "leveling" method described in subsection (c) above. The resulting excess contributions shall be reallocated among those family members whose contributions were combined to determine the actual deferral ratio of the family aggregate, with each such member being allocated an amount of excess contribution in proportion to the contributions of each such member that have been combined. (f) For the purposes of satisfying the limits specified in this Section and in CODE sections 401(a)(4), 410(b), and 401(k), two or more cash or deferred arrange ments may be aggregated, provided that such aggregation is consistent with the provisions of IRC Regs. 1.401(k)-1(b)(3) and 1.401(k)-1(g)(1)(ii); for example, cash or deferred arrangements may be aggregated pursuant to this subsection only if the respective plans of which they are part have the same plan years. All elective contributions that are made under any plan that are aggregated with this PLAN for the purposes of CODE sec. 401(a)(4) or sec. 410(b) (other than sec. 410(b)(2)(A)(ii) are to be treated as if they were made under a single plan. In addition, if any plans are permissively aggregated with this PLAN for the purposes of CODE sec. 401(k), the aggregated plans must also satisfy CODE secs. 401(a)(4) and 410(b) as though they were a single plan. 5.4 Average Contribution Percentage Test (a) For each PLAN YEAR, the PLAN ADMINISTRATOR shall perform (or have performed) an Average Contribution Percentage Test in order to ensure that the PLAN'S receipt and allocation of matching contributions and/or employee contributions, if any, satisfy the requirements of CODE sec. 401(m) and do not impermissibly discriminate in favor of PARTICIPANTS who are HIGHLY COMPENSATED EMPLOYEES ("HCE'S"). Art. V 33 38 The Average Contribution Percentage ("ACP") Test shall compare the ACP of those PARTICIPANTS who are HCE'S with the ACP of those PARTICIPANTS who are not HCE'S. For any group of PARTICIPANTS, the group's ACP equals the average (expressed as a percentage) of the actual contribution ratios of that group's PARTICIPANTS, with each PARTICIPANT'S actual contribution ratio calculated separately. For any PLAN YEAR, a PARTICIPANT'S actual contribution ratio consists of the sum of the following contributions (if any) which have been received by the PLAN on the PARTICIPANT'S behalf for that PLAN YEAR: (1) "matching" employer contributions (within the meaning of CODE sec. 401(m)(4)(A)); (2) employee contributions; and (3) any Elective Contributions and QUALIFIED NONELECTIVE CONTRIBUTIONS ("QNC'S") that the PLAN ADMINISTRATOR, in the exercise of his sole discretion, chooses to take into account for the purposes of ACP testing (except that the PLAN ADMINISTRATOR'S discretion in choosing to include any Elective Contributions and QNC'S is limited to the extent that such inclusion satisfies the conditions and requirements set forth in 26 CFR 1.401(m)-1(b)(5)); with such sum expressed as a percentage of the PARTICIPANT'S COMPENSATION. For purposes of this Section 5.4, in any PLAN YEAR, the PLAN ADMINISTRATOR may elect to use compensation as described in Section 5.1.1(d) or "compensation" as described in the definition of HCE in Article II instead of COMPENSATION, for every PARTICIPANT. Also the PLAN ADMINISTRATOR may elect to limit COMPENSATION (or the applicable alternative) for every PARTICIPANT to COMPENSATION received while participating in the PLAN. In determining a PARTICIPANT'S actual contribution ratio, matching contributions made on behalf of the PARTICIPANT may be taken into account only to the extent that they satisfy the following conditions. (1) The matching contribution must be allocated to an account maintained on behalf of the PARTICIPANT as of a day within the plan year being considered. (2) The amount of the matching contribution is actually paid to the plan pursuant to which the matching contribution is made no later than the end of the twelve-consecutive-month period immediately following the plan year to which the contribution relates. (3) The matching contribution is made on behalf of the PARTICIPANT on account of the PARTICIPANT'S elective contributions or employee contributions (if any) for the plan year to which the matching contribution relates. Matching contributions that are forfeited because they relate to excess deferrals, excess contributions or excess aggregate contributions shall not be taken into account. Art. V 34 39 (b) For each PLAN YEAR, the ACP for the group of Eligible PARTICIPANTS who are HCES for that PLAN YEAR shall not exceed the greater of (1) or (2), where (1) equals 125% of the ACP for the group of Eligible PARTICIPANTS who are non-HCES for that PLAN YEAR; and (2) equals the lesser of (A) and (B), where (A) equals 200% of the ACP for the group of Eligible PARTICIPANTS who are non-HCES for that PLAN YEAR; and (B) equals the ACP for the group of Eligible PARTICIPANTS who are non-HCES for that PLAN YEAR, plus 2 percentage points (or such other amount as may be prescribed by the Secretary of the Treasury). For the purposes of this subsection, "Eligible PARTICIPANTS" means those PARTICIPANTS who are directly or indirectly eligible to make an employee contribution or to receive an allocation of matching contributions (including matching contributions derived from Forfeitures, if any) under the terms of this PLAN for the PLAN YEAR being reviewed. If a PARTICIPANT has "excess deferrals" according to Section 4.2.1(c) or "excess contributions" for the PLAN YEAR according to Section 5.3, then such excess deferrals and/or excess contributions shall be calculated and distributed prior to determining the PARTICIPANT'S excess aggregate contributions for the PLAN YEAR. (c) If for a PLAN YEAR the ACP limits of subsection (b) above are exceeded, the amount of excess aggregate contributions to be attributed to each HCE shall be determined by the following leveling method. The PLAN ADMINISTRATOR shall reduce the employee contributions and, if necessary, the matching contributions that had been allocated pursuant to the PLAN YEAR for that PLAN YEAR on behalf of the HCE with the highest actual contribution ratio. This reduction shall be made only to the extent required to (1) enable the PLAN to meet the ACP limits, or (2) cause the HCES actual contribu tion ratio to equal the next highest actual contribution ratio, whichever occurs first. This process shall be repeated by the PLAN ADMINISTRATOR until the ACP test limits of subsection (b) above have been met. For each PLAN YEAR, the amount of excess aggregate contributions, if any, for each HCE shall equal the sum of the HCE'S employee contributions and matching contributions, if any, plus any QUALIFIED NONELECTIVE CONTRIBUTIONS and Elective Contributions that are treated as matching contributions (determined prior to the application of this subsection) in determining the HCE'S actual contribution ratio, minus the product of the HCE'S actual contribution ratio (determined after applica tion of this subsection) multiplied by the HCE'S COMPENSATION. Determinations of actual contribution ratios shall be rounded to the nearest one-hundredth of one percent of the PARTICIPANT'S COMPENSATION. Art. V 35 40 (d) After the close of the PLAN YEAR to which the excess aggregate contributions are attributable, but within twelve months after such PLAN YEAR'S close, the PLAN ADMINISTRATOR shall designate the amount (if any) of the excess aggregate contributions (plus any earnings, gains, or losses described in Section 6.2 on such contributions) that are attributable to amounts received and accumulated under the PLAN on each HCE'S behalf. Such excess aggregate contributions shall be forfeited, if forfeitable. These forfeited amounts shall be reallocated to PARTICIPANTS who are NHCES for the PLAN YEAR. Each such PARTICIPANT shall be allocated a portion of the total forfeited amounts so that such portion, when compared to the total of the forfeited amounts, shall bear the same direct proportion that the amount of Basic Matching Contribution being allocated to the PARTICIPANT pursuant to Section 4.1.1, subsection (a), bears to the entire amount of Basic Matching Contribution that is allocated to all such NHCE PARTICIPANTS pursuant to Section 4.1.1(a). If not forfeitable, the amount of the excess aggregate contribution and any earnings, gains, or losses shall be distributed to the HCE on whose behalf the excess aggregate contribution was received. If such excess aggregate contribu tions are distributed more than 2 1/2 months after the last day of the PLAN YEAR in which such excess amounts arose, a 10% excise tax will be imposed on the EMPLOYER with respect to these amounts. (e) Any of the provisions of this Section to the contrary notwithstanding, in determining the actual contribution ratio of a PARTICIPANT who is an HCE, the family aggregation rules described in paragraph (4) of the definition in Article II of HIGHLY COMPENSATED EMPLOYEE shall apply, and the actual contribution ratio of any such family aggregate shall equal the actual contribution ratio determined by combining the contributions received by the PLAN on behalf of and COMPENSATION paid to all eligible family members. After the actual contribution ratio of such a family aggregate has been determined, the amount of excess aggregate contributions (if any) that were allocated on behalf of the family aggregate shall be determined and corrected according to the "leveling" method described in subsection (c) above. The resulting excess aggregate contributions shall be reallocated among those family members whose contributions were combined to determine the actual contribution ratio of the family aggregate, with each such member being allocated an amount of excess aggregate contribution in proportion to the contributions of each such member that have been combined. (f) Any provisions of this Section to the contrary notwithstanding, for the purposes of determining whether this PLAN satisfies the ACP test, all employee and matching contributions that are made under any plans that are aggregated with this PLAN for the purposes of CODE sec. 401(a)(4) and/or 410(b) (other than CODE sec. 410(b)(2)(A)(ii)) shall be aggregated and treated as if made under a single plan. In addition, if any plans are permissively aggregated with this PLAN for the purposes of ACP testing, then the aggregated plans must also satisfy CODE secs. 401(a)(4) and 410(b) as though they were a single plan. Art. V 36 41 Also, if a PARTICIPANT who is a HIGHLY COMPENSATED EMPLOYEE also participates in other retirement plans sponsored by the EMPLOYER to which employer matching contributions (as defined in CODE sec. 401(m)(4)(A)) or employee contributions are made, then all such contributions made on the PARTICIPANT'S behalf shall be aggregated for the purposes of this Section . However, plans may be aggregated pursuant to this subsection (f) only if they have the same plan year. 5.5 Multiple Use of Alternative Limitation (a) Any provisions of this PLAN to the contrary notwithstanding, if for any PLAN YEAR a multiple use of the alternative limitation occurs with respect to two or more cash or deferred arrangements ("CODA's") and/or plans maintained by the EMPLOYER, such multiple use shall be corrected by reducing the actual deferral percentage ("ADP") or actual contribution percentage ("ACP") of HCE'S who are eligible to participate in such CODA's and/or plans. (b) Multiple use of the alternative limitation occurs if the following conditions are met: (1) one or more HCE'S are eligible to defer compensation pursuant to a CODA subject to CODE sec. 401(k) and sponsored by the EMPLOYER, and also are allocated contributions pursuant to a plan subject to CODE sec. 401(m) and sponsored by the EMPLOYER; and (2) the ADP for the group of HCE'S eligible to defer compensation pursuant to the CODA exceeds 125% of the ADP for the group of non-HCE'S and the ACP for the group of HCE'S allocated contributions pursuant to the PLAN subject to CODE sec. 401(m) exceeds 125% of the ACP for the group of non-HCE'S; and (3) the sum of the ADP for the group of HCE'S eligible to defer compensation pursuant to the CODA and the ACP for the group of HCE'S allocated contributions pursuant to the PLAN subject to CODE sec. 401(m) exceeds the "Aggregate Limit". The "Aggregate Limit" is the greater of (A) and (B), where: (A) equals the sum of: (i) 125% of the greater of the ADP or the ACP for the group of non- HCE'S, and (ii) 2 plus the lesser of the ADP or the ACP for the group of non- HCE'S, but not more than 200% of the lesser of the ADP or the ACP for the group of non-HCE'S; and (B) equals the sum of: (i) 125% of the lesser of the ADP or the ACP for the group of non- HCE'S, and Art. V 37 42 (ii) 2 plus the greater of the ADP or the ACP for the group of non- HCE'S, but no more than 200% of the greater of the ADP or the ACP for the group of non-HCE'S. (c) So that there is no multiple use of the alternative limitation, all HCE'S who were eligible to have deferred compensation under the CODA and who were also allocated contributions under an EMPLOYER-sponsored plan subject to CODE sec. 401(m) testing shall have their ADP reduced in the manner described in 26 CFR 1.401(k)-1(f)(2). Art. V 38 43 ARTICLE VI ADMINISTRATION OF PLAN ASSETS 6.1.1 The Investment Fund All funds received by the PLAN pursuant to Article IV, including amounts deposited with the INSURANCE COMPANY under an annuity or insurance contract, shall be credited to the trust fund. The trust fund shall be of a suitable nature to hold the funds and to provide the benefits payable under this PLAN. The PLAN ADMINISTRATOR shall create and maintain adequate records to disclose the interest in the trust fund of each PARTICIPANT or, where appropriate, his BENEFICIARY. Such records shall be in the form of INDIVIDUAL ACCOUNTS, and credits and charges shall be made to such accounts in the manner herein described. These amounts shall be maintained for accounting purposes only and shall not represent any segregated or identifiable portion of the trust fund. All deposits to the trust fund shall be applied for the exclusive benefit of PARTICIPANTS and their BENEFICIARIES, except for such reasonable expenses as may be incurred in the establishment or operation of the PLAN and which are not otherwise paid. Except as provided in Sections 8.1.3 and 8.5, no amounts in the trust fund, nor any earnings attribut able thereto, may ever revert to the EMPLOYER prior to full satisfaction of all liabilities under the PLAN. 6.1.2 EMPLOYEE Directed Investments Amounts held in the trust fund shall be allocated among a variety of investment options made available and selected by the TRUSTEES pursuant to the contract with the INSURANCE COMPANY. Each PARTICIPANT and BENEFICIARY may direct the allocation of the amounts held in the trust fund on his behalf among these investment options. To the extent that the PARTICIPANT or BENEFICIARY does not direct the investment of such amounts received on his behalf, the remainder will automatically be allocated to and invested in one of the investment options available under the INSURANCE COMPANY contract and pursuant to the TRUSTEES' direction. Each PARTICIPANT and BENEFICIARY may elect to redirect the investment of amounts held in the trust fund on his behalf. Any of the above-specified directives to allocate, re-allocate, transfer or remove funds from or among the various investment options shall be effective for the purposes of this PLAN only prospectively after reasonable notice to the INSURANCE COMPANY and subject to any restrictions on the amount or timing of transfers to or from particular investment options, according to the terms of the INSURANCE COMPANY contract or procedures established and uniformly applied by the PLAN ADMINISTRATOR. Art. VI 39 44 6.2 Account Adjustments INDIVIDUAL ACCOUNTS shall be valued as of the last day of each calendar quarter and every other day on which earnings, gains, and losses are credited. Each Active Account shall be credited with earnings, gains, and losses according to the terms of its underlying investments. PLAN expenses described in Section 6.4 shall be allocated at least once in every calendar quarter to INDIVIDUAL ACCOUNTS existing on that allocation date. Each INDIVIDUAL ACCOUNT shall receive an allocation of such expenses in the same proportion that the balance of the INDIVIDUAL ACCOUNT bears to the sum of the balances of all INDIVIDUAL ACCOUNTS. The allocation dates shall be determined according to a uniform, consistent, and nondiscriminatory procedure approved by the PLAN ADMINISTRATOR. For purposes of this Section , Active Account means each INDIVIDUAL ACCOUNT, any Suspense Account, and each other account that can accrue earnings, gains, and losses, such as an account used for holding Forfeitures until they can be applied as provided in Article IV. 6.3 Distribution Adjustments The amount of any distribution from an INDIVIDUAL ACCOUNT maintained on behalf of a PARTICIPANT pursuant to the terms of this PLAN shall be charged against that INDIVIDUAL ACCOUNT as of the date such distribution is made. 6.4 Expenses For any PLAN YEAR, the EMPLOYER may pay the expenses of operating and maintaining the PLAN. Such payment shall be in addition to and independent of any contributions to the PLAN or assets held by the PLAN. Absent prompt and timely payment by the EMPLOYER, the expenses of operating and maintaining the PLAN for the PLAN YEAR shall be allocated to INDIVIDUAL ACCOUNTS pursuant to Section 6.2, EXCEPT that any expenses attributable to the single sum benefit payment fee for a distribution other than at death, TOTAL AND PERMANENT DISABILITY or RETIREMENT shall be directly charged against that PARTICIPANT'S INDIVIDUAL ACCOUNTS. Art. VI 40 45 ARTICLE VII DISTRIBUTIONS 7.1 Termination of Employment (Including Disability) Before RETIREMENT (a) If a PARTICIPANT'S employment as an EMPLOYEE is terminated due to his TOTAL AND PERMANENT DISABILITY, or due to any other reason except his death or RETIREMENT, he may elect to receive his VESTED BENEFIT. To be effective for the purposes of this PLAN, such an election must be delivered in writing to the PLAN ADMINISTRATOR before the ANNUITY STARTING DATE that he has selected. In the election the PARTICIPANT shall specify a form in which the VESTED BENEFIT is to be distributed from among the forms described in Section 7.4, and also an ANNUITY STARTING DATE (see Section 2.2), provided that no distribution under this Section shall be made or commence before the PARTICIPANT'S date of termination as an EMPLOYEE, nor later than the date which would be the PARTICIPANT'S NORMAL RETIREMENT DATE had he not terminated such employment until then. (b) In any event, the PLAN ADMINISTRATOR (or TRUSTEE, as applicable) shall distribute to the PARTICIPANT his entire VESTED BENEFIT in a lump sum as soon as adminis tratively practicable after the time of his termination, provided that as of the ANNUITY STARTING DATE the PARTICIPANT'S VESTED BENEFIT has not ever exceeded $3,500 as of the date of any prior distribution to the PARTICIPANT. If the PARTICIPANT'S entire VESTED BENEFIT equals zero as of the date his SERVICE terminates, then the PARTICIPANT shall be deemed to have received a distribution of his entire VESTED BENEFIT as of that date of termination. (c) Any distribution that is made to a PARTICIPANT pursuant to this Section shall be in lieu of any and all other benefits, present or contingent, to which the PARTICIPANT may be entitled under the terms of this PLAN, with the difference between amount distributed and the sum of all of his INDIVIDUAL ACCOUNTS' balances becoming a Forfeiture as of the ANNUITY STARTING DATE, subject to disposition pursuant to Section 4.1.5. However, if a distribution is made pursuant to this Section to a PARTICIPANT whose Vested Percentage is less than 100%, the PARTICIPANT shall have until the end of a period of five consecutive BREAK IN SERVICE YEARS, or five years after the first date as of which the PARTICIPANT is subsequently reemployed by the EMPLOYER, if earlier, to resume employment as an EMPLOYEE and repay to the PLAN the amount previously distributed, whereupon his INDIVIDUAL ACCOUNT balances shall be restored to the extent of the amounts repaid, plus any amounts forfeited pursuant to Section 4.1.5, provided that in any event such balances shall be restored to not less than the amounts that existed immediately prior to the distribution. 7.2 Death Benefits (a) If a PARTICIPANT who is credited with a VESTED BENEFIT dies prior to the ANNUITY STARTING DATE of his VESTED BENEFIT, then the PLAN shall distribute a death benefit on his behalf. Art. VII 41 46 The amount of the death benefit shall be the actuarial equivalent of his VESTED BENEFIT (after having taken into account any security interest in his VESTED BENEFIT that the PLAN has as a result of any currently outstanding loan to the PARTICIPANT). (b) Unless the PARTICIPANT elects otherwise as provided in subsection (d) below, if the PARTICIPANT has a "surviving spouse" (as such term is defined in this Section below) as of his date of death, the death benefit shall be payable to such surviving spouse. If the PARTICIPANT has no surviving spouse, the death benefit will be paid to the PARTICIPANT'S designated BENEFICIARY. If the PARTICIPANT'S VESTED BENEFIT has always had a lump sum value of $3,500 or less as of the death benefit's ANNUITY STARTING DATE, then that benefit shall be distributed in the form of a lump sum, and the ANNUITY STARTING DATE of that benefit shall be as soon as administratively practicable (in any event, within one year) following the PARTICIPANT'S date of death. (c) "Surviving spouse" means a spouse to whom the PARTICIPANT was married throughout the one-year period ending on the earlier of: (1) the date the PARTICIPANT'S death benefit payments commence under the terms of this PLAN PROVIDED that if the PARTICIPANT was married within one year of the date his benefit payments began and he and his spouse from such marriage were married for at least a one-year period ending on the date of the PARTICIPANT'S death, such PARTICIPANT and such spouse shall be treated as having been married throughout the one-year period ending on the date the PARTICIPANT'S benefit payments began, or (2) the date of the PARTICIPANT'S death. (d) (1) Subject to paragraph (2) below, at any time a PARTICIPANT may elect a specifically designated non-spouse BENEFICIARY to replace his surviving spouse as the BENEFICIARY. He may also at any time revoke such election and make another election. Any such election or revocation shall be in writing and shall be effective upon receipt by the PLAN ADMINISTRATOR. (2) An election by a PARTICIPANT pursuant to paragraph (1) shall not take effect unless: (A) the PARTICIPANT'S spouse, in a writing received by the PLAN ADMINIS TRATOR and witnessed by the PLAN ADMINISTRATOR or a notary public, acknowledges the effect of and consents to the PARTICIPANT'S election; or (B) it is established to the PLAN ADMINISTRATOR'S satisfaction that the spousal consent described in (A) above cannot be obtained because there is no spouse, because the spouse cannot be located, or because of other circumstances which render obtaining such spousal consent impossible. Art. VII 42 47 (e) The PARTICIPANT'S death benefit shall be distributed to the surviving spouse or other designated BENEFICIARY in the form of a lump sum, and the ANNUITY STARTING DATE of that benefit shall be as soon as administratively practicable (in any event, within one year) following the PARTICIPANT'S date of death. However, the person to whom that benefit is to be distributed, whether the surviving spouse or other designated BENEFICIARY, may elect to have the death benefit distributed in any other form of benefit described in Section 7.4 and not precluded thereby. To be effective for the purposes of this PLAN, such an election must be in writing, and must be received by the PLAN ADMINISTRATOR prior to the death benefit's ANNUITY STARTING DATE. Given such an election, the ANNUITY STARTING DATE for the death benefit would then occur within 90 days after receipt of that election. In any event, any death benefit payable pursuant to this Section shall commence or be distributed not later than the time period described in (1) or (2) below, as appropriate: (1) if payable to a surviving spouse (or child of the PARTICIPANT, as provided below), not later than December 31 of the calendar year in which the PARTICIPANT would have attained 70 1/2; or (2) if payable to any other BENEFICIARY, not later than the first anniversary of the PARTICIPANT'S death; PROVIDED that, if said spouse or BENEFICIARY cannot be located within the applicable time period specified above, the PLAN ADMINISTRATOR may delay commencement or distribution of payments for a period ending not later than the first day of the first month beginning after the sixtieth day following the date on which such spouse or BENEFICIARY has been identified and located by the PLAN ADMINISTRATOR and the PLAN ADMINISTRATOR has received any necessary docu mentation of death. A death benefit payable to any surviving child of the PARTICIPANT shall be treated as if payable to the surviving spouse for purposes of (1) above in this subsection PROVIDED that such benefit will become payable to the surviving spouse as of the date such child reaches age 21 or as of such other time as prescribed by the Secretary of the Treasury under regulations. If a surviving spouse is eligible to receive death benefits under this PLAN, and if that surviving spouse dies prior to the ANNUITY STARTING DATE of those death benefits, then the death benefits to which the deceased spouse had been entitled shall be payable on his or her behalf within such a time-frame as would be appro priate if the deceased spouse had been the PARTICIPANT, with the date of death of the surviving spouse being substituted for the PARTICIPANT'S. However, the exceptions provided in CODE sec. 401(a)(9)(B)(iv) shall not be available regarding any surviving spouse of the PARTICIPANT'S surviving spouse. (f) If a PARTICIPANT dies after his VESTED BENEFIT has been distributed in the form of a lump sum, there shall be no benefit payable from the PLAN as a result of his death. If his VESTED BENEFIT has been distributed in the form of an annuity, any benefit payable as a result of his death shall be determined solely under the terms of the annuity that was distributed, provided that the remaining portion of such Art. VII 43 48 benefit, if any, shall be distributed to the beneficiary at least as rapidly as provided in the terms of said annuity but in any event consistent with CODE sec. 401(a)(9)(B). If a PARTICIPANT dies while receiving the Payments from Account described in Section 7.4 before his entire VESTED BENEFIT has been distributed, his surviving spouse or BENEFICIARY may elect in writing to the PLAN ADMINISTRATOR to receive the previously undistributed portion of such VESTED BENEFIT in the form of a lump sum; in any event, the remaining portion of such benefit, if any, shall be distributed at least as rapidly as under the terms of said Payments from Account in effect for the PARTICIPANT at death. 7.3 RETIREMENT A PARTICIPANT, regardless of his status as an EMPLOYEE, shall have attained RETIREMENT Age when he has attained age 65, which shall be his NORMAL RETIREMENT AGE. A PARTICIPANT who has attained RETIREMENT Age may retire by designating in writing to the PLAN ADMINISTRATOR a RETIREMENT DATE, which shall be his RETIREMENT benefit's ANNUITY STARTING DATE, and which may be the first day of any month after he has attained NORMAL RETIREMENT AGE, but not later than the latest date permitted by the provisions of Section 7.5 regarding Commencement of Payments. This latter date shall be the RETIRE MENT DATE of any PARTICIPANT who has not, prior thereto, designated a RETIREMENT DATE. If the date on which the PARTICIPANT attains NORMAL RETIREMENT AGE is the first day of a month, that date shall be his NORMAL RETIREMENT DATE. Otherwise, the PARTICIPANT'S NORMAL RETIREMENT DATE shall be the first day of the first month following his attainment of NORMAL RETIREMENT AGE. Upon RETIREMENT, a PARTICIPANT shall commence to receive his VESTED BENEFIT as provided in Section 7.5. 7.4 Form of RETIREMENT Benefit (a) Unless an optional form of benefit has been selected pursuant to subsection (b) below, the RETIREMENT benefit payable to a PARTICIPANT at the time of his RETIRE MENT shall be the actuarial value of his VESTED BENEFIT distributed in the form of a Lump Sum, which is a single payment in an amount equal to the PARTICIPANT'S VESTED BENEFIT. (b) A PARTICIPANT may elect to waive receipt of his RETIREMENT benefit in the form of a Lump Sum, and instead to receive his RETIREMENT benefit in one of the following forms. (1) Annuity for a Period Certain - monthly income payable for a certain period elected by the PARTICIPANT of not more than 240 months. If the PARTICIPANT dies after his RETIREMENT DATE, or if the PARTICIPANT'S surviving spouse (or other BENEFICIARY designated according to Section 7.5(b)) dies after commencement of payments, but before the end of the certain period, payments will commence or be continued for the remainder of the certain period to the PARTICIPANT'S surviving spouse or other BENEFICIARY (or, if the Art. VII 44 49 annuity is distributed pursuant to Section 7.2, to a BENEFICIARY designated by the PARTICIPANT'S surviving spouse or BENEFICIARY, as applicable,) PROVIDED, however, that the certain period elected shall not extend beyond (1) the life expectancy of the PARTICIPANT, (2) the life expectancies of the PARTICIPANT and his surviving spouse or designated BENEFICIARY, as applicable, (3) if payable pursuant to Section 7.2, the life expectancy of the surviving spouse or designated BENEFICIARY, as applicable, or (4) 60 months, if by operation of Section 8.6 the PARTICIPANT'S BENEFICIARY is his estate. However, this optional form may be elected only if the amount of monthly benefit payable to the PARTICIPANT would exceed 50% of the amount he would receive in the form of a straight life annuity. (2) Partial Distributions - payments in an amount specified by the PARTICIPANT, except that the amount of each distribution may not be less than $1,000. (c) Solely for the purposes of distributing to a PARTICIPANT his VESTED BENEFIT where such distribution has not occurred prior to his REQUIRED BEGINNING DATE (see Section 7.5(d)(2) below), the PARTICIPANT may elect to receive the distribution to commence as of his REQUIRED BEGINNING DATE in the form of Payments from Account, rather than in one of the forms of RETIREMENT benefit payment already provided by this Article VII. Payments from Account shall mean periodic payments in an amount specified by the PARTICIPANT or his surviving spouse or other BENEFICIARY designated according to Section 7.5(b) continuing until such time as the PARTICIPANT'S VESTED BENEFIT (adjusted for subsequent Net Adjustments) is exhausted, PROVIDED however that the period over which said payments are to be made shall not extend beyond (1) the life expectancy of the PARTICIPANT, (2) the life expectancies of the PARTICIPANT and his surviving spouse or other designated BENEFICIARY, (3) if payable pursuant to Section 7.2, the life expectancy of the surviving spouse or other designated BENEFICIARY, or (4) 60 months, if by operation of Section 8.6 the PARTICIPANT'S BENEFICIARY is his estate. 7.5 RETIREMENT Benefits: Election of Forms and Commencement of Payments (a) Applicability of this Section In the case of a PARTICIPANT who will receive a distribution pursuant to Section 7.1 due to his termination of employment before his attainment of RETIREMENT Age, the form of the distribution and the time of commencement of payments will be as provided in that section. The form and time of commencement of death benefits payable to BENEFICIARIES shall be governed according to Section 7.2. The form and time of commencement of any other benefits payable pursuant to this PLAN will be determined according to this section and Section 7.4. In any event, all distributions required under this Section shall be determined and made in accordance with the Income Tax Regulations under CODE sec. 401(a)(9), including the minimum distribution incidental benefit requirement of sec. 1.401(a)(9)-2 of the regulations. Art. VII 45 50 (b) Election A PARTICIPANT may elect to name a person as BENEFICIARY or to replace the person currently designated by him or this PLAN to be his BENEFICIARY. Such an election may be revoked and replaced with another such election. However, to be effective for the purposes of this PLAN, any such an election or revocation must be made in writing and received by the PLAN ADMINISTRATOR within ninety (90) days before the PARTICIPANT'S ANNUITY STARTING DATE, and must satisfy the spousal consent requirements described in subsection (c) below, and must specifically designate the form in which the benefits shall be paid. In addition, if the election is to replace the person currently designated by the PARTICIPANT pursuant to this PLAN (or if there is no such designation by the PARTICIPANT, then the person (if any) designated by this PLAN) to be his BENEFICIARY, then the election must specifically designate the person who is to become the BENEFICIARY. (c) Spousal Consent An election by a PARTICIPANT to name a BENEFICIARY other than his spouse or to change his BENEFICIARY shall not have any effect for the purposes of this PLAN unless: (1) the PARTICIPANT'S spouse, in a writing received by the PLAN ADMINISTRATOR, acknowledges the effect of and consents to the PARTICIPANT'S election within 90 days before the ANNUITY STARTING DATE, and the writing is witnessed by the PLAN ADMINISTRATOR or a notary public; or (2) it can be established to the PLAN ADMINISTRATOR'S satisfaction that spousal consent cannot be obtained because there is no spouse, or because the spouse cannot be located, or because of other circumstances which render obtaining such spousal consent impossible. Any consent by a spouse (or establishment that the consent of the spouse cannot be obtained) pursuant to this subsection shall be effective only with respect to such spouse. (d) Commencement of Payments (1) Unless a PARTICIPANT otherwise elects in a writing received by the PLAN ADMINISTRATOR prior to the PARTICIPANT'S ANNUITY STARTING DATE, payment of the PARTICIPANT'S VESTED BENEFIT shall begin not later than the 60th day after the close of the PLAN YEAR in which occurs the latest of: (A) the PARTICIPANT'S attainment of NORMAL RETIREMENT AGE; (B) the 10th anniversary of the date on which the PARTICIPANT commenced participation in this PLAN; or (C) the PARTICIPANT'S termination of employment as an EMPLOYEE, provided that if the PARTICIPANT has failed to provide the PLAN ADMINISTRATOR with sufficient information as to age and marital status or any other relevant Art. VII 46 51 information, so that the amounts of payment may not be determined, or if the PARTICIPANT cannot be located, then the PLAN ADMINISTRATOR may delay commencement of payments for not more than 60 days after the earliest date on which the amount and form of payment may be determined under the terms of this PLAN, or the PARTICIPANT is located. The amount of payment in the event of such a delay shall be retroactive to the PARTICIPANT'S RETIREMENT DATE. Notwithstanding any provisions of this paragraph (1) to the contrary, the failure of a PARTICIPANT and the PARTICIPANT'S spouse to consent to the distribution of a benefit while that benefit is immediately distributable pursuant to this Section shall be deemed to be an election to defer commencement of payment of that benefit. (2) Any provisions of this PLAN to the contrary notwithstanding, the entire vested interest of the PARTICIPANT in benefits under this PLAN: (A) will be distributed to the PARTICIPANT not later than the PARTICIPANT'S REQUIRED BEGINNING DATE, or (B) will be distributed, beginning not later than the PARTICIPANT'S REQUIRED BEGINNING DATE, over the life of the PARTICIPANT or over the lives of the PARTICIPANT and a designated beneficiary (or over a period not extending beyond the life expectancy of the PARTICIPANT or the life expectancy of the PARTICIPANT and a designated beneficiary). For the purpose of determining the amount to be distributed as of the PARTICIPANT'S REQUIRED BEGINNING DATE, his VESTED BENEFIT shall be valued as of December 31 of the calendar year immediately preceding his REQUIRED BEGINNING DATE. The PARTICIPANT may elect for these required distributions to be paid in any of the forms of benefit described in Section 7.4, subject to any spousal consent requirements that may apply pursuant to this PLAN. Absent such an election, these distributions automatically shall be payable in the form described in Section 7.4(a). (3) If a PARTICIPANT'S interest is to be distributed in a form other than a Lump Sum, the following minimum distribution rules shall apply on or after the PARTICIPANT'S REQUIRED BEGINNING DATE. (A) If the PARTICIPANT'S benefit is to be distributed over (1) a period not extending beyond the life expectancy of the PARTICIPANT or the joint life and last survivor expectancy of the PARTICIPANT and the PARTICIPANT'S Beneficiary, or (2) a period not extending beyond the life expectancy of the Beneficiary, then the amount required to be distributed for each calendar year, beginning with distributions for the first distribution calendar year, must at least equal the quotient obtained by dividing the PARTICIPANT'S benefit by the applicable life expectancy. Art. VII 47 52 (B) For calendar years beginning before January 1, 1989, if the PARTICIPANT'S spouse (if any) is not the Beneficiary, the method of distribution selected must assure that at least 50% of the present value of the amount available for distribution is paid within the life expectancy of the PARTICIPANT. (C) For calendar years beginning after December 31, 1988, the amount to be distributed each year, beginning with distributions for the first distribution calendar year, shall not be less than the quotient obtained by dividing the PARTICIPANT'S benefit by the lesser of (1) the applicable life expectancy, or (2) if the PARTICIPANT'S spouse (if any) is not the Beneficiary, the applicable divisor determined from the table set forth in Q&A-4 of section 1.401(a)(9)-2 of the Income Tax Regulations. Distributions after the death of the PARTICIPANT shall be distributed using the applicable life expectancy referenced in subsection (3)(A) above as the relevant divisor without regard to Regulations sec. 1.401(a)(9)-2. (D) The minimum distribution required for the PARTICIPANT'S first distribution calendar year must be made on or before the PARTICIPANT'S REQUIRED BEGINNING DATE. The minimum distribution for other calendar years, including the minimum distribution for the distribution calendar year in which the PARTICIPANT'S REQUIRED BEGINNING DATE occurs, must be made on or before December 31 of that distribution calendar year. If the PARTICIPANT'S benefit is distributed in the form of an annuity purchased from an INSURANCE COMPANY, any such distribution shall be made in accordance with the requirements of CODE sec. 401(a)(9) and the regulations promulgated thereunder. (4) Any additional amounts of VESTED BENEFIT accrued by the PARTICIPANT after his REQUIRED BEGINNING DATE shall be distributed annually in the form of a lump sum consistent with the requirements of CODE sec. 401(a)(9) and applicable regulations. (5) Once distributions have begun to a 5% owner under this subsection, they must continue to be distributed even if the PARTICIPANT ceases to be a 5% owner in a subsequent year. (6) For the purposes of this subsection, "applicable life expectancy" means the life expectancy (or joint and last survivor expectancy) calculated using the attained age of the PARTICIPANT (or designated beneficiary) as of the PARTICIPANT'S (or designated beneficiary's) birthday in the applicable calendar year reduced by one for each calendar year which has elapsed since the date the life expectancy was first calculated. If the life expectancy is being recalculated, the applicable life expectancy shall be the life expectancy as so recalculated. Art. VII 48 53 The applicable calendar year shall be the first distribution calendar year, and if the life expectancy is being recalculated, each such succeeding calendar year. If annuity payments commence before the REQUIRED BEGINNING DATE, the applicable calendar year is the year such payments commence. If the distribution is in the form of an immediate annuity purchased after the PARTICIPANT'S death with the PARTICIPANT'S remaining VESTED BENEFIT, the applicable calendar year is the year of purchase. (7) Unless otherwise elected by the PARTICIPANT (or spouse, as applicable) by the time distributions are required to begin, life expectancies shall be recal- culated annually. If such an election has been made by the PARTICIPANT (or spouse, as applicable), it shall be irrevocable as to the PARTICIPANT (or spouse) and shall apply to all subsequent years. The life expectancy of a nonspouse beneficiary may not be recalculated. 7.6 Loans to PARTICIPANTS Each PARTICIPANT and BENEFICIARY may apply to obtain loans from the PLAN according to the procedures and limits described below. (a) Any application for a loan may only be made in writing, and will become effective only upon receipt by the PLAN ADMINISTRATOR. The principal amount of the loan requested may not be less than one thousand dollars ($1,000.00). (b) The PLAN ADMINISTRATOR may choose to grant or deny the request in a reasonably equivalent and nondiscriminatory manner, consistent with the requirements of section 401 (and all other relevant provisions) of the Internal Revenue Code, as amended. However, under no circumstances shall a loan be made by this PLAN to any person who is or is deemed to be (or has as a member of his immediate family) an "owner-employee" (as defined in CODE 4975(d)) or a "shareholder-employee" of an S Corporation (as defined in CODE secs. 4975(d) and 1379(d)). (c) If the request is granted and an amount is loaned to the PARTICIPANT or BENEFICIARY (hereinafter "the Borrower"), the resulting liability of the Borrower for repayment of the loan to the PLAN shall be accounted through the establishment of a Segregated Investment Fund into which the principal amount of the loan shall be entered as of the date on which the amount of the loan is provided to the Borrower. Any such loan shall be treated as a directed investment by the Borrower of PLAN assets separate and apart from the Investment Fund of the INSURANCE COMPANY or any other assets of the PLAN. As such, any earnings, gains or losses attributable to the loan shall be credited only to the Segregated Investment Fund representing that loan, and shall in turn be allocated solely to the Borrower's Individual Accounts. (d) Each loan shall bear interest at a reasonable fixed rate established by the PLAN ADMINISTRATOR with reference to the economic conditions and interest rates being Art. VII 49 54 charged by local financial institutions for similar loans with similar collateral as of the time when the loan request is being processed. In addition, the PLAN ADMINISTRATOR may require the Borrower to pay any administrative fees that are deemed to be necessary to establish or maintain the Segregated Investment Fund, provided that all such fees or fee schedules shall be disclosed to the Borrower at the time the loan is made and again prior to any modification of such fees or schedules by the PLAN ADMINISTRATOR (which may be enacted by the PLAN ADMINISTRATOR at any time that the PLAN ADMINISTRATOR determines that such modification is appropriate, in the exercise of his or her fiduciary duty), and further provided that the ability to obtain loans from the PLAN shall remain available to all Borrowers on a reasonably equivalent basis. Loans shall not be made available to HCE'S in an amount greater than the amount made available to non-HCE'S; however, maximum loan amounts may vary directly according to the size of each PARTICIPANT'S vested accrued benefit under this PLAN. Each amount received in repayment of the loan shall be credited to the Borrower's Segregated Investment Fund as of the day on which it was received by the PLAN ADMINISTRATOR, after its having first been reduced by any administrative fees charged by the PLAN ADMINISTRATOR pursuant to the preceding paragraph. (e) Each loan shall be evidenced by a negotiable promissory note signed by the Borrower within 90 days before the loan is made, and secured by a portion of the Borrower's Vested Benefit, with such portion equal to the amount that is loaned to the Borrower at the time of the loan's origination. The note shall state that in the event of the Borrower's default on the loan, the Borrower agrees to be bound by the provisions of this PLAN, and particularly of this Section. The PLAN ADMINISTRATOR, in the exercise of his sole discretion, may require that additional security or documentation be provided by the Borrower. (f) Immediately after the origination of any PLAN loan to the Borrower, the total amount of the outstanding balances of all loans made to the Borrower from this PLAN may not exceed the lesser of: (1) 50% of the present value of the Borrower's vested interest in amounts held under the PLAN on the Borrower's behalf (determined immediately after the loan's origination); or (2) $50,000, reduced by the excess (if any) of: (A) the highest outstanding balance of all loans to the Borrower, under all qualified retirement plans maintained by the EMPLOYER, during the one-year period ending on the day before the date as of which the most recent loan was made, over (B) the outstanding balance of all loans to the Borrower, under all qualified retirement plans maintained by the EMPLOYER, on the date as of which the most recent loan was made. Art. VII 50 55 For the purposes of this subsection (f), "EMPLOYER" shall be as defined in Article II, and in addition shall mean any other employers which when taken together with the EMPLOYER(S) sponsoring this PLAN are treated as a single employer under section 414(b), (c) or (m) of the Internal Revenue Code, as amended. For the purposes of this subsection (f), simplified employee pension plans shall not be regarded as qualified retirement plans. (g) Each loan shall be subject to substantially level amortization with payments at least quarterly. (h) Each loan shall be distributed (if at all) as soon as reasonably practicable, but in any event not later than 90 days after the date on which the PLAN ADMINISTRATOR receives the prescribed loan request. (i) Whenever possible, loans shall be repaid to the PLAN through periodic payroll deductions from the Borrower's COMPENSATION (if any). (j) With the consent of the PLAN ADMINISTRATOR, the Borrower may at any time prepay an amount against the outstanding balance of the loan; however, unless the entire outstanding balance is prepaid, repayment installments must continue to be made periodically according to the pre-arranged repayment schedule. Provided the PLAN ADMINISTRATOR consents, a Borrower may refinance any loan that he has outstanding from the PLAN. The procedures and limits applying to refinancing a loan shall be substantially the same as those prescribed herein for obtaining a loan. (k) At any time before it has been completely repaid (including principal and interest), a loan under this PLAN shall be in default as of the earlier of: (1) the day immediately following the date on which any periodic installment payment required under the Promissory Note is not received by the holder of the Note when due; (2) the date as of which any amount becomes distributable to a Borrower from the PLAN, including for example the Borrower's date of RETIREMENT, but only to the extent that such distribution would result in the loan balance equaling more than the Borrower's vested interest in the PLAN'S assets after such distribution; or (3) the fifth anniversary of the date on which the amount of the loan was paid from the PLAN to the Borrower. (l) If the PLAN ADMINISTRATOR as holder of the Promissory Note determines that a loan under this PLAN is in default, then at the option of the PLAN ADMINISTRATOR, the Borrower may be given a reasonable amount of time (in any event not exceeding 60 days) to cure the default by repaying all amounts that have become due as of that date. Art. VII 51 56 If the default results from a distribution of excess elective deferrals (pursuant to CODE sec. 402(g)(2)), excess contributions (pursuant to CODE sec. 401(k)(8)), or excess aggregate contributions (pursuant to CODE sec. 401(m)(6)), if any, then the Borrower may cure the default by repaying to the PLAN an amount sufficient to reduce the outstanding balance of the loan to an amount equal to not more than the Borrower's vested interest in PLAN Assets remaining after such distribution. (m) In addition, as of the date of such default, the PLAN shall immediately stop accepting elective deferrals (if any) on that Borrower's behalf until such time as the loan is no longer in default. (n) If there is security for the loan available in addition to or instead of the Borrower's vested interest in PLAN assets, then upon default, the holder of the Promissory Note may (but is not required to) look to that other security for liquidation and repayment of the loan. (o) To the extent that a default of a loan is not cured or is not repaid through security other than the Borrower's vested interest in the PLAN'S assets, then the PLAN ADMINISTRATOR shall reduce the Borrower's vested interest in the PLAN'S assets. The amount of such reduction shall equal the outstanding balance of the loan, including any interest that has accrued as of that date of determination, except that if the default has resulted from a distribution of PLAN assets that has been made to bring the PLAN into compliance with any of the nondiscrimination limits and tests of the CODE (as specified e.g. in CODE secs. 401(k), 401(m), or 415), then the amount of the reduction shall equal only that amount which is necessary to cure the default by reducing the outstanding balance of the loan to an amount equal to the Borrower's vested interest in the PLAN'S assets as of that date of determination and after the distribution has been made. Any reduction in a Borrower's vested interest in PLAN assets accomplished pursuant to this paragraph shall immediately result in a corresponding reduction and offset of the outstanding balance of the loan as of that date of determination. However, under any circumstances, a Borrower's vested interest in the PLAN'S assets may not be reduced pursuant to this subsection (o) sooner or to a greater extent than such amounts become distributable consistent with the provisions of CODE sec. 401(k), all other relevant CODE sections, and regulations promulgated thereunder. (p) In the event that a loan from this PLAN to a Borrower is treated as a distribution under CODE sec. 72, and/or under applicable Department of Labor regulations, the Borrower's obligation to repay the loan shall remain unchanged by such distribution treatment. (q) When the Borrower is no longer indebted under the Promissory Note (e.g. due to the complete repayment of the loan, or due to recovery of the loan's security upon default), the Borrower's Segregated Investment Fund shall then be closed. Art. VII 52 57 ARTICLE VIII GENERAL PROVISIONS 8.1.1 PLAN Modification: Authority The COMPANY reserves the right to amend, modify, or terminate the PLAN at any time, provided that no amendment or modification shall act to reduce the balances of the INDIVIDUAL ACCOUNTS of any PARTICIPANT accrued to the time of such amendment or modification. 8.1.2 PLAN Modification: Merger No merger, consolidation, or transfer of the assets or liabilities of this PLAN with or to any other qualified plan shall be undertaken unless, after such merger, consolidation, or transfer, each PARTICIPANT would, if the PLAN then terminated, receive a benefit not less than the benefit he would have received had the PLAN terminated immediately prior to such merger, consolidation, or transfer. 8.1.3 PLAN Modification: Termination Upon termination or partial termination of this PLAN, or the complete discontinuance of contributions by the EMPLOYER (as defined in CODE secs. 1.401-6(c) and 1.411(d)-2(d)), the rights of each affected PARTICIPANT to benefits accrued to the date of termination or partial termination, or the complete cessation of contributions by the EMPLOYER, shall be fully vested to the extent funded. Distributions due to termination shall be made in a form provided for in this PLAN and shall meet any applicable requirements of CODE secs. 401(a)(11), 411, and 417. However, Elective Contributions shall be distributed because of PLAN termination only if the EMPLOYER does not establish or maintain a successor plan within the meaning of IRC Reg. 1.401(k)-(l)(d)(3) or because of other events described in IRS Reg. 1.401(k)-(l)(d)(1)(iii), (iv), and (v). If, after the allocation of the PLAN'S assets pursuant to the PLAN'S termination, all liabilities of the PLAN have been satisfied in full and there remain surplus PLAN assets not necessary to satisfy the liabilities of the PLAN, such surplus shall revert to the EMPLOYER, consistent with the provisions of the termination amendment of this PLAN. 8.2.1 Duties: PLAN ADMINISTRATOR The PLAN ADMINISTRATOR has the discretionary authority to control and manage the operation and administration of the PLAN, including the specific duties outlined below. The PLAN ADMINISTRATOR in his sole discretion shall make such rules, regulations, interpretations, and computations and shall take such other actions to administer the PLAN as he may deem appropriate. Such rules, regulations, computations, and other actions shall be conclusive and binding upon all persons. Duties of the PLAN ADMINISTRATOR include, but are not limited to, determination of benefits and eligibility to participate, payment of funds to the INSURANCE COMPANY or TRUSTEE, authorization of benefit payments and payment of any expenses incurred in the Art. VIII 53 58 administration of the PLAN. The PLAN ADMINISTRATOR may employ such consultants and advisors as he deems necessary or desirable for carrying out his duties under the PLAN. 8.2.2 Duties: EMPLOYER Duties of the EMPLOYER include, but are not limited to, payment of funds to the INSURANCE COMPANY or TRUSTEE, in addition to payment of any expenses incurred in the administration of the PLAN. The EMPLOYER shall indemnify and hold harmless any fiduciary who is an employee of the EMPLOYER from any and all claims, loss, damages, expense (including counsel fees), and liability (including amounts paid in settlement with the EMPLOYER'S written consent) arising from any act or omission of the fiduciary, except when the same is judicially determined to be done due to the gross negligence or willful misconduct of the fiduciary. 8.3 Benefit Claims Procedure Any PARTICIPANT in this PLAN, or his BENEFICIARY, may make a claim for benefits due to him under this PLAN by delivering a written application to the PLAN ADMINISTRATOR. If a claim is wholly or partially denied, notice of the decision shall be furnished to the claimant by the PLAN ADMINISTRATOR within 90 days after receipt of the claim by the PLAN ADMINISTRATOR unless special circumstances require an extension of time for processing the claim. If an extension of time is required the PLAN ADMINISTRATOR shall furnish the claimant with written notice of that fact, including the reason why an extension is required and an estimated date upon which a final decision is expected, which shall be not later than 180 days after the claim was made. In that event, if the claim is denied in whole or part, written notice of denial shall be given as soon as practicable, but not later than 180 days after the claim was made. A notice of denial of a claim shall state: (a) the specific reason or reasons for the denial; (b) reference to the specific PLAN provisions upon which the denial was based; and (c) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such additional material or information is required. If this notice is not furnished within the time provided in this Section, the claim shall be deemed wholly denied. 8.4 Review Procedure In the event that a claim is denied under this PLAN, the claimant or his authorized representative may apply in writing to the PLAN ADMINISTRATOR within 60 days of receiving notice of the denial or, if no written notice of denial is received within the 180-day period prescribed in Section 8.3, within 60 days after the expiration of said 180 day period, asking that the denial be reviewed. This time limit may be extended by the PLAN ADMINISTRATOR if an extension appears to be reasonable in view of the nature of the claim and the pertinent circumstances. Upon receipt of such application, the PLAN ADMINISTRATOR shall afford the claimant an opportunity to review pertinent documents and to Art. VIII 54 59 submit issues and comments in writing. A decision on review shall be rendered by the PLAN ADMINISTRATOR not later than 60 days after the claimant's application for review unless an extension of time for processing is required, in which case a decision will be made as soon as possible, but not later than 120 days after the request for review was made. If an extension of time is required, the PLAN ADMINISTRATOR shall give the claimant written notice of that fact before the extension period begins. A decision on review shall be in writing and shall include specific reasons for the decision and specific references to the PLAN provisions on which the decision is based. If the claimant has not received written decision on review within 60 days after the request for review was received, or within 120 days if an extension of time was required, the claim will be considered wholly denied on review. 8.5 Qualification of the PLAN and Conditions of Contributions This PLAN, together with any insurance or annuity contracts or trust agreement used in conjunction with it, is intended to meet the requirements of the Internal Revenue Service for approval as a tax-exempt plan or trust under Section 401 of the CODE. Any amend ments which may be necessary to meet these requirements shall be made retroactive to the date upon which the PLAN failed to meet these requirements. This PLAN is adopted with the intent and on the conditions that the Internal Revenue Service shall by ruling or determination letter establish that the PLAN is "qualified" within the meaning of Section 401 of the CODE, that any trust which is part of this PLAN at its adoption is exempt from taxation pursuant to Section 501 of the CODE and that contributions to the PLAN by the EMPLOYER are deductible pursuant to Section 404 of the CODE. If any of these conditions are determined initially by the Internal Revenue Service not to be the case, all contributions to this PLAN made prior to such determination by the Internal Revenue Service shall be returned to the person or persons who made them and the PLAN shall terminate unless the EMPLOYER amends the PLAN to meet these conditions and such amendment is determined by the Internal Revenue Service to meet these conditions, PROVIDED that the application for such determination was made by the time prescribed by law for filing the EMPLOYER'S return for the taxable year in which the PLAN was adopted, or such later date as the Secretary of the Treasury may prescribe. Contributions to this PLAN are made with the intent and on the condition that such contributions are deductible under Section 404 of the CODE. If any contribution by the EMPLOYER is disallowed as a deduction by the Internal Revenue Service then, to the extent the deduction is disallowed, the contribution shall be refunded to the EMPLOYER within one year after the disallowance of the deduction. If any contribution by the EMPLOYER is made by a mistake of fact, such contribution shall be refunded to the EMPLOYER within one year after the payment of the contribution. If a refund occurs pursuant to this Section, the amount which shall be returned to the EMPLOYER shall be the excess of the amount which was contributed over the amount (1) which was deductible, or (2) which would have been contributed absent the mistake of fact (as the case may be), without any earnings but net of any losses attributable to such excess. 8.6 BENEFICIARIES Art. VIII 55 60 Any payments due under the PLAN to a PARTICIPANT'S BENEFICIARY shall be paid according to the BENEFICIARY designation last filed in writing with the PLAN ADMINISTRATOR by the PARTICIPANT. If no such designation is made, payments shall be made in the following order of priority: (a) to the surviving spouse of the PARTICIPANT; (b) if no spouse survives the PARTICIPANT, then to the children of the PARTICIPANT in equal shares, with a share by right of representation to the then surviving children of any deceased child; or (c) if neither a spouse, children nor grandchildren survive the PARTICIPANT, then to the PARTICIPANT'S estate. 8.7 Spendthrift Clause (a) General Rule Subject to the exception specified in subsection (b) below, benefits payable under this PLAN shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution, or levy of any kind, either voluntary or involuntary, including any such liability which is for alimony or other payments for the support of a spouse or former spouse, or for any other relative of the EMPLOYEE, prior to actually being received by the person entitled to the benefit under the terms of the PLAN except as provided below, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, charge or otherwise dispose of any right to benefits payable hereunder shall be void; also, the PLAN shall not in any manner be liable for, nor subject to, the debts, contracts, liabilities, engagements or torts of any person entitled to benefits hereunder. (b) Exception The provisions of subsection (a) above to the contrary shall not withstand a right to a benefit payable under this PLAN that has been created, assigned or recognized pursuant to a "qualified domestic relations order", as defined in CODE sec. 414(p). Administration of the PLAN with respect to qualified domestic relations orders shall at all times be consistent with CODE sec. 414, regulations promulgated thereunder, and any other provisions of state and federal law that may be applicable. Payment of a benefit to an alternate payee pursuant to a qualified domestic relations order may be made prior to the time such payment could be made to the PARTICIPANT, provided that such payment is consistent with the provisions of this PLAN in all respects except for the time of payment. 8.8 OWNER-EMPLOYEES: Other Trades or Businesses If this PLAN provides contributions or benefits for one or more OWNER-EMPLOYEES who control both the business for which this PLAN is established and one or more other trades or businesses, this PLAN and the plan established for the other trades or businesses must, when looked at as a single plan, satisfy CODE secs. 401(a) and (d) for the employees of this and all other trades or businesses. Art. VIII 56 61 If the PLAN provides contributions or benefits for one or more OWNER-EMPLOYEES who control one or more other trades or businesses, the employees of the other trades or businesses must be included in a plan which satisfies CODE secs. 401(a) and (d) and which provides contributions and benefits not less favorable than provided for OWNER-EMPLOYEES under this PLAN. 8.9 Annuities Any provisions of this PLAN to the contrary notwithstanding: (a) any annuity contract distributed from this PLAN shall contain express provisions sufficient to make such contract nontransferable; and (b) the terms of any annuity contract purchased and distributed by the PLAN to a PARTICIPANT or PARTICIPANT'S spouse shall comply and be consistent with the requirements of this PLAN. 8.10 Limitations of the EMPLOYER'S Liability To the extent permitted by law, the liability of the EMPLOYER with respect to any and all obligations arising from or in any way connected with this PLAN shall be limited to amounts already contributed. 8.11 Non-Guarantee of Employment This PLAN shall not be considered to constitute a contract of employment and nothing contained in the PLAN shall give any EMPLOYEE the right to be retained in employment, nor shall anything contained in the PLAN interfere with the EMPLOYER'S right to discharge or retire any EMPLOYEE at any time. Participation in the PLAN shall not give any EMPLOYEE any right or claim in any benefits except as specifically provided in this PLAN. 8.12 Applicable Law The provisions of this PLAN shall be governed, construed, and administered in accordance with federal law, and to the extent that state law is not preempted by federal law, the law of the state of California. Art. VIII 57 62 ARTICLE IX DIRECT ROLLOVERS 9.1 General Rule This Article applies to distributions made on or after January 1, 1993. Notwithstanding any provision of the PLAN to the contrary that would otherwise limit a distributee's election under this Article a distributee may elect, at the time and in the manner prescribed by the PLAN ADMINISTRATOR, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover. 9.2 Definitions (a) Eligible rollover distribution: An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee's designated beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under section 401(a)(9) of the CODE; and the portion of any distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities). (b) Eligible retirement plan: An eligible retirement plan is an individual retirement account described in Section 408(a) of the CODE, an individual retirement annuity described in Section 408(b) of the CODE, an annuity plan described in Section 403(a) of the CODE, or a qualified trust described in Section 401(a) of the CODE, that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity. (c) Distributee: A distributee includes an EMPLOYEE or former EMPLOYEE. In addition, the EMPLOYEE'S or former EMPLOYEE'S surviving spouse and the EMPLOYEE'S or former EMPLOYEE'S spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Section 414(p) of the CODE, are distributees with regard to the interest of the spouse or former spouse. (d) Direct rollover: A direct rollover is a payment by the PLAN to the eligible retirement plan specified by the distributee. Art. IX 58 63 NATIONAL INSURANCE GROUP 401(k) PLAN FIRST AMENDMENT WHEREAS, National Insurance Group, a California corporation ("the Company") has adopted the National Insurance Group 401 (k) Plan ("the Plan") which became effective July 1, 1996; and WHEREAS, the Company has the authority to amend the Plan pursuant to Section 8.1.1 of the Plan; and WHEREAS, the Company desires to permit Participants to change the amount of Elective Contributions each quarter; NOW, THEREFORE, the Plan is hereby amended pursuant to the authority stated in Section 8.1.1 of the Plan to read as set forth on the attached page, which is incorporated herein by reference as follows: ARTICLE IV CONTRIBUTIONS Section 4.2.1 Elective Contributions: Amount For illustrative purposes, the new provisions have been underlined, but only for the purposes of this Amendment; their final form within the Plan shall not include the underlining. This Amendment shall be effective July 1, 1996. It is effective with respect to Employees who terminate employment with the Employer on or after the effective date of the Amendment so that the rights to benefits from the Plan, if any, of Employees who terminated employment before that date shall be determined according to the Plan as it was on the date they terminated employment, except as may be otherwise specifically provided in this Amendment, and except to the extent required by law. This Amendment is adopted on condition that the Internal Revenue Service does not ever determine, by ruling or determination letter, that this Amendment would result in the Plan's failure to be "qualified" in the meaning of Section 401 (a) of the Internal Revenue Code of 1986, as amended, and exempt from taxation under Section 501 (a) of the Code. If the Internal Revenue Service does determine that this Amendment would disqualify the Plan and it appears that no modification to it which would be satisfactory to the Employer would also be acceptable to the Service, then the Amendment shall be void and of no effect. ADOPTED this 15th day of October 1996. NATIONAL INSURANCE GROUP, a California corporation By: /s/ Robert P. Barbarowicz ------------------------------ Robert P. Barbarowicz ------------------------------ Print or TYPE NAME Title: Executive Vice President ------------------------------ 64 otherwise paid to the EMPLOYER. In addition, each Elective Contribution shall be paid to the PLAN by the EMPLOYER no later than the last day of the twelve-month period immediately following the PLAN YEAR with respect to which the contribution is made. (b) Election A PARTICIPANT may elect to change the amount of his elective deferrals, and therefore the amount of the Elective Contributions made on his behalf, within the limits prescribed in subsection (a) above. A PARTICIPANT may also elect to cease his elective deferrals and Elective Contributions altogether, or, having done so, may elect to recommence them. A PARTICIPANT'S election to commence, recommence or to change the amount of his elective deferrals may become effective only as of the first day of any prospective calendar quarter. A PARTICIPANT'S election to cease his elective deferrals altogether may become effective only as of the first day of any prospective payroll period. Any of the provisions of this subparagraph (b) to the contrary notwithstanding, any election described by this subparagraph (b) regarding elective deferrals may become effective only after written notice delivered to the PLAN ADMINISTRATOR within a reasonable time prior to the effective date of the election. (c) Limit on Amount The total sum of any PARTICIPANT'S elective deferrals for any taxable year of the PARTICIPANT may not exceed the limit prescribed by IRC Reg. 1.402(g)-l(c). (Generally, for taxable years beginning in 1996, that limit equals $9,500, except for adjustments made to take into account elective deferrals made to annuity contracts under CODE sec. 403(b)). For the purposes of this subsection (c), "elective deferrals" has the meaning defined in IRC Reg. 1.402(g)-l (b), including (but not limited to) Elective Contributions received by this PLAN on the PARTICIPANT'S behalf. For any PARTICIPANT, if this limit on elective deferrals is exceeded, then the following corrective measures are permitted. (1) The PARTICIPANT may notify the PLAN ADMINISTRATOR of the excess deferral, and may request that the PLAN ADMINISTRATOR distribute to the PARTICIPANT an amount not exceeding the lesser of: (A) the amount of the excess deferral, plus all income allocable to the excess deferral; 65 PARTICIPATION AGREEMENT For Participation by Controlled Group Members By executing this Participation Agreement, Pinnacle Data Corporation ("Participating Employer"), elects to become a participating employer in the National Insurance Group 401 (k) Plan (the "Plan"), as if the Participating Employer were a signatory to that Plan. The Participating Employer accepts, and agrees to be bound by, all of the provisions of the Plan as made by National Insurance Group, a California corporation, the signatory Employer to the Execution Page of the Plan. 1. The Effective Date of the Participating Employer's participation in the designated Plan is July 1, 1996. 2. The Participating Employer's adoption of this Plan constitutes the adoption of a new plan by the Participating Employer. Dated this 8th day of November 1996. Participating Employer: Pinnacle Data Corporation By: /s/ Gerry Gauer ------------------------------- Title: Senior Vice President - Operations ------------------------------- Acceptance by the signatory Employer to the Execution Page of the Plan on this 8th day of November, 1996 Signatory Employer: National Insurance Group By: /s/ Robert P. Barbarowicz ------------------------------ Title: Executive Vice President ------------------------------ 66 PARTICIPATION AGREEMENT For Participation by Controlled Group Members By executing this Participation Agreement, Great Pacific Insurance Company ("Participating Employer"), elects to become a participating employer in the National Insurance Group 401 (k) Plan (the "Plan"), as if the Participating Employer were a signatory to that Plan. The Participating Employer accepts, and agrees to be bound by, all of the provisions of the Plan as made by National Insurance Group, a California corporation, the signatory Employer to the Execution Page of the Plan. 1. The Effective Date of the Participating Employer's participation in the designated Plan is July 1, 1996. 2. The Participating Employer's adoption of this Plan constitutes the adoption of a new plan by the Participating Employer. Dated this 8th day of November 1996. Participating Employer: Great Pacific Insurance Company By: /s/ R.J. Lelieur ------------------------------- Title: Vice President ------------------------------- Acceptance by the signatory Employer to the Execution Page of the Plan on this 8th day of November , 1996 Signatory Employer: National Insurance Group By: /s/ Robert P. Barbarowicz ------------------------------ Title: Executive Vice President ------------------------------ 67 PARTICIPATION AGREEMENT For Participation by Controlled Group Members By executing this Participation Agreement, Fastrac Systems, Inc. ("Participating Employer"), elects to become a participating employer in the National Insurance Group 401 (k) Plan (the "Plan"), as if the Participating Employer were a signatory to that Plan. The Participating Employer accepts, and agrees to be bound by, all of the provisions of the Plan as made by National Insurance Group, a California corporation, the signatory Employer to the Execution Page of the Plan. 1. The Effective Date of the Participating Employer's participation in the designated Plan is July 1, 1996. 2. The Participating Employer's adoption of this Plan constitutes the adoption of a new plan by the Participating Employer. Dated this 8th day of November 1996. Participating Employer: Fastrac Systems, Inc. By: /s/ R. J. Lelieur ------------------------------- Title: Vice President ------------------------------- Acceptance by the signatory Employer to the Execution Page of the Plan on this 8th day of November , 1996 Signatory Employer: National Insurance Group By: /s/ Robert P. Barbarowicz ------------------------------ Title: Executive Vice President ------------------------------ 68 PARTICIPATION AGREEMENT For Participation by Controlled Group Members By executing this Participation Agreement, Fastrac Systems, Inc. Insurance Agent & Broker ("Participating Employer"), elects to become a participating employer in the National Insurance Group 401 (k) Plan (the "Plan"), as if the Participating Employer were a signatory to that Plan. The Participating Employer accepts, and agrees to be bound by, all of the provisions of the Plan as made by National Insurance Group, a California corporation, the signatory Employer to the Execution Page of the Plan. 1. The Effective Date of the Participating Employer's participation in the designated Plan is July 1, 1996. 2. The Participating Employer's adoption of this Plan constitutes the adoption of a new plan by the Participating Employer. Dated this 8th day of November 1996. Participating Employer: Fastrac Systems, Inc. Insurance Agent & Broker By: /s/ R. J. Lelieur ------------------------------- Title: Vice President ------------------------------- Acceptance by the signatory Employer to the Execution Page of the Plan on this 8th day of November , 1996 Signatory Employer: National Insurance Group By: /s/ Robert P. Barbarowicz ------------------------------ Title: Executive Vice President ------------------------------ EX-11.1 7 COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11.1 NATIONAL INSURANCE GROUP AND SUBSIDIARIES COMPUTATION OF WEIGHTED AVERAGE SHARES OUTSTANDING AND EARNINGS PER SHARE for the year ended December 31, 1994, 1995 and 1996 There are no differences between primary and fully diluted earnings per share.
1994 1995 1996 --------- --------- --------- Weighted average common shares......................... 4,678,729 4,679,697 3,885,740 Common shares issuable under outstanding stock options.............................................. -- -- 31,686 --------- --------- --------- Total....................................... 4,678,729 4,679,697 3,917,426 ========= ========= ========= Net income (loss) (in thousands)....................... $ (1,084) $ (4,864) $ 1,274 Per share results: Net income (loss)........................... $ (0.23) $ (1.04) $ 0.33
Please refer to Note 13 of the Consolidated Financial Statements for a description of the method used to calculate earnings per share. EX-24.1 8 POWER OF ATTORNEY 1 Exhibit 24.1 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose name and individual signature appears below constitutes and appoints Robert P. Barbarowicz and Gregory S. Saunders (each of them with full power of substitution and with full power to act without the other), his true and lawful attorneys-in-fact and agents, with the power of substitution and resubstitution, for the undersigned, in such person's name, place and stead, in any and all capacities, to sign an Annual Report for the fiscal year ended December 31, 1996 on Form 10-K, and any all subsequent amendments thereto, and to file such Annual Report on Form 10-K, with any amendments thereto, so signed with all exhibits thereto and any other and all documents in connection therewith, with the Securities and Exchange Commission, hereby granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and to perform any and all acts and things requisite and necessary to be done in and about the premises, as fully, to all intents and purposes, as the undersigned might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.
NAME AND SIGNATURE TITLE DATE /s/ Mark A. Speizer Chairman of the Board March 25, 1997 - -------------------------- and Chief Executive Mark A. Speizer Officer and Director (Principal Executive Officer) /s/ Bruce A. Cole President and Director March 25, 1997 - -------------------------- Bruce A. Cole /s/ Gregory S. Saunders Executive Vice President, March 25,1997 - -------------------------- Treasurer and Chief Gregory S. Saunders Financial Officer (Principal Financial Officer)
1 2
NAME AND SIGNATURE TITLE DATE - ------------------ ----- ---- /s/ Robert J. Lelieur Vice President and March 25,1997 - ------------------------ Controller (Principal Robert J. Lelieur Accounting Officer) /s/ Nuno Brandolini Director March 25,1997 - ----------------------- d'Adda - ----------------------- Nuno Brandolini d'Adda /s/ Saul B. Jodel Director March 25,1997 - ----------------------- Saul B. Jodel /s/ Kevin R. McCarthy Director March 25,1997 - ----------------------- Kevin R. McCarthy
2 EX-27.1 9 FINANCIAL DATA SCHEDULE
7 0000815555 NATIONAL INSURANCE GROUP 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 13,171 0 0 2,051 36 0 32,573 1,204 0 2,187 47,112 2,198 4,753 0 0 1,333 0 0 17,592 10,960 47,112 13,585 1,975 0 25,123 4,002 6,296 28,827 1,558 284 1,274 0 0 0 1,274 .33 .33 3,055 3,970 32 2,318 2,541 2,198 32
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