-----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, C/qBP2W17SA8NyglFKKVpo7iiT+15MjuJ3x3T8Cqmcm8etNrj59+yyyvCZJZ7HEI EZn0Cs/rmS+ZCItUN+QuBg== 0000891618-98-001328.txt : 19980330 0000891618-98-001328.hdr.sgml : 19980330 ACCESSION NUMBER: 0000891618-98-001328 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 18 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 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: SEC FILE NUMBER: 000-16332 FILM NUMBER: 98575116 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 DEC. 31, 1997 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 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____TO_____ COMMISSION FILE NUMBER: 0-16332 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: (650) 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 common stock held by nonaffiliates of the Registrant, based upon the average of bid and asked price of the Common Stock on March 26, 1998 on the Nasdaq National Market System was approximately $23,881,377. Shares of Common Stock held by each officer and director and by each person who owns 10% 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 26, 1998 was 4,042,882. DOCUMENTS INCORPORATED BY REFERENCE The information called for by Part III is incorporated by reference to the definitive Proxy Statement for the Annual Meeting of Stockholders of the Company to be held June 15, 1998, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1997. 2 FORWARD-LOOKING STATEMENTS In addition to historical information, this Report contains forward-looking statements. 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. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected or inferred in these forward-looking statements. Factors that might 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." These forward-looking statements reflect management's opinions as of the date of this report. Undue reliance should not be placed on such forward looking statements. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including, without limitation, the Quarterly Reports on Form 10-Q to be filed by the Company in 1998. PART I ITEM 1. BUSINESS INTRODUCTION National Insurance Group, a California corporation ("National"), and its wholly-owned subsidiaries provide specialized information services through technology, tracking services, outsourcing services and related insurance products to financial institutions located throughout the United States and in Canada. 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 the customers of the Company to: o determine if residential or commercial real estate is located inside or outside a federally-designated Special Flood Hazard Area ("SFHA"), with respect to real estate which is collateral for loans being financed or serviced by customers of the Company or for other purposes (the "Flood Zone Determination Services"); o obtain real estate tax data from various local, county and state taxing authorities nationwide with respect to real estate which is collateral for loans being financed or serviced by the customers of the Company, facilitate the payment to such taxing authorities by mortgage lenders and mortgage loan servicing companies from certain escrowed funds collected for real estate taxes from their borrowers with each monthly loan payment for real estate taxes to such taxing authorities, and inform mortgage lenders and mortgage servicing companies whether the real estate taxes on property securing real estate loans have been paid and perform certain tasks of the Company's customers on an outsourced basis (the "Real Estate Tax Services"); and o monitor the insurance coverage on collateral securing residential mortgages (predominantly one-to-four unit family dwellings), motor vehicle and other consumer loans and leases and, to a lesser extent, commercial mortgages, disburse insurance premiums collected from borrowers with each monthly loan payment for insurance coverage on behalf of mortgage lenders and mortgage servicing companies and perform certain tasks of the Company's customers on an outsourced basis (collectively, the "Tracking and Outsourcing Services"). When the Tracking and Outsourcing Services indicate that hazard insurance coverage on the collateral securing the loan has lapsed, the customer may contract with the Company to provide specialized, fire, allied peril or physical damage insurance (generally referred to as "lender-placed" insurance, formerly referred to by the Company as "force-place" insurance), that generally insures the improvements or personal property on the collateral security. The Company provides this lender-placed insurance through its wholly-owned subsidiary Great Pacific Insurance Company, in 48 states and the District of Columbia and through nonaffiliated insurance companies in the remainder of the United States. 1 3 The Company also provides flood insurance, for which the risk is assumed by an agency of the U. S. Government under the National Flood Insurance Program ("NFIP"). In addition, the Company provides fire and allied peril insurance with respect to properties on which financial institutions have foreclosed, and physical damage insurance on motor vehicles. Great Pacific Insurance Company is rated "A" ("Excellent") by A.M. Best Company, a nationally recognized insurance statistical and rating service. National's wholly-owned subsidiaries (the "Subsidiaries") are: o Pinnacle Data Corporation, a California corporation ("Pinnacle") o Pinnacle Real Estate Tax Services, Inc., a Delaware corporation ("PinTax-VA") o Pinnacle Real Estate Tax Services of New York, Inc., a Delaware corporation ("PinTax-NY", which together with PinTax-VA, are referred to in this Report collectively as "PinTax") o Pinnacle Management Solutions Insurance Services, a California corporation ("PMSIS"), formerly named Fastrac Systems, Inc. Insurance Agent & Broker o Great Pacific Insurance Company, a California corporation ("GPIC") o Fastrac Systems, Inc., a California corporation ("Fastrac") o New Arts Acquisition, Inc., a Delaware corporation ("New Arts") The Company began operations in 1972 as an independent general insurance agency (which now operates as a subsidiary of National under the name "Pinnacle Management Solutions Insurance Services"), providing financial institutions with fire and related insurance products written by nonaffiliated companies. In 1977, the Company formed GPIC to underwrite the business being generated by PMSIS. During the mid-1980s, the Company developed computer software systems to provide financial institutions with an economical 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 expanded the Company's Tracking and Outsourcing Services to provide outsourcing capabilities. PMSIS provides the Tracking and Outsourcing Services for mortgage lenders and servicers. Fastrac provides those services for motor vehicle leasing companies. Fastrac operated as a wholly-owned subsidiary of PMSIS until February 1998, at which time it became a wholly-owned subsidiary of National. Beginning in the late 1980s, the Company developed and test-marketed its Flood Zone Determination Services. Such services assist a financial institution that is financing improved real estate in meeting its federally mandated obligation to advise potential borrowers whether such improvement is located inside or outside of an SFHA. Federal law and certain secondary markets require: (i) that regulated real estate lenders and users of such markets determine and disclose to each mortgage loan applicant whether the property securing such loan is located inside or outside of an SFHA; and (ii) that borrowers maintain flood insurance in force as long as the mortgaged property is located within an SFHA. These Flood Zone Determination Services are provided by Pinnacle. In September 1997, two newly formed wholly-owned subsidiaries of National, PinTax-VA and PinTax-NY, acquired substantially all the assets and assumed certain liabilities of American Realty Tax Services, Inc., a Virginia corporation ("ARTS-VA"), and American Realty Tax Services of New York, Inc., a Virginia corporation ("ARTS-NY", which together with ARTS-VA, are referred to in this Report collectively as "ARTS"). The acquisition is referred to in this Report as the "PinTax Acquisition". PinTax provides the customers of the Company with the Real Estate Tax Services. The Company's information services and insurance products are marketed nationwide by its direct sales force to mortgage bankers and other financial institutions (including mortgage origination/servicing companies, commercial banks, savings and loans, credit unions, motor vehicle leasing firms and others). In addition, its Tracking and Outsourcing Services are marketed to motor vehicle leasing firms in Canada by its direct sales force. Additional sales are made, on an indirect basis, through independent sales representatives and insurance agents and brokers. 2 4 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 inside or outside of an SFHA as defined by the Federal Emergency Management Agency ("FEMA"). The Company's database has been developed by merging about 80,000 of the approximately 126,000 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 the subject property is located inside or outside of an SFHA. If located in an SFHA, 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. Real Estate Tax Services Market The Company markets its Real Estate Tax Services to mortgage bankers and financial institutions that own or service real estate loan portfolios ("Servicers"). In order to prevent the placement of a lien for unpaid real estate taxes on real property which is the collateral for a loan, Servicers generally have a need to monitor whether real property taxes are paid to the taxing authority when due. In many cases Servicers require borrowers to pay to the Servicer a portion of real property taxes on the subject property with each mortgage loan payment ("Escrowed Loans"). The Servicer holds such funds in escrow and then remits them to the appropriate taxing authority when due. The Company provides Servicers with outsourcing for real property tax related tasks usually performed by the Servicers for both Escrowed Loans and non-Escrowed Loans. Such services include identification of applicable taxing authorities, research regarding real estate parcel identification numbers, and in the case of Escrowed Loans, disbursement of funds by check or electronic funds transfer and transmission of electronic data, tax bills and tax listings to taxing authorities, and, in the case of non-Escrowed Loans, searching records of taxing authorities to determine whether taxes are delinquent. Insurance Tracking and Outsourcing Services Market The Company markets its Tracking and Outsourcing Services to Servicers. In many cases, the Company also sells lender-placed insurance to Servicers that use its insurance Tracking and Outsourcing 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. In exchange for insurance premiums payable by the Company's customers and/or for fees, the Company provides its customers with access to the Company's database and tracking systems. In other cases, the Company's clients transfer many of their tasks associated with servicing the customer's loan portfolio. Such tasks performed by the Company for its customers is referred to as "Outsourcing". In addition, Servicers will acquire ownership of some property through foreclosure which property is sometimes referred to as Real Estate Owned ("REO"). Servicers need to insure the improvements located on REO for perils such as fire 3 5 and vandalism. The Company insures certain REO for fire and allied peril ("REO Insurance"). The Company primarily focuses its marketing efforts on Servicers with mortgage loan, consumer loan (primarily motor vehicle) or motor vehicle lease portfolios. Specialized Insurance Market The Company markets its specialized insurance including lender-placed insurance, REO Insurance and, in certain cases, flood insurance, to Servicers. 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 or if the insurance is canceled or otherwise terminated, Servicers may order lender-placed insurance from the Company. The Company sells lender-placed insurance and REO Insurance to customers that use its Tracking and Outsourcing Services and to customers which track their own loans and order such insurance. The Company primarily sells flood insurance to customers that also use its Flood Zone Determination Services. See "Business - Market Overview - Flood Zone Determination Services Market" and "- Insurance Tracking and Outsourcing Services Market". INFORMATION SERVICES The Company's information services consist of Flood Zone Determination Services, Real Estate Tax Services and Tracking and Outsourcing Services. Information services contributed 58.5% of consolidated revenues in 1997. See Note 23 of Notes to Consolidated Financial Statements. Flood Zone Determination Services Through Pinnacle, the use of the Company's on-line computerized Flood Zone Determination Services system is offered nationwide to financial institutions and others who originate loans secured by real property. The proprietary system is a relational database of digitized geographical information which determines whether or not a particular property address is located inside or outside of 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 inside or outside of 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 prints flood zone certificates (which describe, among other things, whether the subject property is located inside or outside of an SFHA), certain disclosure notices, and, for some customers, flood insurance policy rating information for flood insurance policies placed through PMSIS and, in most cases, with GPIC. Pinnacle offers life of loan services whereby Pinnacle will automatically notify its customers of changes in the SFHA status of properties in their mortgage loan portfolios. Life of loan service is available during the term of the customer's agreement with Pinnacle, or throughout the term of the loan, depending upon the fee paid for the life of loan service. Real Estate Tax Services Since September 1997, the Company has provided Real Estate Tax Services to Servicers on a nationwide basis. In order to prevent the placement of a lien for unpaid real estate taxes on real property which is the collateral for a loan, Servicers generally have a need to monitor whether real property taxes are paid to the taxing authority when due. In many cases Servicers require borrowers to pay to the Servicer a portion of real property taxes with each mortgage loan payment. The Servicer holds such funds in escrow and then remits them to the appropriate taxing authority when due. The Company provides Servicers with outsourcing services for real property tax related tasks usually performed by the Servicers for both Escrowed Loans and non-Escrowed Loans. Such services include identification of applicable taxing authorities, research regarding real estate parcel identification numbers, for escrowed loans, disbursement of funds by check or electronic funds transfer and transmission of electronic data, tax bills and tax listings to taxing authorities, and, for non-Escrowed Loans, searching records of taxing authorities to determine whether real estate taxes are delinquent. The Company has begun offering to perform, for a fee, certain additional tasks now performed by its customers, referred to as "Tax Outsourcing". 4 6 Tracking and Outsourcing Services The Company, through PMSIS and Fastrac, provides its Tracking and Outsourcing Services to financial institutions located throughout the United States and Canada. The tracking system utilizes Company-developed special-purpose, proprietary software and database systems to provide multiple tracking features for mortgages, motor vehicle and personal property loan and motor vehicle lease portfolios, as well as for REO properties. The Tracking and Outsourcing 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, ordering and canceling lender-placed and/or REO insurance coverage, and accounting for multiple premium transactions. Outsourcing performed by PMSIS and Fastrac includes opening customers' inbound mail, inputting insurance information relating to the tracked collateral into the Company's database and receiving that information from insurance companies by electronic data interchange ("EDI"), making and receiving telephone calls for clients and sending correspondence to customers of the Company's clients, and disbursing Escrowed Loans insurance premiums on behalf of the Company's clients to insurance companies. In addition, the Company's customers have online real-time access to their data and information in the Company's database. Customers who process their own insurance transactions may access the computer system of PMSIS and Fastrac to order lender-placed insurance or REO insurance. See "Business-- Insurance Products - Lender-Placed Insurance". The Company believes its Tracking and Outsourcing 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 and Flood Zones, Inc. 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 real estate tax services business is also highly competitive. The major competitors in the real estate tax services business include Transamerica Real Estate Tax Service, First American Real Estate Tax Services and Lereta Corporation. 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 and outsourcing industry is also highly competitive. The major competitors in the insurance tracking and outsourcing industry include American Security Insurance Group, ZC Sterling Corporation, Balboa Life and Casualty and Insureco Inc. 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. INSURANCE PRODUCTS The Company provides the following specialized insurance products to its Tracking and Outsourcing Services and Flood Zone Determination Services customers, other financial institutions and insurance agents and brokers. Insurance products contributed 44.5% of consolidated revenues in 1997. See Note 23 to Notes to Consolidated Financial Statements. Lender-Placed Insurance Lender-placed insurance is purchased by financial institutions when their borrowers, whose loans are secured by real property or personal property (primarily motor vehicles), fail to provide the financial institutions with adequate evidence of fire and certain allied perils insurance covering improvements to real property or physical damage insurance on personal property, as the case may be. The financial institutions pay insurance premiums to GPIC and ordinarily 5 7 are entitled to reimbursement of the premiums paid from their borrowers in accordance with the terms of their loans. In the Company's experience, approximately 64% to 68% of lender-placed insurance coverage terminates or is canceled within a year of the date the policy is issued. GPIC 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 lender-placed policies. REO insurance premiums may be higher than lender-placed premiums because of the higher risks involved in insuring REO property, which is often vacant. Financial institutions ordinarily require immediate coverage for lender-placed and REO insurance, but generally do not have readily available underwriting information on the subject risk. Due to the lack of underwriting information, GPIC 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 lender-placed insurers, is unusual in the property and casualty insurance industry which traditionally underwrites each risk on an individual or class basis. GPIC 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, GPIC is required to refund, at a minimum, an unearned premium calculated pursuant to applicable statutes or regulations. GPIC's primary customers for lender-placed 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 GPIC on one-to-four unit dwellings accounted for approximately 79% of GPIC's lender-placed and REO insurance for fiscal years 1993 through 1997. GPIC also offers lender-placed motor vehicle and personal property physical damage insurance products to financial institutions with loans secured by motor vehicles 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. GPIC also underwrites motor vehicle physical damage insurance through an unaffiliated 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 automobile insurance market. GPIC writes lender-placed and REO insurance on a direct basis in 48 states and the District of Columbia. GPIC assumed some of the risk and premium on lender-placed and REO insurance in the other states by being the primary reinsurer on such business generated by PMSIS. See "Business - Insurance Operations - Insurance Agency Operations". Flood Insurance In 1987, the Company entered into an agreement with the Federal Insurance Administration of FEMA enabling GPIC 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. GPIC receives a commission based upon a percentage of premium for each policy it writes under the WYO Program. GPIC provides its flood insurance policies under the WYO Program to customers who utilize the Flood Zone Determination Services of Pinnacle and the Tracking and Outsourcing Services of PMSIS and through insurance agents and brokers. Competition GPIC's major competitors in the highly competitive lender-placed insurance industry include the major competitors of PMSIS in the insurance tracking and outsourcing 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 6 8 greater financial, marketing and other resources than GPIC. 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 and price. The Company believes it competes favorably with respect to these factors. INSURANCE OPERATIONS Insurance Agency Operations PMSIS is a general insurance agent for GPIC and other insurance companies. PMSIS has entered into agency agreements to sell lender-placed and REO insurance in the states where GPIC 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 PMSIS agreements, the unaffiliated insurance companies pay PMSIS commissions for policies sold. These agency agreements allow PMSIS to initiate and maintain relationships with customers and to continue these relationships following termination of the agency agreements. PMSIS also markets flood insurance policies on behalf of GPIC and other WYO Program insurance companies. PMSIS is currently licensed and regulated as an insurance agent and broker in California and as a nonresident insurance agent and/or broker in 31 other states, and the District of Columbia, with licensing pending in one other state. In 17 other states, PMSIS transacts insurance services through licensed agents who are officers and employees of PMSIS. 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, GPIC, like many of its lender-placed insurance competitors, insures for a flat premium rate coverage for almost all property within predesignated limits and territories without the application of underwriting criteria to individual risks. GPIC determines its flat premium rate based on its underwriting experience and knowledge of the industry in which it operates. GPIC uses actuaries to determine such premium rates only where mandated by law or regulations. Accordingly, GPIC may be insuring individual risks that it might not have insured if it had information obtained in the traditional underwriting process. The motor vehicle physical damage insurance written through an unaffiliated general agent is underwritten using more traditional methods of underwriting. Policies and Endorsements For its lender-placed insurance products, GPIC 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. GPIC customizes its policy language and forms to meet the specific needs of its customers. GPIC has also developed some special endorsements, including one which provides that some lender-placed 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. The maximum limit of GPIC's insurance coverage overall is generally $3 million per property location for lender-placed insurance, $500,000 per location for REO insurance, $100,000 per vehicle for lender-placed physical damage insurance and $50,000 for the motor vehicle physical damage written through an unaffiliated general agent. In certain cases, GPIC grants its customers a higher maximum limit and, additionally, GPIC 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 GPIC's net premiums earned. For flood insurance, GPIC uses policy language, coverage limits and rates provided by FEMA. 7 9 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, GPIC's loss ratio, expense ratio and combined ratio.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 1993 1994 1995 1996 1997 ----- ----- ----- ----- ----- Loss ratio................................... 38.5% 37.8% 35.5% 30.0% 34.0% Expense ratio................................ 53.4% 55.7% 66.6% 61.2% 63.1% ----- ----- ----- ----- ----- Combined ratio............................... 91.9% 93.5% 102.1% 91.2% 97.1% ===== ===== ===== ===== ===== Property and casualty industry combined ratio (fire) (1)................. 111.7% 109.2% 107.6% 96.5% -- ===== ===== ===== ===== =====
(1) Based on property and casualty insurance industry statistics (fire) published by A.M. Best Company as of December 31, 1996. Industry statistics for 1997 are not available from A.M. Best Company as of the date of this report. The Company does not currently write any casualty insurance. The increase in the combined ratio from 1996 to 1997 was primarily due to an increase of the loss ratio from 30% to 34% which was the result of an increase in the number and average size of claims. The average loss per new claim reported increased from $5,513 in 1996 to $7,693 in 1997. The number of new claims increased from 726 reported in 1996 to 843 reported in 1997. 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 premium to surplus. GPIC's premium-to-surplus ratio for the periods indicated are shown in the following table.
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- Net premiums written to surplus ratio...... 1.0 0.8 0.6 0.5 0.8 Property and casualty industry average(1).. 1.3 1.1 1.0 1.0 --
(1) Based on property and casualty insurance industry statistics published by A.M. Best Company as of December 31, 1996. Industry statistics for 1997 are not available from A.M. Best Company as of the date of this report. The Company does not currently write any casualty insurance. The increase in net premiums written to surplus ratio from 1996 to 1997 was primarily the result of an increase in net written premiums in 1997 over 1996. 8 10 Loss and LAE Reserves GPIC 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 GPIC 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 GPIC 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 lender-placed, REO, flood and motor vehicle 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 for known and unreported claims than with many other lines of insurance. 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, 1997, the Company had $29 million of investment assets. GPIC held approximately $25 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. GPIC also maintains a large portion of its investments in short-term instruments in order to maintain the ability to fund large losses of GPIC'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, 1997.
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1995 1996 1997 ------ ------ ------- Average investment............................. $38,080 $34,888 $30,711 Net investment income.......................... 2,042 1,975 1,839 Average annualized yield....................... 5.4% 5.7% 6.0%
The following table summarizes by type, the investments of the Company as of December 31, 1997 (dollars in thousands). With the exception of equity securities and certain debt securities, the Company's investments are either insured by the Federal Deposit Insurance Corporation or have one of the top three designations from the National Association of Insurance Commissioners ("NAIC"), which correspond to an "investment grade" rating. 9 11
PERCENT AMOUNT OF TOTAL ----- -------- Short-term investments............................ $2,726 9.4% Certificates of Deposit........................... 9,928 34.5% U.S. Government-backed securities................. 1,859 6.4% Obligations of states and municipalities.......... 8,907 30.9% Corporate Bonds................................... 1,193 4.1% Equity securities................................. 4,200 14.6% Mortgage-backed securities........................ 36 0.1% ------- ----- Total investments........................ $28,849 100.0% ======= =====
The table set forth below indicates the expected maturity distribution of GPIC's fixed income securities and short-term investments as of December 31, 1997 (dollars in thousands).
PERCENT OF AMOUNT PORTFOLIO One year or less...................................$ 9,467 39.7% One year to five years............................. 12,664 53.1% Six years to ten years............................. 1,697 7.1% More than ten years................................ 36 0.1% -------- ----- Total fixed income securities and short-term investments $ 23,864 100.0% ======== =====
Reinsurance In order to limit the maximum losses for which it might otherwise be solely responsible under its policies, GPIC 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 GPIC's "retention". GPIC pays treaty reinsurers a percentage of net premiums written and/or earned to cover reinsurance costs. Subject to certain limitations, in 1997 GPIC retained on non-flood insurance, and in 1998 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. GPIC also purchases catastrophic reinsurance, under which GPIC 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 GPIC 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 $15.0 million for all losses during the term. Each of the catastrophic reinsurance agreements has a one (1) year term. GPIC from time to time purchases another form of reinsurance called "facultative reinsurance" for an individual policy or group of policies to protect GPIC and its treaty reinsurers from certain risks or when the amount of insurance exceeds the maximum amount covered under various reinsurance treaties. GPIC negotiates the cost of facultative reinsurance on a case-by-case basis. Flood insurance issued by GPIC is reinsured by an agency of the federal goverment. The purchase of reinsurance does not relieve GPIC of liability for the full amount of loss in the event the reinsurer fails or refuses to pay the reinsured portion. To date, GPIC has collected full reinsurance reimbursement on all claims submitted to its reinsurers. During 1995, GPIC ceded non-flood insurance losses of $6,600 to reinsurers related to losses that occurred in 1992. There were no losses ceded to reinsurers in 1996 or 1997 on non-flood insurance policies. In 1996 and 1997, GPIC paid 4.9% and 4.0%, respectively, of its earned premiums for its excess and catastrophic reinsurance treaties. 10 12 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 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 operations of PinTax are generally not subject to regulation by any government agency. PinTax interacts regularly with taxing authorities in various jurisdictions and, in many cases, in order to obtain the information required to carry out its operations, PinTax must comply with the rules and regulations promulgated by such taxing authorities. However, neither such taxing authorities nor any other government agency directly regulates the activities of PinTax. GPIC is subject to regulation by government agencies in California, its state of domicile, and in the remaining states in which it transacts insurance. 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 GPIC and its affiliates. Licensing in Other Jurisdictions In order to issue policies on a direct basis in a state, GPIC 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. GPIC currently is licensed to write insurance in the following 46 states and the District of Columbia: Alabama Indiana Missouri Rhode Island Alaska Illinois Montana South Carolina Arizona Iowa Nebraska South Dakota Arkansas Kansas Nevada Tennessee California Kentucky New Jersey Utah Colorado Louisiana New Mexico Virginia Connecticut Maine North Carolina West Virginia Delaware Maryland North Dakota Washington Florida Massachusetts Ohio Wisconsin Georgia Michigan Oklahoma Wyoming Hawaii Minnesota Oregon Idaho Mississippi Pennsylvania In addition, GPIC is authorized to write insurance in Texas and Vermont on a surplus lines basis. 11 13 GPIC is in the process of obtaining requisite approvals to write insurance on a direct basis in New Hampshire. PMSIS (or, as to some states, at least one of PMSIS's officers) must be licensed in any state in which it operates. PMSIS is currently licensed in California and as a nonresident insurance agent and broker in 31 other states and the District of Columbia with licensing pending in one other state. PMSIS is subject to laws and regulations and is regulated by the insurance commissioner in each state in which it conducts its insurance agency or brokerage business. Restrictions on Dividends Payable by GPIC to the Company As a nonoperating holding company, a principal source of National's liquidity is the cash dividends received from its subsidiaries, principally GPIC and Pinnacle. GPIC is subject to laws and regulations which restrict its ability to pay dividends. GPIC 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, GPIC 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 GPIC's policy holder surplus as of the previous December 31, or (ii) The net income of GPIC, 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 GPIC In addition to the dividend payment restrictions set forth above, California law has three additional methods of regulating an insurance company's relationships and transactions with its affiliates. The first is the requirement that an insurer file and keep current a "Form B" registration statement identifying the affiliated members of the insurer's holding company system and disclosing the agreements in force, relationships existing and transactions outstanding between the insurance company and its affiliates. The matters that must be reported in the registration statement include all types of financial transactions, transactions not in the ordinary course, the insurer's guarantee of affiliate obligations, management agreements, service contracts and cost-sharing agreements, tax allocation agreements, reinsurance agreements, stock pledges, dividends and distributions. An insurer's registration statement must be filed annually. In addition, the registration statement must be updated on a monthly basis to disclose any reportable transaction that occurred in the prior monthly period. The second method of regulating transactions between an insurer and its affiliates is the requirement that the insurer give the California Insurance Department not less than thirty days' prior written notice of certain types of transactions, with the Department having the right to disapprove the transaction during the notice period. The third method is the requirement that the Insurance Commissioner be notified within thirty days of any investment by the insurer in another corporation if such would cause the total investments in that company by all members of the insurer's holding company system to exceed ten percent of the other company's voting securities. 12 14 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. Companies having statutory surplus less than that determined necessary by the RBC model will likely be required to adequately address certain risk factors (underwriting risk, investment risk and other off-balance sheet risk) and will be subject to varying degrees of regulatory intervention, depending upon their level of capital inadequacy. The RBC model for the 1997 annual statement did not indicate an impairment of GPIC's measurement of capital adequacy. 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. GPIC is required to participate in such insolvency funds and associations and contributed $23,056 in 1996 and $1,179 in 1997 to such funds and associations. GPIC 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. GPIC made certain significant contributions to the California FAIR Plan Association in 1996 and 1997. 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 GPIC 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 GPIC. Any purchase resulting in such an acquisition of control of GPIC would require prior action by the California Commissioner of Insurance. MARKETING The Company's information services and insurance products are marketed nationwide and in Canada by its sales and marketing staff. 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 until recently had 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 products and services to meet the needs of its customers. The Company uses direct mail and select advertising to augment its sales efforts. The Company has an Internet site with an address of www.naig.com. 13 15 SIGNIFICANT CUSTOMERS In 1997, Advanta Mortgage Corp. accounted for 11.8% of consolidated revenues of the Company. During the second half of 1997 the Company received notice that Advanta Mortgage Corp. and one other customer would not renew their hazard tracking, outsourcing and lender-placed insurance contracts. Such customers accounted for 7.3% of consolidated revenues in 1995, 11.2% in 1996 and 18.8% in 1997. Management believes that the decrease in revenue due to the loss of these customers may be delayed and offset, in part, by changes in certain reserves potentially arising from the customers' departures, and additional business from new and existing customers. The decrease in revenue will also be delayed by the rate at which the unearned premium for such customers is earned over the year 1998. The Company is presently unable to estimate the amount of such offsets, which are dependent upon numerous factors, including, without limitation, the general health of the mortgage banking and vehicle financing industries; interest rates, general economic conditions, the realization of expected new business from new and existing customers and other factors. The loss of such customers may affect adversely the results of operations and earnings of the Company in 1998. See also, "Management's Discussion and Analysis of Financial Condition and Results of Operations." EMPLOYEES As of December 31, 1997, the Company employed approximately 621 persons. 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. BUSINESS SEGMENT DATA The principal industry segments in which the Company operates are information services and insurance products. 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 in South San Francisco, California which are used as the Company's headquarters and as the primary operations center for GPIC, PMSIS, Fastrac, and Pinnacle. In addition the Company leases space in Concord, California and Tucson, Arizona, which is currently used by Pinnacle primarily for making manual flood zone determinations. The Company leases space in Springfield, Ohio which is used by Fastrac with respect to its motor vehicle insurance tracking and outsourcing operations. The Company leases space in Vienna, Virginia and Warwick, Rhode Island, which is used as the primary operations centers of PinTax. The Company also leases other sales and service offices. 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 pending litigation or group of similar items of pending 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 1997. EXECUTIVE OFFICERS OF THE COMPANY The executive officers of the Company and their ages as of March 25, 1998, are set forth below. Except for Mr. Bergstrom, Mr. Gauer, and Mr. Padilla the following hold the indicated office with respect to National and each of the Subsidiaries. 14 16
Name Age Position with National --- -- ---------------------- Mark A. Speizer......... 54 Chairman of the Board and Chief Executive Officer Bruce A. Cole........... 50 President Robert P. Barbarowicz... 51 Executive Vice President, General Counsel and Secretary Gregory S. Saunders..... 35 Executive Vice President, Treasurer and Chief Financial Officer Douglas H. Helm......... 56 Executive Vice President, Business Development and Strategic Marketing George R. Jump.......... 47 Executive Vice President, Sales Gunnar Bergstrom........ 34 Executive Vice President of PinTax Gerry L. Gauer.......... 33 Executive Vice President of Pinnacle Larry Padilla........... 48 Executive Vice President of Fastrac and PMSIS
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 the Company. 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 and Chairman of the Board of the 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 of the Company. 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. HELM was elected Executive Vice President, Business Development and Strategic Marketing in May 1997. From July 1995 to May 1997, Mr. Helm was President and Chief Executive Officer of the Property/Casualty Division of InsWeb Corporation. From 1989 to 1995, Mr. Helm was Executive Vice President, Sales and Marketing of the Company. Mr. Helm held a variety of executive offices and management positions in the insurance industry from 1970 to 1997. MR. JUMP was elected Executive Vice President, Sales in November 1997. Mr. Jump assumed responsibility for the sales area of the Company in February 1998. Mr. Jump joined the Company in 1993 and had served as a Vice 15 17 President and Senior Vice President of Sales of the Company's subsidiaries from 1993 to 1997. Prior to joining the Company, Mr. Jump was the Vice President, Marketing of American Security Group from 1980 to 1993. MR. BERGSTROM was elected Executive Vice President and General Manager of PinTax in September 1997. From 1996 to 1997, Mr. Bergstrom served with Chicago Title & Trust Company in their Mergers, Acquisitions and New Business Development Unit. Prior to 1996, Mr. Bergstrom served as Executive Vice President of ARTS-VA and ARTS-NY. MR. GAUER was elected Executive Vice President and General Manager of Pinnacle in November 1997 and served as Senior Vice President and General Manager of Pinnacle since 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 customer service, production and human resources functions as well as facilities management. In such capacity he managed a staff, including professional appraisers, productions managers, supervisors and processors. MR. PADILLA joined Fastrac Systems, Inc. and PMSIS in June 1996 as Senior Vice President and General Manager and was elected as Executive Vice President and General Manager in November 1997. 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. Prior to May 1994 Mr. Padilla held various executive positions with other financial institutions. 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 tortious 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 motor vehicle 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. PART II 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 STOCK PRICE CASH DIVIDENDS ---------- DECLARED PER HIGH LOW SHARE --- -- ----- 1996 First Quarter $ 7.13 $ 5.50 $0.00 Second Quarter 7.25 5.25 $0.00 Third Quarter 7.38 5.63 $0.00 Fourth Quarter 6.88 4.38 $0.00 16 18 1997 First Quarter $ 7.75 $ 4.25 $0.00 Second Quarter 8.00 6.13 $1.08 Third Quarter 11.13 6.38 $0.11 Fourth Quarter 10.88 8.00 $0.11 The average of the last closing bid and ask prices of the Common Stock, as reported on the Nasdaq National Market System on March 26, 1998, was $9.75 per share. As of March 26, 1998, 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 GPIC. GPIC, 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 GPIC 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, 1997, the maximum dividend permitted to be paid in 1998 by GPIC to National is limited to approximately $2.5 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 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. 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, 1993, 1994, 1995, 1996 and 1997. 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. 17 19
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------- 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF OPERATIONS DATA Net premiums written........................ $ 22,549 $ 20,036 $ 14,956 $ 12,636 $ 20,501 ======== ======== ======== ======== ======== Net premiums earned......................... $ 23,265 $ 20,858 $ 17,020 $ 13,585 $ 19,038 Real estate information services (1)........ 11,693 7,978 10,593 18,499 23,492 Tracking fees............................... 2,477 3,012 4,786 5,479 7,543 Net commission income....................... 462 1,103 1,502 1,145 1,166 Net investment income....................... 1,797 1,836 2,042 1,975 1,839 ------- ------- ------- ------- -------- Total revenues......................... 39,694 34,787 35,943 40,683 53,078 ------- ------- ------- ------- -------- Loss and LAE ............................... 8,952 7,873 6,044 4,002 6,482 Commissions paid to nonaffiliates........... 4,989 4,739 4,079 1,954 1,837 Personnel expenses.......................... 12,890 13,677 16,891 18,948 23,127 All other expenses.......................... 7,532 9,096 12,252 14,221 16,930 Non-recurring expense....................... -- 1,020 4,100 -- -- ------- ------- ------- ------- -------- Total expenses (1)..................... 34,363 36,405 43,366 39,125 48,376 ------- ------- ------- ------- -------- Income (loss) before provision for income taxes.................................... 5,331 (1,618) (7,423) 1,558 4,702 Provision for (benefit from) income taxes............................. 1,687 (534) (2,559) 284 1,436 -------- -------- -------- -------- -------- Net income (loss)........................... $ 3,644 $ (1,084) $ (4,864) $ 1,274 $ 3,266 ======== ======== ======== ======== ======== Net income (loss) per share (2)............. $ 0.85 $ (0.23) $ (1.04) $ 0.33 $ 0.79 Weighted average common and common equivalent shares outstanding (2)........ 4,270 4,679 4,679 3,917 4,127 Dividends per share......................... $ 0.32 $ 0.20 $ 0.00 $ 0.00 $ 1.30 BALANCE SHEET DATA Total investments........................... $ 43,008 $ 38,957 $ 37,202 $ 32,573 $ 28,849 Total assets................................ $ 63,699 $ 55,092 $ 52,096 $ 47,112 $ 66,742 Total shareholders' equity.................. $ 41,949 $ 37,290 $ 32,881 $ 28,552 $ 27,780
- ---------- (1) Revenues for real estate information services include revenues in 1997 from PinTax subsequent to the PinTax Acquisition. Total expenses include expenses from PinTax subsequent to the PinTax Acquisition. (2) Net income (loss) per share is presented as diluted earnings per share. The weighted average shares outstanding includes the number of shares issuable upon exercise of outstanding options as calculated using the treasury stock method. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL National Insurance Group provides specialized information services through technology, tracking services, outsourcing services and related insurance products to mortgage bankers and financial institutions located throughout the United States. The Company's primary sources of revenues are fees billed to customers who use Flood Zone Determination Services, Real Estate Tax Services, premiums and commissions earned from its specialized insurance products, Tracking and Outsourcing Services and investment income. 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 18 20 determinations 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. The Company generates fees on Real Estate Tax Services by charging a fee for each property tracked for tax information. The fees cover services for a one year period, or, for a higher fee, for the life of the loan, where the Company tracks the tax information for its customer during the term of the loan or over the term of the agreement with the particular customer. An additional fee will be generally charged for tax outsourcing. Net premiums written represent direct and assumed premiums generated by GPIC, 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. Tracking and Outsourcing fees are generated by providing Tracking and Outsourcing Services and are usually based on the number of loans or leases tracked. Net commission income represents commissions received from nonaffiliated insurance companies for lender-placed insurance produced by PMSIS and from the Federal Emergency Management Agency ("FEMA") for flood insurance written by GPIC. The Company's insurance products include lender-placed 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 lender-placed and flood insurance 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 lender-placed 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 and earned premiums. Since 1993, the reserve has been established at approximately 64% to 68% of gross premiums written. Premiums are written directly by GPIC or by third party insurance companies in certain states where GPIC is not licensed or where its products are not approved. The following table summarizes premiums written net of cancellations after application of the reserve for return premiums during the periods indicated (in thousands):
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1995 1996 1997 ------- ------- ------- Gross Premiums Written (net of cancellations).. $17,127 $15,594 $24,141 Gross Premiums Ceded........................... (2,171) (2,958) (3,640) ------- ------- ------- Net Premiums Written........................... $14,956 $12,636 $20,501 ======= ======= =======
The Company's strategy includes expanding its authorization to write premiums on a direct basis and reducing premiums ceded to reinsurers. At the present time, 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 17 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 1995, the Company ceded non-flood insurance losses of $6,600 to reinsurers, and for which it has been fully reimbursed. The Company did not cede any losses to reinsurers in 1996 or 1997 for non-flood insurance losses. 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 purchase reinsurance with U.S. insurers rated in the "A" categories by A.M. Best Company) at the time of such purchase and by diversifying the reinsurance pool. 19 21 Loss and loss adjustment expenses ("LAE") represent losses paid related to insurance underwritten or reinsured by GPIC, 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 bonuses paid to Company employees and related employee benefits. All other expenses primarily consist of occupancy costs, including office rent and utilities, insurance expenses, 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's effective income tax rate was 34%, 18%, and 31% for 1995, 1996 and 1997, 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 8 of Notes to Consolidated Financial Statements. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 130 will have a material impact on its financial statements. In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 131 will have a material impact on the Company's financial statements. Acquisition On September 18, 1997, the Company's newly formed PinTax subsidiaries acquired substantially all the assets and assumed certain liabilities of ARTS. The acquisition agreement, dated August 15, 1997, as amended (the "Agreement"), was entered into by and among ARTS, the shareholders of ARTS, the Company and New Arts. As consideration for the acquisition of certain assets of ARTS, New Arts paid $9.8 million in cash, including transaction costs, and agreed to assume certain liabilities of ARTS. Pursuant to the Agreement, if the cash revenue received by the Company on certain contracts of PinTax exceeds certain targets for the twelve months ending April 30, 1998, the Company is required to pay additional consideration of up to $4 million according to a formula as set forth in the Agreement ("Additional Consideration"). Fifty percent of the Additional Consideration may be paid in the form of a three year note bearing interest at eight percent per annum. The remaining fifty percent of the Additional Consideration may be paid in cash. See Note 22 of Notes to Consolidated Financial Statements. The PinTax Acquisition was accounted for as a purchase of assets. As of the purchase date, the fair market value of the assets acquired from ARTS was approximately $4.4 million, and the fair market value of liabilities assumed was approximately $7.3 million, including approximately $7 million of deferred revenue related to ARTS' then existing portfolio of loans. The amount of goodwill recorded as of the date of PinTax Acquisition was $12.7 million, which is being amortized over a 25-year period as a result of long standing vendor and customer relationships. Goodwill is classified on the Company's balance sheet under "Intangible Assets". The majority of tax service revenues earned by PinTax are from "life of loan" servicing contracts, which require customers to pay an up-front, one-time fee to receive Real Estate Tax Services over the life of a loan. The revenue from 20 22 "life of loan" contracts is recognized over the estimated life of the loans in proportion to the amount of expenses incurred to service the real estate property tax tracking on the subject loans. Since the bulk of expenses incurred in providing real estate property tax tracking on the loans occurs in the first year, a majority of the "life of loan" revenue is recognized within the first year of servicing. The remainder of the revenue is amortized in accordance with the estimated rate at which loans are paid off or otherwise are removed from the servicing portfolio. As a result of this revenue recognition policy, PinTax records a deferred revenue reserve on its balance sheet. As of December 31, 1997, deferred "life of loan" tax servicing revenue was approximately $7.0 million. This is approximately the same amount of deferred revenue as of the date of the PinTax Acquisition. Year 2000 Compliance 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, some of the Company's systems are already Year 2000 compliant, and the Company believes that Year 2000 compliance will be achieved prior to December 31, 1998 on the balance of its systems. The Company does not anticipate any significant 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 solely in connection with Year 2000 compliance will be treated as period costs and will be expensed as incurred. The Company's customers and companies and others from which the Company receives data are also dependent upon computer systems. It is out of the Company's control whether such entities are or will be Year 2000 compliant; however, the Company believes that most of them are aware of the issue. 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, ----------------------------- 1995 1996 1997 ----- ----- ----- Net premiums earned ........................... 47.4% 33.4% 35.9% Real estate information services .............. 29.5 45.4 44.2 Tracking fees ................................. 13.3 13.5 14.2 Net commission income ......................... 4.2 2.8 2.2 Net investment income ......................... 5.6 4.9 3.5 ----- ----- ----- Total revenue .......................... 100.0 100.0 100.0 ----- ----- ----- Loss and LAE .................................. 16.8 9.8 12.2 Commissions paid to nonaffiliates ............. 11.3 4.8 3.5 Personnel expenses ............................ 49.3 46.6 43.6 All other expenses ............................ 25.7 34.7 31.9 Non-recurring expense ......................... 17.5 0.0 0.0 ----- ----- ----- Total expenses ......................... 120.6 96.2 91.2 ----- ----- ----- Income (loss) before provision for income taxes (20.6) 3.8 8.9 Provision for (benefit from) income taxes ..... (7.1) 0.7 2.7 ----- ----- ----- Net income (loss) ............................. (13.5)% 3.1% 6.2% ===== ===== =====
21 23 YEAR ENDED DECEMBER 31, 1996 VERSUS YEAR ENDED DECEMBER 31, 1997 The dollar amounts referred to in this section comparing operating results for the year ended December 31, 1996 with December 31, 1997 are approximate amounts stated in millions and are based on the financial statements included elsewhere in this Report, which amounts are stated in thousands. All percentages referred to in this section comparing operating results for the year ended December 31, 1996 with December 31, 1997 are approximate percentages and are based only on dollar amounts set forth in the financial statements contained elsewhere in this Report, which amounts are stated in thousands. Revenue Total revenue increased from $40.7 million in 1996 to $53.1 million in 1997, an increase of $12.4 million or 30.5%. Net premiums written increased from $12.6 million in 1996 to $20.5 million in 1997, an increase of $7.9 million or 62.7%. The increase in net premiums written was principally due to growth in loan portfolios of the Company's existing and former Tracking and Outsourcing Services clients. There was no material price change related to the Company's insurance products in 1997. Net premiums earned increased from $13.6 million in 1996 to $19.0 million in 1997, an increase of $5.5 million, or 40.1%. The increase was primarily due to an increase in net written premiums, as previously described. Real estate information services revenue (consisting of revenue from Pinnacle and PinTax) increased from $18.5 million in 1996 to $23.5 million in 1997, an increase of $5.0 million, or 27.0%. Approximately $2 million of the increase was the result of PinTax, which was acquired in September 1997. The remainder of the increase was the result of higher flood zone determination volumes from existing customers. The Company's overall price level for its real estate information services did not materially change in 1997. Tracking fees increased from $5.5 million in 1996 to $7.5 million in 1997, an increase of $2.1 million or 37.7%. The increase was primarily due to higher volumes of motor vehicle leases tracked for new and existing customers. Expenses Loss and LAE was $4.0 million in 1996 (29.5% of net premiums earned) and $6.5 million in 1997 (34.0% of net premiums earned), an increase of $2.5 million, or 62.0%. The increase was due to an increase in the number and average size of claims. The average loss per new claim reported increased from $5,513 in 1996 to $7,693 in 1997. The number of new claims increased from 726 reported in 1996 to 843 reported in 1997. Commissions paid to nonaffiliates decreased from $2.0 million (14.4% of premiums earned) in 1996 to $1.8 million (9.6% of premiums earned) in 1997, a decrease of $117,000, or 6.0%. The reduction in commissions paid to nonaffiliates was a result of relatively higher growth in net written and earned premiums from clients which do not earn commissions on the Company's insurance products. Personnel expenses increased from $18.9 million in 1996 to $23.1 million in 1997, an increase of $4.2 million, or 22.1%. The increase in personnel expenses was due to an increase in incentive compensation and staff additions in response to several factors, primarily an increase in the volume of flood zone determinations and loans tracked. To a lesser extent, the PinTax Acquisition contributed to additional personnel costs in 1997. Personnel expenses as a percent of total revenue decreased from 46.6% in 1996 to 43.6% in 1997. All other expenses increased from $14.2 million in 1996 to $16.9 million in 1997, an increase of $2.7 million, or 19.0%. Approximately $1.4 million of the 1996 expenses was as a result of retention agreements entered into with certain executives in June 1996. 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. The 22 24 remaining increase in all other expenses was due to several factors, including an increase in direct costs related to growth in revenues (e.g., data, telecommunications cost, postage) and an increase in sales, marketing, consulting and advertising costs. As a result of the above factors, income before provision for income taxes increased from $1.6 million in 1996 to $4.7 million in 1997, an increase of $3.1 million, or 202%. YEAR ENDED DECEMBER 31, 1995 VERSUS YEAR ENDED DECEMBER 31, 1996 The dollar amounts referred to in this section comparing operating results for the year ended December 31, 1995 with December 31, 1996 are approximate amounts stated in millions and are based on the financial statements included elsewhere in this Report, which amounts are stated in thousands. All percentages referred to in this section comparing operating results for the year ended December 31, 1995 with December 31, 1996 are approximate percentages and are based only on dollar amounts set forth in the financial statements contained elsewhere in this Report, which amounts are stated in thousands. Revenue Total revenue increased from $35.9 million in 1995 to $40.7 million in 1996, an increase of $4.8 million or 13.2%. Net premiums written decreased from $15.0 million in 1995 to $12.6 million in 1996, a decrease of $2.4 million or 15.5%. The decrease in net premiums written 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 20.2%. The decrease was partially due to the increase in reserve for return premiums and also partially due to a decline in written premiums. Real estate information services revenue increased from $10.6 million in 1995 to $18.5 million in 1996, an increase of $7.9 million or 74.6%. 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 14.5%. 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 33.8%. The decline in losses and LAE was a direct result of fewer losses and loss adjustment expenses incurred during 1996 than in 1995. 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 (24.0% of premiums earned) in 1995 to $2.0 million (14.4% of premiums earned) in 1996, a decrease of $2.1 million, or 52.1%, 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 12.2%. The increase in personnel expenses was due to staff additions and increased outside labor in response to the 23 25 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 16.1%. 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. Non-recurring expenses decreased from $4.1 million in 1995 to $0 in 1996. In 1995, the Company accrued an additional $4.1 million for the constitutionally mandated roll-back of insurance premiums under Proposition 103. 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. 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 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 GPIC are subject to certain regulatory restrictions which are described below. The Company's primary sources of cash are from operating income and lines of credit. In 1997, the Company derived a substantial portion of its operating cash from the operating profits from Pinnacle, as well as the net premiums written from GPIC. The Company has reserved certain amounts of the net written premiums it received in 1997 for a variety of purposes, including reserves for return premiums, unearned premiums and loss reserves. The Company believes that its cash flow from operations, existing cash balances and lines of credit will be sufficient to meet its working capital needs for the foreseeable future. GPIC 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, 1997, the Company had cash and short-term investments aggregating $10.4 million. Of the Company's cash and short-term investments, $8.7 million is held by GPIC. Insurance companies, including GPIC, 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 GPIC 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, 1997, GPIC had net income of $1.7 million and as of December 31, 1997, statutory policyholders' surplus of $25.6 million. For the year ended December 31, 1997, the maximum dividend permitted to be paid by GPIC to National was approximately $2.8 million. For 1998, the maximum dividend permitted to be paid by GPIC to National is approximately $2.6 million. See "Market for Registrant's Common Equity and Related Stockholder Matters" and Note 14 of Notes to Consolidated Financial Statements. In connection with the PinTax Acquisition, National and New Arts entered into a term note facility (the "Term Facility") with the Company's primary commercial bank. The Term Facility allows for a maximum borrowing of $11.3 million, including $2 million for any Additional Consideration which may be payable pursuant to the Agreement on or before May 25, 1998. The Term Facility matures in May 2003 and calls for interest payments at the rate of the lending bank's prime rate plus one and one-quarter percent, beginning September 1997. Principal is paid monthly, 24 26 beginning May 30, 1998, in accordance with a variable amortization schedule. Collateral for the loan includes non-insurance company cash deposits of the Company, the common stock of Pinnacle, as well as the stock of PinTax and of New Arts. As of December 31, 1997, the Company has utilized $9.3 million of the $11.3 million Term Facility. On April 2, 1997, the Company obtained a $5 million revolving credit facility from the Company's primary commercial bank (the "Revolving Facility"). On September 18, 1997, the Revolving Facility was amended. The primary amendment to the Revolving Facility was the reduction in borrowing limits to $1 million from $5 million. As of December 31, 1997, the Company had no borrowings under the Revolving Facility and was in compliance with the financial covenants of the Revolving Facility. The Revolving Facility expires March 31, 1999. See Note 7 of Notes to Consolidated Financial Statements. In September 1996, the Company concluded a note agreement with the Company's primary commercial bank providing $2.0 million for the purpose of partially financing the repurchase of 705,300 shares of its common stock. As of December 31, 1997 the unpaid balance of this note was approximately $333,000. The total purchase price of the stock was approximately $5.0 million. See Note 7 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, 1997, totaled $27.8 million or $6.73 per share compared to $28.6 million or $7.28 per share at December 31, 1996. 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, 1997, the Company's net written premium to policyholder surplus ratio was .8 to 1. See "Business--Insurance Operations--Insurance Operating Ratios". Inflation or deflation and other factors generally affect 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. There is no public securities market for certain investments held by the Company. As of December 31, 1997, such investments were limited partnership interests with an original cost of $220,000. 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. Significant Customers In 1997, Advanta Mortgage Corp. accounted for 11.8% of consolidated revenues of the Company. During the second half of 1997 the Company received notice that Advanta Mortgage Corp. and one other customer would not renew their hazard tracking, outsourcing and lender-placed insurance contracts. Such customers accounted for 7.3% of consolidated revenues in 1995, 11.2% in 1996 and 18.8% in 1997. Management believes that the decrease in revenue due to the loss of these customers may be delayed and offset, in part, by changes in certain reserves potentially arising from the customers' departures, and additional business from new and existing customers. The decrease in revenue will also be delayed by the rate at which the unearned premium for such customers is earned over the year 1998. The Company is presently unable to estimate the amount of such offsets, which are dependent upon numerous factors, including, without limitation, the general health of the mortgage banking and vehicle financing industries and of the 25 27 Company's customers; interest rates, general economic conditions, the realization of expected new business from new and existing customers and other factors. The loss of such customers may affect adversely the results of operations and earnings of the Company in 1998. Additional Expenses The Company anticipates that it may incur certain costs in 1998 in connection with various new business activities, including building its customer base, reorganizing operations and carrying on its product quality improvement programs. The overall goal of these activities is to enhance the long term value of the Company. The Company has begun to hire additional personnel, purchase new computer and other equipment, lease additional office space and incur other expenses in connection with these business activities. There can be no assurance that such costs will be offset by increases in revenue; and, in any event, the Company expects that any increase in revenue will lag the periods in which expenses are incurred. Furthermore, there can be no assurances that the hiring of additional personnel or the reorganizing of operations will lead to higher profitability. If such increases in expenses are not fully offset by increases in revenue, the Company's financial position and results of operations and earnings could be materially adversely affected. 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 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 amount of net written premium and the rate of cancellation of insurance policies, the addition or loss of customers, changes in the number of loans or personal property leases being tracked for customers, increases or decreases in interest rates, and catastrophic loss events. For example, in 1992 GPIC incurred net losses relating to the Los Angeles riots and Hurricane Andrew of $612,000 and $527,000, respectively. In November 1993, GPIC 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 and Real Estate Tax 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. The number of loans or leases for which the Company provides Tracking and Outsourcing Services may increase or decrease depending upon, among other things, the number of new loans or leases serviced by its customers and the volume of loans or leases paid off or sold to others. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Operating Results - The Insurance Industry". 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, GPIC 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 26 28 been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject GPIC 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 GPIC 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 GPIC 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 GPIC. Any significant changes in GPIC's estimate of ultimate losses on reported claims may materially adversely affect the results of GPIC's operations in the period reported. GPIC has in the past experienced adverse developments in its loss reserves. GPIC's loss and loss adjustment expense reserves are reviewed on an annual basis by unaffiliated actuaries. GPIC's most recent actuarial review of such reserves as of December 31, 1997 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 GPIC under the terms of its policies and agreements. GPIC also maintains a reserve for return premiums which is based upon GPIC's historical experience. As is prevalent in the lender-placed insurance industry, a substantial amount of GPIC'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 GPIC uses as a basis for recording written premiums or the loss of customers. No assurance can be given that the reserve for return premiums will be adequate to cover actual refunded premiums paid by GPIC in the future. See, "Business - Insurance Operations". Underwriting Risks Traditional insurance companies underwrite risks individually or by class, following an in-depth analysis of such risks. Although GPIC applies underwriting techniques to a small portion of insured risks, the immediate coverage required by purchasers of lender-placed insurance and REO Insurance generally requires GPIC to write specialized insurance within predesignated limits and geographic areas, at a flat rate, without the application of traditional underwriting criteria to individual risks. Accordingly, GPIC may be insuring individual risks that it might not have insured had it applied traditional analysis to such risks. In addition, GPIC may not have adequate spread of risk in a particular geographic area. See "Business - Insurance Operations - Underwriting". Reinsurance Considerations GPIC's business is partially dependent upon its ability to cede to reinsurers risks insured by GPIC. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of GPIC, which can affect GPIC's level of business and profitability. GPIC is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay GPIC for the losses of the insureds. As a result of the anticipated increased cost and more limited availability of reinsurance, in the future, GPIC may elect to retain a higher portion of the risk historically ceded to reinsurers. If GPIC were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by GPIC. This increased exposure could have a material adverse effect on the Company's results of operations. See "Business - Regulation - Reinsurance". Errors and Omissions Pinnacle 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 27 29 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. PinTax indemnifies its customers for real estate late-payment penalties, interest on late-paid taxes and loss of tax payment discounts as a result of certain errors or omissions made by PinTax. PMSIS and Fastrac indemnify customers for certain errors and omissions made by either of them. The Company maintains insurance coverage in the maximum aggregate amount of $5 million for certain types of errors and omissions. The policy is on a claims made and occurrence basis. While to date the Company has experienced no significant losses related to errors or omissions and maintains reserves equal to its self insured retention for errors and omissions losses, there can be no assurance such reserves will prove adequate in the future or that the Company's insurance will avert adverse impacts as a result of any errors or omissions. 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 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. Shortage of Skilled Labor The Company's delivery and upgrade of products and services to its customers is dependent upon, among other factors, the Company's ability to attract and retain key analytical and management professionals, including skilled computer programmers and systems analysts. Businesses located in San Francisco, San Mateo, Contra Costa and Santa Clara counties of California are experiencing a tightening of the local labor market for these professionals, which may result in one or more of the following: an increase in personnel costs, a delay in service installations and a reduction in customer service. The Company is unable to predict when the conditions in the local labor market will change. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 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 Information regarding executive officers called for by this Item is set forth in a separate item captioned "Executive Officers of the Company" and included in Part I of this Report. Other information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed on or before April 30, 1998, and such information is incorporated herein by reference. 28 30 ITEM 11. EXECUTIVE COMPENSATION Information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed on or before April 30, 1998, and such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed on or before April 30, 1998, and such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed on or before April 30, 1998, and such information is incorporated herein by reference. 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....................................... 31 Consolidated Balance Sheets, December 31, 1997 and 1996................. 32 Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995....................................... 33 Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995................... 34 Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996 and 1995................................. 35 Notes to Consolidated Financial Statements.............................. 36 (2) FINANCIAL STATEMENT SCHEDULES: Report of Independent Accountants on Financial Statement Schedules...... 55 I Summary of Investments Other than Investments in Related Parties... 56 II Condensed Financial Information of Registrant (Parent Company)..... 57 III Supplementary Insurance Information Concerning Property Casualty Operations .............................................. 60 IV Reinsurance........................................................ 61
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. 29 31 (b) REPORTS ON FORM 8-K National filed a Form 8-K on October 3, 1997 relating to the acquisition of PinTax, which included as exhibits a Purchase Agreement dated August 15, 1997, Amendment No.1 to the Purchase Agreement dated September 18, 1997, and a press release dated September 18, 1997. National filed a Form 8-K/A on November 26, 1997 which filed certain financial statements which were unavailable at the time the initial Form 8-K was filed, including, (i) American Realty Tax Services, Inc.("ARTS") and American Realty Tax Services of New York, Inc. ("ARTS-NY") Combined Balance Sheets as of December 31, 1995 and December 31, 1996, (ii) ARTS and ARTS-NY Combined Statements of Operations for the years ended December 31, 1995 and December 31, 1996, (iii) ARTS and ARTS-NY Combined Statements of Shareholders' Deficit commencing January 1, 1995 and ending December 31, 1996, (iii) ARTS and ARTS-NY Combined Statements of Cash Flows for the years ended December 31, 1995 and December 31, 1996, (iv) ARTS and ARTS-NY Combined Balance Sheets as of June 30, 1996 and June 30, 1997, (v) ARTS and ARTS-NY Combined Statements of Operations for the six months ended June 30, 1996 and June 30, 1997, (vi) Pro Forma Combined Financial Statements for the year ended December 31, 1996, and (vii) Pro Forma Combined Statement of Operations for the year ended December 31, 1996 and the six months ended June 30, 1997. (c) EXHIBITS See Item 14 (a) (3) above. (d) FINANCIAL STATEMENT SCHEDULES See Item 14 (a) (2) above. 30 32 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, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. San Francisco, California February 6, 1998 31 33 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
AS OF DECEMBER 31, ------------------ 1996 1997 ------ ------- ASSETS Investments: Fixed maturities at market (amortized cost: $18,293 in 1996 and $15,098 in 1997)............................................... $18,538 $15,359 Equity securities at market....................................... 2,051 4,200 Short-term investments, at cost (which approximates market)....... 11,984 9,290 ------ ------- Total investments............................................. 32,573 28,849 Cash .............................................................. 1,204 1,113 Net premiums and accounts receivable.................................. 5,181 8,990 Accrued interest receivable........................................... 377 449 Net property and equipment............................................ 3,484 5,424 Deferred acquisition costs............................................ 2,186 2,704 Deferred federal income taxes......................................... 421 3,117 Intangible assets..................................................... -- 13,178 Other assets.......................................................... 1,686 2,918 ------ ------- Total assets.................................................. $47,112 $66,742 ======= ======= LIABILITIES Reserve for losses and LAE............................................ $ 2,198 $ 3,232 Unearned premiums..................................................... 4,753 6,217 Commissions payable................................................... 584 837 Accrued expenses and other liabilities................................ 4,247 6,125 Drafts payable........................................................ 295 832 Notes payable......................................................... 1,333 9,601 Reserve for return premiums........................................... 2,382 4,399 Reserve for Proposition 103........................................... 2,268 --- Deferred revenue...................................................... 500 7,719 ------- ------- Total liabilities............................................. $18,560 $38,962 ======= ======= Commitments (Note 15) 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, 4,032,882 and 3,896,937 in 1997 and 1996, respectively........................................................ $17,592 $18,610 Retained earnings..................................................... 10,960 9,170 ------- -------- Total shareholders' equity.................................... 28,552 27,780 ------- ------- Total liabilities and shareholders' equity............................ $47,112 $66,742 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 32 34 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------ 1995 1996 1997 ----------- ----------- ----------- Net premiums written ....................... $ 14,956 $ 12,636 $ 20,501 Change in unearned premiums ................ 2,064 949 (1,463) ----------- ----------- ----------- Net premiums earned ........................ 17,020 13,585 19,038 Real estate information services ........... 10,593 18,499 23,492 Tracking fees .............................. 4,786 5,479 7,543 Net commissions income ..................... 1,502 1,145 1,166 Net investment income ...................... 2,042 1,975 1,839 ----------- ----------- ----------- Total revenues ..................... 35,943 40,683 53,078 ----------- ----------- ----------- Loss and LAE ............................... 6,044 4,002 6,482 Commissions paid to nonaffiliates .......... 4,079 1,954 1,837 Personnel expenses ......................... 16,891 18,948 23,127 All other expenses ......................... 12,252 14,221 16,930 Non-recurring expenses ..................... 4,100 -- -- ----------- ----------- ----------- Total expenses ..................... 43,366 39,125 48,376 ----------- ----------- ----------- Income (loss) before provision for (benefit from) income taxes ............. (7,423) 1,558 4,702 Provision for (benefit from) income taxes... (2,559) 284 1,436 ----------- ----------- ----------- Net income (loss) .......................... $ (4,864) $ 1,274 $ 3,266 =========== =========== =========== Earnings per share: Basic: Weighted average shares outstanding ...... 4,679,201 4,109,655 3,946,257 Basic EPS ................................ $ (1.04) $ 0.31 $ 0.83 Diluted: Weighted average shares outstanding ...... 4,679,201 4,141,360 4,127,382 Diluted EPS .............................. $ (1.04) $ 0.31 $ 0.79
The accompanying notes are an integral part of these consolidated financial statements. 33 35 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, 1995 ..................... 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 Net unrealized gain on fixed maturities and equity securities, net of deferred tax .. -- -- 48 48 Options exercised ............................. 136 1,018 -- 1,018 Net income .................................... -- -- 3,266 3,266 Dividends paid ................................ -- -- (5,104) (5,104) ------- -------- -------- -------- Balance, December 31, 1997 .................... 4,033 $ 18,610 $ 9,170 $ 27,780 ======= ======== ======== ========
Dividends declared per share were $1.30 for the year ended December 31, 1997. 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. 34 36 NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------- 1995 1996 1997 -------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) ....................................... $ (4,864) $ 1,274 $ 3,266 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ....................... 2,193 1,758 1,536 Loss on sale of equipment ........................... 1,040 288 -- Change in assets and liabilities net of effects from the purchase of ARTS: (Increase) decrease in net premiums and accounts receivable, and accrued interest receivable .... (89) 339 (2,686) (Increase) decrease in deferred acquisition costs .. 949 438 (517) Increase (decrease) in insurance liabilities ....... (3,179) (767) 5,051 Increase (decrease) in reserve for Prop. 103 ....... 4,100 (2,266) (2,268) (Increase) decrease in tax assets .................. (1,292) 1,169 123 Other, net ......................................... 709 (200) 348 -------- --------- -------- Net cash provided (used) by operating activities ............................ (433) 2,033 4,853 -------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments ................................. (43,518) (123,509) (56,382) Maturity of investments ................................. 45,273 128,138 60,106 Purchase of equipment ................................... (1,350) (1,445) (2,969) Purchase of ARTS ........................................ -- -- (9,881) -------- --------- -------- Net cash provided (used) by investing activities ............................. 405 3,184 (9,126) -------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of notes ......................... -- 2,000 9,268 Principal payments on notes payable ..................... -- (667) (1,000) Repurchase of common stock .............................. -- (5,667) -- Stock options exercised ................................. 6 188 1,018 Dividends to shareholders ............................... -- -- (5,104) --------- --------- --------- Net cash provided (used) by financing activities .............................. 6 (4,146) 4,182 --------- --------- --------- Net increase (decrease) in cash ............................. (22) 1,071 (91) Cash at beginning of year ................................... 155 133 1,204 --------- --------- --------- Cash at end of year ......................................... $ 133 $ 1,204 $ 1,113 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 35 37 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 (the "Subsidiaries") Pinnacle Data Corporation ("Pinnacle"), Pinnacle Real Estate Tax Services, Inc. ("PinTax-VA"), Pinnacle Real Estate Tax Services of New York, Inc. ("PinTax-NY", which together with PinTax-VA are referred to collectively as "PinTax"), Pinnacle Management Solutions Insurance Services ("PMSIS" formerly known as Fastrac Systems, Inc. Insurance Agent and Broker), Great Pacific Insurance Company ("GPIC"), Fastrac Systems, Inc. ("Fastrac") and New Arts Acquisition, Inc. ("New Arts"). The Subsidiaries have transactions with each other in the ordinary course of business. PMSIS receives a commission for business it writes which is insured or reinsured by GPIC and receives fees from GPIC. Certain expenses are shared among the Subsidiaries for providing insurance Tracking and Outsourcing Services. All significant intercompany accounts and transactions have been eliminated. National and its Subsidiaries provide specialized information services through technology, tracking services, outsourcing services and related insurance products to mortgage bankers and other financial institutions located throughout the United States and in Canada. 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 the customers of the Company to: o determine if residential or commercial real estate is located inside or outside a federally-designated Special Flood Hazard Area ("SFHA"), with respect to real estate which is collateral for loans being financed or serviced by customers of the Company or for other purposes, (the "Flood Zone Determination Services"); o obtain real estate tax data from various local, county and state taxing authorities nationwide with respect to real estate which is collateral for loans being financed or serviced by the customers of the Company, facilitate the payment to such taxing authorities by mortgage lenders and mortgage loan servicing companies from certain escrowed funds collected for real estate taxes from their borrowers with each monthly loan payment for real estate taxes to such taxing authorities, and inform mortgage lenders and mortgage servicing companies whether the real estate taxes on property securing real estate loans have been paid and perform certain tasks of the Company's customers on an outsourced basis (the "Real Estate Tax Services"); and o monitor the insurance coverage on collateral securing residential mortgages (predominantly one-to-four unit family dwellings), motor vehicle and other consumer loans and leases and, to a lesser extent, commercial mortgages, disburse insurance premiums collected from borrowers with each monthly loan payment for insurance coverage on behalf of mortgage lenders and mortgage servicing companies and perform certain tasks of the Company's customers on an outsourced basis (collectively, the "Tracking and Outsourcing Services"). When the Tracking and Outsourcing Services indicate that insurance coverage has lapsed, the customer may contract with the Company to provide specialized, fire, allied peril or physical damage insurance (generally referred to as "lender-placed" insurance, formerly referred to by the Company as "force-place" insurance), which the Company provides through its wholly-owned subsidiary Great Pacific Insurance Company, in 48 states and the District of Columbia and through nonaffiliated insurance companies in the remainder of the United States. The Company also provides flood insurance, for which the risk is assumed by an agency of the U. S. Government under the National Flood Insurance Program ("NFIP"). In addition, the Company provides fire and allied peril insurance with respect to properties on which financial institutions have foreclosed, and physical damage insurance on motor vehicles. Great Pacific Insurance 36 38 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Company is rated "A" ("Excellent") by A.M. Best Company, a nationally recognized insurance statistical and rating service. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the significant accounting policies adopted by National and its Subsidiaries in the accompanying financial statements: 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 common stock, preferred stock and limited partnership interests. 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 carried at market value or at cost in the event market values are not readily determinable. 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 classified its fixed maturity and equity security investments as held-to-maturity. Held-to-maturity investments were carried at amortized cost. The Company's investment policies are designed to 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. Data processing equipment and purchased software and office furniture and equipment are depreciated over five (5) years, and motor vehicles 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. Internal costs associated with software development of the Company's products have been expensed as incurred. Costs associated with software development by third parties are capitalized and depreciated over the estimated useful life of the software. Intangible assets include only goodwill, which is the excess of cost over fair market value of the Company's acquired entities. Goodwill is amortized on a straight-line basis over a period of twenty-five years. The Company evaluates the recoverability of long-lived assets such as goodwill by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are 37 39 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) adjusted to their fair values. Based on these evaluations, there were no adjustments to the carrying value of long-lived assets in 1996 or 1997. 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 refund as defined by law or regulation. In certain circumstances, the Company grants refunds in excess of the 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. Real estate information services revenue consists of revenues from Pinnacle and PinTax. Revenue for Pinnacle is recognized as income in the period in which Flood Zone Determination Services are performed. For certain customers, Pinnacle provides "life of loan" services. In these cases, for an up-front additional fee, Pinnacle is required to provide certain services during the life of the loan (the period of time the loan remains in a customer's portfolio). For cash revenues received under "life of loan" agreements, revenues are recognized in proportion to the variable costs incurred over the life of a loan. Substantially all of the variable costs incurred to provide such services occur within the first year of a loan's life. Pinnacle recognizes deferred revenue in reflection of its future servicing obligation for its "life of loan" customers. The majority of tax service revenues earned by PinTax are from "life of loan" servicing contracts, which require customers to pay an up-front, one-time fee to receive Real Estate Tax Services over the life of a loan. The revenue from "life of loan" contracts is recognized over the estimated life of the loans in proportion to the amount of expenses incurred to service the real estate property tax tracking on the subject loans. Since the bulk of expenses incurred in providing real estate property tax tracking on the loans occurs in the first year, a majority of the "life of loan" revenue is recognized within the first year of servicing. The remainder of the revenue is amortized in accordance with the estimated rate at which loans are paid off or otherwise are removed from the servicing portfolio. As a result of this revenue recognition policy, PinTax records a deferred revenue reserve on its balance sheet. As of December 31, 1997, deferred revenue for "life of loan" tax servicing was approximately $7.0 million. This is approximately the same amount of deferred revenue as of the date of the PinTax Acquisition. Tracking fee revenue consists primarily of fees earned in connection with providing Tracking and Outsourcing Services for Fastrac's motor vehicle leasing customers. Tracking fee revenue is recognized in the period in which it is earned. Commission income is recorded when earned, net of an estimated reserve for cancellation. 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. 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. 38 40 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 130 will have a material impact on its financial statements. In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 131 will have a material impact on its 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 the net income (loss) or shareholders' equity. 3. INVESTMENTS (a) Fixed-maturity investments available for sale (in thousands):
AS OF DECEMBER 31, 1996 AS OF DECEMBER 31, 1997 ---------------------------------------------- ---------------------------------------------- ESTIMATED ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET COST GAIN LOSS VALUE COST GAIN LOSS VALUE ------- ------- ----- ------- ------- ------- ----- ------- U.S. Government securities ........... $ 2,599 $ 10 $-- $ 2,609 $ 1,849 $ 10 $-- $ 1,859 State and municipal bonds ................ 10,282 235 -- 10,517 8,656 251 -- 8,907 Corporate Bonds ....... -- -- -- -- 1,193 -- -- 1,193 Certificates of deposit 5,331 -- -- 5,331 3,364 -- -- 3,364 Mortgage-backed securities ........... 81 -- -- 81 36 -- -- 36 ------- ------- ----- ------- ------- ------- ----- ------- Total .............. $18,293 $ 245 $-- $18,538 $15,098 $ 261 $-- $15,359 ======= ======= ===== ======= ======= ======= ===== =======
39 41 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) At December 31, 1997, 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 ---------------------------------------- ------------------------------------------ CORPORATE & CORPORATE & STATE AND U.S. STATE AND U.S. MUNICIPAL CERTIFICATES GOVT. MUNICIPAL CERTIFICATE GOVT. AMOUNTS IN THOUSANDS BONDS OF DEPOSIT SECURITIES BONDS OF DEPOSIT SECURITIES -------------------- ------- ------- ------- ------- ------- ------- Within one year .............. $ 757 $ -- $ -- $ 762 $ -- $ -- One through five years ....... 6,940 3,364 799 7,106 3,364 808 Six through ten years ........ 2,151 -- 1,050 2,232 -- 1,051 More than ten years .......... -- -- -- -- -- -- Mortgage-backed securities ... -- -- 36 -- -- 36 ------- ------- ------- ------- ------- ------- Total........................$ 9,848 $ 3,364 $ 1,885 $10,100 $ 3,364 $ 1,895 ======= ======= ======= ======= ======= =======
There were no sales of fixed-maturity investments in 1996 or 1997. (b) Equity Securities Available for Sale: 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. At December 31, 1997 the Company had market rate preferred stock and common stock with a cost of $3,525,145 and $353,276, respectively, an unrealized gain (loss) of $126,793 and $(25,151), respectively, and a market value of $3,651,938 and $328,125, respectively. At December 31, 1997, the Company had limited partnership interests with a cost of $220,000. The unrealized gain or loss on these interests cannot be ascertained, because market values are not readily determinable. (c) The components of investment income are as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1995 1996 1997 ------- ------- ------- Fixed maturities and equity securities........ $ 1,181 $ 1,246 $ 1,047 Short-term investments........................ 947 739 655 Net realized gains (losses)................... (3) 17 170 Investment expenses........................... (83) (27) (33) ------- ------- ------- Net investment income......................... $ 2,042 $ 1,975 $ 1,839 ======= ======= =======
40 42 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 4. PROPERTY AND EQUIPMENT The components of property and equipment are as follows (in thousands):
AS OF DECEMBER 31, -------------------------- 1996 1997 -------- -------- Office furniture and equipment .................. $ 3,240 $ 3,726 Data processing equipment ....................... 6,618 8,360 Software ........................................ 4,579 4,751 Leasehold improvements .......................... 1,023 1,381 Other ........................................... -- 499 -------- -------- 15,460 18,717 Less accumulated depreciation and amortization... (11,976) (13,293) -------- -------- Total .................................... $ 3,484 $ 5,424 ======== ========
Depreciation and amortization expense (in thousands) was $2,160, $1,758, and $1,536, in 1995, 1996, and 1997 respectively. 5. DEFERRED ACQUISITION COSTS Changes in deferred acquisition costs are summarized as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------- 1995 1996 1997 ------- ------- ------- Deferred acquisition costs, beginning of period... $ 3,573 $ 2,624 $ 2,186 Additions ........................................ 8,648 5,859 9,161 Amortization expense ............................. (9,597) (6,297) (8,643) ------- ------- ------- Deferred acquisition costs, end of period ........ $ 2,624 $ 2,186 $ 2,704 ======= ======= =======
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. 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, ---------------------------------------- 1995 1996 1997 ------- ------- ------- Reserves for losses and LAE at beginning of year ... $ 3,360 $ 3,055 $ 2,198 ------- ------- ------- Losses and LAE: Provision for losses and LAE for claims occurring in current year ..................... 6,378 3,971 6,364 Increase (decrease) in estimated losses and LAE for claims occurring in prior years ... (334) 31 119 ------- ------- ------- 6,044 4,002 6,483 ------- ------- ------- Losses and LAE payments for claims occurring during: Current year ................................... 4,329 2,487 3,292 Prior years .................................... 2,020 2,372 2,157 ------- ------- ------- 6,349 4,859 5,449 ------- ------- ------- Reserves for losses and LAE at end of year ......... $ 3,055 $ 2,198 $ 3,232 ======= ======= =======
41 43 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. NOTES PAYABLE In September 1996, a note agreement for $2,000,000 was entered into with the Company's primary commercial bank (the "Term Note"). The Term 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 Term Note is the outstanding capital stock of Pinnacle, which consists of 1,000 shares. As of December 31, 1997, the unpaid balance of this note was approximately $333,000. In connection with the PinTax Acquisition, National and New Arts entered into a term note facility (the "Term Facility") with the Company's primary commercial bank. The Term Facility allows for a maximum borrowing of $11.3 million, including $2 million for any Additional Consideration which may be payable pursuant to the Agreement on or before May 25, 1998. The Term Facility matures in May 2003 and calls for interest payments at the rate of prime plus one and one-quarter percent, beginning September 1997. Principal is payable monthly, beginning May 30, 1998, in accordance with a variable amortization schedule. Collateral for the loan includes non-insurance company cash deposits of the Company, the common stock of Pinnacle, as well as the stock of PinTax and of New Arts. As of December 31, 1997, the Company has utilized $9.3 million of the $11.3 million Term Facility. On April 2, 1997, the Company obtained a $5 million revolving credit facility (the "Revolving Facility") from the Company's primary commercial bank. On September 18, 1997, the Company amended the Revolving Facility. The primary amendment to the Revolving Facility was the reduction in borrowing limits to $1 million from $5 million. As of December 31, 1997, the Company had no borrowings under the Revolving Facility and was in compliance with the financial covenants of the Revolving Facility. The same financial covenants govern the Term Note, the Term Facility and the Revolving Facility. The primary financial covenants are: (i) a minimum tangible net worth requirement; (ii) a cash flow coverage requirement; and, (iii) a minimum profitability requirement, whereby the Company must be profitable from year-to-year and cannot report net losses for two consecutive quarters. Interest paid for 1995, 1996 and 1997 was $0, $41,025 and $365,352, respectively. The minimum principal payments due under all of the Company's notes payable as of December 31, 1997 is as follows (in thousands):
Principal Year Payment ------- -------- 1998............... $ 926 1999............... 965 2000............... 1,063 2001............... 2,004 2002............... 2,209 2003............... 2,434 ------ Total.............. $9,601 ======
42 44 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 8. INCOME TAX The components of income tax expense (benefit) are as follows (in thousands):
AS OF DECEMBER 31, ---------------------------------------- 1995 1996 1997 ------- ------- ------- Federal Current ....... $(1,508) $ (829) $ 1,257 Deferred ...... (1,142) 1,091 (147) Subtotal ... (2,650) 262 1,110 ------- ------- ------- State Current ....... 91 22 150 Deferred ...... -- -- 176 ------- ------- ------- Subtotal ... 91 22 326 ------- ------- ------- Total ......... $(2,559) $ 284 $ 1,436 ======= ======= =======
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:
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 1995 1996 1997 ---- ---- ---- Tax at federal statutory rate ................... 35% 35% 35% Tax-Exempt investment income .................... (9) (13) (4) State tax net of federal benefits ............... -- -- 5 Rate differential on net operating loss carryback ................................ -- -- (4) Other ........................................... 8 (4) (1) --- --- --- Total ...................................... 34% 18% 31% === === ===
The components of the net deferred tax balance as of December 31, 1995, 1996 and 1997 are as follows (in thousands):
ASSET (LIABILITY) ----------------------------------- 1995 1996 1997 ------- ------- ------- Unearned premium reserve .... $ 388 $ 323 $ 423 Deferred acquisition costs .. (892) (743) (919) Loss reserve discounting .... 39 90 68 Prepaid expenses ............ (95) (134) 1 Deferred revenue ............ 335 170 3,190 Proposition 103 reserve ..... 1,541 -- -- Accrued liabilities ......... 181 613 412 Depreciation ................ -- -- (132) Other ....................... 93 102 74 ------- ------- ------- Total .................. $ 1,590 $ 421 $ 3,117 ======= ======= =======
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. 43 45 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, ----------------------------------- 1995 1996 1997 ------- ------ ------- Unearned premium reserve ........................... $ 140 $ 65 $ (100) Deferred acquisition costs ......................... (323) (149) 176 Write-down of carrying value of equity securities... 78 -- -- Loss reserve discounting ........................... 23 (51) 22 Prepaid expenses ................................... 140 39 (135) Deferred revenue ................................... (134) 165 (3,020) Prop. 103 reserve .................................. (1,394) 1,541 -- Accrued liabilities ................................ 307 (432) 201 Depreciation ....................................... -- -- 132 Other .............................................. 21 (87) 28 ------- ------- ------- Total ......................................... $(1,142) $ 1,091 $(2,696) ======= ======= =======
Taxes paid in 1995, 1996 and 1997 were $91,000, $22,000, and $1,576,296 respectively. Tax refunds received for 1995, 1996 and 1997 were $627,000, $798,000, and $1,340,638 respectively. 9. EMPLOYEE BENEFIT PLAN The Company adopted a defined contribution 401(k) plan on July 1, 1996. All employees of the Company are eligible to participate in the plan at the beginning of a calendar quarter following completion of ninety days of continuous employment as defined in the 401(k) plan. 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 and $82,406 for 1997. 10. 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. 11. EARNINGS PER SHARE In February 1997, FASB 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 implemented SFAS No. 128 in 1997. The impact SFAS No. 128 is set forth in the following tables. The earnings per share for 1995 and 1996 were restated to reflect SFAS No. 128. 44 46 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) BASIC EPS UNDER SFAS NO. 128
1995 1996 1997 ---------- ----------- ------------ Weighted average common shares ..... 4,679,201 4,109,655 3,946,257 Net income (loss) (in thousands) ... $ (4,864) $ 1,274 $ 3,266 Per share results: Net income (loss) ......... $ (1.04) $ 0.31 $ 0.83 DILUTED EPS UNDER SFAS NO. 128 1995 1996 1997 ----------- ----------- ----------- Weighted average common shares ..... 4,679,201 4,109,655 3,946,257 Common shares issuable under outstanding stock options ........ -- 31,705 181,125 ----------- ----------- ----------- Total ..................... 4,679,201 4,141,360 4,127,382 =========== =========== =========== Net income (loss) (in thousands).... $ (4,864) $ 1,274 $ 3,266 Per share results: Net income (loss) ......... $ (1.04) $ 0.31 $ 0.79
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 1995, the Company had a loss per share which is calculated based upon the number of common shares outstanding. 12. 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 1,106,820 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 $1,000, $14,235 and $189,032 during 1995, 1996, and 1997, respectively. This amount has been credited directly to common stock. 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 45 47 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 Principles 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 $0 for 1995, $584,000 for 1996 and $708,327 for 1997. Earnings per share would not have been affected in 1995, but would have been $0.23 in 1996 and $0.61 in 1997. The pro forma effect on net income for 1995, 1996 and 1997 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 1997, 1996 and 1995, is estimated at $4.37, $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 1997 and 1996:
1996 1997 ----------- ----------- Dividend yield............. 0% 0% Expected volatility........ 42.41% 46.30% Risk-free interest rates... 5.11%-6.77% 5.73%-6.75% Expected life.............. 5 years 5 years
The following table summarizes option activity during 1996 and 1997 for the 1986 Stock Option Plan, as amended, and 1991 Director Option Plan, as amended.
1996 1997 ----------------------------- ---------------------------- WEIGHTED AVERAGE WEIGHTED AVERAGE EXERCISE PRICE PER EXERCISE PRICE PER OPTIONS SHARE OPTIONS SHARE ---------- -------- ---------- -------- Shares issuable under outstanding options at January 1 ................... 771,830 $ 6.66 1,144,783 $ 6.65 Options granted ........................ 566,000 $ 6.14 288,000 $ 8.65 Options exercised ...................... (22,540) $ 6.64 (135,945) $ 6.10 Options canceled or forfeited .......... (170,507) $ 5.64 (327,186) $ 6.67 ---------- -------- ---------- -------- Shares issuable under outstanding options at December 31 ................. 1,144,783 $ 6.65 969,652 $ 7.32 ========== ======== ========== ======== Options exercisable at December 31...... 836,970 $ 6.84 723,297 $ 7.63 ========== ======== ========== ========
46 48 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 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 or consulting 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, 1997.
AVERAGE WEIGHTED AVERAGE RANGE OF WEIGHTED NUMBER OF REMAINING LIFE EXERCISE PRICE PER EXERCISE PRICES OUTSTANDING OPTIONS (YEARS) SHARE --------------- ------------------- ------- ----- $5.13 - $7.30 754,402 7.46 $ 6.19 $8.88 - $13.00 211,406 8.49 $ 11.19 $14.58 - $15.25 3,844 4.09 $ 14.75 ------- ---- --------- Total: 969,652 7.67 $ 7.32 ======= ==== =========
Options exercisable:
WEIGHTED RANGE OF NUMBER EXERCISABLE AT AVERAGE EXERCISE EXERCISE PRICES DECEMBER 31, 1997 PRICE PER SHARE --------------- ----------------- --------------- $5.13 - $7.30 508,047 $ 6.09 $8.88 - $13.00 211,406 $ 11.19 $14.58 - $15.25 3,844 $ 14.75 ------- --------- Total: 723,297 $ 7.63 ======= =========
13. 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 represented 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 7 to Notes to Consolidated Financial Statements. 14. DIVIDEND RESTRICTION California law limits the payment of dividends to National by GPIC. The maximum dividend that may be paid without prior approval of the California Insurance Commissioner is limited to the greater of 10% of policyholders' surplus 47 49 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (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 GPIC at December 31, 1996. Statutory policyholders' surplus and net income of GPIC is as follows (in thousands):
1995 1996 1997 ----------- -------- ------- Statutory policyholders' surplus...... $ 23,687 $ 26,765 $ 25,580 Net income (loss)..................... $ (1,892) $ 2,758 $ 1,627
California law further prohibits the payment of dividends without prior approval of the California Department of Insurance (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 statutory annual statement filed with the Department, 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. GPIC paid National approximately $2.5 million in dividends in 1997. There were no cash dividends paid by GPIC in 1995 or 1996. 15. COMMITMENTS The Company has entered into operating leases for office space for National and the Subsidiaries' home office, Fastrac's branch offices in Springfield, Ohio, Pinnacle's office in Concord, California, PinTax's office in Vienna, Virginia and other offices. Rental expense under operating leases was $1,134,000, $1,175,000 and $1,447,000 in 1995, 1996 and 1997, respectively. National has entered into employment contracts with certain key employees which are not at-will employment agreements. Base compensation expense (not including bonus or commission) under such employment contracts was $199,493, $286,019 and $590,000 in 1995, 1996 and 1997, 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, 1997, National had commitments for such future compensation with respect to employment contracts with Mark Speizer and Bruce Cole. The future minimum payments due under commitments at December 31, 1997 are as follows (in thousands):
OPERATING EMPLOYMENT FOR THE YEAR ENDING DECEMBER 31, LEASES AGREEMENTS -------------------------------- ------ ---------- 1998 ............................................ $1,918 $ 590 1999 ............................................ 1,506 306 2000 ............................................ 583 -- 2001 ............................................ 191 -- 2002 ............................................ 39 -- ------ ------ Total minimum payments $4,237 $ 896
16. PROPOSITION 103 On October 25, 1995, GPIC entered into a stipulation and consent order with the California Insurance Department to resolve GPIC's rollback obligation related to California Proposition 103. Pursuant to that settlement, GPIC 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 GPIC's total written premiums 48 50 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) in California for policies in Proposition 103 lines issued or renewed during the rollback year. Pursuant to the settlement, the rollback refund constitutes GPIC's entire rollback obligation and fully discharges GPIC 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 GPIC 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 GPIC from time to time between November 8, 1989 and the date the settlements were approved. In October 1997, the amount of the uncashed refund checks were escheated to the State of California in accordance with its laws. The Company had previously established adequate reserves to cover such payments. 17. REINSURANCE GPIC, 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 GPIC in the event any reinsurer is unable or will not fulfill the obligations assumed under the agreements. GPIC limits its credit risk associated with reinsurance recoverables by evaluating the financial condition of members of the reinsurance pool, and diversifying the pool participants. For the years ended December 31, 1995, 1996, and 1997, there were no receivables recorded under reinsurance treaties. For the years ended December 31, 1995, 1996 and 1997, ceded reinsurance premiums, exclusive of flood reinsurance premiums, were $933,000, $691,000, and $780,338, respectively, and with respect to losses in such years, there were no ceded reinsurance losses. GPIC 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, 1995, 1996, and 1997, ceded reinsurance premiums for this program were $1,234,000, $2,268,000, and $2,859,438 respectively. 18. MAJOR CUSTOMERS During 1995, National and Subsidiaries derived 13% of total revenues from one customer, all of which was for insurance services. During 1996, National and Subsidiaries derived 9% of total revenues from one customer, of which all was for insurance services. During 1997, National and Subsidiaries derived 11.8% of total revenues from one customer, all of which was for insurance services. In the second half of 1997 the Company received notice that such customer and one other customer, which, combined, accounted for 18.8% of consolidated revenues in 1997, would not renew their hazard tracking, outsourcing and lender-placed insurance contracts. 19. RELATED PARTY TRANSACTIONS 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. 49 51 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) One of the companies which provides reinsurance to the Company is Constitution Reinsurance Corporation. Bard E. Bunaes, a director of the Company, is also Chairman of the Board and Chief Executive Officer of Constitution Reinsurance Corporation. Constitution Reinsurance Corporation has been a reinsurer of the Company in excess of 15 years. In 1996 and 1997 premiums paid to Constitution Reinsurance Corporation by the Company with respect to such reinsurance totaled approximately $34,000 and $70,000, respectively. In September 1996 National entered into a consulting agreement (the "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 was for one year; and the term was extended for an additional period of one year, which expires on September 11, 1998. Pursuant to the Consulting Agreement, Scorpion receives an annual fee of $300,000 plus reimbursement for reasonable out-of-pocket costs and expenses. Nuno Brandolini is the sole shareholder, a director and chief executive officer of Scorpion. Kevin McCarthy is a director and president of Scorpion. Messrs. Brandolini and McCarthy were directors of National from July 1996 to July 1997. 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 was evidenced by a Convertible Promissory Note, in the principal amount of $300,000, which earned interest at the rate of 10% per annum. Mr. Brandolini and Mr. McCarthy, who were directors of National, are also directors, officers and shareholders of Hydrodynamics. The transaction was identified and recommended to the Company by Scorpion pursuant to the Consulting Agreement. In December 1996, Hydrodynamics commenced voluntary proceedings under Chapter 11 of the federal bankruptcy laws. In February 1997, Arabella, S.A. ("Arabella") 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. Mr. Brandolini is also a director of Arabella. In July 1997, an affiliate of Scorpion, known as Scorpion Acquisition, LLC ("Scorpion Acquisition"), sold to Mark A. Speizer certain rights previously granted to Scorpion Acquisition by Mr. Speizer to acquire shares of National owned by Mr. Speizer. In consideration for sale of such rights to Mr. Speizer, Mr. Speizer will pay to Scorpion Acquisition an amount equal to the greater of $4,000,000 or 50% of the notional profits that would have been earned on a notional 924,000 shares of Common Stock with a notional cost of $7.75 per share, each subject to certain defined adjustments. Profits are determined by reference to the average closing price of Common Stock (and the average closing price of securities other than Common Stock paid by dividend, spin-off or otherwise on Common Stock ["Distributed Stock"]) during the fifteen business days preceding and the fifteen business days following June 30, 2002, or if Scorpion Acquisition has made an election permitted under its purchase agreement with Mr. Speizer, that date between January 1, 2000 and June 30, 2002 that is so elected. Mr. Speizer may pay the purchase price in cash or in shares of National or shares of Distributed Stock subject to having received any necessary approvals or exemptions from the California Insurance Commissioner as may be required by statute or regulation. In August 1997, National invested $100,000 for a limited partnership interest in Pizza Partners, L.P., a Delaware limited partnership. Among other things, such partnership was formed to acquire a number of Pizza Hut restaurants in Northern California, Oregon and Nevada. The investment was identified and recommended to the Company by Scorpion pursuant to the Consulting Agreement. 50 52 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In July 1997, Arabella acquired 300,000 shares of the Company's stock from Mr. Speizer and was paid $2 million by Mr. Speizer in repayment of a loan made to Mr. Speizer in May 1996. See Note 20 of Notes to Consolidated Financial Statements. In November 1997, such shares were transferred to Scorpion Acquisition by Arabella in exchange for an 80% interest in Scorpion Acquisition. Mr. Brandolini and Mr. McCarthy each own an 8.4% interest as members of Scorpion Acquisition. Mr. Paul Caland owns an 80% interest in Scorpion Acquisition, which interest Mr. Caland acquired from Arabella in December 1997. The interests of Messrs. Brandolini, McCarthy and Caland in Scorpion Acquisition and the transfer of the member interests of Arabella to Mr. Caland are based upon information filed by Scorpion Acquisition and Mr. Caland in a Schedule 13D with the Securities and Exchange Commission on February 27, 1997. In January 1998 the Compensation Committee of the Board of Directors granted each of Mr. Brandolini and Mr. McCarthy an option to purchase 37,500 shares of the Company's common stock. The grants were made pursuant to the Company's 1986 Stock Option Plan, as amended, and with reference to Mr. Brandolini and Mr. McCarthy acting as consultants to the Company through Scorpion. The terms and conditions of the grants are the same as those pertaining to grants to employees and other consultants of the Company. 20. 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 its wholly-owned subsidiaries. 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. 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 current proceedings is likely to have a materially adverse effect on the consolidated financial position of the Company. 22. ACQUISITION On September 18, 1997, two wholly-owned subsidiaries of the Company, Pinnacle American Realty Tax Services, Inc., a Delaware corporation ("PARTS-VA"), and Pinnacle American Realty Tax Services of New York, Inc., a Delaware corporation ("PARTS-NY"), acquired substantially all the assets and assumed certain liabilities of American Realty Tax Services, Inc., a Virginia corporation ("ARTS-VA"), and American Realty Tax Services of New York, Inc., a Virginia corporation ("ARTS-NY") (ARTS-NY and ARTS-VA, collectively "ARTS"). The acquisition agreement, dated August 15, 1997, as amended (the "Agreement"), was entered into by and among ARTS, the shareholders of ARTS, the Company, and New Arts. On October 1, 1997, PARTS-VA changed its name to Pinnacle Real Estate Tax Services, Inc. and PARTS-NY changed its name to Pinnacle Real Estate Tax Services of New York, Inc. The business of PinTax is providing Real Estate Tax Services. As consideration for the acquisition of certain assets of ARTS. New Arts paid $9.8 million in cash and agreed to assume certain liabilities of ARTS. Pursuant to the Agreement, if the cash revenue received by the Company for certain contracts of PinTax exceeds certain targets for the twelve months ended and including April 30, 1998, PinTax is required 51 53 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) to pay additional consideration of up to $4 million according to a formula as set forth in the Agreement ("Additional Consideration"). If such amount is paid, it will increase goodwill by a like amount. Fifty percent of the Additional Consideration may be paid in the form of a three year note bearing interest at eight percent per annum. The remaining fifty percent of the Additional Consideration may be paid in cash. National has agreed to guarantee the payment of these obligations. The PinTax Acquisition was accounted for as a purchase of assets. The fair market value of the assets acquired from ARTS was approximately $4.4 million. The fair market value of liabilities assumed was approximately $7.3 million, including approximately $7 million of deferred revenue related to ARTS' then existing portfolio of loans. The amount of goodwill recorded as of the date of PinTax Acquisition was $12.7 million, which is being amortized over a 25-year period as a result of long standing vendor and customer relationships. Goodwill is classified on the Company's balance sheet under "Intangible Assets". The following pro forma financial statements reflect the results of operations for 1997 and 1996 as though the PinTax Acquisition had occurred at the beginning of the respective periods. The pro forma figures include the following adjustments: (i) goodwill amortization expense of $510,000 in 1996 and $379,000 in 1997; (ii) a reduction in investment income on investments not purchased as part of the PinTax Acquisition of $635,000 and $11,000 in 1996 and 1997, respectively, which had been credited to ARTS' expenses; and, (iii) interest on the debt incurred in connections with the PinTax Acquisition of $868,000 in 1996 and $590,000 in 1997. Pro Forma Combined Statements of Operations For the Years Ended December 31, 1996 and December 31, 1997 (unaudited; figures in thousands except per share amounts)
Pro Forma ----------------------- 1996 1997 ------- ------- Revenues ............ $49,082 $58,648 Expenses ............ 48,029 54,361 ------- ------- Income before taxes . 1,053 4,287 Tax provision ....... 77 1,266 ------- ------- Net income .......... $ 976 $ 3,021 ======= ======= Net income per share: Basic ............ $ 0.24 $ 0.77 ======= ======= Diluted .......... $ 0.24 $ 0.73 ======= =======
23. SEGMENT REPORTING In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 131 will have a material impact on its financial statements. The principal segments of the Company are the following: Information Services ....The Company provides contract services, including insurance tracking and outsourcing, property tax data management and outsourcing, and flood zone determinations for financial institutions and others. 52 54 NATIONAL INSURANCE GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Insurance Products ......The Company provides lender-placed insurance for financial institutions when their borrowers fail to maintain adequate insurance in force, provides fire insurance on foreclosed real estate and provides motor vehicle physical damage insurance. In addition, the Company issues flood insurance policies in the federal Write Your Own Program ("WYO Program"). 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, -------------------------------------------------------- 1995 1996 1997 --------------- ---------------- --------------- AMOUNT % AMOUNT % AMOUNT % Information services ..... $15,379 42.8% $23,978 58.9% $31,035 58.5% Insurance products ....... 20,564 57.2% 16,705 41.1% 22,043 41.5% ------- ----- ------- ----- ------- ----- $35,943 100.0% $40,683 100.0% $53,078 100.0% ======= ===== ======= ===== ======= =====
CONSOLIDATED PRE-TAX INCOME (LOSS) FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------ 1995 1996 1997 -------- -------- -------- (IN THOUSANDS) Information services ........ $ 13 $ 3,545 $ 6,883 Insurance products .......... 5,559 7,820 9,212 General corporate expenses .. (8,895) (9,807) (11,393) Non-recurring charges ....... (4,100) -- -- -------- -------- -------- $ (7,423) $ 1,558 $ 4,702 ======== ======== ========
53 55 Identifiable assets, capital expenditures, and depreciation and amortization by segment for the years ended as of December 31, 1996 and 1997 are as follows (in thousands):
DECEMBER 31, 1996 DECEMBER 31, 1997 ------------------------------------------- ----------------------------------------- DEPRECIATION DEPRECIATION CAPITAL AND CAPITAL AND ASSETS EXPENDITURES AMORTIZATION ASSETS EXPENDITURES AMORTIZATION -------- ------------ ------------ -------- ------------ ------------ Information Services .. $ 15,338 $ 1,206 $ 1,291 $ 32,658 $ 2,097 $ 1,102 Insurance Products .... 32,321 239 467 32,778 1,400 434 Holding Company ....... (547) -- -- 1,306 -- -- -------- -------- -------- -------- -------- -------- $ 47,112 $ 1,445 $ 1,758 $ 66,742 $ 3,497 $ 1,536
24. RESULTS BY QUARTER (UNAUDITED)
QUARTER ENDED --------------------------------------------------------------------------------------------- MARCH JUNE SEPT. DEC. MARCH JUNE SEPT. DEC. 31, 30, 30, 31, 31, 30, 30, 31, 1996 1996 1996 1996 1997 1997 1997 1997 --------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Total revenue ...................... $ 10,423 $ 10,132 $ 10,115 $ 10,013 $ 10,914 $ 12,593 $ 13,227 $ 16,342 Income before provision for (benefit from) income taxes ...... 234 (1,350) 1,371 1,303 1,179 1,335 1,361 828 Net income (loss) .................. 149 (857) 870 1,112 802 838 878 749 Net income (loss) per share- diluted .......................... $ 0.03 $ (0.18) $ 0.19 $ 0.28 $ 0.20 $ 0.21 $ 0.22 $ 0.18 Net income (loss) per share-basic .. $ 0.03 $ (0.18) $ 0.19 $ 0.28 $ 0.21 $ 0.21 $ 0.22 $ 0.19
54 56 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 6, 1998 55 57 SCHEDULE I NATIONAL INSURANCE GROUP AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997
AMOUNT AT NUMBER OF WHICH SHOWN SHARES OR MARKET IN THE PRINCIPAL COST VALUE BALANCE SHEET --------- ----------- ----------- ----------- Fixed Maturities: Bonds and notes: U.S. Government securities ... $ 1,849,207 $ 1,858,594 $ 1,858,594 Municipalities ............... 6,651,853 6,853,326 6,853,326 States ....................... 2,003,785 2,053,479 2,053,479 Corporate ..................... 1,192,708 1,192,437 1,192,437 Certificates of deposit ...... 3,364,577 3,364,577 3,364,577 Mortgage-backed securities ... 36,533 36,533 36,533 ----------- ----------- ----------- Total Fixed Maturities ..... 15,098,663 15,358,946 15,358,946 ----------- ----------- ----------- Equity Securities: Preferred stock Public Utilities ............. 64,564 1,785,395 1,877,188 1,877,188 Financial Institutions ....... 52,000 1,139,750 1,174,250 1,174,250 Industrial ................... 34,000 600,000 600,500 600,500 Common stock Industrial ................. 35,000 353,276 328,125 328,125 Other ........................... 220,000 220,000 220,000 ----------- ----------- ----------- Total Equity Securities .... 4,098,421 4,200,063 4,200,063 ----------- ----------- ----------- Short-term Investments .......... 9,290,085 9,290,085 9,290,085 ----------- ----------- ----------- Total Investments .......... $28,487,169 $28,849,094 $28,849,094 =========== =========== ===========
56 58 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) BALANCE SHEETS DECEMBER 31, 1996 AND 1997
1996 1997 ------------ ------------ ASSETS Short-term investments and cash .......................... $ (42,845) $ 153,350 Investments in subsidiaries .............................. 27,397,827 25,902,253 Federal and State Income Taxes Receivables ............... -- 484,990 Deferred Federal Income Taxes Receivables ................ -- 153,113 Other assets ............................................. 4,267,506 3,277,279 ------------ ------------ Total assets ..................................... $ 31,622,488 $ 29,970,985 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Federal and state income taxes payable ................... $ 316,817 $ -- Accrued Liabilities ...................................... 1,054,814 1,857,222 Deferred federal income taxes ............................ 365,448 -- Notes payable ............................................ 1,333,333 333,333 ------------ ------------ Total liabilities ................................ 3,070,412 2,190,555 ------------ ------------ Shareholders' equity Common stock .......................................... 17,591,787 18,610,173 Retained earnings ..................................... 10,960,289 9,170,257 ------------ ------------ Total shareholders' equity ....................... 28,552,076 27,780,430 ------------ ------------ Total liabilities and shareholders' equity ....... $ 31,622,488 $ 29,970,985 ============ ============
57 59 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
1995 1996 1997 ----------- ----------- ----------- Net investment income ...................... $ 67,979 $ 14,495 $ 105,251 Operating expenses ......................... (1,141,735) 29,229 69,978 Provision for (benefit from) income taxes .. (116,145) (991,959) 139,020 Equity in net income of subsidiaries ....... (3,674,831) 2,221,737 2,951,733 ----------- ----------- ----------- Net income (loss) .................... $(4,864,732) $ 1,273,502 $ 3,265,982 =========== =========== ===========
58 60 SCHEDULE II NATIONAL INSURANCE GROUP AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 INCREASE (DECREASE) IN CASH
1995 1996 1997 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) ....................................... $(4,864,732) $ 1,273,502 $ 3,265,982 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed equity in net income of subsidiaries ... 3,674,831 (2,221,737) (2,951,733) Decrease in taxes payable ............................ (322,198) (241,060) (1,320,368) Other ................................................ (1,875,270) 5,149,149 1,792,635 ----------- ----------- ----------- Net cash provided (used) by operating activities ........ $(3,387,369) $ 3,959,854 $ 786,516 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments ................................. $ -- $ -- $(2,393,731) Maturity of investments ................................. 3,220,857 143,000 2,173,731 ----------- ----------- ----------- Net cash provided (used) by investing activities ........ $ 3,220,857 $ 143,000 $ (220,000) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from capital contributions ..................... $ -- $ -- $ 4,495,000 Dividends paid .......................................... -- -- (5,103,706) Proceeds from stock options exercised ................... 4,992 188,601 1,018,385 Repurchase of common stock .............................. -- (5,667,365) -- Proceeds from (payments to) notes payable ............... -- 1,333,333 (1,000,000) ----------- ----------- ----------- Net cash provided (used) by financing activities ........ 4,992 (4,145,431) (590,321) ----------- ----------- ----------- Net decrease in cash .................................... (161,520) (42,577) (23,805) Cash at beginning of year ............................... 161,252 (268) (42,845) ----------- ----------- ----------- Cash at end of year ..................................... $ (268) $ (42,845) $ (66,650) =========== =========== ===========
59 61 SCHEDULE III NATIONAL INSURANCE GROUP AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION CONCERNING PROPERTY CASUALTY OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
1995 1996 1997 ----------- ------------ ------------ Deferred policy acquisition costs ..................... $ 2,623,562 $ 2,186,586 $ 2,704,326 Reserves for unpaid claims and claims adjustment Expenses .......................................... 3,054,710 2,198,478 3,231,589 Less reserve discount ................................. -- -- -- Unearned premiums ..................................... 5,703,396 4,753,448 6,216,693 Earned premiums ....................................... 17,020,440 13,585,007 19,037,427 Net investment income ................................. 2,042,225 1,974,925 1,838,888 Claims and claim adjustment expenses incurred Related to: Current year ...................................... 6,378,000 3,971,000 6,364,000 Prior year ........................................ (334,000) 31,000 119,000 Amortization of deferred policy acquisition costs ..... 9,597,252 6,296,010 8,643,187 Paid claims and claim adjustment expense .............. 6,349,000 4,859,000 5,449,000 Net premiums written .................................. 14,955,906 12,635,058 20,500,672
60 62 SCHEDULE IV NATIONAL INSURANCE GROUP AND SUBSIDIARIES REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
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, 1997 $ 20,326,220 $ 780,338 $ (9,689) $19,536,193 (0.0)% ============ ============ ========== =========== === 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)% ============ ============ ========== =========== === Auto physical damage insurance premiums: Year ended December 31, 1997 $ 672,540 $ -- $ -- $ 672,540 0.0% ============ ============ ========== =========== === Year ended December 31, 1996 $ (18,430) $ -- $ -- $ (18,430) 0.0% ============ ============ ========== =========== === Year ended December 31, 1995 $ 254,462 $ 10,810 $ (11) $ 243,652 0.0% ============ ============ ========== =========== === Flood insurance premiums: Year ended December 31, 1997 $ 2,859,438 $ 2,859,438 -- -- 0.0% ============ ============ ========== =========== === Year ended December 31, 1996 $ 2,267,703 $ 2,267,703 -- -- 0.0% ============ ============ ========== =========== === Year ended December 31, 1995 $ 1,234,443 $ 1,234,443 -- -- 0.0% ============ ============ ========== =========== ===
61 63 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 26, 1998 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 Officer, March 26, 1998 - -------------------------- and Chairman of the Board Mark A. Speizer /s/ BRUCE A. COLE - -------------------------- Director and President March 26, 1998 Bruce A. Cole /s/ GREGORY S. SAUNDERS - -------------------------- Executive Vice President, Treasurer March 26, 1998 Gregory S. Saunders and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ BARD E. BUNAES - -------------------------- Director March 26, 1998 Bard E. Bunaes /s/ LAWRENCE M. GOODMAN - -------------------------- Director March 26, 1998 Lawrence M. Goodman /s/ SAUL B. JODEL - -------------------------- Director March 26, 1998 Saul B. Jodel
62 64 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------ ----------- 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, 1997 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 (1996) (6) 10.5 Memoranda of Reinsurance as to First Property Per Risk Excess of Loss Reinsurance Agreements and the First, Second and Third Property Catastrophe Excess Reinsurance Agreements (1997) (9) 10.6 Memoranda of Reinsurance as to First Property Per Risk Excess of Loss Reinsurance Agreements and the First, Second and Third Property Catastrophe Excess Reinsurance Agreements (1998) 10.7 Second Amendment of John R. Gaulding At-Will Employment Agreement dated July 10, 1996 10.7 by and John R. Gaulding, National Insurance Group, its current and future subsidiaries (7) 10.8 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) 10.9 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) 10.10 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) 10.11 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) 10.12 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) 10.13 Sublease Agreement dated March 24, 1994 between the Company and PHH Homequity Corporation for the premises located at 1855 Gateway Boulevard, Concord, California (5) Office Lease dated January 1, 1998 between Pinnacle Data Corporation and Systron Business 10.14 Center, LLC, for the premises at 2727 Systron Drive, Concord, California (exhibits omitted). 10.15 Form of Indemnification Agreement between Registrant and its officers and directors (4) 10.16 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)
63 65 EXHIBIT NUMBER DESCRIPTION - ------ ----------- 10.17 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) 10.18 Mark A. Speizer Employment Agreement dated July 11, 1996 by and between National and Mark A. Speizer (7) 10.19 Bruce A. Cole Employment Agreement dated July 11, 1996 by and between National and Bruce A. Cole (7) 10.20 Employment Agreement effective August 12, 1996 by and between National and Robert P. Barbarowicz (9) 10.21 Consulting Agreement dated September 11, 1996 by and between National and Scorpion Holdings, Inc. (8) 10.22 Employment Agreement dated March 10, 1997 by and between National and Gregory S. Saunders (9) 10.23 Employment Agreement dated May 7, 1997 by and between National and Douglas H. Helm (10) 10.24 Assets Purchase Agreement by and among New ARTS Acquisition, Inc., National Insurance Group, American Realty Tax Services, Inc., American Realty Tax Services of New York, Inc., and Certain Shareholders dated August 15, 1997 and Amendment No. 1 to Assets Purchase Agreement dated September 18, 1997 (11) 10.25 Credit Terms and Conditions dated April 2, 1997, by and between National Insurance Group and Imperial Bank and Amendment No. 1 to Credit Terms and Conditions dated September 17, 1997, by and between National Insurance Group and Imperial Bank (12) 10.26 Credit Terms and Conditions dated September 11, 1997, by and between New Arts Acquisition, Inc. and Imperial Bank (12) 10.27 Note dated September 11, 1997, made by New Arts Acquisition, Inc. payable to Imperial Bank in the original principal amount of $11,268,000 (12) 10.28 Addendum to Note dated September 11, 1997, made by New Arts Acquisition, Inc. (12) 10.29 Note dated September 11, 1997, made by National Insurance Group payable to Imperial Bank in the original principal amount of $1,000,000 (12) 10.30 Letter Amendment dated March 20, 1998, which amends the Note dated September 11, 1997, made by National Insurance Group payable to Imperial Bank in the original principal amount of $1,000,000. 10.31 Continuing Guarantee dated September 11, 1997, by National Insurance Group for the benefit of Imperial Bank (12) 10.32 General Security Agreement dated September 11, 1997, by New Arts Acquisition, Inc. for the benefit of Imperial Bank (12) 10.33 Pledge Agreement dated September 10, 1996, by and between National Insurance Group and Imperial Bank, as amended by Amendment No. 1 to Pledge Agreement dated April 2, 1997, and as further amended by Amendment No. 2 to Pledge Agreement dated September 18, 1997 (12) 10.34 401(k) Plan, First Amendment to 401(k) Plan and Participation Agreements (9) 10.34 401(k) Plan, as amended, dated as of October 1, 1997, ValuSelect Trust Agreement, and Adoption Agreement 11.1 Computation of Weighted Average Shares Outstanding and Earnings per Share 64 66 21.1 Subsidiaries of Company 24.1 Power of Attorney 27.1 Financial Data Schedule 27.2 Restated Financial Data Schedule for September 30, 1997 27.3 Restated Financial Data Schedule for June 30, 1997 27.4 Restated Financial Data Schedule for March 31, 1997 27.5 Restated Financial Data Schedule for December 31, 1996 27.6 Restated Financial Data Schedule for September 30, 1996 27.7 Restated Financial Data Schedule for June 30, 1996 27.8 Restated Financial Data Schedule for March 31, 1996 27.9 Restated Financial Data Schedule for December 31, 1995 - --------------- (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. (9) Incorporated by reference to exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1996. (10) Incorporated by reference to exhibits filed with the Company's Form 10-Q for the quarter ended June 30, 1997. (11) Incorporated by reference to exhibits filed with the Company's Form 8-K dated September 18, 1997. (12) Incorporated by reference to exhibits filed with the Company's Form 10-Q for the quarter ended September 30, 1997. THE REGISTRANT WILL FURNISH ANY EXHIBIT UPON THE PAYMENT OF A REASONABLE FEE, WHICH FEE SHALL BE LIMITED TO THE REGISTRANT'S REASONABLE EXPENSES IN FURNISHING SUCH EXHIBIT. 65 EX-10.1 2 1986 STOCK OPTION PLAN, AS AMENDED THROUGH 7/11/97 1 EXHIBIT 10.1 NATIONAL INSURANCE GROUP 1986 STOCK OPTION PLAN (AS AMENDED THROUGH JULY 11, 1997) 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 compensated for such consulting services, and any director of the Company whether compensated for such services or not; provided that 2 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 1,106,820 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 regulations promulgated thereunder ("Officers"), who are not Directors, and Employees who are neither Directors nor Officers. -2- 3 (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: (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 -3- 4 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 determine 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: (i) No Employee shall be granted, in any fiscal year of the Company, Options to purchase more than 150,000 Shares. -4- 5 (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 price on such exchange on the date of grant of the Option, as reported in the Wall Street Journal. -5- 6 (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 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 -6- 7 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 (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 -7- 8 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 adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. -8- 9 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: (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. -9- 10 (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 amend ment 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 aforementioned 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. 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 lia- -10- 11 bility 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 consent, 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 (1998) 1 EXHIBIT 10.6 Number: C-98-01332 Renewal of: C-97-01332 REASSURED: NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY South San Francisco, California CONTRACT: FIRST PER RISK EXCESS OF LOSS REINSURANCE CONTRACT Effective January 1, 1998 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, 1998 to January 1, 1999, 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. Page 1 OF 10 2 Number: C-98-01332 Renewal of: C-97-01332 TERRITORY: This reinsurance shall cover wherever the Reassured's policies apply. 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 Net Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $175,000 payable in equal quarterly installments of $43,750 each on January 1, April 1, July 1, and October 1, 1998. 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, Page 2 OF 10 3 Number: C-98-01332 Renewal of: C-97-01332 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 (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. Seepage and Pollution as per ISO wording, or so deemed; p. Transmission and Distribution Lines. GENERAL CONDITIONS: Definition of Loss Occurrence Clause (Property Business) to include LPO 515 definition of hours clause as attached, and as follows: - 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 Page 3 OF 10 4 Number: C-98-01332 Renewal of: C-97-01332 Definition of Occurrence (Casualty Business) Extra Contractual Obligations (100%) Excess of Policy Limits (100%) Definition of Net Loss Clause (which shall include defense costs but not limited to expenses incurred in determination of coverage, and Declaratory Judgment Expenses) 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 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 Page 4 OF 10 5 Number: C-98-01332 Renewal of: C-97-01332 authority to bind the participation of such Reinsurer. Page 5 OF 10 6 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01332 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 Name - -------------------------------------------------- ----- ---- Constitution Reinsurance Corporation 20.00% Cronin New York, New York FEIN# 13-5009848 NAIC# 21032 Continental Casualty Company 7.00% Kristen Chicago, Illinois FEIN# 36-2114545 NAIC# 20443 Employers Mutual Casualty Company 1.50% Freese Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 5.00% Kurtzweil Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Folksamerica Reinsurance Company 5.00% Luger New York, New York FEIN# 13-2997499 NAIC# 38776 Hartford Fire Insurance Company 7.00% Rettig Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut
Page 6 OF 10 7 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01332
Direct Placement through Towers Perrin Reinsurance Share Name - -------------------------------------------------- ----- ---- PMA Reinsurance Corporation 6.00% Stoner Philadelphia, Pennsylvania FEIN# 23-2153760 NAIC# 39675 Republic Western Insurance Company 3.00% Thapa Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 10.00% Schiffer 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% Norris New York, New York FEIN# 13-2758523 NAIC# 20362 through Sumitomo Marine Re Management, Inc. New York, New York Sydney Reinsurance Corporation 10.00% Sullivan Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 USF Re Insurance Company 13.50% Dik Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 10.00% Etheridge Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 ------ Total Placement 100.00%
Page 7 OF 10 8 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01332 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 Hartford Fire Insurance Company 7.00% Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut
Page 8 OF 10 9 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01332
Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- 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 Sydney Reinsurance Corporation 10.00% Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 USF Re Insurance Company 13.50% 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 9 OF 10 10 REINSURANCE COVER NOTE NO. C-98-01332 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, 1998 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: March 17, 1998 ---------------------------------- Page 10 OF 10 11 EXHIBIT A DEFINITION OF LOSS OCCURRENCE (PROPERTY) 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. - 1 - 12 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 Preamble, 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. - 2 - 13 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This Contract does not cover any loss or liability accruing to the Reassured directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and critical facilities as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of prescribed substances, and for reprocessing, salvaging, chemically separating, storing or disposing of spent nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operation of Paragraphs 1. and 2. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where the Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where the said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. 4. Without in any way restricting the operation of Paragraphs 1., 2. and 3. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurers or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. This Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "prescribed substances" shall have the meaning given to it by the Atomic Energy Control Act R.S.C. 1985 (c), A-16 or by any law amendatory thereof. 7. Reassured to be sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. - 1 - 14 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 8. Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer caused: a. By any nuclear incident as defined in the Nuclear Liability Act or any other nuclear liability act, law or statute, or any law amendatory thereof or nuclear explosion, except for ensign loss or damage which results directly from fire, lightning or explosion of natural, coal or manufactured gas; b. By contamination by radioactive material. NOTE: Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, Paragraph 8. of this Clause shall only apply to all original contracts of the Reassured whether new, renewal or replacement which became effective on or after December 31, 1992. - 2 - 15 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and "critical facilities" as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of "special nuclear material," and for reprocessing, salvaging, chemically separating, storing or disposing of "spent" nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of Paragraphs 1. and 2. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. However on and after 1st January 1960 this SubParagraph 3.B. shall only apply provided the said radioactive contamination exclusion provision has been approved by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operations of Paragraphs 1., 2. and 3. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. It is understood and agreed that this Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. - 1 - 16 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 6. The term "special nuclear material" shall have the meaning given it in the Atomic Energy Act of 1954 or by any law amendatory thereof. 7. Reassured to be the sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. NOTE: Without in any way restricting the operation of Paragraph 1. hereof, it is understood and agreed that: (a) all policies issued by the Reassured on or before December 31, 1957 shall be free from the application of the other provisions of this Clause until expiry date of December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. (b) with respect to any risk located in Canada policies issued by the Reassured on or before December 31, 1958 shall be free from the application of the other provisions of this Clause until expiry date or December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. NOTES: 1) The words printed in italic text in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. 2) Wherever used herein the term "Company" shall be understood to mean "Reassured," "Reinsured" or whatever other term is used in the attached reinsurance Agreement to designate the reinsured company. - 2 - 17 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE 1. This Contract does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, it is agreed that for all purposes of this Contract all the original liability contracts of the Reassured, whether new, renewal or replacement, of the following classes, namely: Personal Liability, Farmers Liability, Storekeepers Liability, which become effective on or after December 31, 1984, shall be deemed to include, from their inception dates and thereafter, the following provision: LIMITED EXCLUSION PROVISION This Policy does not apply to bodily injury or property damage with respect to which an Insured is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other group or pool of insurers or would be an Insured under any such policy but for its termination upon exhaustion of its limit of liability. With respect to property, loss of use of such property shall be deemed to be property damage. 3. Without in any way restricting the operation of Paragraph 1. of this Clause it is agreed that for all purposes of this Contract all the original liability contracts of the Reassured, whether new, renewal or replacement, of any class whatsoever (other than Personal Liability, Farmers Liability, Storekeepers Liability, or Automobile Liability contracts), which become effective on or after December 31, 1984, shall be deemed to include, from their inception dates and thereafter, the following provision: BROAD EXCLUSION PROVISION It is agreed that this Policy does not apply: a. To liability imposed by or arising under the Nuclear Liability Act; nor b. To bodily injury or property damage with respect to which an Insured under this policy is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other insurer or group or pool of insurers or would be an Insured under any such policy but for its termination upon exhaustion of its limit of liability; nor - 1 - 18 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE c. To bodily injury or property damage resulting directly or indirectly from the nuclear energy hazard arising from: (1) the ownership, maintenance, operation or use of a nuclear facility by or on behalf of an Insured; (2) the furnishing by an Insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility; and (3) the possession, consumption, use, handling, disposal or transportation of fissionable substances, or of other radioactive material (except radioactive isotopes, away from a nuclear facility, which have reached the final stage of fabrication so as to be usable for any scientific, medical, agricultural, commercial or industrial purpose) used, distributed, handled, or sold by an Insured. AS USED IN THIS POLICY 1. The term "nuclear energy hazard" means the radioactive, toxic, explosive or other hazardous properties of radioactive material; 2. The term "radioactive material" means uranium, thorium, plutonium, neptunium, their respective derivatives and compounds, radioactive isotopes of other elements and any other substances that the Atomic Energy Control Board may, by regulation, designate as being prescribed substances capable of releasing atomic energy, or as being requisite for the production, use or application of atomic energy; 3. The term "nuclear facility" means: a. Any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of plutonium, thorium, and uranium, or any one or more of them; b. Any equipment or device designed or used for (i) separating the isotopes of plutonium, thorium and uranium, or any one or more of them, (ii) processing or utilizing spent fuel, or (iii) handling, processing or packaging waste; c. Any equipment or device used for the processing, fabricating or alloying of plutonium, thorium or uranium enriched in the isotope uranium 233 or in the isotope uranium 235, or any one or more of them if at any time the total amount of such material in the custody of the Insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235; d. Any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste radioactive material; - 2 - 19 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE and includes the site on which any of the foregoing is located, together with all operations conducted thereon and all premises used for such operations. 4. The term "fissionable substance" means any prescribed substance that is, or from which can be obtained, a substance capable of releasing atomic energy by nuclear fission. 5. With respect to property, loss of use of such property shall be deemed to be property damage. - 3 - 20 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE 1. This reinsurance does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. 2. Without in any way restricting the operation of Paragraph 1. of this Clause it is understood and agreed that for all purposes of this reinsurance all the original policies of the Reassured (new, renewal and replacement) of the classes specified in Clause II of this Paragraph 2. from the time specified in Clause III in this Paragraph 2. shall be deemed to include the following provision (specified as the Limited Exclusion Provision): Limited Exclusion Provision* I. It is agreed that the policy does not apply under any liability coverage to injury, sickness, disease, death or destruction, bodily injury or property damage with respect to which an insured under the policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability. II. Family Automobile Policies (liability only), Special Automobile Policies (private passenger automobiles, liability only), Farmers Comprehensive Personal Liability Policies (liability only), Comprehensive Personal Liability Policies (liability only) or policies of a similar nature; and the liability portion of combination forms related to the four classes of policies stated above, such as the Comprehensive Dwelling Policy and the applicable types of Homeowners Policies. III. The inception dates and thereafter of all original policies as described in II. above, whether new, renewal or replacement, being policies which either (a) become effective on or after 1st May, 1960, or (b) become effective before that date and contain the Limited Exclusion Provision set out above; provided this paragraph 2 shall not be applicable to Family Automobile Policies, Special Automobile Policies, or policies or combination policies of a similar nature, issued by the Reassured on New York risks, until 90 days following approval of the Limited Exclusion Provision by the Governmental Authority having jurisdiction thereof. 3. Except for those classes of policies specified in Clause II of paragraph 2 and without in any way restricting the operation of paragraph 1 of this Clause, it is understood and agreed that for all purposes of this reinsurance the original liability policies of the Reassured (new, renewal and replacement) affording the following coverages: - 1 - 21 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE Owners, Landlords and Tenants Liability, Contractual Liability, Elevator Liability, Owners or Contractors (including railroad) Protective Liability, Manufacturers and Contractors Liability, Product Liability, Professional and Malpractice Liability, Storekeepers Liability, Garage Liability, Automobile Liability (including Massachusetts Motor Vehicle or Garage Liability) shall be deemed to include with respect to such coverages, from the time specified in Clause V of this paragraph 3, the following provision (specified as the Broad Exclusion Provision): Broad Exclusion Provision* It is agreed that the policy does not apply: I. Under any Liability Coverage, to injury, sickness, disease, death or destruction, bodily injury or property damage (a) with respect to which an insured under the policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability; or (b) resulting from the hazardous properties of nuclear material and with respect to which (1) any person or organization is required to maintain financial protection pursuant to the Atomic Energy Act of 1954, or any law amendatory thereof, or (2) the insured is, or had this policy not be issued would be, entitled to indemnity from the United States of America, or any agency thereof, under any agreement entered into by the United States of America, or any agency thereof, with any person or organization. II. Under any Medical Payments Coverage, or under any Supplementary Payments Provision relating to immediate medical or surgical relief, first aid to expenses incurred with respect to bodily injury, sickness, disease or death, bodily injury resulting from the hazardous properties of nuclear material and arising out of the operation of a nuclear facility by any person or organization. III. Under any Liability coverage, to injury, sickness, disease, death or destruction, bodily injury or property damage resulting from the hazardous properties of nuclear material, if (a) the nuclear material (1) is at any nuclear facility owned by, or operated by or on behalf of, an insured or (2) has been discharged or dispersed therefrom; (b) the nuclear material is contained in spent fuel or waste at any time possessed, handled, used, processed, stored, transported or disposed of by or on behalf on an insured; or - 2 - 22 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE (c) the injury, sickness, disease, death or destruction, bodily injury or property damage arises out of the furnishing by an insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility, but if such facility is located within the United States of America, its territories, or possessions or Canada, this exclusion (c) applies only to injury to or destruction of property at such nuclear facility / property damage to such nuclear facility and any property there at. IV. As used in this endorsement: "hazardous properties" include radioactive, toxic or explosive properties; "nuclear material" means source material, special nuclear material or by-product material; "source material," "special nuclear material," and "byproduct material" have the meanings given them in the Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel" means any fuel element or fuel component, solid or liquid, which has been used or exposed to radiation in a nuclear reactor; "waste" means any waste material (1) containing byproduct material and (2) resulting from the operation by any person or organization of any nuclear facility included within the definition of nuclear facility under paragraph (a) or (b) thereof; "nuclear facility" means (a) any nuclear reactor, (b) any equipment or device designed or used for (1) separating the isotopes of uranium or plutonium, (2) processing or utilizing spent fuel, or (3) handling, processing or packaging waste, (c) any equipment or device used for the processing, fabricating or alloying of special nuclear material if at any time the total amount of such material in the custody of the insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235, (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste, and includes the site on which any of the foregoing is located, all operations conducted on such site and all premises used for such operations; "nuclear reactor" means any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of fissionable material; With respect to injury to or destruction of property, the word "injury or "destruction" includes all forms of radioactive contamination of property. "Property damage" includes all forms of radioactive contamination of property. V. The inception dates and thereafter of all original policies affording coverages specified in this paragraph 3, whether new, renewal or replacement, being policies which become effective on or after 1st May, 1960, provided this paragraph 3 shall not be applicable to - 3 - 23 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE (i) Garage and Automobile Policies issued by the Reassured on New York risks, or (ii) statutory liability insurance required under Chapter 90, General Laws of Massachusetts, until 90 days following approval of the Broad Exclusion Provision by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operation of paragraph 1 of this Clause, it is understood and agreed that paragraphs 2 and 3 are not applicable to original liability policies of the Reassured in Canada and that with respect to such policies this Clause shall be deemed to include the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian Underwriters' Association or the Independent Insurance Conference of Canada NOTES: 1) The words printed in italic text in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. 2) Wherever used herein the term "Company" shall be understood to mean "Reassured," "Reinsured" or whatever other term is used in the attached reinsurance Agreement to designate the reinsured company. - 4 - 24 POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE SECTION A Excluding: (a) All Business derived directly or indirectly from any Pool, Association or Syndicate which maintains its own reinsurance facilities. (b) Any Pool or Scheme (whether voluntary or mandatory) formed after March 1, 1968 for the purpose of insuring Property whether on a country-wide basis or in respect of designated areas. This exclusion shall not apply to so-called Automobile Insurance Plans or other Pools formed to provide coverage for Automobile Physical Damage. SECTION B It is agreed that business written by the Company for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in the following Pools, Association or Syndicates, whether by way of insurance or reinsurance, is excluded hereunder: Industrial Risk Insurers; Association Factory Mutuals; Improved Risk Mutuals. Any Pool, Association or Syndicate formed for the purpose of writing Oil, Gas or Petro- Chemical Plants and/or Oil or Gas Drilling Rigs. United States Aircraft Insurance Group, Canadian Aircraft Insurance Group, Associated Aviation Underwriters, American Aviation Underwriters. Section B does not apply: (a) Where the Total Insured Value over all interests of the risk in question is less than $250,000,000. (b) To interests traditionally underwritten as Inland Marine or Stock and/or Contents written on a Blanket basis. (c) To Contingent business Interruption, except when the Company is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above, other than as provided for under Section B (a). (d) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational Establishments, Public Utilities (other than Railroad Schedules) and Builders Risks on the classes or risks specified in this subsection (d) only. NOTE: Wherever used herein the term "Company" shall be understood to mean "Company," "Reinsured," "Reassured" or whatever other term is used in the attached reinsurance document to designate the reinsured company of companies. - 1 - 25 INSOLVENCY FUNDS EXCLUSION CLAUSE 1. This Contract excludes all liability of the Reassured arising, by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed; which provides for any assessment of or payment or assumption by the Reassured of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. - 1 - 26 Number: C-98-01371 Renewal of: C-97-01371 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, 1998 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, 1998 to January 1, 1999, 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 8 27 Number: C-98-01371 Renewal of: C-97-01371 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: 1.030% of Gross Net Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $215,000 payable in equal quarterly installments of $53,750 each at January 1, April 1, July 1, and October 1, 1998. 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; PAGE 2 OF 8 28 Number: C-98-01371 Renewal of: C-97-01371 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. REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. PAGE 3 OF 8 29 Number: C-98-01371 Renewal of: C-97-01371 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 30 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01371 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 Name - -------------------------------------------------- ----- ---- Constitution Reinsurance Corporation 8.50% Cronin New York, New York FEIN# 13-5009848 NAIC# 21032 Folksamerica Reinsurance Company 8.00% Luger New York, New York FEIN# 13-2997499 NAIC# 38776 Hartford Fire Insurance Company 10.00% Rettig Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut Nationwide Mutual Insurance Company 7.50% Wilson Columbus, Ohio FEIN# 31-4177100 NAIC# 23787 Republic Western Insurance Company 5.00% Thapa Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 8.00% Schiffer St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Re, Inc. New York, New York Sydney Reinsurance Corporation 10.00% Sullivan Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219
PAGE 5 OF 8 31 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01371
Direct Placement through Towers Perrin Reinsurance Share Name - -------------------------------------------------- ----- ---- USF Re Insurance Company 10.00% Dik Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 25.00% Etheridge Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Winterthur Reinsurance Corporation of America 8.00% Rivera New York, New York FEIN# 13-3531373 NAIC# 10006 ------ Total Placement 100.00%
PAGE 6 OF 8 32 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01371 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 Hartford Fire Insurance Company 10.00% Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Management Company Hartford, Connecticut 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 Re, Inc. New York, New York Sydney Reinsurance Corporation 10.00% Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219
PAGE 6 OF 8 33 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01371
Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- USF Re Insurance Company 10.00% 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 7 OF 8 34 REINSURANCE COVER NOTE NO. C-98-01371 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA FIRST PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1998 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: March 17, 1998 --------------------------------------- PAGE 8 OF 8 35 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. 4. No individual losses occasioned by an event that would be covered by 72 or 120 hours - 1 - 36 clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. - 2 - 37 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This Contract does not cover any loss or liability accruing to the Reassured directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and critical facilities as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of prescribed substances, and for reprocessing, salvaging, chemically separating, storing or disposing of spent nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operation of Paragraphs 1. and 2. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where the Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where the said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. 4. Without in any way restricting the operation of Paragraphs 1., 2. and 3. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurers or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. This Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "prescribed substances" shall have the meaning given to it by the Atomic Energy Control Act R.S.C. 1985 (c), A-16 or by any law amendatory thereof. 7. Reassured to be sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. - 1 - 38 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 8. Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer caused: a. By any nuclear incident as defined in the Nuclear Liability Act or any other nuclear liability act, law or statute, or any law amendatory thereof or nuclear explosion, except for ensign loss or damage which results directly from fire, lightning or explosion of natural, coal or manufactured gas; b. By contamination by radioactive material. NOTE: Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, Paragraph 8. of this Clause shall only apply to all original contracts of the Reassured whether new, renewal or replacement which became effective on or after December 31, 1992. - 2 - 39 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and "critical facilities" as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of "special nuclear material," and for reprocessing, salvaging, chemically separating, storing or disposing of "spent" nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of Paragraphs 1. and 2. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. However on and after 1st January 1960 this SubParagraph 3.B. shall only apply provided the said radioactive contamination exclusion provision has been approved by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operations of Paragraphs 1., 2. and 3. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. It is understood and agreed that this Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "special nuclear material" shall have the meaning given it in the Atomic Energy Act of 1954 or by any law amendatory thereof. - 1 - 40 NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 7. Reassured to be the sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. NOTE: Without in any way restricting the operation of Paragraph 1. hereof, it is understood and agreed that: (a) all policies issued by the Reassured on or before December 31, 1957 shall be free from the application of the other provisions of this Clause until expiry date of December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. (b) with respect to any risk located in Canada policies issued by the Reassured on or before December 31, 1958 shall be free from the application of the other provisions of this Clause until expiry date or December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. NOTES: 1) The words printed in italic text in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. 2) Wherever used herein the term "Company" shall be understood to mean "Reassured," "Reinsured" or whatever other term is used in the attached reinsurance Agreement to designate the reinsured company. - 2 - 41 POOLS, ASSOCIATIONS, SYNDICATES EXCLUSION CLAUSE (FLORIDA AMENDED) SECTION A It is agreed that the following is excluded hereunder: (a) All business derived directly or indirectly from any Pool, Association or Syndicate which maintains its own reinsurance facilities. (b) Any Pool or Scheme, (whether voluntary or mandatory) formed after 1st March 1968 for the purpose of insuring property whether on a countrywide basis or in respect of designated areas. This exclusion shall not apply to so-called Automobile Insurance Plans or other Pools formed to provide coverage for Automobile Physical Damage. SECTION B It is agreed that business written by the Reassured for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in the following Pools, Associations or Syndicates, whether by way of insurance or reinsurance, is excluded hereunder: Industrial Risk Insurers Associated Factory Mutuals Improved Risk Mutuals Any Pool, Association or Syndicate formed for the purpose of writing oil, gas or petro- chemical plants and/or oil or gas drilling rigs United States Aircraft Insurance Group Canadian Aircraft Insurance Group Associated Aviation Underwriters American Aviation Underwriters Section B does not apply: (a) Where the Total Insured Value over all interests of the risk in question is less than $250,000,000. (b) To interests traditionally underwritten as Inland Marine or Stock and/or Contents written on a Blanket Basis. (c) To Contingent Business Interruption, except when the Reassured is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above. (d) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational Establishments, Public Utilities (other than Railroad Schedules), and Builder's Risks on the classes of risks specified in this subsection (d) only. - 1 - 42 SECTION C NEVERTHELESS, the Reinsurers specifically agree that liability accruing to the Reassured from its participation in Residual Market Mechanisms including but limited to: (a) The following so-called "Coastal Pools": Alabama Insurance Underwriting Association Florida Windstorm Insurance Underwriting Association (FWUA) Louisiana Insurance Underwriting Association Mississippi Insurance Underwriting Association North Carolina Insurance Underwriting Association South Carolina Windstorm and Hail Underwriting Association Texas Catastrophe Property Insurance Association (b) All "Fair Plan" and "Rural Risk Plan" business, and (c) Florida Property and Casualty Joint Underwriting Association (FPCJUA) and Residential Property and Casualty Joint Underwriting Association (RPCJUA), for all perils otherwise protected hereunder shall not be excluded, except that this reinsurance does not include any increase in such liability resulting from: (1) The inability of any participant in such Residual Market Mechanisms to meet its liability, (2) Any claim against such Residual Market Mechanisms or any participant therein, including the Reassured, whether by way of subrogation or otherwise, brought by or on behalf of any insolvency fund (as defined in the Insolvency Funds Exclusion Clause in this Contract). SECTION D Notwithstanding SECTION C above, in respect of the FWUA, FPCJUA and RPCJUA, where an assessment is made against the Reassured by the FWUA, the FPCJUA, the RPCJUA, or any combination thereof, the maximum loss that the Reassured may include in the Ultimate Net Loss in respect of any loss occurrence hereunder shall not exceed the lesser of: (1) The Reassured's assessment from the relevant entity (FWUA, FPCJUA and/or RPCJUA) for the accounting year in which the loss occurrence commenced, or (2) The product of the following: (a) The Reassured's percentage participation in the relevant entity for the accounting year in which the loss occurrence commenced; and (b) The relevant entity's total losses in such loss occurrence. Any assessments for accounting years subsequent to that in which the loss occurrence commenced may not be included in the Ultimate Net Loss hereunder. Moreover, notwithstanding - 2 - 43 SECTION C above, in respect of the FWUA, the FPCJUA and/or the RPCJUA, the Ultimate Net Loss hereunder shall not include any monies expended to purchase or retire bonds as a consequence of being a member of the FWUA, the FPCJUA and/or RPCJUA. For the purposes of this Contract, the Reassured may not include in the Ultimate Net Loss any assessment or any percentage assessment levied by the FWUA, the FPCJUA and/or the RPCJUA to meet the obligations of an insolvent insurer member or other party, or to meet any obligations arising from the deferment by the FWUA, FPCJUA and/or RPCJUA of the collection of monies. NOTES: Wherever used herein the terms: "Reassured" shall be understood to mean "Company," "Reinsured," "Reassured" or whatever other term is used in the attached reinsurance document to designate the reinsured company or companies. "Agreement" shall be understood to mean "Agreement," "Contract," "Policy" or whatever other term is used to designate the attached reinsurance document. "Reinsurers" shall be understood to mean "Reinsurers," "Underwriters" or whatever other term is used in the attached reinsurance document to designate the reinsurer or reinsurers. - 3 - 44 INSOLVENCY FUNDS EXCLUSION CLAUSE 1. This Contract excludes all liability of the Reassured arising, by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed; which provides for any assessment of or payment or assumption by the Reassured of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. - 1 - 45 Number: C-98-01402 Renewal of: C-97-01402 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, 1998 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, 1998 to January 1, 1999, 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 2 OF 8 46 Number: C-98-01402 Renewal of: C-97-01402 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: 1.430% of Gross Net Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $300,000 payable in equal quarterly installments of $75,000 at January 1, April 1, July 1, and October 1, 1998. 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 3 OF 8 47 Number: C-98-01402 Renewal of: C-97-01402 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 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. REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. PAGE 4 OF 8 48 Number: C-98-01402 Renewal of: C-97-01402 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 5 OF 8 49 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01402 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 Name - -------------------------------------------------- ----- ---- Constitution Reinsurance Corporation 5.00% Cronin New York, New York FEIN# 13-5009848 NAIC# 21032 Continental Casualty Company 14.50% Kristen Chicago, Illinois FEIN# 36-2114545 NAIC# 20443 Employers Mutual Casualty Company 2.25% Freese Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 7.50% Kurtzweil Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Folksamerica Reinsurance Company 8.00% Luger New York, New York FEIN# 13-2997499 NAIC# 38776 Insurance Company of the West 8.00% Dean San Diego, California FEIN# 95-2769232 NAIC# 27847 Nationwide Mutual Insurance Company 7.50% Wilson Columbus, Ohio FEIN# 31-4177100 NAIC# 23787
PAGE 6 OF 8 50 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01402
Direct Placement through Towers Perrin Reinsurance Share Name - -------------------------------------------------- ----- ---- Reliance Insurance Company 2.10% Barrows Philadelphia, Pennsylvania FEIN# 23-0580680 NAIC# 24457 through Reliance Reinsurance Corporation Philadelphia, Pennsylvania St. Paul Fire and Marine Insurance Company 8.00% Schiffer St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Re, Inc. New York, New York United Fire & Casualty Company 0.50% Stanford Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 USF Re Insurance Company 8.15% Dik Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 25.00% Etheridge Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 Winterthur Reinsurance Corporation of America 3.50% Rivera New York, New York FEIN# 13-3531373 NAIC# 10006 ------- Total Placement 100.00%
PAGE 7 OF 8 51 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01402 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 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
PAGE 6 OF 8 52 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01402
Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- 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 Re, Inc. United Fire & Casualty Company 0.50% Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 USF Re Insurance Company 8.15% 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 53 REINSURANCE COVER NOTE NO. C-98-01402 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA SECOND PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1998 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: March 17, 1998 --------------------------------------- PAGE 8 OF 8 54 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. - 1 - 55 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. - 2 - 56 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This Contract does not cover any loss or liability accruing to the Reassured directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and critical facilities as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of prescribed substances, and for reprocessing, salvaging, chemically separating, storing or disposing of spent nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operation of Paragraphs 1. and 2. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where the Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where the said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. 4. Without in any way restricting the operation of Paragraphs 1., 2. and 3. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurers or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. This Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "prescribed substances" shall have the meaning given to it by the Atomic Energy Control Act R.S.C. 1985 (c), A-16 or by any law amendatory thereof. 7. Reassured to be sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. - 1 - 57 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 8. Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer caused: a. By any nuclear incident as defined in the Nuclear Liability Act or any other nuclear liability act, law or statute, or any law amendatory thereof or nuclear explosion, except for ensign loss or damage which results directly from fire, lightning or explosion of natural, coal or manufactured gas; b. By contamination by radioactive material. NOTE: Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, Paragraph 8. of this Clause shall only apply to all original contracts of the Reassured whether new, renewal or replacement which became effective on or after December 31, 1992. - 2 - 58 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and "critical facilities" as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of "special nuclear material," and for reprocessing, salvaging, chemically separating, storing or disposing of "spent" nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of Paragraphs 1. and 2. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. However on and after 1st January 1960 this SubParagraph 3.B. shall only apply provided the said radioactive contamination exclusion provision has been approved by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operations of Paragraphs 1., 2. and 3. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. It is understood and agreed that this Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "special nuclear material" shall have the meaning given it in the Atomic Energy Act of 1954 or by any law amendatory thereof. - 1 - 59 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 7. Reassured to be the sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. NOTE: Without in any way restricting the operation of Paragraph 1. hereof, it is understood and agreed that: (a) all policies issued by the Reassured on or before December 31, 1957 shall be free from the application of the other provisions of this Clause until expiry date of December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. (b) with respect to any risk located in Canada policies issued by the Reassured on or before December 31, 1958 shall be free from the application of the other provisions of this Clause until expiry date or December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. NOTES: 1) The words printed in italic text in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. 2) Wherever used herein the term "Company" shall be understood to mean "Reassured," "Reinsured" or whatever other term is used in the attached reinsurance Agreement to designate the reinsured company. - 2 - 60 POOLS, ASSOCIATIONS, SYNDICATES EXCLUSION CLAUSE (FLORIDA AMENDED) SECTION A It is agreed that the following is excluded hereunder: (a) All business derived directly or indirectly from any Pool, Association or Syndicate which maintains its own reinsurance facilities. (b) Any Pool or Scheme, (whether voluntary or mandatory) formed after 1st March 1968 for the purpose of insuring property whether on a countrywide basis or in respect of designated areas. This exclusion shall not apply to so-called Automobile Insurance Plans or other Pools formed to provide coverage for Automobile Physical Damage. SECTION B It is agreed that business written by the Reassured for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in the following Pools, Associations or Syndicates, whether by way of insurance or reinsurance, is excluded hereunder: Industrial Risk Insurers Associated Factory Mutuals Improved Risk Mutuals Any Pool, Association or Syndicate formed for the purpose of writing oil, gas or petro-chemical plants and/or oil or gas drilling rigs United States Aircraft Insurance Group Canadian Aircraft Insurance Group Associated Aviation Underwriters American Aviation Underwriters Section B does not apply: (a) Where the Total Insured Value over all interests of the risk in question is less than $250,000,000. (b) To interests traditionally underwritten as Inland Marine or Stock and/or Contents written on a Blanket Basis. (c) To Contingent Business Interruption, except when the Reassured is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above. (d) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational Establishments, Public Utilities (other than Railroad Schedules), and Builder's Risks on the classes of risks specified in this subsection (d) only. SECTION C NEVERTHELESS, the Reinsurers specifically agree that liability accruing to the Reassured from its participation in Residual Market Mechanisms including but limited to: - 1 - 61 (a) The following so-called "Coastal Pools": Alabama Insurance Underwriting Association Florida Windstorm Insurance Underwriting Association (FWUA) Louisiana Insurance Underwriting Association Mississippi Insurance Underwriting Association North Carolina Insurance Underwriting Association South Carolina Windstorm and Hail Underwriting Association Texas Catastrophe Property Insurance Association (b) All "Fair Plan" and "Rural Risk Plan" business, and (c) Florida Property and Casualty Joint Underwriting Association (FPCJUA) and Residential Property and Casualty Joint Underwriting Association (RPCJUA), for all perils otherwise protected hereunder shall not be excluded, except that this reinsurance does not include any increase in such liability resulting from: (1) The inability of any participant in such Residual Market Mechanisms to meet its liability, (2) Any claim against such Residual Market Mechanisms or any participant therein, including the Reassured, whether by way of subrogation or otherwise, brought by or on behalf of any insolvency fund (as defined in the Insolvency Funds Exclusion Clause in this Contract). SECTION D Notwithstanding SECTION C above, in respect of the FWUA, FPCJUA and RPCJUA, where an assessment is made against the Reassured by the FWUA, the FPCJUA, the RPCJUA, or any combination thereof, the maximum loss that the Reassured may include in the Ultimate Net Loss in respect of any loss occurrence hereunder shall not exceed the lesser of: (1) The Reassured's assessment from the relevant entity (FWUA, FPCJUA and/or RPCJUA) for the accounting year in which the loss occurrence commenced, or (2) The product of the following: (a) The Reassured's percentage participation in the relevant entity for the accounting year in which the loss occurrence commenced; and (b) The relevant entity's total losses in such loss occurrence. Any assessments for accounting years subsequent to that in which the loss occurrence commenced may not be included in the Ultimate Net Loss hereunder. Moreover, notwithstanding SECTION C above, in respect of the FWUA, the FPCJUA and/or the RPCJUA, the Ultimate Net Loss hereunder shall not include any monies expended to purchase or retire bonds as a consequence of being a member of the FWUA, the FPCJUA and/or RPCJUA. - 2 - 62 For the purposes of this Contract, the Reassured may not include in the Ultimate Net Loss any assessment or any percentage assessment levied by the FWUA, the FPCJUA and/or the RPCJUA to meet the obligations of an insolvent insurer member or other party, or to meet any obligations arising from the deferment by the FWUA, FPCJUA and/or RPCJUA of the collection of monies. NOTES: Wherever used herein the terms: "Reassured" shall be understood to mean "Company," "Reinsured," "Reassured" or whatever other term is used in the attached reinsurance document to designate the reinsured company or companies. "Agreement" shall be understood to mean "Agreement," "Contract," "Policy" or whatever other term is used to designate the attached reinsurance document. "Reinsurers" shall be understood to mean "Reinsurers," "Underwriters" or whatever other term is used in the attached reinsurance document to designate the reinsurer or reinsurers. - 3 - 63 INSOLVENCY FUNDS EXCLUSION CLAUSE 1. This Contract excludes all liability of the Reassured arising, by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed; which provides for any assessment of or payment or assumption by the Reassured of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. - 1 - 64 Number: C-98-01493 Renewal of: C-97-01493 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, 1998 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, 1998 to January 1, 1999, 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. PAGE 1 OF 9 65 Number: C-98-01493 Renewal of: C-97-01493 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: 0.720% of Gross Net Earned Premium Income. MINIMUM AND DEPOSIT PREMIUM: Deposit Premium of $150,000 payable in equal quarterly installments of $37,500 at January 1, April 1, July 1, and October 1, 1998. 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; PAGE 2 OF 9 66 Number: C-98-01493 Renewal of: C-97-01493 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. REINSURERS: 100% placement through Towers Perrin Reinsurance. See attached Schedule for listing of Reinsurers and their respective participations. PAGE 3 OF 9 67 Number: C-98-01493 Renewal of: C-97-01493 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 9 68 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01493 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 Name - -------------------------------------------------- ----- ---- Constitution Reinsurance Corporation 5.00% Cronin New York, New York FEIN# 13-5009848 NAIC# 21032 Employers Mutual Casualty Company 2.25% Freese Des Moines, Iowa FEIN# 42-0234980 NAIC# 21415 First Excess & Reinsurance Corporation 5.50% Kurtzweil Jefferson City, Missouri FEIN# 43-1037123 NAIC# 32018 Hartford Fire Insurance Company 7.00% Rettig Hartford, Connecticut FEIN# 06-0383750 NAIC# 19682 through Hartford Re Company Hartford, Connecticut Insurance Company of the West 8.00% Dean San Diego, California FEIN# 95-2769232 NAIC# 27847 Nationwide Mutual Insurance Company 7.50% Wilson Columbus, Ohio FEIN# 31-4177100 NAIC# 23787 PMA Reinsurance Corporation 7.00% Stoner Philadelphia, Pennsylvania FEIN# 23-2153760 NAIC# 39675
PAGE 5 OF 9 69 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01493
Direct Placement through Towers Perrin Reinsurance Share Name - -------------------------------------------------- ----- ---- Republic Western Insurance Company 5.00% Thapa Phoenix, Arizona FEIN# 86-0274508 NAIC# 31089 St. Paul Fire and Marine Insurance Company 8.00% Schiffer St. Paul, Minnesota FEIN# 41-0406690 NAIC# 24767 through St. Paul Re, Inc. New York, New York The Sumitomo Marine & Fire Insurance Company Ltd. 3.25% Norris New York, New York FEIN# 13-2758523 NAIC# 20362 through Sumitomo Marine Re Management, Inc. New York, New York Sydney Reinsurance Corporation 15.00% Sullivan Philadelphia, Pennsylvania FEIN# 23-1641984 NAIC# 10219 United Fire & Casualty Company 3.00% Stanford Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 USF Re Insurance Company 7.50% Dik Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 16.00% Etheridge Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 ------ Total Placement 100.00%
PAGE 6 OF 9 70 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01493 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 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
PAGE 7 OF 9 71 SCHEDULE REINSURERS ATTACHING TO COVER NOTE NO. C-98-01493
Direct Placement through Towers Perrin Reinsurance Share - -------------------------------------------------- ----- 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 Re, Inc. 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 United Fire & Casualty Company 3.00% Cedar Rapids, Iowa FEIN# 42-0644327 NAIC# 13021 USF Re Insurance Company 7.50% Boston, Massachusetts FEIN# 04-1590940 NAIC# 11835 Vesta Fire Insurance Corporation 16.00% Birmingham, Alabama FEIN# 63-0598629 NAIC# 11762 ------ Total Placement 100.00%
PAGE 8 OF 9 72 REINSURANCE COVER NOTE NO. C-98-01493 FOR NATIONAL INSURANCE GROUP COMPANIES GREAT PACIFIC INSURANCE COMPANY SOUTH SAN FRANCISCO, CALIFORNIA THIRD PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE JANUARY 1, 1998 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: March 17, 1998 --------------------------------------- PAGE 9 OF 9 73 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. 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. - 1 - 74 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This Contract does not cover any loss or liability accruing to the Reassured directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and critical facilities as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of prescribed substances, and for reprocessing, salvaging, chemically separating, storing or disposing of spent nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operation of Paragraphs 1. and 2. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where the Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where the said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. 4. Without in any way restricting the operation of Paragraphs 1., 2. and 3. of this Clause, this Contract does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurers or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. This Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "prescribed substances" shall have the meaning given to it by the Atomic Energy Control Act R.S.C. 1985 (c), A-16 or by any law amendatory thereof. 7. Reassured to be sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. - 2 - 75 CANADA NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 8. Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, this Contract does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer caused: a. By any nuclear incident as defined in the Nuclear Liability Act or any other nuclear liability act, law or statute, or any law amendatory thereof or nuclear explosion, except for ensign loss or damage which results directly from fire, lightning or explosion of natural, coal or manufactured gas; b. By contamination by radioactive material. NOTE: Without in any way restricting the operation of Paragraphs 1., 2., 3. and 4. of this Clause, Paragraph 8. of this Clause shall only apply to all original contracts of the Reassured whether new, renewal or replacement which became effective on or after December 31, 1992. - 3 - 76 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 1. This reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy Risks. 2. Without in any way restricting the operation of Paragraph 1. of this Clause, this reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: a. Nuclear reactor power plants including all auxiliary property on the site, or b. Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and "critical facilities" as such, or c. Installations for fabricating complete fuel elements or for processing substantial quantities of "special nuclear material," and for reprocessing, salvaging, chemically separating, storing or disposing of "spent" nuclear fuel or waste materials, or d. Installations other than those listed in Paragraph 2.c. above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of Paragraphs 1. and 2. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this Paragraph 3. shall not operate: a. Where Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or b. Where said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. However on and after 1st January 1960 this SubParagraph 3.B. shall only apply provided the said radioactive contamination exclusion provision has been approved by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operations of Paragraphs 1., 2. and 3. hereof, this reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. It is understood and agreed that this Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "special nuclear material" shall have the meaning given it in the Atomic Energy Act of 1954 or by any law amendatory thereof. - 1 - 77 U.S.A. NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE 7. Reassured to be the sole judge of what constitutes: a. Substantial quantities, and b. The extent of installation, plant or site. NOTE: Without in any way restricting the operation of Paragraph 1. hereof, it is understood and agreed that: (a) all policies issued by the Reassured on or before December 31, 1957 shall be free from the application of the other provisions of this Clause until expiry date of December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. (b) with respect to any risk located in Canada policies issued by the Reassured on or before December 31, 1958 shall be free from the application of the other provisions of this Clause until expiry date or December 31, 1960 whichever first occurs whereupon all the provisions of this Clause shall apply. NOTES: 1) The words printed in italic text in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. 2) Wherever used herein the term "Company" shall be understood to mean "Reassured," "Reinsured" or whatever other term is used in the attached reinsurance Agreement to designate the reinsured company. - 2 - 78 INSOLVENCY FUNDS EXCLUSION CLAUSE 1. This Contract excludes all liability of the Reassured arising, by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed; which provides for any assessment of or payment or assumption by the Reassured of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. - 1 - 79 POOLS, ASSOCIATIONS, SYNDICATES EXCLUSION CLAUSE (FLORIDA AMENDED) SECTION A It is agreed that the following is excluded hereunder: (a) All business derived directly or indirectly from any Pool, Association or Syndicate which maintains its own reinsurance facilities. (b) Any Pool or Scheme, (whether voluntary or mandatory) formed after 1st March 1968 for the purpose of insuring property whether on a countrywide basis or in respect of designated areas. This exclusion shall not apply to so-called Automobile Insurance Plans or other Pools formed to provide coverage for Automobile Physical Damage. SECTION B It is agreed that business written by the Reassured for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in the following Pools, Associations or Syndicates, whether by way of insurance or reinsurance, is excluded hereunder: Industrial Risk Insurers Associated Factory Mutuals Improved Risk Mutuals Any Pool, Association or Syndicate formed for the purpose of writing oil, gas or petro-chemical plants and/or oil or gas drilling rigs United States Aircraft Insurance Group Canadian Aircraft Insurance Group Associated Aviation Underwriters American Aviation Underwriters Section B does not apply: (a) Where the Total Insured Value over all interests of the risk in question is less than $250,000,000. (b) To interests traditionally underwritten as Inland Marine or Stock and/or Contents written on a Blanket Basis. (c) To Contingent Business Interruption, except when the Reassured is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above. (d) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational Establishments, Public Utilities (other than Railroad Schedules), and Builder's Risks on the classes of risks specified in this subsection (d) only. - 1 - 80 SECTION C NEVERTHELESS, the Reinsurers specifically agree that liability accruing to the Reassured from its participation in Residual Market Mechanisms including but limited to: (a) The following so-called "Coastal Pools": Alabama Insurance Underwriting Association Florida Windstorm Insurance Underwriting Association (FWUA) Louisiana Insurance Underwriting Association Mississippi Insurance Underwriting Association North Carolina Insurance Underwriting Association South Carolina Windstorm and Hail Underwriting Association Texas Catastrophe Property Insurance Association (b) All "Fair Plan" and "Rural Risk Plan" business, and (c) Florida Property and Casualty Joint Underwriting Association (FPCJUA) and Residential Property and Casualty Joint Underwriting Association (RPCJUA), for all perils otherwise protected hereunder shall not be excluded, except that this reinsurance does not include any increase in such liability resulting from: (1) The inability of any participant in such Residual Market Mechanisms to meet its liability, (2) Any claim against such Residual Market Mechanisms or any participant therein, including the Reassured, whether by way of subrogation or otherwise, brought by or on behalf of any insolvency fund (as defined in the Insolvency Funds Exclusion Clause in this Contract). SECTION D Notwithstanding SECTION C above, in respect of the FWUA, FPCJUA and RPCJUA, where an assessment is made against the Reassured by the FWUA, the FPCJUA, the RPCJUA, or any combination thereof, the maximum loss that the Reassured may include in the Ultimate Net Loss in respect of any loss occurrence hereunder shall not exceed the lesser of: (1) The Reassured's assessment from the relevant entity (FWUA, FPCJUA and/or RPCJUA) for the accounting year in which the loss occurrence commenced, or (2) The product of the following: (a) The Reassured's percentage participation in the relevant entity for the accounting year in which the loss occurrence commenced; and (b) The relevant entity's total losses in such loss occurrence. Any assessments for accounting years subsequent to that in which the loss occurrence commenced may not be included in the Ultimate Net Loss hereunder. Moreover, notwithstanding SECTION C above, in respect of the FWUA, the FPCJUA and/or the RPCJUA, - 2 - 81 the Ultimate Net Loss hereunder shall not include any monies expended to purchase or retire bonds as a consequence of being a member of the FWUA, the FPCJUA and/or RPCJUA. For the purposes of this Contract, the Reassured may not include in the Ultimate Net Loss any assessment or any percentage assessment levied by the FWUA, the FPCJUA and/or the RPCJUA to meet the obligations of an insolvent insurer member or other party, or to meet any obligations arising from the deferment by the FWUA, FPCJUA and/or RPCJUA of the collection of monies. NOTES: Wherever used herein the terms: "Reassured" shall be understood to mean "Company," "Reinsured," "Reassured" or whatever other term is used in the attached reinsurance document to designate the reinsured company or companies. "Agreement" shall be understood to mean "Agreement," "Contract," "Policy" or whatever other term is used to designate the attached reinsurance document. "Reinsurers" shall be understood to mean "Reinsurers," "Underwriters" or whatever other term is used in the attached reinsurance document to designate the reinsurer or reinsurers. - 3 - EX-10.14 4 OFFICE LEASE DATED JANUARY 1, 1998 1 OFFICE LEASE between SYSTRON BUSINESS CENTER, LLC Landlord and PINNACLE DATA COPORATION Tenant January 1, 1998 2 TABLE OF CONTENTS
PAGE ---- Article 1 REAL PROPERTY, BUILDING, AND PREMISES.............................................................2 1.1 Lease of Premises............................................................................2 1.2 Appurtenant Rights...........................................................................2 1.3 Landlord's Reservation of Rights.............................................................2 1.4 Preparation of Premises; Acceptance..........................................................2 1.5 Rentable Area................................................................................2 1.6 Right of First Offer.........................................................................2 Article 2 LEASE TERM........................................................................................3 2.1 Lease Term. .................................................................................3 2.2 Confirmation of Lease Information............................................................3 2.3 Lease Year...................................................................................3 2.4 Delay in Delivery of Premises................................................................3 2.5 Option To Extend Term........................................................................4 Article 3 BASE RENT.........................................................................................5 3.1 Definition of "Base Rent"--Limited Setoff....................................................5 3.2 Initial Payment; Proration...................................................................5 3.3 Application of Payments......................................................................5 Article 4 ADDITIONAL RENT...................................................................................5 4.1 Additional Rent; Rent........................................................................5 4.2 Definitions..................................................................................5 4.3 Calculation and Payment of Additional Rent...................................................9 4.4 Taxes and Other Charges for Which Tenant Is Directly Responsible.............................9 4.5 Landlord's Books and Records; Tenant's Audit Rights..........................................9 Article 5 SECURITY DEPOSIT.................................................................................10 Article 6 USE..............................................................................................10 6.1 Permitted Use. .............................................................................10 6.2 Rules and Regulations.......................................................................10 6.3 Additional Restrictions on Use..............................................................10 Article 7 COMPLIANCE WITH LAWS.............................................................................10 7.1 Definition of "Laws and Orders."............................................................10 7.2 Repairs, Replacements, Alterations, and Improvements........................................10 7.3 Collateral Estoppel.........................................................................10 Article 8 HAZARDOUS MATERIAL...............................................................................11 8.1 Use of Hazardous Material...................................................................11 8.2 Indemnification.............................................................................11 8.4 Remediation Obligations; Tenant's Rights on Cleanup by Landlord.............................11 8.5 Definition of "Hazardous Material.".........................................................11 Article 9 UTILITIES AND SERVICES...........................................................................11 9.1 Standard Tenant Utilities and Services......................................................11 9.2 Overstandard Tenant Use.....................................................................12 9.3 Interruption of Utilities...................................................................12 Article 10 REPAIRS AND MAINTENANCE..........................................................................12 10.1 Tenant's Repair and Maintenance Obligations................................................12 10.2 Landlord's Repair and Maintenance Obligations..............................................13 Article 11 ALTERATIONS AND ADDITIONS........................................................................13 11.1 Landlord's Consent to Alterations..........................................................13 11.2 Compliance of Alterations With Laws and Insurance Requirements.............................14 11.3 Manner of Construction.....................................................................14 11.4 Payment for Improvements...................................................................14 11.5 Construction Insurance.....................................................................14 11.6 Landlord's Property........................................................................14 11.7 Initial Improvements.......................................................................15 Article 12 COVENANT AGAINST LIENS...........................................................................15 Article 13 EXCULPATION, INDEMNIFICATION, AND INSURANCE......................................................15 13.2 Exculpation................................................................................15 13.3 Indemnification............................................................................15 13.4 Compliance With Insurer Requirements.......................................................16 13.5 Tenant's Liability Coverage................................................................16 13.6 Tenant's Workers' Compensation and Employer Liability Coverage.............................17 13.7 Tenant's First Party Insurance.............................................................17 13.8 Other Insurance Coverage...................................................................18 13.9 Form of Policies and Additional Requirements...............................................18 13.10 Waiver of Subrogation......................................................................18 13.11 Disclosures Regarding Real Property........................................................18 Article 14 DAMAGE AND DESTRUCTION ..........................................................................19 14.1 Repair of Damage by Landlord...............................................................19 14.2 Repair Period Notice.......................................................................19 14.3 Landlord's Option To Terminate or Repair...................................................19
-i- 3 TABLE OF CONTENTS (CONTINUED)
PAGE ---- 14.4 Tenant's Option To Terminate..................................................................19 14.5 Rent Abatement Due to Casualty................................................................19 14.6 Damage Near End of Term.......................................................................19 14.7 Effective Date of Termination; Rent Apportionment.............................................19 14.8 Waiver of Statutory Provisions................................................................19 Article 15 CONDEMNATION........................................................................................20 15.1 Definition of "Condemnation.".................................................................20 15.2 Effect on Rights and Obligations..............................................................20 15.3 Termination of Lease..........................................................................20 15.4 Effect of Condemnation if Lease Is Not Terminated.............................................20 15.5 Allocation of Award...........................................................................20 15.6 Temporary Taking.............................................................................21 Article 16 ASSIGNMENT AND SUBLEASING...........................................................................21 16.1 Restricted Transfers..........................................................................21 16.2 Transfer Procedure............................................................................21 16.3 Landlord's Consent............................................................................22 16.4 Transfer Premium..............................................................................22 16.5 Effect of Transfer............................................................................22 16.6 Transfers of Ownership Interests and Other Organizational Changes.............................22 Article 17 SURRENDER OF PREMISES...............................................................................23 17.1 Surrender of Premises.........................................................................23 17.2 Removal of Tenant Property by Tenant..........................................................23 Article 18 HOLDING OVER........................................................................................23 18.1 Holdover Rent.................................................................................23 Article 19 ESTOPPEL CERTIFICATES ...........................................................23 19.1 Obligation To Provide Estoppel Certificates...................................................23 19.2 Failure To Deliver............................................................................23 Article 20 SUBORDINATION, NONDISTURBANCE, AND ATTORNMENT.......................................................24 20.1 Automatic Subordination; Nondisturbance Agreement To Include Specified Terms..................24 20.2 Subordination Agreement.......................................................................24 20.3 Attornment....................................................................................24 20.4 Notice of Default; Right To Cure..............................................................24 Article 21 DEFAULTS AND REMEDIES...............................................................................24 21.1 Tenant's Default..............................................................................24 21.2 Replacement of Statutory Notice Requirements..................................................24 21.3 Landlord's Remedies on Tenant's Default.......................................................25 21.4 Form of Payment After Default.................................................................25 21.5 Efforts To Relet..............................................................................25 21.6 Acceptance of Rent Without Waiving Rights.....................................................25 21.7 Tenant's Remedies on Landlord's Default.......................................................25 Article 22 LANDLORD'S RIGHT TO PERFORM TENANT'S OBLIGATIONS....................................................26 22.1 Landlord's Right To Perform Tenant's Obligations..............................................26 22.2 Reimbursement by Tenant.......................................................................26 Article 23 LATE PAYMENTS.......................................................................................26 23.1 Late Charges..................................................................................26 23.2 Interest......................................................................................26 Article 24 NONWAIVER...........................................................................................26 24.1 Nonwaiver.....................................................................................26 24.2 Acceptance and Application of Payment; Not Accord and Satisfaction............................26 Article 25 DISPUTE RESOLUTION..................................................................................26 25.1 Waiver of Right to Jury Trial.................................................................26 25.2 Resolving Disagreement Over Fair Market Rental Value..........................................27 Article 26 ATTORNEY FEES AND COSTS.............................................................................27 26.1 Attorney Fees and Costs.......................................................................28 Article 27 LANDLORD'S ACCESS TO PREMISES.......................................................................28 27.1 Landlord's Access to Premises.................................................................28 27.2 Restrictions on Entry; Tenant's Waiver........................................................28 27.3 Method of Entry...............................................................................28 27.4 Emergency Entry...............................................................................28 Article 28 SIGNS...............................................................................................28 28.1 Building Name; Landlord's Signage Rights......................................................28 28.2 Tenant's Signage Rights.......................................................................28 Article 29 TENANT PARKING......................................................................................29 29.1 Number of Parking Spaces......................................................................29 29.2 Changes in Location, Layout, and Service......................................................29 Article 30 MISCELLANEOUS.......................................................................................29 30.1 Captions......................................................................................29
-ii- 4 30.2 Word Usage...................................................................................29 30.3 Counting Days................................................................................29 30.4 Entire Agreement; Amendments.................................................................29 30.5 Exhibits.....................................................................................29 30.6 Partial Invalidity...........................................................................29 30.7 Binding Effect...............................................................................29 30.8 Independent Covenants........................................................................29 30.9 Governing Law................................................................................29 30.10 Notices......................................................................................29 30.11 Force Majeure--Specific Exceptions...........................................................30 30.12 Time of the Essence..........................................................................30 30.13 Modifications Required by Landlord's Lender..................................................30 30.14 Recording....................................................................................30 30.15 Liability of Landlord........................................................................30 30.16 Transfer of Landlord's Interest..............................................................30 30.17 Submission of Lease..........................................................................31 30.18 Legal Authority..............................................................................31 30.19 Right To Lease...............................................................................31 30.20 No Air Rights................................................................................31 30.21 Brokers......................................................................................31
-iii- 5 OFFICE LEASE This Office Lease is made by the Landlord and Tenant named below, who agree as follows: Part I SUMMARY OF BASIC LEASE INFORMATION The basic terms of this Lease are: 1. Date of Lease: January 1, 1998 2. Landlord: Systron Business Center, LLC, a California limited liability company 3. Tenant: Pinnacle Data Corporation, a California corporation 4. Premises and Building: (a) Building (Section 1.1): 2727 Systron Drive, Concord, CA. The "Building" located on the Real Property is shown on the attached Exhibit A. (b) Total Number of Rentable Square Feet in the Building (Section 1.1): 90,948 (c) Premises (Section 1.1): Approximately 30,000 Rentable Square Feet of space located in the Building, as shown on Exhibit A. (d) Expansion of Premises (Section 1.6): Tenant has a right of first refusal to expand the Premises to include additional space that may become available, as shown on Exhibit A, during the term of the Lease, such right of first refusal to be exercised in accordance with Section 1.6. 5. Lease Term: (a) Duration (Section 3.1): Ten (10) years and zero (0) months. (b) Lease Commencement Date (Section 3.1): March 15, 1998. (c) Lease Expiration Date (Section 2.1): The last day of the month in which the tenth (10th) anniversary of the Lease Commencement Date occurs. (d) Optional Term Extensions (Section 2.5): Two (2) extensions for five (5) years each. 6. Base Rent (Section 3.1): (Measured From Lease Commencement Date) Base Rent is subject to adjustment as set forth in Section 3.1.
Months Monthly Base Rent - ------ ----------------- 3/15/98-10/31/98 Rental Abatement 11/1/98-2/28/03 $40,500 3/1/03-8/31/05 $42,000 9/1/05-Lease Expiration Date $45,000
7. Additional Rent (Article 4): Tenant's Share of Increased Direct Expenses (Section 4.2.6): Approximately 32.99%. 8. Security Deposit (Article 5): None 9. Permitted Use (Section 6.1): General office. 10. Liability insurance (minimum) (Section 13.5.10): (a) General aggregate limit: $3,000,000. (b) Personal injury and advertising injury limit: $3,000,000. (c) Each occurrence limit: $2,000,000 (d) Fire damage liability limit (any one fire): $2,000,000. 11. Late charge and interest (Article 23): (a) Late charge (Section 23.1): Three percent (3%). (b) Interest on delinquent Rent (Section 23.2): Wall Street Journal Prime Rate (or if such rate is no longer published such other prime rate reasonably selected by Landlord) plus two percent (2%). 6 2.4 Delay in Delivery of Premises. If Substantial Completion of the Tenant Improvements has not occurred by the Outside Date, as defined in Section 2.4.1, Tenant's sole remedy, in addition to those stated in Section 3.1, shall be to terminate this Lease as provided in this Section 2.4. 2.4.1. Definition of "Outside Date." For purposes of this Section 2.4, the Outside Date shall be April 15, 1998, as extended by the number of days of Tenant Delays described in Exhibit B and by the number of days of Force Majeure delays as defined in Section 30.11. 2.4.2. Tenant's Termination Notice. If Substantial Completion of the work that Landlord is required to do pursuant to the Leasehold Improvement Agreement has not occurred by the Outside Date, Tenant's sole remedy shall be the right to deliver a notice to Landlord ("Outside Date Termination Notice") electing to terminate this Lease effective on Landlord's receipt of the Outside Date Termination Notice ("Effective Date"). The Outside Date Termination Notice must be delivered by Tenant to Landlord, if at all, no earlier than the Outside Date and no later than thirty (30) days after the Outside Date. 2.5 Option To Extend Term. Landlord grants to Tenant two (2) options to extend the Lease Term (each, an Extension Option) for a period of five (5) years (each an Option Term) each, subject to the conditions described in this Section 2.5. Tenant shall have no other right to extend the term beyond the last Option Term. 2.5.1. Conditions of Option. Each Extension Option shall be subject to the following conditions: (a) The Extension Option may be exercised only by written notice delivered by Tenant to Landlord as provided in Section 2.5.3 and only if, as of the date of delivery of the notice or as of the commencement of the applicable Option Term, Tenant is not in Default under this Lease after the expiration of any applicable cure periods. (b) The rights contained in this Section 2.5 may be exercised only by the originally named Tenant. (c) If Tenant properly exercises the Extension Option, the Lease Term, as it applies to the entire Premises then leased by Tenant, shall be extended for the applicable Option Term. 2.5.2. Option Rent. The Rent payable by Tenant during the Option Term ("Option Rent") shall be equal to ninety-five percent (95%) of the Fair Market Rental Value of the Premises as of the commencement of the applicable Option Term. For purposes of this Section 2.5, Fair Market Rental Value of the Premises shall be the rental rate, including all escalations, at which tenants lease comparable space as of the commencement of the Option Term. No over-standard tenant improvements installed by Tenant will have an impact on the determination of the Fair Market Rental Value. For purposes of this Section 2.5.2, "comparable space" shall be office space that is: (a) Not subleased; (b) not subject to another tenant's expansion rights; (c) comparable in size, location, floor height and quality to the Premises; (d) leased for a term comparable to the Option Term; and (e) located in comparable buildings in the Concord/Walnut Creek area. 2.5.3. Exercise of Option. The Extension Option must be exercised by Tenant, if at all, only at the time and in the manner provided in this Section 2.5.3. 2.5.3.1 Interest Notice. If Tenant wishes to exercise an Extension Option, Tenant shall deliver written notice ("Interest Notice") to Landlord no less than six (6) months before the expiration of the initial Lease Term. 2.5.3.2 Option Rent Notice. After receipt of Tenant's Interest Notice, Landlord shall deliver notice ("Option Rent Notice") to Tenant no less than four (4) months before the expiration of the initial Lease Term, stating the Option Rent, based on Landlord's determination of the Fair Market Rental Value of the Premises as of the date that is four (4) months before the commencement date of the Option Term. 2.5.3.3 Exercise Notice. If Tenant wishes to exercise the Extension Option, Tenant must, on or before the earlier of (a) the date occurring ninety (90) days before the expiration of the initial Lease Term or the first Option Term, as the case may be or (b) the date occurring thirty (30) days after Tenant's receipt of the Option Rent Notice, exercise the Extension Option by delivering written notice ("Exercise Notice") to Landlord. 2.5.3.4 Objection to Option Rent. If Tenant wishes to contest the Option Rent stated in the Option Rent Notice, Tenant must provide, with the Exercise Notice, written notice to Landlord that Tenant objects to the stated Option Rent. If Tenant provides such written objection, the parties shall follow the procedure described in Section 25.2, and the Option Rent shall be determined as set forth in that Section. 2.5.3.5 Failure To Deliver Timely Notice. If Tenant fails to deliver a timely Interest Notice: (a) Tenant shall not lose its right to exercise the Extension Option and shall still be entitled to deliver the Exercise Notice; (b) Landlord shall not be required to deliver the Option Rent Notice; (c) Tenant shall be considered to have objected to the Option Rent; and (d) The parties shall follow the procedure described in Section 25.2, and the Option Rent shall be determined as set forth in that Section. 2.5.4. Amendment to Lease. If Tenant timely exercises its Extension Option, Landlord and Tenant shall, within fifteen (15) days after the Option Rent is determined under this Section 2.5 or Article 25, execute an amendment to this Lease extending the Lease Term on the terms and conditions set forth in this Section 2.5. Such amendment shall provide for the Base Year to be adjusted to the first year of each Option Term. -4- 7 (d) The cost of licenses, certificates, permits, and inspections. (e) The cost of contesting the validity or applicability of any government enactments that may affect the Operating Expenses. (f) The costs incurred in connection with the implementation and operation of a transportation system management program or similar program. (g) The cost of insurance carried by Landlord, in amounts reasonably determined by Landlord, provided, however, that earthquake insurance shall be maintained only to the extent it is available at a commercially reasonable price and, if earthquake insurance is not included in the Base Year but is subsequently carried by Landlord, the Base Year Operating Expenses will be adjusted as if earthquake insurance had been carried. (h) Fees, charges, and other costs including management fees (or amounts in lieu of such fees), which management fees shall not exceed three percent (3%) of rents, consulting fees, legal fees, and accounting fees of all persons engaged by Landlord or otherwise reasonably incurred by Landlord in connection with the operation, management, maintenance, and repair of the Real Property. (i) The cost of parking area maintenance, repair, and restoration, including resurfacing, repainting, restriping, and cleaning. (j) Wages, salaries, and other compensation and benefits of all persons providing services to the Real Property, including those engaged in the operation, maintenance, or security of the Real Property plus employer's Social Security taxes, unemployment taxes, insurance, and any other taxes imposed on Landlord that may be levied on those wages, salaries, and other compensation and benefits. Notwithstanding anything to the contrary in this Section 4.2.3.1(j), Landlord's general overhead expenses shall not be included in Operating Expenses. If any of Landlord's employees provide services for more than one building of Landlord, only the prorated portion of those employees' wages, salaries, other compensation and benefits, and taxes reflecting the percentage of their working time devoted to the Real Property shall be included in Operating Expenses. (k) Payments under any easement, license, operating agreement, declaration, restrictive covenant, or instrument relating to the sharing of costs by the Real Property. (l) Amortization (including interest on the unamortized cost at a rate equal to the floating commercial loan rate announced from time to time by Bank of America, N.T.&S.A. (or such other bank reasonably selected by Landlord) as its prime rate plus two (2) percentage points per annum of the cost of acquiring or renting personal property used in the maintenance, repair, and operation of the Building and Real Property. (m) The cost of capital improvements or other costs incurred in connection with the Real Property that are intended as a labor-saving device or to effect other economies in the maintenance or operation of all or part of the Real Property to the extent of Landlord's reasonable estimate of savings in Operating Expenses as a result of such costs. All such permitted capital expenditures shall be amortized (including interest on the unamortized cost at the rate stated in Section (l)) over their useful life, as reasonably determined by Landlord. (n) The cost to clean, paint and waterproof the Real Property. Notwithstanding the foregoing, to the extent that any such costs are considered capital expenditures per Generally Accepted Accounting Principles, such capital expenditures shall be amortized (including interest on the unamortized costs at the rate stated in Section (l)) over their useful life as reasonably determined by Landlord. 4.2.4. Adjustment of Operating Expenses. Operating Expenses shall be adjusted as follows: 4.2.4.1 Gross-Up Adjustment When Building Is Less Than Fully Occupied. If the occupancy of the Building during any part of the Base Year is less than 100 percent, Landlord shall make an appropriate adjustment of the variable components of Operating Expenses for the Base Year, as reasonably determined by Landlord using sound accounting and management principles, to determine the amount of Operating Expenses that would have been incurred had the Building been 100 percent occupied. This amount shall be considered to have been the amount of Operating Expenses for the Base Year. For purposes of this Section 4.2.4.1, "variable components" include only those component expenses that are affected by variations in occupancy levels. 4.2.4.2 Exclusions From Operating Expenses. Despite any other provision of Section 4.2, Operating Expenses shall not include: (a) Depreciation, interest, or amortization on mortgages or ground lease payments, except as otherwise stated in this Section 4.2. (b) Legal fees incurred in negotiating and enforcing tenant leases. (c) Real estate brokers' leasing commissions. (d) Initial improvements or alterations to tenant spaces. (e) The cost of providing any service directly to and paid directly by any tenant. -6- 8 (f) Any costs expressly excluded from Operating Expenses elsewhere in this Lease. (g) Costs of any items for which Landlord receives reimbursement from insurance proceeds or a third party. Insurance proceeds shall reduce Operating Expenses in the year in which they are received, except that any deductible amount under any insurance policy shall be included within Operating Expenses. (h) Costs of capital improvements, except as otherwise stated in this Section 4.2. 4.2.4.3 Additional Operating Expense Exclusions. Despite any other provision of Section 4.2, Operating Expenses shall also not include: (a) Interest, principal, depreciation, attorney fees, costs of environmental investigations or reports, points, fees, and other lender costs and closing costs on any mortgage or mortgages, ground lease payments, or other debt instrument encumbering the Real Property. (b) Insurance premiums to the extent of any refunds of those premiums. (c) Any bad debt loss, rent loss, or reserves for bad debt or rent loss. (d) Landlord's costs of electricity and other utilities, items, benefits, and services that are provided to other tenants or occupants at no special cost but that are only offered or provided to Tenant at a special or increased cost. (e) Interest or penalties resulting from late payment of any operating expense by Landlord due to Landlord's negligence or willful misconduct (unless Landlord in good faith disputes a charge and subsequently loses or settles that dispute) or due to the negligence or willful misconduct of another tenant. (f) Costs, fees, and compensation paid to Landlord, or to Landlord's subsidiaries or affiliates, for services in or to the Real Property to the extent that they exceed the charges for comparable services rendered by an unaffiliated third party of comparable skill, competence, stature, and reputation. (g) Costs associated with: (1) Operation of the business of the ownership of the Real Property or entity that constitutes Landlord or Landlord's property manager, as distinguished from the cost of Building operations, including the costs of partnership or corporate accounting and legal matters; defending or prosecuting any lawsuit with any mortgagee, lender, ground lessor, broker, tenant, occupant, or prospective tenant or occupant; selling or syndicating any of Landlord's interest in the Real Property; and disputes between Landlord and Landlord's property manager; (2) Landlord's general corporate or partnership overhead and general administrative expenses, including the salaries of management personnel who are not directly related to the Real Property and primarily engaged in the operation, maintenance, and repair of the Real Property, except to the extent that those costs and expenses are included in the management fees, so long as these costs do not exceed reasonable industry standards; or (3) Wages, salaries, and other compensation paid to any executive employee of Landlord or Landlord's property manager above the grade of building manager for the Building or paid to any off-site personnel, so long as these costs do not exceed reasonable industry standards. (h) Advertising and promotional expenditures primarily directed toward leasing tenant space in the Real Property. (i) Leasing commissions, space-planning costs, attorney fees and costs, disbursements, and other expenses: (1) Incurred in connection with leasing, other negotiations, or disputes with tenants, occupants, prospective tenants, or other prospective occupants of the Building; or (2) associated with the enforcement of any leases. (j) Costs incurred (including permit, license, and inspection fees but excluding utilities) or cash consideration paid in renovating or otherwise improving, decorating, painting, or redecorating space for tenants, prospective tenants, or other occupants or in renovating or redecorating vacant space available for those tenants, prospective tenants, or other occupants. This exclusion does not apply to remove from Operating Expenses the costs of ordinary maintenance supplied to the tenants of the Building or the costs for renovating or otherwise improving, decorating, painting, or redecorating the common areas of the Real Property. (k) Costs arising from: (1) Hazardous Material, as defined in Section 8.5, that was installed by Landlord, its agents, or employees and that, at the time of installation, Landlord knew or should have known was Hazardous Material; or (2) despite any other provision of this Lease (including any provision relating to capital expenditures), the presence of any Hazardous Material in or about the Premises, Building, or Real Property (including Hazardous Material in the ground, water, or soil) that was not placed in the Premises, Building, or Real Property by Tenant and/or Tenant Parties as defined in Section 13.1. -7- 9 (l) Expenses, costs, and disbursements relating to, or arising directly or indirectly from, the testing for or analysis, handling, removal, treatment, disposal, remediation, or replacement of asbestos or asbestos-containing materials in, on, around, beneath, or from the Real Property. (m) Costs incurred because the Building or common areas violate any valid, applicable building code, regulation, or law in effect and as interpreted by government authorities before the date of this Lease. (n) Except as provided in Section 4.2.3.1(m) Capital improvement, capital replacement, or related costs. 4.2.5. Tax Expenses. "Tax Expenses" means all federal, state, county, or local government or municipal taxes, fees, charges, or other impositions of every kind (whether general, special, ordinary, or extraordinary) that are paid or incurred by Landlord during any Expense Year (without regard to any different fiscal year used by any government or municipal authority) because of or in connection with the ownership, leasing, and operation of the Real Property. Tax Expenses shall include taxes, fees, and charges such as real property taxes, general and special assessments, transit taxes, leasehold taxes, and taxes based on the receipt of rent (including gross receipts or sales taxes applicable to the receipt of rent, unless required to be paid by Tenant); personal property taxes imposed on the fixtures, machinery, equipment, apparatus, systems, and equipment; appurtenances; furniture; and other personal property used in connection with the Real Property. Tax Expenses shall also include taxes, assessments or charges imposed on a real property tax bill for the Real Property for the implementation and operation of a transportation system management program or similar program, in each case if required by law. 4.2.5.1 Adjustment of Taxes. Tenant hereby acknowledges that title to the Real Property was transferred to Landlord during 1997 before the execution of this Lease, that the Real Property has been or is in the process of being permanently reassessed (as distinguished from a so-called "Proposition 8" reassessment) to reflect Landlord's purchase price for the Real Property and that Tax Expenses for the Base Year shall take into account such reassessment. In addition, for purposes of this Lease, Tax Expenses shall be calculated as if the tenant improvements in the Building were fully constructed and the Real Property, the Building, and all tenant improvements in the Building were fully assessed for real estate tax purposes for the entire Base Year. These provisions shall survive the Lease Expiration Date or other termination of this Lease. 4.2.5.2 Included Tax Expenses. Tax Expenses shall include: (a) Any assessment, tax, fee, levy, or charge in addition to, or in partial or total substitution of, any assessment, tax, fee, levy, or charge previously included within the definition of "real property tax." Tenant and Landlord acknowledge that Proposition 13 was adopted by the voters of the State of California in June 1978 and that assessments, taxes, fees, levies, and charges may be imposed by government agencies for services such as fire protection; street, sidewalk, and road maintenance; conservation; refuse removal; and other government services formerly provided without charge to property owners or occupants. In further recognition of the decrease in the level and quality of government services and amenities as a result of Proposition 13 (or as a result of any other restriction on real property taxes whether by law or by choice of the applicable legislative or assessing body), Tax Expenses shall also include any government or private assessments (or the Building's contribution toward a government or private cost-sharing agreement) for the purpose of augmenting or improving the quality of services and amenities normally provided by government agencies. Tenant and Landlord intend that all new and increased assessments, taxes, fees, levies, and charges and all similar assessments, taxes, fees, levies, and charges be included within the definition of "Tax Expenses" for purposes of this Lease. (b) Any assessment, tax, fee, levy, or charge allocable to, or measured by, the area of the Premises or the rent payable under this Lease, including any gross income tax with respect to the receipt of that rent, or on or relating to the possession, leasing, operating, management, maintenance, alteration, repair, use, or occupancy by Tenant of the Premises or any portion of the Premises. (c) Any assessment, tax, fee, levy, or charge on this transaction or any document to which Tenant is a party, creating or transferring an interest or an estate in the Premises. (d) Any possessory taxes charged or levied in place of real property taxes. 4.2.5.3 Contest Costs; Refunds. Any expenses incurred by Landlord in attempting to protest, reduce, or minimize Tax Expenses shall be included in Tax Expenses in the Expense Year in which those expenses are paid. Such tax refunds shall be deducted from Tax Expenses in the Expense Year in which they are received by Landlord. 4.2.5.4 Excluded Taxes. Despite any other provision of Section 4.2.5 (except as provided in Section 4.2.5.2 or levied entirely or partially in lieu of Tax Expenses), the following shall be excluded from Tax Expenses: (a) All excess profits taxes, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes, federal and state income taxes, and other taxes applied or measured by Landlord's general or net income (as opposed to rents, receipts, or income attributable to operations at the Building); (b) Any items included as Operating Expenses; and (c) Any items paid by Tenant under Section 4.4. 4.2.5.5 Proposition 13 Protection. Despite any other provision of this Lease, if during the Lease Term, any sale, refinancing, or change in ownership of all or part of the Real Property is consummated and, as a result, all or part of the Real Property is reassessed ("Reassessment") for real estate tax purposes by the appropriate government authority, the terms of this Section 4.2.5.5 shall apply. Tenant hereby acknowledges that title to the Real Property was transferred to Landlord -8- 10 during 1997 before the execution of this Lease, that the Real Property has been or is in the process of being permanently reassessed (as distinguished from a so-called "Proposition 8" reassessment) to reflect Landlord's purchase price for the Real Property and that Tax Expenses for the Base Year shall take into account to such reassessment. (a) Tenant shall not be obligated to pay any portion of the Tax Increase relating to a Reassessment occurring during the Term. (b) For purposes of this Section 4.2.5.5, the term "Tax Increase" shall mean that portion of the Tax Expenses, as calculated immediately following the Reassessment, that is attributable solely to the Reassessment. Accordingly, a Tax Increase shall not include any portion of the Tax Expenses, as calculated immediately following the Reassessment, that is: (1) Attributable to the initial assessment of the value of the Real Property, the Base Building, or the tenant improvements located in the Building; (2) attributable to assessments or adjustments to assessments pending immediately before the Reassessment that were conducted during, and included in, that Reassessment or that were otherwise rendered unnecessary following the Reassessment; or (3) attributable to the annual inflationary increase in real estate taxes. 4.2.6. Tenant's Share. "Tenant's Share" means the percentage stated in Summary Section 7(a). Tenant's Share is calculated by multiplying the number of Rentable Square Feet of the Premises by 100 and dividing the product by the total Rentable Square Feet in the Building. If either the Premises or the Building is expanded or reduced, Tenant's Share shall be appropriately adjusted. Tenant's Share for the Expense Year in which that change occurs shall be determined on the basis of the number of days during the Expense Year in which each such Tenant's Share was in effect. 4.3 Calculation and Payment of Additional Rent. Tenant's Share of any Direct Expenses for any Expense Year shall be calculated and paid as follows: 4.3.1. Calculation. Tenant shall pay Tenant's Share of Direct Expenses for each Expense Year in the manner stated in Section 4.3.2. 4.3.2. Statement of Actual Increased Direct Expenses and Payment by Tenant. Landlord shall endeavor to give to Tenant on or before the first day of April following the end of each Expense Year a statement ("Statement") stating the Direct Expenses incurred or accrued for that preceding Expense Year and the amount of the Increased Direct Expenses. On receipt of the Statement for each Expense Year ending during the Lease Term, Tenant shall pay, with its next installment of Base Rent due, the full amount of Tenant's Share of such Increased Direct Expenses, less the amounts (if any) paid during that Expense Year as Estimated Increased Direct Expenses (as defined in Section 4.3.3). Landlord's failure to furnish the Statement for any Expense Year in a timely manner shall not prejudice Landlord from enforcing its rights under this Article 4. Even if the Lease Term has expired and Tenant has vacated the Premises, if when the final determination is made of Tenant's Share of the Increased Direct Expenses for the Expense Year in which this Lease terminates it is determined that Tenant owes Tenant's Share of Increased Direct Expenses, Tenant shall immediately pay to Landlord the amount calculated under Section 4.3.1. The provisions of this Section 4.3.2 shall survive the expiration or earlier termination of the Lease Term. Tenant shall not be obligated to pay the amount of Increased Direct Expenses with respect to any Expense Year if Landlord fails to deliver to Tenant a Statement with respect to such Expense Year within one (1) year after the end of such Expense Year. Landlord may deliver a corrected Statement to Tenant with respect to any Expense Year if the corrected Statement is delivered to Tenant within eighteen (18) months after the end of such Expense Year, and Tenant shall pay the Increased Direct Expenses as provided on the corrected Statement. Notwithstanding the foregoing, Landlord may deliver a Statement or corrected Statement to Tenant with respect to Tax Expenses for any Expense Year within ninety (90) days after receipt of a bill for Tax Expenses for any prior Expense Year. If any corrected Statement shall evidence a refund due to Tenant, Landlord shall promptly deliver the same together with such refund to Tenant, notwithstanding the expiration of the aforesaid periods. 4.3.3. Statement of Estimated Increased Direct Expenses. Landlord shall give Tenant a yearly expense estimate statement ("Estimate Statement") stating Landlord's reasonable estimate ("Estimate") of the total amount of Increased Direct Expenses for the then current Expense Year and Tenant's Share of such Increased Direct Expenses ("Estimated Expenses"). Landlord's failure to furnish the Estimate Statement for any Expense Year in a timely manner shall not preclude Landlord from enforcing its rights to collect Increased Direct Expenses under this Article 4. Tenant shall pay with each installment of Base Rent due, one-twelfth (1/12) of the Estimated Expenses for the then-current Expense Year. Until a new Estimate Statement is furnished, Tenant shall pay monthly, along with the monthly Base Rent installments, an amount equal to one twelfth (1/12th) of the total Estimated Expenses stated in the previous Estimate Statement delivered by Landlord to Tenant. 4.3.4. Refund of Overpayment of Direct Expenses. If the Statement shows that the Direct Expenses for any Expense Year ending or beginning within the Lease Term is less than the Estimated Expenses actually paid by Tenant for that Expense Year, Landlord shall credit Tenant's next payment of Base Rent and Estimated Expenses with the amount by which Tenant's payments of Estimated Expenses exceed the actual Direct Expenses due for that Expense Year. If the Statement shows that Tenant's payments of Estimated Expenses exceed the actual Direct Expenses due for that Expense Year by more than three and one-half percent (3 1/2%), the Landlord shall pay to Tenant annual interest on the overpaid amount, from the date overpaid until credited or refunded, at theinterest rate stated in Section 23.2 of this Lease. If the Statement is provided to Tenant after the end of the Lease Term, Landlord shall include with the Statement a refund of the amount by which Tenant's payments of Estimated Expenses exceed the actual Direct Expenses due for that Expense Year, along with any interest due in accordance with this Section 4.3.4. 4.4 Taxes and Other Charges for Which Tenant Is Directly Responsible. Tenant shall reimburse Landlord, on demand, as Additional Rent for any taxes required to be paid by Landlord that are not already included in Tax Expenses (excluding state, -9- 11 local, and federal personal or corporate income taxes measured by the net income of Landlord from all sources and estate and inheritance taxes) regardless of whether such taxes are now customary or within the contemplation of the parties to this Lease, when those taxes are: (a) Measured by or reasonably attributable to: (1) The cost or value of Tenant's equipment, furniture, fixtures, and other personal property located in the Premises; or (2) the cost or value of any leasehold improvements made in or to the Premises by or for Tenant (to the extent that the cost or value of those leasehold improvements exceeds the cost or value of a building-standard build-out, as determined by Landlord, regardless of whether title to those improvements is vested in Tenant or Landlord); or (b) Assessed either on this transaction or on any document to which Tenant is a party that creates or transfers an interest or an estate in the Premises. 4.5 Landlord's Books and Records; Tenant's Audit Rights. Tenant and its authorized representatives may examine, inspect, audit, and copy the records of Landlord regarding each Statement at Landlord's office during normal business hours within six (6) months after the furnishing of the Statement. Unless Tenant takes written exception to any item within one (1) year after the furnishing of that Statement, the Statement shall be considered as final and accepted by Tenant except that Landlord may, at any time during the one-year period, following the delivery of the statement submit a corrected Statement to Tenant if Operating Expenses and Tax Expenses on the original Statement were overstated or understated. Tenant and its authorized representatives shall have the right, at Tenant's cost and on no less than ten (10) days' prior written notice to Landlord and during Landlord's normal business hours, to audit Landlord's records regarding Operating Expenses and Tax Expenses. Such an audit shall be performed at Landlord's principal accounting offices by a certified public accounting firm. That firm's primary business must be certified public accounting and may not be compensated on the basis of the amount of Direct Expenses saved by Tenant as a result of such audit, and that firm shall be selected by Tenant and approved by Landlord. Landlord's approval shall not be unreasonably delayed or withheld. There shall be no more than one (1) audit of Operating Expenses or Tax Expenses for any twelve-month (12-month) period. To facilitate an audit by Tenant, Landlord shall keep its books and records applicable to Operating Expenses and Tax Expenses available to Tenant on a reasonable basis for the longer of (1) two (2) years after the Lease Expiration Date or (2) one (1) year after the resolution of any dispute concerning Operating Expenses and Tax Expenses. Any audit of Operating Expenses and Tax Expenses for any calendar year must be begun one (1) year after Landlord's delivery of the Statement for that year, or the right to audit Operating Expenses and Tax Expenses for that year shall be deemed waived. Tenant agrees diligently to pursue and complete (or to drop) any audit begun by Tenant, and Landlord agrees it shall not unreasonably interfere with the execution of Tenant's audit rights. Tenant shall bear all fees and costs of the audit, unless the parties determine that Operating Expenses and Tax Expenses taken as a whole for the Real Property for any Expense Year, were overstated by more than three and one-half percent (3.5%). In that event, Landlord shall pay for the reasonable costs of that audit. Pending resolution of any disputes over Operating Expenses and Tax Expenses, Tenant shall pay to Landlord any Additional Rent alleged to be due from Tenant as reflected on Landlord's Statement or any invoice issued on the basis of Landlord's Statement. Article 5 SECURITY DEPOSIT [Intentionally Omitted] Article 6 USE 6.1 Permitted Use. Tenant shall use and occupy the Premises solely for the "Permitted Use," as defined in the Summary. Tenant shall not use or occupy, or permit the Premises to be used or occupied, for any other purpose without Landlord's prior written consent, which may be withheld in Landlord's sole and absolute discretion. 6.2 Rules and Regulations. Tenant shall comply with the rules attached to this Lease as Exhibit D and any reasonable non discriminatory amendments or additions promulgated by Landlord from time to time for the safety, care, and cleanliness of the Premises, Building, and Real Property or for the preservation of good order ("Rules and Regulations") as long as the Rules and Regulations do not take precedence over the specific terms and conditions of this Lease. Landlord shall not be responsible to Tenant for the failure of any other tenants or occupants of the Building to comply with the Rules and Regulations. 6.3 Additional Restrictions on Use. In addition to complying with other provisions of this Lease concerning use of the Premises: (a) Tenant shall not use or allow any person to use the Premises for any purpose that is contrary to the Rules and Regulations, that violates any Laws and Orders, that constitutes waste or nuisance, that would unreasonably interfere with another occupant's permitted use of the Building or that does not comply with the standards set forth in Section 6.4; (b) Tenant shall not use or allow any person to use the Premises for any purpose that violates any recorded covenants, conditions, and restrictions that now or later affect the Real Property; and (c) Tenant shall not use or allow any person to use the Premises for any purpose, use or manner of use that would generate unreasonable noise, unreasonable risk of fire or unreasonable odors, or for any purpose that would directly or materially interfere with other tenants' permitted uses of their demised premises. -10- 12 Article 7 COMPLIANCE WITH LAWS 7.1 Definition of "Laws and Orders." For purposes of this Lease, the term "Laws and Orders" includes all federal, state, county, city, or government agency laws, statutes, ordinances, standards, rules, requirements, or orders now in force or hereafter enacted, promulgated, or issued. The term also includes government measures regulating or enforcing public access or occupational or health or safety standards for employers, employees, landlords, or tenants. 7.2 Repairs, Replacements, Alterations, and Improvements. Tenant, at Tenant's sole expense, shall promptly make all repairs, replacements, alterations, or improvements needed to comply with all Laws and Orders to the extent that the Laws and Orders relate to or are triggered by (a) Tenant's particular use of the Premises, or (b) any Alterations made in the Premises. Except for compliance required as a result of Tenant's particular use of the Premises and/or any Alternation made in the Premises, Landlord, at Landlord's sole expense, shall promptly make all repairs, replacements, alterations, or improvements in the Premises and/or the Common Area needed to comply with all Laws and Orders. 7.3 Collateral Estoppel. The judgment of any court of competent jurisdiction, or the admission of Tenant in any judicial or administrative action or proceeding that Tenant has violated any Laws and Orders shall be conclusive, between Landlord and Tenant, of that fact, whether or not Landlord is a party to that action or proceeding. Article 8 HAZARDOUS MATERIAL 8.1 Use of Hazardous Material. Tenant shall not cause or permit any Hazardous Material, as defined in Section 8.5, to be generated, brought onto, used, stored, or disposed of in or about the Premises or the Real Property by Tenant or its agents, employees, contractors, subtenants, or invitees, except for such office products that are required in the ordinary course of Tenant's business conducted on the Premises or are otherwise approved by Landlord. Tenant shall: (a) Use, store, and dispose of all such Hazardous Material in strict compliance with all applicable statutes, ordinances, and regulations in effect during the Lease Term that relate to public health and safety and protection of the environment ("Environmental Laws"), including those Environmental Laws identified in Section 8.4; and (b) Comply at all times during the Lease Term with all Environmental Laws. 8.2 Indemnification. Tenant shall, at Tenant's sole expense and with counsel reasonably acceptable to Landlord, indemnify, defend, and hold harmless the Landlord and the Landlord's shareholders, directors, officers, employees, partners, affiliates, and agents with respect to all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises or the Real Property, or the violation of any Environmental Law, by Tenant or Tenant's agents, contractors, or invitees. This indemnification includes all losses, liabilities, obligations, penalties, fines, claims, actions (including remedial or enforcement actions of any kind and administrative or judicial proceedings, orders, or judgments), damages (including consequential and punitive damages), and costs (including attorney, consultant, and expert fees and expenses) resulting from the release or violation. This indemnification shall survive the expiration or termination of this Lease. 8.3 Indemnification by Landlord. Tenant acknowledges receipt of the "Report of Soil and Groundwater Assessment, ASE Job No. 3106, Former Systron/Donner/Whittaker Facility," prepared by AquaScience Engineers, dated May 29, 1997 ("Environmental Report"). Landlord shall, at Landlord's sole expense and with counsel reasonably acceptable to Tenant, indemnify, defend, and hold harmless the Tenant Parties to the extent of all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises or the Real Property or the violation of any Environmental Law occurring before the Lease Commencement Date, including without limitation the Hazardous Material identified in the Environmental Report, and all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises or the Real Property or the violation of any Environmental Law by Landlord Parties or any party other than Tenant, occurring after the Lease Commencement Date. This indemnification includes all losses, liabilities, obligations, penalties, fines, claims, actions (including remedial or enforcement actions of any kind and administrative or judicial proceedings, orders, or judgments), damages (including consequential and punitive damages), and costs (including attorney, consultant, and expert fees and expenses) resulting from the release or violation. This indemnification shall survive the expiration or termination of this Lease. 8.4 Remediation Obligations; Tenant's Rights on Cleanup by Landlord. If the presence of any Hazardous Material brought onto the Premises or the Real Property by Tenant or by Tenant's employees, agents, contractors, or invitees results in contamination of the Real Property, Tenant shall promptly take all necessary actions, at Tenant's sole expense, to return the Real Property to the condition that existed before the introduction of such Hazardous Material. Tenant shall first obtain Landlord's approval of the proposed remedial action. This provision does not limit the indemnification obligations set forth in Section 8.2. 8.5 Definition of "Hazardous Material." As used in this Article 8, the term "Hazardous Material" shall mean any hazardous or toxic substance, material, or waste that is or becomes regulated by the United States, the State of California, or any local government authority having jurisdiction over the Building. Hazardous Material includes: (a) Any "hazardous substance," as that term is defined in the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) (42 United States Code Sections 9601-9675); (b) "Hazardous waste," as that term is defined in the Resource Conservation and Recovery Act of 1976 (RCRA) (42 United States Code Sections 6901-6992k); (c) any pollutant, contaminant, or hazardous, dangerous, or toxic chemical, material, or substance, within the meaning of any other applicable federal, state, or local law, regulation, ordinance, or requirement (including consent decrees and administrative orders imposing liability or standards of conduct concerning any hazardous, dangerous, or toxic waste, substance, -11- 13 or material, now or hereafter in effect); (d) petroleum products; (e) radioactive material, including any source, special nuclear, or byproduct material as defined in 42 United States Code Sections 2011-2297g-4; (f) asbestos in any form or condition; and (g) polychlorinated biphenyls ("PCBs") and substances or compounds containing PCBs. Article 9 UTILITIES AND SERVICES 9.1 Standard Tenant Utilities and Services. Subject to applicable government rules, regulations, and guidelines and the rules or actions of the public utility furnishing the service, Landlord shall provide the following utilities and services unless otherwise stated in this Lease: 9.1.1. Heating and Air-Conditioning. 9.1.1.1 Hours and Specifications. Landlord shall provide heating, ventilation, and air-conditioning ("HVAC") on Mondays through Fridays from 8 a.m. through 7 p.m. ("Building Hours") except for the dates of observation of New Year's Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day, and other locally and nationally recognized holidays that are observed by a majority of the Comparable Buildings ("Holidays"). 9.1.2. Electricity. Landlord shall provide electricity for lighting and power in the Premises during Building Hours except for Holidays. All costs for electricity for lighting and power used by Tenant outside of Building Hours or on Holdidays shall be paid by Tenant. Electricity for Tenant's lighting and other power purposes shall be at a nominal 208/220 volts. No electrical circuit for the supply of power shall require a current capacity exceeding twenty (20) amperes. Landlord shall replace lamps, starters, and ballasts for Building Standard lighting fixtures within the Premises on Tenant's request. The cost of such replacement shall be included in Operating Expenses. Tenant shall replace lamps, starters, and ballasts for non-Building Standard lighting fixtures within the Premises at Tenant's expense. All lighting installed as a part of the initial Tenant Improvements shall be considered "Building Standard". 9.1.3. Water. Landlord shall provide city water from the regular outlets for drinking, lavatory, and toilet purposes. 9.1.4. Janitorial Services. Landlord shall provide janitorial services in and about the Premises and the restrooms in the Common Areas serving the Premises on Mondays through Fridays, except on Holidays, in accordance with the specifications attached to this Lease as Exhibit E. 9.2 Overstandard Tenant Use. Tenant shall not, without Landlord's prior written consent, use heat-generating machines, machines other than normal fractional horsepower office machines, or equipment or lighting other than building standard lights in the Premises that may materially adversely affect the temperature otherwise maintained by the air-conditioning system or materially increase the water normally furnished to the Premises by Landlord under Section 9.1. Landlord shall have the right to install supplementary air-conditioning units or other facilities at locations in the Premises reasonably approved by Tenant, including supplementary or additional metering devices. Within thirty (30) days after billing by Landlord, Tenant shall pay Landlord's actual cost for such supplementary facilities, including the cost of (a) installation, operation, and maintenance; and (b) increased wear and tear on existing equipment. If Tenant uses water, electricity, heat, or air-conditioning in excess of that required to be supplied by Landlord under Section 9.1, Tenant shall pay to Landlord, within thirty (30) days after billing, Landlord's actual cost of providing such excess service, without profit or overhead but including the cost of (a) installation, operation, and maintenance of equipment installed to supply the excess service; and (b) increased wear and tear on existing equipment caused by Tenant's excess consumption. Landlord may install devices to separately meter any increased use. Within thirty (30) days after billing by Landlord, Tenant shall pay the increased cost directly to Landlord, including the cost of the additional metering devices. Tenant's use of electricity shall never exceed the capacity of the feeders serving the Building and Premises or the risers or wiring installation. Landlord and Tenant agree that Tenant's use shall not be considered to exceed such capacity as long as Tenant's use of lighting fixtures and incidental use equipment in the Premises does not exceed 20 watts of connected load per rentable square foot of the Premises to the applicable bus riser. If Tenant wishes to use heat, ventilation, or air-conditioning during hours other than those for which Landlord is obligated to supply such utilities under Section 9.1, Tenant shall give Landlord reasonable prior notice of Tenant's desired use, and Landlord shall supply such utilities to Tenant at an hourly cost to Tenant as shall be calculated to reimburse Landlord for Landlord's actual cost of supplying such utilities, without profit or overhead but including the cost of increased wear and tear on existing equipment caused by such non- Building-Hour use. Amounts payable by Tenant to Landlord under this Section 9.2 for use of additional utilities and services shall be considered Additional Rent under this Lease and shall be billed on a monthly basis. 9.3 Interruption of Utilities. Except as provided in Section 21.7.2, Tenant agrees that Landlord shall not be liable for damages, by abatement of Rent or otherwise, for failure to furnish or delay in furnishing any service (including telephone and telecommunication services) or for diminution in the quality or quantity of any service when the failure, delay, or diminution is entirely or partially caused by: (a) Repairs, replacements, or improvements; (b) strike, lockout, or other labor trouble; (c) inability to secure electricity, gas, water, or other fuel at the Building after reasonable effort to do so; (d) accident or casualty; (e) act or Default of Tenant or other parties; or (f) any other cause beyond Landlord's reasonable control. -12- 14 Such failure, delay, or diminution shall not be considered to constitute an eviction or a disturbance of Tenant's use and possession of the Premises or relieve Tenant from paying Rent or performing any of its obligations under this Lease, subject to Section 21.7.2. Landlord shall not be liable under any circumstances for a loss of or injury to property or for injury to or interference with Tenant's business, including loss of profits through, in connection with, or incidental to a failure to furnish any of the utilities or services under this Article 9. Landlord may comply with mandatory or voluntary controls or guidelines promulgated by any government entity relating to the use or conservation of energy, water, gas, light, or electricity or the reduction of automobile or other emissions without creating any liability of Landlord to Tenant under this Lease, subject to Section 21.7.2, as long as compliance with voluntary controls or guidelines does not materially and unreasonably interfere with Tenant's use of the Premises. Article 10 REPAIRS AND MAINTENANCE 10.1 Tenant's Repair and Maintenance Obligations. Subject to Articles 14 and 15, and except as provided in Section 10.2, Tenant shall, at Tenant's sole expense and in accordance with the terms of this Lease (including Article 11), repair and maintain in good order and condition (reasonable wear and tear excepted) the interior of the entire Premises, including without limitation all heating, ventilation, air conditioning, plumbing, electricity, life safety, rest rooms, lavatories, and other Building systems located within the Premises. Despite the foregoing, if Landlord is responsible for construction of the improvements under the Leasehold Improvement Agreement, Tenant shall not be responsible for the repair of any latent defects in such improvements that Landlord was required to construct to the extent that such defects existed as of the Lease Commencement Date and were of such a nature that Tenant could not normally discover them in the exercise of reasonable diligence in Tenant's inspection of the Premises on or before the Lease Commencement Date and are reported to Landlord within one (1) year after the Commencement Date. Any repair and maintenance work affecting the Building systems shall be performed only by the contractor used by Landlord in the Real Property for such work, unless that contractor is unwilling or unable to perform the work, in which event Tenant may use the services of another qualified contractor reasonably approved by Landlord. Landlord may, but need not, make such repairs and maintenance if: (a) Tenant fails to perform any repair and maintenance obligation within thirty (30) days after written notice by Landlord to Tenant of the need for such repairs and maintenance; or (b) Tenant fails to commence any repair and maintenance obligation for which the reasonable completion period exceeds thirty (30) days, and to diligently prosecute this obligation to completion. Within thirty (30) days after a written demand from Landlord (including a reasonably particularized statement), Tenant shall pay Landlord Landlord's reasonable, actual, out-of-pocket costs incurred in connection with the repairs and maintenance plus interest at the Lease Rate from the date these costs are incurred until the date of Tenant's repayment. Despite any other provision of this Section 10.1, in the event of an emergency Landlord shall have the right to perform any Tenant repair and maintenance obligation that Tenant fails to perform promptly. Within thirty (30) days after written demand (including a reasonably particularized statement), Tenant shall pay Landlord Landlord's reasonable costs incurred in connection with the repair and maintenance obligation. 10.2 Landlord's Repair and Maintenance Obligations. Subject to Articles 14 and 15, Landlord shall, as part of the Operating Expenses (to the extent permitted by Article 4), repair and maintain in good order and condition (reasonable wear and tear excepted): (a) All portions of the Building that are outside the Premises, including the structural portions of the Premises, areas and building systems above the ceiling of the Premises and on the inside of each of the walls to the Premises, the roof and foundations, the life safety systems, and any maintenance of perimeter walls, including glazing of exterior windows; b) All other Common Areas located on the Real Property. Repairs shall be made promptly after written notice from Tenant or other actual notice to Landlord of the need for such repair to keep the applicable portion of the Premises, Building, Real Property, and other items in the condition described in this clause. Landlord shall not be in Default of its repair and maintenance obligations under this Section 10.2 if Landlord performs the repairs and maintenance within thirty (30) days after written notice by Tenant to Landlord of the need for such repairs and maintenance, except that in the event Tenant notifies Landlord that repairs are required on an emergency basis to prevent injury to persons, significant damage to property, or material interference with Tenant's operation of its business, then Landlord shall commence the repair as soon as is reasonably possible. If, due to the nature of the particular repair or maintenance obligation, more than thirty (30) days are reasonably required to complete it, Landlord shall not be in Default under this Section 10.2 if Landlord begins work within this thirty-day (30-day) period and diligently prosecutes this work to completion. Except as provided in Section 21.7.2, no abatement of rent and no liability of Landlord shall result for any injury to or interference with Tenant's business arising from the making of or failure to make any repairs, replacements, alterations, or improvements in or to any portion of the Premises, Building, Real Property, fixtures, appurtenances, or equipment. Tenant waives and releases its rights, including its right to make repairs at Landlord's expense, under California Civil Code Sections 1941-1942 or any similar law, statute, or ordinance now or hereafter in effect. Article 11 ALTERATIONS AND ADDITIONS 11.1 Landlord's Consent to Alterations. Tenant may not make any improvements, alterations, additions, or changes to the Premises ("Alterations") without obtaining Landlord's prior written consent. -13- 15 11.1.1. Consent Procedure. Tenant shall request such consent by written notice to Landlord, which must be accompanied by the plans and specifications for the proposed work. Landlord shall either give or withhold its consent within fifteen (15) days of the receipt by Landlord of Tenant's request for consent. 11.1.2. Reasonable Consent. Landlord shall not unreasonably withhold its consent to proposed Alterations. The Alterations for which Landlord may reasonably withhold consent include but are not limited to those that would or could: (a) Affect the structure of the Building; (b) affect the Building systems of the Building; (c) result in Landlord's being required under Laws and Orders to perform any work that Landlord could otherwise avoid or defer ("Additional Required Work"), unless Tenant agrees in writing to pay for the entire cost of the design and construction of the Additional Required Work; (d) result in a material increase in the demand for utilities or services that Landlord is required to provide, unless Tenant agrees to pay the additional cost; or (e) cause an increase in the premiums for hazard or liability insurance carried by Landlord, unless Tenant agrees to pay the amount of the increase in premiums. 11.1.3. Costs of Review. If it is reasonably necessary for Landlord to obtain the assistance of architects, engineers, or other consultants to evaluate the proposed Alterations, Tenant shall reimburse Landlord for amounts paid by Landlord for the reasonable fees and costs of those consultants in reviewing the proposed Alterations. 11.1.4. Minor Alterations. Despite any other provision of this Section 11.1 but subject to all other provisions of this Article 11, Tenant shall be permitted to make Alterations to the interior improvements of the Premises without Landlord's prior written consent but only if: (a) At least fifteen (15) days before construction is begun, Tenant gives Landlord written notice of the nature and extent of the intended Alterations, specifying the contractor that Tenant intends to use; (b) the proposed Alterations do not affect the exterior appearance or structure of the Building or the Building systems or otherwise require a building permit; (c) the proposed Alterations could not result in Landlord's being required to perform any Additional Required Work; (d) the proposed Alterations do not involve the installation of stairways, vaults, or other equipment or improvements that would cost more to remove than ordinary improvements for general office use; (e) the proposed Alterations do not involve or affect any asbestos or asbestos-containing materials in the Building; and (f) the particular Alteration, together with all other Alterations made within twelve (12) months of the particular Alteration, does not cost more than Twenty Thousand Dollars ($20,000) in the aggregate. 11.1.5. Removal of Alterations. When Tenant requests Landlord's consent to a proposed Alteration, or before the commencement of any Alteration for which Landlord's consent is not required, Tenant may ask Landlord in writing whether Landlord will require that the Alteration be removed on expiration or earlier termination of the Lease Term. Landlord shall respond to this inquiry in writing within fifteen (15) days. If Landlord states in its response that it will not require removal, Tenant shall not be required to remove this Alteration. 11.2 Compliance of Alterations With Laws and Insurance Requirements. Tenant shall cause all Alterations to comply with the following: (a) Applicable Laws and Orders; and (b) applicable requirements of a fire-rating bureau. Tenant shall also comply with those requirements in the course of constructing the Alterations. Before beginning construction of any Alteration, Tenant shall obtain a valid building permit and any other permits that may be required by any government entity having jurisdiction over the Premises. Tenant shall provide copies of those permits to Landlord before the work begins. Tenant shall, at Tenant's sole expense, perform any Additional Required Work which shall be subject to the same requirements as any Alteration. If any Additional Required Work must be performed outside the Premises, Landlord may elect to perform that work at Tenant's expense. 11.3 Manner of Construction. Tenant shall build Alterations entirely within the Premises and in conformance with Landlord's construction rules and regulations, using only contractors and subcontractors reasonably approved in writing by Landlord. All work relating to any Alterations shall be done in a good and workmanlike manner, using new materials equivalent in quality to those used in the construction of the initial improvements to the Premises. All work shall be diligently prosecuted to completion. Tenant shall ensure that all work is performed in a manner that does not obstruct access to or through the Real Property or its Common Areas and that does not interfere either with other tenants' use of their premises or with any other work being undertaken or the Real Property. Tenant shall take all measures necessary to ensure that labor peace is maintained at all times. Within twenty (20) days after completion of any Alterations, Tenant shall deliver to Landlord a reproducible copy of the drawings of Alterations as built. 11.4 Payment for Improvements. Tenant shall promptly pay all charges and costs incurred in connection with any Alteration, as and when required by the terms of any agreements with contractors, designers, or suppliers. At least seven (7) days before beginning construction of any Alteration, Tenant shall give Landlord written notice of the expected commencement date of that construction to permit Landlord to post and record a notice of nonresponsibility. On completion of any Alteration, Tenant shall: -14- 16 (a) Cause a timely notice of completion to be recorded in the office of the recorder of the county in which the Building is located, in accordance with Civil Code Section 3093 or any successor statute; (b) Deliver to Landlord evidence of full payment and final unconditional waivers of all liens for labor, services, or materials; and (c) Reimburse Landlord for any actual expenses paid to third parties or for additional expenses reasonably incurred by Landlord in connection with the construction of any Alteration (in addition to the expenses described in Section 11.1.3). 11.5 Construction Insurance. Before construction begins, Tenant shall deliver to Landlord reasonable evidence that damage to, or destruction of, the Alterations during construction will be covered either by the policies that Tenant is required to carry under Article 13 or by a policy of builder's all-risk insurance in an amount approved by Landlord. If Landlord requires Tenant to provide builder's all-risk insurance for the proposed Alterations, Tenant shall provide a copy of the policy, any endorsements, and an original certificate of insurance that complies with Section 13.9.3. Tenant shall cause each contractor and subcontractor to maintain all workers' compensation insurance required by law and liability insurance (including property damage) in amounts reasonably required by Landlord. Tenant shall provide evidence of that insurance to Landlord before construction begins. 11.6 Landlord's Property. By written notice to Tenant at least either sixty (60) days before expiration of the Lease Term or fifteen (15) days after any earlier termination of this Lease, Landlord may require Tenant, at Tenant's sole expense, to remove any Alterations specified by Landlord and restore the Premises to their configuration and condition before the Alterations were made (unless Landlord previously notified Tenant that such removal would not be required, under Section 11.1.5). If Tenant fails to complete that restoration before expiration of the Lease Term or, in the case of earlier termination, within fifteen (15) days after written notice from Landlord requesting the restoration, Landlord may do so and charge the cost of the restoration to Tenant. 11.7 Initial Improvements. The construction of the initial improvements to the Premises shall be governed by the terms of the Leasehold Improvement Agreement, attached to this Lease as Exhibit B, and not the terms of this Article 11. Article 12 COVENANT AGAINST LIENS Tenant shall not be the cause of any liens or allow such liens to exist, attach to, be placed on, or encumber Landlord's or Tenant's interest in the Premises, Building, or Real Property by operation of law or otherwise. Tenant shall not suffer or permit any lien of mechanics, material suppliers, or others to be placed against the Premises, Building, or Real Property with respect to work or services performed or claimed to have been performed for Tenant or materials furnished or claimed to have been furnished to Tenant or to the Premises on behalf of or for the benefit of Tenant. Landlord has the right at all times to post and keep posted on the Premises any notice that it considers necessary for protection from such liens. If any such lien attaches or Tenant receives notice of any such lien, Tenant shall cause the lien to be released and removed of record within ten (10) days after Landlord's demand. Despite any other provision of this Lease, if the lien is not released and removed within ten (10) days after Landlord delivers notice of the lien to Tenant, Landlord may immediately take all action necessary to release and remove the lien, without any duty to investigate the validity of it. All expenses (including reasonable attorney fees) incurred by Landlord in connection with release of the lien shall be considered Additional Rent under this Lease and be immediately due and payable by Tenant. Article 13 EXCULPATION, INDEMNIFICATION, AND INSURANCE 13.1 Definition of "Tenant Parties" and "Landlord Parties." For purposes of this Article 13, the term "Tenant Parties" refers singularly and collectively to Tenant and Tenant's officers, directors, shareholders, partners, trustees, members, agents, employees, and independent contractors as well as to all persons and entities claiming through any of these persons or entities. The term "Landlord Parties" refers singularly and collectively to Landlord and Landlord's officers, directors, shareholders, partners, trustees, members, agents, employees, and independent contractors as well as to all persons and entities claiming through any of these persons or entities. 13.2 Exculpation. 13.2.1. Exculpation. To the fullest extent permitted by law, Tenant, on its behalf and on behalf of all Tenant Parties, waives all claims (in law, equity, or otherwise) against Landlord Parties arising out of, knowingly and voluntarily assumes the risk of, and agrees that Landlord Parties shall not be liable to Tenant Parties for any of the following to the extent the same occur on or about the Premises: (a) The injury or death of any person; or (b) The loss of, injury or damage to, or destruction of any tangible or intangible property, including the resulting loss of use, economic losses, and consequential or resulting damage of any kind from any cause. -15- 17 This exculpation clause shall not apply to claims against Landlord Parties to the extent that a final judgment of a court of competent jurisdiction establishes that the injury, loss, damage, or destruction was proximately caused by Landlord Parties' negligence, fraud, willful injury to person or property, or violation of law. 13.3 Indemnification. 13.3.1. Tenant's Indemnification of Landlord Parties. To the fullest extent permitted by law but subject to this Section 13.3, Tenant shall, at Tenant's sole expense and with counsel reasonably acceptable to Landlord, indemnify, defend, and hold harmless Landlord Parties from and against all Claims, as defined in Section 13.3.2, from any cause arising out of or relating (directly or indirectly) to this Lease, the tenancy created under this Lease, or the Premises, including: (a) The use or occupancy, or manner of use or occupancy, of the Premises or Real Property by Tenant Parties; (b) Any act, error, omission, or negligence of Tenant Parties in, on, or about the Real Property; (c) Tenant's conducting of its business; (d) Any alterations, activities, work, or things done, omitted, or permitted by Tenant Parties in, at, or about the Premises or Real Property, including the violation of or failure to comply with any applicable laws, statutes, ordinances, standards, rules, regulations, orders, decrees, or judgments in existence on the Lease Commencement Date or enacted, promulgated, or issued after the date of this Lease, except to the extent that compliance with such legal requirements is expressly made the responsibility of Landlord in Article 7 or 10, and (e) Any breach or Default in performance of any obligation on Tenant's part to be performed under this Lease. 13.3.2. Definition of Claims. For purposes of this Lease, "Claims" means any and all claims, losses, costs, damage, expenses, liabilities, liens, actions, causes of action (whether in tort or contract, law or equity, or otherwise), charges, assessments, fines, and penalties of any kind (including consultant and expert expenses, court costs, and attorney fees actually incurred). 13.3.3. Type of Injury or Loss. This indemnification extends to and includes Claims for: (a) Injury to any persons (including death at any time resulting from that injury); (b) Loss of, injury or damage to, or destruction of tangible property (including all loss of use resulting from that loss, injury, damage, or destruction); and (c) Economic losses and consequential or resulting damage. 13.3.4. Indemnification; Consequential Damages. Despite any other provision of this Lease: (a) Tenant's indemnification in Section 13.3.1 shall not apply to any Claim caused by or arising out of the negligence of Landlord Parties or to the extent that a Claim against Landlord Parties actually arises out of the misconduct of Landlord Parties; and (b) Nothing in this Lease shall impose any obligation on Landlord to be responsible or liable for, and Tenant releases Landlord from all liability for, consequential damages suffered by Tenant. 13.3.5. Relationship of Indemnity to Other Lease Obligations. Tenant's agreement to indemnify Landlord under this Article 13 are not intended to and shall not: (a) Restrict, limit, or modify the parties' respective insurance and other obligations under this Lease, such indemnity covenants being independent of the parties' insurance and other obligations; (b) Be restricted, limited, or modified by compliance with their respective insurance requirements and other obligations under this Lease; (c) Relieve any insurance carrier of its obligations under policies required to be carried under this Lease, to the extent that such policies cover, or if carried would have covered, the matters subject to the parties' respective indemnification obligations; or (d) Supersede any inconsistent agreement of the parties set forth in any other provision of this Lease. 13.3.6. Attorney Fees. The prevailing party shall be entitled to recover its actual attorney fees and court costs incurred in enforcing the indemnification clauses set forth in this Section 13.3. 13.4 Compliance With Insurer Requirements. Tenant shall, at Tenant's sole expense, comply with all reasonable requirements, guidelines, rules, orders, and similar mandates and directives in effect on the Lease Commencement Date that (a) have been disclosed to Tenant by Landlord and (b) pertain to Tenant's business operations, conduct, or use of the Premises and the Building, whether imposed by Tenant's insurers, Landlord's insurers, or both. If Tenant's business operations, conduct, or use of the Premises, other than for normal office purposes, later cause any increase in the premium for any insurance policies carried -16- 18 by Landlord, Tenant shall, within ten (10) Business Days after receipt of written notice from Landlord, reimburse Landlord for the increase. Tenant shall, at Tenant's sole expense, comply with all rules, orders, regulations, or requirements of the American Insurance Association (formerly the National Board of Fire Underwriters) and of any similar body in effect during the term of this Lease and any renewal term that (a) have been disclosed to Tenant by Landlord and (b) pertain to Tenant's business operations, conduct, or use of the Premises or the Building. 13.5 Tenant's Liability Coverage. Tenant shall, at Tenant's sole expense, maintain the coverages set forth in this Section 13.5. 13.5.1. Commercial General Liability Insurance. Tenant shall obtain commercial general liability insurance written on an "occurrence" policy form, covering bodily injury, property damage, personal injury, and advertising injury arising out of or relating (directly or indirectly) to Tenant's business operations, conduct, assumed liabilities, or use or occupancy of the Premises or the Building. 13.5.2. Broad Form Coverage. Tenant's liability coverage shall include all the coverages typically provided by the Broad Form Comprehensive General Liability Endorsement, including broad form property damage coverage (which shall include coverage for completed operations). Tenant's liability coverage shall further include premises-operations coverage, owners and contractors protective (OCP) coverage (when reasonably required by Landlord), and the broadest available form of contractual liability coverage. It is the parties' intent that Tenant's contractual liability coverage provide coverage to the maximum extent possible of Tenant's indemnification obligations under this Lease. 13.5.3. Primary Insured. Tenant shall be the first or primary named insured. 13.5.4. Additional Insureds. Landlord and any lender of Landlord shall be named by endorsement as additional insureds under Tenant's general liability coverage. The additional insured endorsement must be on ISO Form CG 20 11 11 85 or an equivalent reasonably acceptable to Landlord. 13.5.5. Cross-Liability; Severability of Interests. Tenant's general liability policies shall be endorsed as needed to provide cross-liability coverage for Tenant, Landlord, and any lender of Landlord and to provide severability of interests. 13.5.6. Primary Insurance Endorsements for Additional Insureds. Tenant's general liability policies shall be endorsed as needed to provide that the insurance afforded by those policies to the additional insureds is primary and that all insurance carried by Landlord Parties is strictly excess and secondary and shall not contribute with Tenant's liability insurance. 13.5.7. Scope of Coverage for Additional Insureds. The coverage afforded to Landlord and any lender of Landlord must be at least as broad as that afforded to Tenant and may not contain any terms, conditions, exclusions, or limitations applicable to Landlord or any lender of Landlord that do not apply to Tenant. 13.5.8. Delivery of Certificate, Policy, and Endorsements. Before the Lease Commencement Date, Tenant shall deliver to Landlord the endorsements referred to in this Section 13.5 as well as a certified copy of Tenant's liability policy or policies and an original certificate of insurance, executed by an agent of the insurer or insurers, evidencing compliance with the liability insurance requirements. Tenant shall obtain a certificate that provides for no less than thirty (30) days' advance written notice to Landlord from the insurer or insurers of any cancellation, nonrenewal, or material change in coverage or available limits of liability and that shall confirm compliance with the liability insurance requirements in this Lease. 13.5.9. Concurrency of Primary, Excess, and Umbrella Policies. Tenant's liability insurance coverage may be provided by a combination of primary, excess, and umbrella policies, but those policies must be absolutely concurrent in all respects regarding the coverage afforded by the policies. The coverage of any excess or umbrella policy must be at least as broad as the coverage of the primary policy. 13.5.10. Liability Limits. The minimum acceptable limits of liability for Tenant's liability insurance are set forth in Summary Section 10. 13.5.11. "Per Location" Endorsement. Tenant shall, at Tenant's sole expense, procure a "per location" endorsement or equivalent reasonably acceptable to Landlord so that the general aggregate and other limits apply separately and specifically to the Premises. 13.5.12. Survival of Insurance Requirements. Tenant shall, at Tenant's sole expense, maintain in full force and effect the liability insurance coverages required under this Lease and shall maintain Landlord Parties and any lender specified by Landlord as additional insureds, as required by Section 13.5.4 of this lease, for a period of no less than two (2) years after expiration or earlier termination of this Lease. 13.6 Tenant's Workers' Compensation and Employer Liability Coverage. Tenant shall procure and maintain workers' compensation insurance as required by law. 13.7 Tenant's First Party Insurance. Tenant shall, at Tenant's sole expense, procure and maintain the first party insurance coverages described in this Section 13.7. 13.7.1. Property Insurance. Tenant shall procure and maintain property insurance coverage for all office furniture, trade fixtures, office equipment, merchandise, and all other items of Tenant's property in, on, at, or about the Premises and the Building, including property installed by, for, or at the expense of Tenant but excluding: -17- 19 (a) "Tenant Improvements," as defined in the Leasehold Improvement Agreement; and (b) Other improvements, betterments, alterations, and additions to the Premises that are insured by Landlord under this Lease. Tenant's property insurance shall fulfill the following requirements: (a) It must be written on the broadest available "all-risk" (special-causes-of-loss) policy form or an equivalent form acceptable to Landlord; (b) It must include an agreed-amount endorsement for no less than one hundred (100) percent of the full replacement cost (new without deduction for depreciation) of the covered items and property; and (c) The amounts of coverage must meet any coinsurance requirements of the policy or policies. It is the parties' intent that Tenant shall structure its property insurance program so that no coinsurance penalty shall be imposed and there shall be no valuation shortfalls or disputes with any insurer or with Landlord. Tenant's property insurance coverage shall include vandalism and malicious mischief coverage, sprinkler leakage coverage, and earthquake sprinkler leakage coverage. Landlord shall maintain full replacement cost property insurance coverage for the "Tenant Improvements," as defined in the Leasehold Improvement Agreement, and for all other improvements, betterments, alterations, and additions to the Premises approved in writing by Landlord. 13.7.2. Business Income and Extra Expense Coverage. Tenant shall further procure and maintain business income (business interruption) insurance and extra expense coverage with coverage amounts that shall reimburse Tenant for all direct or indirect loss of income and charges and costs incurred arising out of all perils insured against by Tenant's property insurance coverage, including prevention of, or denial of use of or access to, all or part of the Premises or the Building, as a result of those perils. The business income and extra expense coverage shall provide coverage for no less than twelve (12) months of the loss of income, charges, and costs contemplated under the Lease and shall be carried in amounts necessary to avoid any coinsurance penalty that could apply. The business income and extra expense coverage shall be issued by the insurer that issues Tenant's other first party coverage. 13.8 Other Insurance Coverage. Once every three (3) years during the Lease Term and on the commencement of any renewal term, Landlord shall have the right to engage insurance consultants to review the insurance coverages maintained by Tenant. If, in the opinion of those consultants, any aspect of Tenant's general liability, property, or other insurance program is inadequate to protect the interests of Landlord, as contemplated by this Article 13, Tenant shall, at its sole expense, comply promptly with the consultant's recommendations. Tenant, however, shall not be required to procure or maintain other or further coverages that are: (a) Beyond those typically maintained by similarly situated parties leasing reasonably similar amounts and types of space for use in comparable buildings in the same submarket; or (b) Not available at commercially reasonable rates. 13.9 Form of Policies and Additional Requirements. 13.9.1. Insurance Independent of Exculpation and Indemnification. Tenant's insurance obligations set forth in Sections 13.4- 13.10 are independent of Tenant's exculpation, indemnification, and other obligations under this Lease and shall not be construed or interpreted in any way to restrict, limit, or modify Tenant's exculpation, indemnification, or other obligations or to limit Tenant's liability under this Lease. 13.9.2. Form of Policies. In addition to the requirements set forth in Section 13.5.8, the insurance required of Tenant under this Article 13 must: (a) Name Landlord and any other party Landlord specifies by endorsement as an additional insured; (b) Be issued by an insurance company with a rating of no less than A-X in the current Best's Insurance Guide, or that is otherwise acceptable to Landlord, and admitted to engage in the business of insurance in the State of California; (c) Be primary insurance for all claims under it and provide that any insurance carried by Landlord Parties and Landlord lenders is strictly excess, secondary, and noncontributing with any insurance carried by Tenant; and (d) Provide that insurance may not be canceled, nonrenewed, or the subject of material change in coverage or available limits of coverage, except on thirty (30) days' prior written notice to Landlord and Landlord's lenders. 13.9.3. Tenant's Delivery of Policy, Endorsements, and Certificates. Tenant shall deliver the policy or policies, along with any endorsements to them and certificates required by this Article 13, to Landlord: (a) On or before the Lease Commencement Date; -18- 20 (b) At least thirty (30) days before the expiration date of any policy; and (c) On renewal of any policy. 13.9.4. Blanket Insurance. Tenant shall be permitted to provide the insurance required under this Lease by obtaining a blanket policy or policies to be maintained by Tenant. The coverages afforded to Landlord and Landlord's lenders under this Lease shall in no way be limited, diminished, or reduced under such blanket policy or policies. 13.10 Waiver of Subrogation. Landlord and Tenant agree to cause the insurance companies issuing their respective property (first party) insurance to waive any subrogation rights that those companies may have against Tenant or Landlord, respectively, as long as the insurance is not invalidated by the waiver. If the waivers of subrogation are contained in their respective insurance policies, Landlord and Tenant waive any right that either may have against the other on account of any loss or damage to their respective property to the extent that the loss or damage is insured under their respective insurance policies. 13.11 Disclosures Regarding Real Property. The Real Property and the Premises are located in a special studies zone as designated under the Alquist-Priolo Special Studies Zone Act (California Public Resources Code Sections 2621-2630) and is located within a special Flood Hazard Area as set forth on a Federal Emergency Management Agency "Flood Insurance Rate Map" or "Flood Hazard Boundary Map" (12 CFR Section 339.6). Article 14 DAMAGE AND DESTRUCTION 14.1 Repair of Damage by Landlord. Tenant agrees to notify Landlord in writing promptly of any damage to the Premises resulting from fire, earthquake, or any other identifiable event of a sudden, unexpected, or unusual nature ("Casualty"). If the Premises are damaged by a Casualty, any Common Areas of the Real Property providing access to the Premises are damaged to the extent that Tenant does not have reasonable access to the Premises, and if neither Landlord nor Tenant has elected to terminate this Lease under this Article 14, Landlord shall promptly and diligently restore such Common Areas, and the Tenant Improvements originally constructed by Landlord, to substantially the same condition as existed before the Casualty, except for modifications required by building codes and other laws. 14.2 Repair Period Notice. Landlord shall, within thirty (30) days after the date of the Casualty, provide written notice to Tenant indicating the anticipated period for repairing the Casualty ("Repair Period Notice"). The Repair Period Notice shall be accompanied by a certified statement executed by the contractor retained by Landlord to complete the repairs or, if Landlord has not retained a contractor, a licensed contractor not affiliated with landlord, certifying the contractor's opinion about the anticipated period for repairing the Casualty. The Repair Period Notice shall also state, if applicable, Landlord's election either to repair or to terminate the Lease under Section 14.3. 14.3 Landlord's Option To Terminate or Repair. Landlord may elect either to terminate this Lease or to effectuate repairs if: (a) The Repair Period Notice estimates that the period for repairing the Casualty exceeds one-hundred and eighty (180) days from the date of the Casualty; (b) The estimated repair cost of the Premises or the Building, even though covered by insurance, exceeds fifty percent (50%) of the full replacement cost; or (c) Insurance proceeds actually received by Landlord are insufficient to pay for at least 95% of the total cost of restoration. Landlord's election shall be stated in the Repair Period Notice. Despite any other provision of this Article 14, Landlord may not elect to terminate this Lease under this Article unless Landlord elects also to terminate the Leases of all similarly situated Tenants, provided that Landlord has the right under each applicable lease to terminate based on the extent of the Casualty. 14.4 Tenant's Option To Terminate. If the Repair Period Notice provided by Landlord indicates that the anticipated period for repairing the Casualty exceeds two-hundred and seventy (270) days, Tenant may elect to terminate this Lease by providing written notice ("Tenant's Termination Notice") to Landlord within thirty (30) days after receiving the Repair Period Notice. If Tenant does not elect to terminate within this thirty-day (30-day) period, Tenant shall be considered to have waived the option to terminate. 14.5 Rent Abatement Due to Casualty. Landlord and Tenant agree that Tenant's Rent shall be fully abated during the period beginning on the later of (a) the date of the Casualty or (b) the date on which Tenant ceases to occupy the Premises and ending on the date of substantial completion of Landlord's restoration obligations as provided in this Article 14 ("Abatement Period"). If, however, Tenant is able to occupy or does occupy a portion of the Premises, Rent shall be abated during the Abatement Period only for the portion of the Premises not able to be occupied by Tenant. Subject to Section 14.4, the Rent abatement provided in this Section 14.5 is Tenant's sole remedy due to the occurrence of the Casualty. Landlord shall not be liable to Tenant or any other person or entity for any direct, indirect, or consequential damage (including lost profits of Tenant or loss of or interference with Tenant's business), whether or not caused by the negligence of Landlord or Landlord's employees, contractors, licensees, or invitees, due to, arising out of, or as a result of the Casualty (including but not limited to the termination of the Lease in connection with the Casualty). Tenant agrees to maintain business interruption insurance in amounts and with coverage no less than that required by Section 13.7.2 to provide coverage regarding such matters. 14.6 Damage Near End of Term. Despite any other provision of this Article 14, if the Premises is destroyed or damaged by a Casualty during the last twelve (12) months of the Lease Term, Landlord and Tenant shall each have the option to terminate -19- 21 this Lease by giving written notice to the other of the exercise of that option within thirty (30) days after that damage or destruction. If Tenant is not then in Default under this Lease, however, Tenant may negate Landlord's election to terminate under this Section 14.6 by electing, within ten (10) days after receipt of Landlord's termination notice, to exercise any unexercised option to extend this Lease. If Tenant negates Landlord's election, this Lease shall continue in effect unless Landlord has the right to, and elects to, terminate this Lease under Section 14.3. 14.7 Effective Date of Termination; Rent Apportionment. If Landlord or Tenant elects to terminate this Lease under this Article 14 in connection with a Casualty, this termination shall be effective thirty (30) days after delivery of notice of such election. Tenant shall pay Rent, properly apportioned up to the date of the Casualty. After the effective date of the termination, Landlord and Tenant shall be discharged of all future obligations under this Lease, except for those provisions that, by their terms, survive the expiration or earlier termination of the Lease. 14.8 Waiver of Statutory Provisions. The provisions of this Lease, including those in this Article 14, constitute an express agreement between Landlord and Tenant that applies in the event of any Casualty to the Premises, Building, or Real Property. Tenant, therefore, fully waives the provisions of any statute or regulation, including California Civil Code Sections 1932(2) and 1933(4), for any rights or obligations concerning a Casualty. Article 15 CONDEMNATION 15.1 Definition of "Condemnation." As used in this Lease, the term "Condemnation" means a permanent taking through (a) the exercise of any government power (by legal proceedings or otherwise) by any public or quasi-public authority or by any other party having the right of eminent domain ("Condemnor") or (b) a voluntary sale or transfer by Landlord to any Condemnor, either under threat of exercise of eminent domain by a Condemnor or while legal proceedings for condemnation are pending. 15.2 Effect on Rights and Obligations. If, during the Lease Term or the period between the date of execution of this Lease and the date on which the Lease Term begins, there is any Condemnation of all or part of the Premises, Building, or Real Property on which the Premises and Building are constructed, the rights and obligations of the parties shall be determined under this Article 15, and Rent shall not be affected or abated except as expressly provided in this Article. Landlord shall notify Tenant in writing of any Condemnation within thirty (30) days after the later of (a) the filing of a complaint by Condemnor or (b) the final agreement and determination by Landlord and Condemnor of the extent of the taking ("Condemnation Notice"). 15.3 Termination of Lease. 15.3.1. Definition of "Termination Date." The "Termination Date" shall be the earliest of: (a) The date on which Condemnor takes possession of the property that is subject to the Condemnation; (b) the date on which title to the property subject to the Condemnation is vested in Condemnor; (c) if Landlord has elected to terminate, the date on which Landlord requires possession of the property in connection with the Condemnation, as specified in written notice delivered to Tenant no less than thirty (30) days before that date; or (d) if Tenant has elected to terminate, thirty (30) days after Landlord's receipt of written notice of termination from Tenant. If both Landlord and Tenant have elected to terminate under this Article 15, the Termination Date shall be the earliest of the dates described in Sections (a)-(c). 15.3.2. Automatic Termination. If the Premises are totally taken by Condemnation, this Lease shall terminate as of the Termination Date, and the Award shall be allocated between Landlord and Tenant in accordance with Section 15.5. 15.3.3. Landlord's Right To Terminate. Landlord shall have the option to terminate this Lease if: (a) Ten percent (10%) or more of the Rentable Square Feet of the Building; (b) any portion of the Building or Real Property reasonably necessary for Landlord to operate the Building is taken through Condemnation, and Landlord also terminates the leases of all other similarly situated tenants (as reasonably determined by Landlord) in the Building; or (c) any other areas providing access to the Real Property are taken through Condemnation, and Landlord also terminates the leases of all other similarly situated tenants (as reasonably determined by Landlord) in the Building. 15.3.4. Tenant's Right To Terminate. Tenant shall have the option to terminate this Lease by providing thirty (30) days' written notice to Landlord if one or more of the following are taken through Condemnation: (a) Thirty percent (30%) or more of the Rentable square feet of the Premises; or (b) any portion of the common area that provides Tenant with its primary access to the Premises and that, if taken, would materially impair Tenant's access to and business activities on the Premises during normal Business Hours. Tenant's notice must be given within thirty (30) days after Tenant's receipt of the Condemnation Notice required by Section 15.2. 15.3.5. Tenant's Waiver. Tenant agrees that its rights to terminate this Lease due to partial Condemnation are governed by this Article 15. Tenant waives all rights it may have under California Code of Civil Procedure Section 1265.130, or otherwise, to terminate this Lease based on a partial Condemnation. 15.3.6. Proration of Rent. If this Lease is terminated under this Article 15, the termination shall be effective on the Termination Date, and Landlord shall prorate Rent to that date. Tenant shall be obligated to pay Rent for the period up -20- 22 to, but not including, the Termination Date as prorated by Landlord. Landlord shall return to Tenant prepaid Rent allocable to any period on or after the Termination Date. 15.4 Effect of Condemnation if Lease Is Not Terminated. If any part of the Premises is taken by Condemnation and this Lease is not terminated: (a) Rent shall be proportionately reduced based on the rentable square footage of the Premises taken; (b) Landlord shall, at Landlord's sole expense, accomplish all necessary restoration to the Premises and the Building resulting from the Condemnation; and (c) Rent shall be abated for the portion of the remaining Premises not usable by Tenant until Landlord completes the restoration. 15.5 Allocation of Award. 15.5.1. Landlord's Right to Award. Except as provided in Section 15.5.2 in connection with a Condemnation: (a) Landlord shall be entitled to receive all compensation and anything of value awarded, paid, or received in settlement or otherwise ("Award"); and (b) Tenant irrevocably assigns and transfers to Landlord all rights to and interests in the Award and fully releases and relinquishes any claim to, right to make a claim on, or interest in the Award. 15.5.2. Tenant's Right to Compensation. Despite Section 15.5.1, Tenant shall have the right to make a separate claim in the Condemnation proceeding for: (1) the taking of the unamortized or undepreciated value of any Alteration owned and paid for by Tenant that Tenant has the right to remove at the end of the Lease Term and that Tenant elects not to remove; (2) reasonable removal and relocation costs for any leasehold improvements that Tenant has the right to remove and elects to remove (if Condemnor approves of the removal); (3) relocation costs under Government Code Section 7262, the claim for which Tenant may pursue by separate action independent of this Lease; and (4) the loss of good will. 15.6 Temporary Taking. If a temporary taking of part of the Premises occurs through (a) the exercise of any government power (by legal proceedings or otherwise) by Condemnor or (b) a voluntary sale or transfer by Landlord to any Condemnor, either under threat of exercise of eminent domain by a Condemnor or while legal proceedings for condemnation are pending, Rent shall abate during the time of such taking in proportion to the portion of the Premises taken. The entire Award relating to the temporary taking shall be and remain the property of Landlord. Tenant irrevocably assigns and transfers to Landlord all rights to and interest in the Award and fully releases and relinquishes any claim to, right to make a claim on, and any other interest in the Award. Article 16 ASSIGNMENT AND SUBLEASING 16.1 Restricted Transfers. 16.1.1. Consent Required; Definition of "Transfer." Except as otherwise provided in this Article 16, Tenant shall obtain Landlord's written consent before entering into or permitting any Transfer. A "Transfer" consists of any of the following, whether voluntary or involuntary, and whether effected by death, operation of law, or otherwise: (a) Any assignment, mortgage, pledge, encumbrance, or other transfer of any interest in this Lease; (b) any sublease or occupancy of any portion of the Premises by any persons other than Tenant and its employees, invitees, guests, and agents; and (c) any of the changes (e.g., a change of ownership or reorganization) included in the definition of Transfer in Section 16.6. Any person to whom any Transfer is made or sought to be made is a "Transferee." 16.1.2. Landlord's Remedies. If a Transfer fails to comply with this Article 16, Landlord may, at its option, do either or both of the following: (a) void the Transfer or (b) declare Tenant in Default under Section 21.1. If Landlord declares Tenant in Default under Section 21.1, Tenant has thirty (30) days in which to cure the Default after receiving written notice of the Default from Landlord notwithstanding any contrary cure period specified in Section 21.1. 16.2 Transfer Procedure. 16.2.1. Transfer Notice. Before entering into or permitting any Transfer, Tenant shall provide in writing to Landlord a "Transfer Notice" at least thirty (30) days before the proposed effective date of the Transfer. The Transfer Notice shall include all of the following: (a) Information regarding the proposed Transferee, including the name, address, and ownership of Transferee; the nature of Transferee's business; and, if the Transferee will be an assignee of this Lease or a subtenant current financial statements of Transferee (certified by an officer, a partner, or an owner of Transferee); and (b) All the material terms of the proposed Transfer, including the consideration payable by Transferee, the portion of the Premises to be transferred ("Subject Space"), a general description of any planned alterations or improvements to the Subject Space that Tenant knows of, the proposed use of the Subject Space, the effective date of the Transfer, and a copy of all documentation concerning the proposed Transfer to the extent then available (with updates as soon as they are available). -21- 23 Within ten (10) Business Days of receipt of the Transfer Notice, Landlord shall notify Tenant in writing if the Transfer Notice is complete. If it is not, Landlord shall inform Tenant what additional information is required to make the Transfer Notice complete. Within three (3) Business Days of receipt of any additional information Landlord requests from time to time, Landlord shall notify Tenant in writing if the Transfer Notice is complete. If Landlord fails to respond within the required time, the Transfer Notice shall be considered complete. Although Landlord may condition its consent to a Transfer on Landlord's reasonable approval of the final Transfer documentation, Landlord may not require such final documentation for completion of the Transfer Notice. 16.2.2. Transfer Fee. Within thirty (30) days after Landlord's written request, Tenant shall pay as Additional Rent any reasonable legal fees that Landlord incurs in reviewing and processing the Transfer Notice ("Transfer Fee") as long as Tenant shall not be required to pay more than $1,500 as a Transfer Fee in connection with any one Transfer; 16.2.3. Limits of Consent. If Landlord consents to any Transfer, the following limits apply: (a) Landlord does not agree to waive or modify the terms and conditions of this Lease. (b) Landlord does not consent to any further Transfer by either Tenant or Transferee. (c) Tenant remains liable under this Lease, and any guarantor of the Lease remains liable under the guaranty. (d) Tenant may enter into that Transfer in accordance with this Article 16 if: (1) The Transfer occurs within six (6) months after Landlord's consent; (2) the Transfer is on substantially the same terms as specified in the Transfer Notice; and (3) Tenant delivers to Landlord, promptly after execution, an original, executed copy of all documentation pertaining to the Transfer in a form reasonably acceptable to Landlord (including Transferee's agreement to be subject and subordinate to the Lease and to assume Tenant's obligations under the Lease that arise after the date of the Transfer to the extent that they apply to the Subject Space). Landlord shall respond promptly after Tenant requests that Landlord approve the form of the Transfer documentation. (e) If the Transfer occurs after six (6) months or the terms of the Transfer have materially changed from those in the Transfer Notice, Tenant shall submit a new Transfer Notice under Section 16.2.1, requesting Landlord's consent. A material change is one the terms of which would have entitled Landlord to refuse to consent to the Transfer initially. A change to the economic terms of the Transfer that makes it more favorable to Transferee shall not, however, be considered a material change. 16.3 Landlord's Consent. Landlord may not unreasonably withhold its consent to any proposed Transfer that complies with this Article 16. 16.3.1. Reasonable Grounds For Denying Consent. Reasonable grounds for denying consent include but are not limited to the following: (a) Transferee's character, reputation, business, or use is not consistent with the character or quality of the Building or the uses of other tenants in the Building; or (b) Transferee's financial condition is inadequate to support the Lease obligations of Transferee under the Transfer documents, after taking into account Tenant's continued financial liability under the Lease. 16.3.2. Unreasonable Grounds For Denying Consent. Notwithstanding anything to the contrary in Section 16.3.1, Transferree's financial condition shall not be a reasonable ground for denying consent if the requested Transfer is as a result of a sale of Tenant or its parent company, National Insurance Group, and the proposed Transferee is the purchasing entity; and either (a) if the proposed transfer will take place during the period covered by the Guaranty in Section 30.22, the Transferee has a net worth equal to that of Tenant at the time of execution of this Lease and an entity with a net worth equal to or greater than that of National Insurance Group at the time of execution of this Lease guarantees the Transferee's obligations and performance under the Lease in a form substantially similar to Exhibit F; or (b) if the proposed Transfer will take place after the period covered by the Guaranty in Section 30.22, the Transferee has a net worth of equal or greater value to that of Tenant at the time of execution of this Lease. For purposes of this Section 16.3.2, "net worth" shall be calculated according to Generally Accepted Accounting Principles. 16.3.3. Landlord's Written Response. Within ten (10) days after receiving the completed Transfer Notice, Landlord shall approve or disapprove the proposed Transfer in writing. 16.4 Transfer Premium. 16.4.1. Transfer Premium Payment. As a reasonable condition to Landlord's consent to any Transfer, Tenant shall pay to Landlord fifty percent (50%) of any Transfer Premium, as defined in Section 16.4.2. 16.4.2. Definition of "Transfer Premium." "Transfer Premium" means all Rent and other consideration actually received by Tenant from Transferee (including key money and bonus money and any payment in excess of fair market value for services rendered by Tenant to Transferee or assets, fixtures, inventory, equipment, or furniture transferred by Tenant to Transferee in connection with the Transfer ("Transferee Rent")), after deducting: (a) The Rent payable by Tenant under this Lease (excluding the Transfer Premium) for the Subject Space ("Tenant Rent"); (b) reasonable leasing commissions paid by Tenant; (c) other reasonable out-of-pocket costs paid by Tenant (including attorney fees, advertising costs, and expenses of readying the Subject Space for occupancy by Transferee); (d) any consideration paid by Tenant to Transferee or any third party to induce Transferee to consummate the Transfer; and (e) any losses Tenant has sustained due to the Subject Space being vacate for a period of time before the transfer. -22- 24 16.4.3. Monthly Payment of Transfer Premium; Calculation. Tenant shall pay the Transfer Premium on a monthly basis, together with its payment of Additional Rent under Article 4. In calculating the Transfer Premium, Tenant shall first deduct all the Transfer Costs from any Transferee Rent received, provided that Transfer Costs referenced in clauses (b), (c) and (d) above shall be amortized over the term of the Transfer. 16.4.4. Audit of Transfer Premium. Tenant shall allow Landlord to review and audit Tenant's books and records for the purpose of verifying Tenant's calculation of the Transfer Premium. 16.5 Effect of Transfer. 16.5.1. Right To Collect Rent. If this Lease is assigned, Landlord may collect Rent directly from Transferee. If all or part of the Premises is subleased and Tenant defaults, Landlord may collect Rent directly from Transferee. Landlord may then apply the amount collected from Transferee to Tenant's monetary obligations under this Lease. Collecting Rent from a Transferee or applying that Rent to Tenant's monetary obligations does not waive any provisions of this Article 16. 16.6 Transfers of Ownership Interests and Other Organizational Changes. 16.6.1. Change of Ownership; Reorganization. For purposes of this Article 16, "Transfer" also includes: (a) If Tenant is a partnership or limited liability company, the transfer, within a twelve-month (12-month) period, of fifty percent (50%) or more of the partnership or membership interests; or the dissolution of the partnership or limited liability company without its immediate reconstitution. (b) For so long as Tenant is a closely held corporation (i.e., one whose stock is not publicly held and not traded through an exchange or over the counter), the sale or other transfer, within a twelve-month (12-month) period, of more than an aggregate of fifty percent (50%) of the voting shares of Tenant (other than to immediate family members by reason of gift or death) or the dissolution, merger, consolidation, or other reorganization of Tenant. Notwithstanding anything to the contrary in this Section 16.6.1, if Tenant is a closely held corporation, it shall not be a Transfer if Tenant's stock becomes publicly held and traded. 16.6.2. Permitted Transfers. Despite any other provision of this Lease, Landlord's consent is not required for any Transfer to an Affiliate, as defined in Section 16.6.3, as long as the following conditions are met: (a) Landlord receives written notice of the Transfer (as well as any documents or information reasonably requested by Landlord regarding the Transfer or Transferee); and (b) Transferee assumes in writing all of Tenant's obligations under this Lease subject to the Transfer. 16.6.3. Definition of "Affiliate." An "Affiliate" means any entity that: (a) controls, is controlled by, or is under common control with Tenant; (b) is the transferee of all or substantially all of Tenant's assets or stock; or (c)results from the merger or consolidation of Tenant with another entity . "Control" means the direct or indirect ownership of more than fifty percent (50%) of the voting securities of an entity or possession of the right to vote more than fifty percent (50%) of the voting interest in the ordinary direction of the entity's affairs. Article 17 SURRENDER OF PREMISES 17.1 Surrender of Premises. No act of either party or its authorized representatives shall constitute acceptance of a surrender of the Premises unless that intent is specifically acknowledged in a writing signed by both parties. At the option of Landlord, a surrender and termination of this Lease shall operate as an assignment to Landlord of all subleases or subtenancies. Landlord shall exercise this option by giving notice of that assignment to all subtenants within ten (10) days after the effective date of the surrender and termination. 17.2 Removal of Tenant Property by Tenant. Upon expiration or termination of the Lease Term, Tenant shall quit the Premises and surrender possession to Landlord in accordance with this Section 17.2. Tenant shall leave the Premises in as good order and condition as when Tenant took possession of the Premises and as thereafter improved by Landlord or Tenant, except for reasonable wear and tear, obsolescence, and repairs that are specifically made the responsibility of Landlord and except as provided in Article 15. Tenant shall, without expense to Landlord, remove or cause to be removed from the Premises: (a) All debris and rubbish; (b) any items of furniture, equipment, freestanding cabinet work, and other articles of personal property owned by Tenant or installed or placed by Tenant at its expense in the Premises; and (c) any similar articles of any other persons claiming under Tenant that Landlord requires to be removed. Tenant shall, at Tenant's sole option and expense, also remove from the Premises all fixtures and trade fixtures installed on the Premises by Tenant at its expense. Tenant shall, at Tenant's expense, repair all damage to the Premises and the Building resulting from that removal. -23- 25 Article 18 HOLDING OVER 18.1 Holdover Rent. If Tenant remains in possession of the Premises after expiration or earlier termination of this Lease without Landlord's consent, Tenant's continued possession shall be on the basis of a tenancy at sufferance and Tenant shall pay as rent during the first sixty (60) days of the holdover period an amount equal to one-hundred and twenty-five percent (125%) of the Base Rent and Additional Rent payable under this Lease for the last full month before the date of expiration or termination. For any holdover period in excess of sixty (60) days, Tenant shall pay an amount equal to one-hundred and fifty percent (150%) of the Base Rent and Additional Rent payable under this Lease for the last full month before the date of expiration or termination. Article 19 ESTOPPEL CERTIFICATES 19.1 Obligation To Provide Estoppel Certificates. Within ten (10) Business Days after receipt of a written request by Landlord, Tenant shall execute and deliver to Landlord an estoppel certificate. The certificate shall contain any information reasonably requested by and/or party or by any existing or prospective lender, mortgagee, or purchaser. 19.2 Failure To Deliver. The failure of Tenant to execute or deliver an estoppel certificate in the required time period shall constitute an acknowledgment by Tenant that the statements requested in the estoppel certificate are true and correct, without exception. The failure by Tenant to execute or deliver an estoppel certificate or other document or instrument as required in this Article 19, for ten (10) Business Days after notice of such failure from the party requesting the certificate, document, or instrument, shall constitute a material breach of this Lease. Article 20 SUBORDINATION, NONDISTURBANCE, AND ATTORNMENT 20.1 Automatic Subordination; Nondisturbance Agreement To Include Specified Terms. This Lease is subject and subordinate to: (a) the lien of any mortgages, deeds of trust, or other encumbrances ("Encumbrances") of the Real Property; (b) all present and future ground or underlying leases ("Underlying Leases") of the Real Property now or hereafter in force against the Real Property; (c) all renewals, extensions, modifications, consolidations, and replacements of the items described in Sections (a)-(b); and (d) all advances made or hereafter to be made on the security of the Encumbrances. Despite any other provision of this Article 20, any Encumbrance holder or lessor may elect that this Lease shall be senior to and have priority over that Encumbrance or Underlying Lease whether this Lease is dated before or after the date of the Encumbrance or Underlying Lease. No such subordination shall be effective unless and until Landlord obtains from the holder of the Encumbrance placed against the premises a commercially-reasonable nondisturbance agreement in recordable form, providing that in the event of any foreclosure, sale under a power of sale, ground or master lease termination, or transfer in lieu of any of the foregoing, or the exercise of any other remedy under any such Encumbrance, Tenant's use, possession, and enjoyment of the Premises shall not be disturbed and this Lease shall continue in full force and effect as long as Tenant is not in Default. 20.2 Subordination Agreement. If Tenant has received the nondisturbance agreement referred to in Section 20.1, Tenant shall, within ten (10) Business Days after Landlord's request, execute any further instruments or assurances in recordable form that Landlord reasonably considers necessary to evidence or confirm the subordination or superiority of this Lease to any such Encumbrances or Underlying Leases. Tenant's failure to execute and deliver such instrument(s) shall constitute a Default under this Lease only if Landlord has first delivered the nondisturbance agreement to Tenant. 20.3 Attornment. Tenant covenants and agrees to attorn to the transferee of Landlord's interest in the Real Property by foreclosure, deed in lieu of foreclosure, exercise of any remedy provided in any Encumbrance or Underlying Lease, or operation of law (without any deductions or setoffs) except as expressly provided in this Lease or in any nondisturbance agreement, if requested to do so by the transferee, and to recognize the transferee as the lessor under this Lease. The transferee shall not be liable for: (a) Any acts, omissions, or Defaults of Landlord that occurred before the sale or conveyance; or (b) The return of any security deposit except for deposits actually paid to the transferee and except as expressly provided in this Lease or in any nondisturbance agreement. 20.4 Notice of Default; Right To Cure. Tenant agrees to give written notice of any default by Landlord to the holder of any prior Encumbrance or Underlying Lease. Tenant agrees that, before it exercises any rights or remedies under the Lease, the lienholder or lessor shall have the right, but not the obligation, to cure the default (either by itself or by a receiver for the Real Property) within the same time, if any, given to Landlord to cure the default, plus an additional thirty (30) days, except that (i) only ten (10) days shall be permitted in the case of a default in the payment of money from Landlord to Tenant; and (ii) in the event of an emergency, the lienholder or lessor shall be required to commence a cure as soon as is reasonably possible, and in the event the lender or lienholder fails to do so, Tenant shall have the right to cure to avoid the risk of in jury to persons, significant damage to property, or material interference with Tenant's operation of its business. Tenant agrees that this cure period shall be extended by the time necessary for the lienholder to begin foreclosure proceedings and to obtain possession of the Building or Real Property, as applicable, as long as the lienholder: (a) Notifies Tenant, within twenty (20) days after receipt of Tenant's notice, of the lienholder's intention to effect this remedy; and (b) Institutes immediate steps to effect this remedy or institutes immediate legal proceedings to appoint a receiver for the Real Property or to foreclose on or recover possession of the Real Property within the thirty-day (30-day) or -24- 26 ten-day (10-day) period and thereafter prosecutes the remedy or legal proceedings to completion with due diligence and continuity. Article 21 DEFAULTS AND REMEDIES 21.1 Tenant's Default. The occurrence of any of the following shall constitute a Default by Tenant under this Lease ("Default"): (a) Tenant's failure to pay when due any Rent required to be paid under this Lease if the failure continues for five (5) Business Days after written notice of the failure from Landlord to Tenant; (b) Tenant's failure to provide any instrument or assurance as required by Section 20.2 or estoppel certificate as required by Section 19.1 if the failure continues for five (5) Business Days after written notice of the failure from Landlord to Tenant; or (c) Tenant's failure to perform any other obligation under this Lease if the failure continues for thirty (30) days after written notice of the failure from Landlord to Tenant. If the required cure of the noticed Default cannot be completed within thirty (30) days, Tenant's failure to perform shall constitute a Default under the Lease unless Tenant undertakes to cure the failure within thirty (30) days and diligently and continuously attempts to complete the cure as soon as reasonably possible. 21.2 Replacement of Statutory Notice Requirements. When this Lease requires service of a notice, that notice shall replace rather than supplement any equivalent or similar statutory notice, including any notices required by Code of Civil Procedure Section 1161 or any similar or successor statute. When a statute requires service of a notice in a particular manner, service of that notice (or a similar notice required by this Lease) in the manner required by Section 30.10 shall replace and satisfy the statutory service-of-notice procedures, including those required by Code of Civil Procedure Section 1162 or any similar or successor statute. 21.3 Landlord's Remedies on Tenant's Default. On the occurrence of a Default by Tenant, Landlord shall have the right to pursue any one or more of the following remedies in addition to any other remedies now or later available to Landlord at law or in equity. These remedies are not exclusive but cumulative. 21.3.1. Termination of Lease. Landlord may terminate this Lease and recover possession of the Premises. Once Landlord has terminated this Lease, Tenant shall immediately surrender the Premises to Landlord. On termination of this Lease, Landlord may recover from Tenant all of the following: (a) The worth at the time of the award of any unpaid Rent that had been earned at the time of the termination, to be computed by allowing interest at the rate set forth in Article 23 but in no case greater than the maximum amount of interest permitted by law; (b) The worth at the time of the award of the amount by which the unpaid Rent that would have been earned between the time of the termination and the time of the award exceeds the amount of unpaid Rent that Tenant proves could reasonably have been avoided, to be computed by allowing interest at the rate set forth in Section 23.2 but in no case greater than the maximum amount of interest permitted by law; (c) The worth at the time of the award of the amount by which the unpaid Rent for the balance of the Lease Term after the time of the award exceeds the amount of unpaid Rent that Tenant proves could reasonably have been avoided, to be computed by discounting that amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of the award plus one percent (1%); (d) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform obligations under this Lease, including brokerage commissions and advertising expenses, expenses of remodeling the Premises for a new tenant (whether for the same or a different use), and any special concessions made to obtain a new tenant; and (e) Any other amounts, in addition to or in lieu of those listed above, that may be permitted by applicable law. 21.3.2. Continuation of Lease in Effect. Landlord shall have the remedy described in Civil Code Section 1951.4, which provides that, when a tenant has the right to sublet or assign (subject only to reasonable limitations), the landlord may continue the lease in effect after the tenant's breach and abandonment and recover Rent as it becomes due. Accordingly, if Landlord does not elect to terminate this Lease on account of any Default by Tenant, Landlord may enforce all of Landlord's rights and remedies under this Lease, including the right to recover all Rent as it becomes due. 21.3.3. Tenant's Subleases. If Landlord elects to terminate this Lease on account of any Default by Tenant, Landlord may: (a) Terminate any sublease, license, concession, or other consensual arrangement for possession entered into by Tenant and affecting the Premises. (b) Choose to succeed to Tenant's interest in such an arrangement. If Landlord elects to succeed to Tenant's interest in such an arrangement, Tenant shall, as of the date of notice by Landlord of that election, have no further right to, or interest in, the Rent or other consideration receivable under that arrangement. -25- 27 21.4 Form of Payment After Default. If, on three (3) occasions within a twelve-month (12-month) period, Tenant fails to pay any amount due under this Lease within five (5) Business Days after the due date or if Tenant draws a check on an account with insufficient funds, Landlord shall have the right to require that any subsequent amounts paid by Tenant to Landlord under this Lease (to cure a Default or otherwise) be paid in the form of cash, money order, cashier's or certified check drawn on an institution acceptable to Landlord, or other form approved by Landlord despite any prior practice of accepting payments in a different form. 21.5 Efforts To Relet. For purposes of this Article 21, Tenant's right to possession shall not be considered to have been terminated by Landlord's efforts to relet the Premises, by Landlord's acts of maintenance or preservation with respect to the Premises, or by appointment of a receiver to protect Landlord's interests under this Lease. This list is merely illustrative of acts that may be performed by Landlord without terminating Tenant's right to possession. 21.6 Acceptance of Rent Without Waiving Rights. Under Article 24, Landlord may accept Tenant's payments without waiving any rights under this Lease, including rights under a previously served notice of Default. If Landlord accepts partial payments after serving a notice of Default, Landlord may nevertheless commence and pursue an action to enforce rights and remedies under the previously served notice of Default, unless the default is entirely cured, without giving Tenant any further notice or demand. 21.7 Tenant's Remedies on Landlord's Default. 21.7.1. Landlord's Default. Except as provided in Section 10.2, Landlord's failure to perform any of its obligations under this Lease shall constitute a default by Landlord under the Lease if the failure continues for thirty (30) days after written notice of the failure from Tenant to Landlord. If the required performance cannot be completed within thirty (30) days, Landlord's failure to perform shall constitute not a default under the Lease unless Landlord fails to undertake to cure the failure within thirty (30) days and diligently and continuously attempts to complete this cure as soon as reasonably possible, except as provided in Section 10.2. 21.7.2. Rent Abatement. If Tenant is unable to use, and does not use, all or part of the Premises ("Affected Area") as a result of an Abatement Event, as defined in Section 21.7.2.1, and if this Abatement Event continues for either (i) three (3) consecutive Business Days, where the cure for the Abatement Event is reasonably within the control of Landlord, or (ii) ten (10) Business Days, where the cure for the Abatement Event is not reasonably within the control of Landlord, after Landlord's receipt of notice from Tenant of the Abatement Event ("Eligibility Period"), the Rent payable under this Lease shall be abated or reduced after the expiration of the Eligibility Period for such time that Tenant continues to be prevented from using, and does not use, the Affected Area in the proportion that the Rentable Area of the Affected Area bears to the total Rentable Area of the Premises. Notwithstanding anything to the contrary in this Section 21.7.2, if an Abatement Event occurs more than once in a one (1) year period, then the Eligibility Period after which Rent is abated shall be reduced to one (1) Business Day, where the cure for the Abatement Event is reasonably within the control of Landlord. 21.7.2.1 Abatement Event. An "Abatement Event" is: (a) Landlord's performance of or failure to perform any repair, maintenance, or alteration that substantially interferes with Tenant's use of the Premises or which concerns an emergency involving risk of life or injury to persons or significant damage to property; (b) Any failure of or interruption in utilities or services required to be supplied by Landlord to the Premises; or (c) Any failure of Landlord to provide Tenant with access to the Premises. Article 22 LANDLORD'S RIGHT TO PERFORM TENANT'S OBLIGATIONS 22.1 Landlord's Right To Perform Tenant's Obligations. All obligations to be performed by Tenant under this Lease shall be performed by Tenant at Tenant's expense and without any reduction of Rent. If Tenant is in Default on any obligation, Landlord may, after notice to Tenant as required by Section 21.2, perform the obligation on Tenant's behalf, without waiving Landlord's rights for Tenant's failure to perform any obligations under this Lease and without releasing Tenant from such obligations. 22.2 Reimbursement by Tenant. Within fifteen (15) days after receiving a statement from Landlord, Tenant shall pay to Landlord the amount of expense reasonably incurred by Landlord, under Section 22.1, in performing Tenant's obligation as Additional Rent. Article 23 LATE PAYMENTS 23.1 Late Charges. If any Rent payment is not received by Landlord or Landlord's designee within ten (10) days after that Rent is due, Tenant shall pay to Landlord a late charge of three percent (3%) of such overdue amount liquidated damages, in lieu of actual damages (other than interest under Section 23.2 and attorney fees and costs under Section 26.1). The parties agree that this late charge represents a reasonable estimate of the expenses that Landlord will incur because of any late payment of Rent (other than interest and attorney fees and costs). Tenant shall pay the late charge as Additional Rent with the next installment of Rent. -26- 28 23.2 Interest. If any Rent payment is not received by Landlord or Landlord's designee within ten (10) days after that Rent is due, Tenant shall pay to Landlord annual interest on the past-due amount, from the date due until paid, at the Prime Rate published by the Wall Street Journal (or if such rate is no longer published such substitute rate reasonable selected by Landlord plus two percent (2%) rate per year ("Lease Rate"). Article 24 NONWAIVER 24.1 Nonwaiver. No waiver of any provision of this Lease shall be implied by any failure of either party to enforce any remedy for the violation of that provision, even if that violation continues or is repeated. Any waiver by a party of any provision of this Lease must be in writing. Such written waiver shall affect only the provision specified and only for the time and in the manner stated in the writing. 24.2 Acceptance and Application of Payment; Not Accord and Satisfaction. No receipt by either party of a lesser payment than the Rent required under this Lease shall be considered to be other than on account of the earliest amount due, and no endorsement or statement on any check or letter accompanying a payment or check shall be considered an accord and satisfaction. Each party may accept checks or payments without prejudice to its right to recover all amounts due and pursue all other remedies provided for in this Lease. Either party's receipt of monies from the other party after giving notice to the other party terminating this Lease in no way reinstates, continues, or extends the Lease Term or affects that Termination Notice. After the service of notice terminating this Lease, the beginning of an action, or the entry of final judgment in any action, either party may receive monies from the other party. The payment and receipt of the payment shall not waive or affect such prior notice, action, or judgment. Article 25 DISPUTE RESOLUTION 25.1 Waiver of Right to Jury Trial. Landlord and Tenant waive their respective rights to trial by jury of any contract or tort claim, counterclaim, cross-complaint, or cause of action in any action, proceeding, or hearing brought by either party against the other on any matter arising out of or in any way connected with this Lease, the relationship of Landlord and Tenant, or Tenant's use or occupancy of the Premises, including any claim of injury or damage or the enforcement of any remedy under any current or future law, statute, regulation, code, or ordinance. Landlord's initials /s/ JAW Tenant's initials /s/ DSG 25.2 Resolving Disagreement Over Fair Market Rental Value. If Tenant timely and effectively objects to Landlord's determination of Fair Market Rental Value under Section 2.5.2, the disagreement shall be resolved under this Section 25.2. 25.2.1. Negotiated Agreement. Landlord and Tenant shall diligently attempt in good faith to agree on the Fair Market Rental Value on or before the tenth (10th) day after Tenant's objection to the Fair Market Rental Value ("Outside Agreement Date"). 25.2.2. Parties' Separate Determinations. If Landlord and Tenant fail to reach agreement on or before the Outside Agreement Date, Landlord and Tenant shall each make a separate determination of the Fair Market Rental Value and notify the other party of this determination within five (5) days after the Outside Agreement Date. 25.2.2.1 Two Determinations. If each party makes a timely determination of the Fair Market Rental Value, those determinations shall be submitted to arbitration in accordance with Section 25.2.3. 25.2.2.2 One Determination. If Landlord or Tenant fails to make a determination of the Fair Market Rental Value within the five-day (5-day) period, that failure shall be conclusively considered to be that party's approval of the Fair Market Rental Value submitted within the five-day (5-day) period by the other party. 25.2.3. Arbitration. If both parties make timely individual determinations of the Fair Market Rental Value under Section 25.2.2, the Fair Market Rental Value shall be determined by arbitration under this Section. 25.2.3.1 Scope of Arbitration. The determination of the arbitrator(s) shall be limited to the sole issue of whether Landlord's or Tenant's submitted Fair Market Rental Value is the closest to the actual Fair Market Rental Value as determined by the arbitrator(s), taking into account the requirements of Section 2.5.2. 25.2.3.2 Qualifications of Arbitrator(s). The arbitrator(s) shall each be a licensed real estate broker who has been active in the leasing or appraising of commercial office properties in the Concord/Walnut Creek area over the ten-year (10-year) period ending on the date of their appointment as arbitrator(s). 25.2.3.3 Parties' Appointment of Arbitrators. Within fifteen (15) days after the Outside Agreement Date, Landlord and Tenant shall each appoint one arbitrator and notify the other party of the arbitrator's name and business address. 25.2.3.4 Appointment of Third Arbitrator. If each party timely appoints an arbitrator, the two (2) arbitrators shall, within ten (10) days after the appointment of the second arbitrator, agree on and appoint a third arbitrator (who shall be qualified under the same criteria set forth above for qualification of the initial two (2) arbitrators) and provide notice to Landlord and Tenant of the arbitrator's name and business address. -27- 29 25.2.3.5 Arbitrators' Decision. Fair Market Rental Value shall be determined within thirty (30) days of the appointment of the third arbitrator and the third arbitrator shall notify Landlord and Tenant hereof immediately. The arbitrators shall have the right to consult experts and competent authorities for factual information or evidence pertaining to a determination of Fair Market Rental Value, but any such consultation shall be made in the presence of both parties, with full right on their parts to cross-examine. Each party-appointed arbitrator shall state in writing his or her determination of Fair Market Rental Value, supported by the reasons therefor, and shall make counterpart copies for each of the other arbitrators. The arbitrators shall arrange for simultaneous exchange of such proposed resolutions and the three appraisals shall be added together and their total divided by three; the resulting quotient shall be the Fair Market Rental Value. If, however, the low appraisal and/or the high appraisal is/are more than ten percent (10%) lower and/or higher than the middle appraisal, the appraisal(s) exceeding such ten percent (10%) limit shall be disregarded. If only one appraisal is disregarded, the remaining two appraisals shall be added together and their total divided by two; the resulting quotient shall be the Fair Market Rental Value. If both the low appraisal and the high appraisal are disregarded as stated in this Section, the middle appraisal shall be the Fair Market Rental Value. 25.2.3.6 If Only One Arbitrator Is Appointed. If either Landlord or Tenant fails to appoint an arbitrator within fifteen (15) days after the Outside Agreement Date, the arbitrator timely appointed by one of them shall reach a decision and notify Landlord and Tenant of that decision within thirty (30) days after the arbitrator's appointment. The arbitrator's decision shall be binding on Landlord and Tenant. 25.2.3.7 If Only Two Arbitrators Are Appointed. If each party appoints an arbitrator in a timely manner, but the two (2) arbitrators fail to agree on and appoint a third arbitrator within the required period, the arbitrators shall be dismissed without delay and the issue of Fair Market Rental Value shall be submitted to binding arbitration under the Commercial Real Estate Arbitration rules of the American Arbitration Association ("AAA"), subject to the provisions of this Section 25.3. 25.2.3.8 If No Arbitrator Is Appointed. If Landlord and Tenant each fail to appoint an arbitrator in a timely manner, the matter to be decided shall be submitted without delay to binding arbitration under Commercial Real Estate Arbitration rules of AAA, subject to the provisions of this Section 25.3. 25.2.3.9 Cost of Arbitration. The cost of the arbitration shall be paid by the losing party. Article 26 ATTORNEY FEES AND COSTS 26.1 Attorney Fees and Costs. If either party undertakes litigation against the other party arising out of or in connection with this Lease, the prevailing party shall be entitled to recover from the other party reasonable attorney fees and court costs incurred. The prevailing party shall be determined under Civil Code Section 1717(b)(1) or any successor statute. Article 27 LANDLORD'S ACCESS TO PREMISES 27.1 Landlord's Access to Premises. Landlord and its agents may, at reasonable times and on reasonable oral or written notice to Tenant, enter the Premises to: (a) Inspect the Premises; (b) show the Premises to prospective purchasers or mortgagees or to ground lessors or underlying lessors; (c) show the Premises, during the final year of the Lease Term, to prospective tenants; (d) serve, post, and keep posted notices; (e) repair, alter, or improve the Premises or Building that Landlord deems necessary or desirable; (f) make necessary repairs to the Building structure or systems; (g) perform services required or permitted of Landlord by law or by this Lease; (h) perform any covenants of Tenant that Tenant fails to perform, in accordance with Article 22; or (i) such other matters as Landlord reasonably deems necessary or desirable. 27.2 Restrictions on Entry; Tenant's Waiver. To the extent reasonably practicable, Landlord shall exercise its rights under this Article 27 at such times and in such a manner as to reasonably minimize the impact on Tenant's business in and occupancy of the Premises. Except in an emergency or when accompanied by an authorized representative of Tenant, Landlord shall not enter Tenant's vaults or the special security areas designated in writing by Tenant. Landlord may enter the Premises under this Article 27 without the abatement of Rent, subject to Section 21.7, and may take reasonable steps to accomplish the stated purposes. Tenant waives any claims for damages caused by Landlord's entry, in accordance with this Article 27, including damage claims for (a) injuries; (b) inconvenience to or interference with Tenant's business; (c) lost profits; and (d) loss of occupancy or quiet enjoyment of the Premises, except to the extent any of the foregoing are caused by the negligence or willful misconduct of Landlord or any of Landlord's agents. 27.3 Method of Entry. Landlord shall at all times have a key or, if applicable, a card key with which to unlock all the doors in the Premises, excluding Tenant's vaults, safes, and special security areas designated in writing by notice to Landlord. In an emergency situation, Landlord shall have the right to use any means that Landlord considers proper to open the doors in and to the Premises. Any such entry into the Premises by Landlord shall not be considered a forcible or unlawful entry into, or a detainer of, the Premises or an actual or constructive eviction of Tenant from any portion of the Premises. 27.4 Emergency Entry. Despite any other provision of this Article 27, Landlord and Landlord's agents may enter the Premises without any advance notice when necessary to address emergency situations. For purposes of this Article, an emergency situation is one that poses a threat of imminent bodily harm or property damage. If Landlord makes an emergency entry onto the Premises when no authorized representative of Tenant is present, Landlord shall provide telephone notice to Tenant as soon as -28- 30 reasonably possible within twenty-four (24) hours after that entry and shall take reasonable steps to secure the Premises until a representative of Tenant arrives at the Premises. Article 28 SIGNS 28.1 Building Name; Landlord's Signage Rights. Subject to Tenant's signage rights under this Article 28, Landlord may at any time change the name of the Building and install, affix, and maintain all signs on the Real Property as Landlord may, in Landlord's sole discretion, desire. Tenant shall not have or acquire any property right or interest in the name of the Building. Tenant may use the name of the Real Property. 28.2 Tenant's Signage Rights. 28.2.1. Tenant's Monument Sign. Tenant shall have the non-exclusive right to construct a monument sign located on the Real Property and fronting on Systron Drive to display Tenant's trade name and direct visitor's to Tenant's driveway ("Monument Sign"). Tenant's right to maintain its name on the Monument Sign shall be subject to the following requirements: (a) All expenses in connection with the construction, installation, and maintenance of Tenant's sign shall be paid by Tenant. (b) The design, size, location, materials, colors, and lighting of the Monument Sign shall be approved by Landlord in Landlord's reasonable discretion. (c) Tenant must obtain all applicable permits and authorizations by government authorities before beginning to install Tenant's name on the Monument Sign. (d) Tenant shall maintain repair and insure the Monument Sign at Tenant's sole cost and expense. 28.2.2. Nontransferability. Tenant's signage rights under this Section 28.2.2. may not be assigned to any assignee of this Lease or to any subtenant of Tenant. 28.2.3. Removal, Repair, and Restoration. On termination or expiration of the Lease Term or on expiration of Tenant's sign rights under this Section 28, Landlord shall have the right to permanently remove the Monument Sign or permanently remove Tenant's name (including its logo) from the Monument Sign, repair any damage to the Monument Sign resulting from the removal of Tenant's name, and restore the land on which the Monument Sign was located to the condition that existed before the installation of the Monument Sign. Tenant shall pay to Landlord, within thirty (30) days after demand, all expenses incurred in connection with that removal, repair, and restoration. 28.2.4. Prohibited Signs and Other Items. Tenant may not display any signs on the exterior or roof of the Building or in the Common Areas of the Building or the Real Property. Tenant may not install or display any signs, window coverings, blinds (even if located behind the Landlord-approved window coverings for the Building), or other items visible from the exterior of the Premises without Landlord's prior written approval, which Landlord may, in Landlord's sole discretion, grant or withhold. Any signs, notices, logos, pictures, names, or advertisements that are installed by or for Tenant without Landlord's approval may be removed without notice by Landlord at Tenant's expense. 28.2.5. Directory. Landlord shall, at Landlord's sole expense, provide and maintain throughout the Lease Term a directory on the Real Property exclusively for the display of the names and suite numbers of tenants on the Real Property. Tenant is entitled to display its name and Premises address in the directory without additional expense to Tenant. Article 29 TENANT PARKING 29.1 Number of Parking Spaces. Tenant shall be entitled to use throughout the Lease Term the number of unreserved parking spaces for use in common with other tenants of the Real Property in the Common Area up to the maximum number set forth in Summary Section 12. 29.2 Changes in Location, Layout, and Service. Landlord specifically reserves the right to grant reserved spaces, change the location, size, configuration, design, layout, and all other aspects of the parking facility. Landlord may close off or restrict access to the parking facility from time to time to facilitate construction, alteration, or improvements, without incurring any liability to Tenant and without any abatement of Rent under this Lease. Landlord shall have no obligation to police or patrol the parking area. Article 30 MISCELLANEOUS 30.1 Captions. The captions of articles and Sections and the table of contents of this Lease are for convenience only and have no effect on the interpretation of the provisions of this Lease. 30.2 Word Usage. Unless the context clearly requires otherwise: -29- 31 (a) The plural and singular numbers shall each be considered to include the other; (b) the masculine, feminine, and neuter genders shall each be considered to include the others; (c) "shall," "will," "must," "agrees," and "covenants" are each mandatory; (d) "may" is permissive; (e) "or" is not exclusive; and (f) "includes" and "including" are not limiting. 30.3 Counting Days. Days shall be counted by excluding the first day and including the last day. For purposes of this Agreement, "Business Day" means any day other than Saturday, Sunday or a holiday observed by national or federally chartered banks. If the last day is a Saturday, Sunday, or legal holiday as described in Government Code Sections 6700- 6701, it shall be excluded. Any act required by this Lease to be performed by a certain day shall be timely performed if completed before 5 p.m. local time on that date. If the day for performance of any obligation under this Lease is a Saturday, Sunday, or legal holiday, the time for performance of that obligation shall be extended to 5 p.m. local time on the first following date that is not a Saturday, Sunday, or legal holiday. 30.4 Entire Agreement; Amendments. This Lease and all exhibits referred to in this Lease constitute the final, complete, and exclusive statement of the terms of the agreement between Landlord and Tenant pertaining to Tenant's lease of space in the Real Property and supersedes all prior and contemporaneous understandings or agreements of the parties. Neither party has been induced to enter into this Lease by, and neither party is relying on, any representation or warranty outside those expressly set forth in this Lease. This Lease may be amended only by an agreement in writing signed by Landlord and Tenant. 30.5 Exhibits. The Exhibits if applicable, attached to this Lease are a part of this Lease and incorporated into this Lease by reference. 30.6 Partial Invalidity. If a court or arbitrator of competent jurisdiction holds any Lease clause to be invalid or unenforceable in whole or in part for any reason, the validity and enforceability of the remaining clauses, or portions of them, shall not be affected. 30.7 Binding Effect. Subject to Article 16, this Lease shall bind and benefit the parties to this Lease and their legal representatives and successors in interest. 30.8 Independent Covenants. This Lease shall be construed as though its covenants between Landlord and Tenant are independent and not dependent. 30.9 Governing Law. This Lease shall be construed and enforced in accordance with the laws of the State of California. 30.10 Notices. All notices (including requests, demands, approvals, or other communications) under this Lease shall be in writing. 30.10.1. Method of Delivery. Notice shall be sufficiently given for all purposes as follows: (a) When personally delivered to the recipient, notice is effective on delivery. (b) When mailed first class to the last address of the recipient known to the party giving notice, notice is effective on delivery. (c) When mailed by certified mail with return receipt requested, notice is effective on receipt if delivery is confirmed by a return receipt. (d) When delivered by overnight delivery Federal Express/Airborne/United Parcel Service/DHL WorldWide Express with charges prepaid or charged to the sender's account, notice is effective on delivery if delivery is confirmed by the delivery service. (e) When sent by telex or fax to the last telex or fax number of the recipient known to the party giving notice, notice is effective on receipt as long as (1) a duplicate copy of the notice is promptly given by first-class or certified mail or by overnight delivery or (2) the receiving party delivers a written confirmation of receipt. Any notice given by telex or fax shall be considered to have been received on the next Business Day if it is received after 5 p.m. (recipient's time) or on a nonbusiness day. 30.10.2. Refused, Unclaimed, or Undeliverable Notices. Any correctly addressed notice that is refused, unclaimed, or undeliverable because of an act or omission of the party to be notified shall be considered to be effective as of the first date that the notice was refused, unclaimed, or considered undeliverable by the postal authorities, messenger, or overnight delivery service. 30.10.3. Addresses. Addresses for purposes of giving notice are set forth in Summary Section 13. Either party may change its address or telex or fax number by giving the other party notice of the change in any manner permitted by this Section 30.11. 30.10.4. Lenders and Ground Lessor. If Tenant is notified of the identity and address of Landlord's lender or ground or underlying lessor, Tenant shall give to that lender or ground or underlying lessor written notice of any default by Landlord under the terms of this Lease. 30.11 Force Majeure--Specific Exceptions. The time for performance of an obligation other than the payment of money under this Lease shall be extended for the period during which a party is prevented from performing by acts of God, government, or other force or event beyond the reasonable control of that party. -30- 32 30.12 Time of the Essence. Time is of the essence of this Lease and each of its provisions and Exhibits. 30.13 Modifications Required by Landlord's Lender. If any institutional lender of Landlord (e.g., bank, savings and loan association, pension fund, insurance company, real estate investment trust) reasonably requires a modification of this Lease, Tenant shall agree to that modification as long as: (a) Base Rent, Additional Rent, and any other amounts required to be paid under this Lease, and the time and manner of payment, will not be changed. (b) The Term (including any Option Terms and the times governing Tenant's exercise of any options) will not be changed. (c) Tenant's possession of the Premises and rights to possession and use of other parts of the Building and Real Property will not be changed. (d) Landlord's obligations to Tenant under this Lease will not be reduced, and Tenant's obligations to Landlord under this Lease will not be increased. Tenant shall execute an amendment to this Lease evidencing modifications required and permitted under this Section 30.13 within a reasonable time after receipt of a written request. 30.14 Recording. Neither this Lease nor any short form of this Lease shall be recorded. 30.15 Liability of Landlord. The liability of Landlord (including all persons and entities that comprise Landlord, and any successor landlord) and any recourse by Tenant against Landlord under all provision of this Lease shall be limited to the interest of Landlord and Landlord's successors in interest in and to the Real Property. On behalf of itself and all persons claiming by, through, or under Tenant, Tenant expressly waives and releases Landlord from any personal liability for breach of this Lease. 30.16 Transfer of Landlord's Interest. On a transfer of all of Landlord's interest in the Building and Real Property and in this Lease, Landlord shall be released from all liability and obligations under this Lease that accrue after the effective date of transfer, and the following restrictions: (a) Landlord shall not be released from its obligations under this Lease unless the transferee agrees in writing, for the benefit of Tenant, to assume Landlord's obligations under this Lease from and after the date of transfer; and (b) If Landlord assigns its interest in this Lease to a lender as additional security, this assignment shall not release Landlord from its obligations under this Lease; 30.17 Submission of Lease. Submission of this document for examination or signature by the parties does not constitute an option or offer to lease the Premises on the terms in this document or a reservation of the Premises in favor of Tenant. This document is not effective as a lease or otherwise until executed and delivered by both Landlord and Tenant. 30.18 Legal Authority. 30.18.1. Corporate Authority. If either party is a corporation: (a) Each individual signing this Lease on behalf of that corporation represents and warrants that each of them is duly authorized to execute and deliver this Lease on behalf of the corporation; (b) That the corporation is duly organized and validly existing under the laws of a state of the United States; and (c) That corporation and the individuals signing this Lease on its behalf covenant that, within thirty (30) days after the date of this Lease, the corporation shall deliver to the other party a duly certified copy of a resolution of the corporation's board of directors authorizing execution of this Lease. 30.18.2. Partnership Authority. If either party is a partnership or a limited liability partnership, each individual executing this Lease on behalf of the partnership represents and warrants that: (a) Each of them is duly authorized to execute and deliver this Lease on behalf of the partnership in accordance with the partnership agreement, or an amendment to the partnership agreement, now in effect; and (b) That the partnership and the individual signing this Lease on its behalf covenant that, within fifteen (15) days after the date of this Lease, the partnership shall deliver to Landlord a duly certified copy of a resolution, a certificate or other evidence reasonably satisfactory to Landlord that the partnership has authorized execution of this Lease. 30.18.3. Limited Liability Company Authority. If either party is a limited liability company, each individual executing this Lease on behalf of that company represents and warrants that: (a) The individual(s) executing this Lease on behalf of the company have full power and authority under the company's governing documents to execute and deliver this Lease in the name of and on behalf of the company; -31- 33 (b) The company is a limited liability company duly organized and validly existing under the laws of a state of the United States; and (c) The company and the individuals signing this Lease on his behalf covenant that, within fifteen (15) days after the date of this Lease, the company shall deliver to the Landlord a duly certified copy of a resolution or other document reasonably satisfactory to Landlord confirming authorization of the execution of this Lease. 30.19 Right To Lease. Landlord reserves the absolute right to contract with any other person or entity to be a tenant in the Building as Landlord, in Landlord's sole business judgment, determines best to promote the interests of the Building. Tenant does not rely on the expectation, and Landlord does not represent, that any specific tenant or type or number of tenants will, during the Lease Term, occupy any space in the Building. 30.20 No Air Rights. No rights to any view from the Premises or to exterior light or air to the Premises are created under this Lease. 30.21 Brokers. Landlord and Tenant each represents to the other that it has had no dealings with any real estate broker or agent in connection with the negotiation of this Lease, except for the real estate brokers or agents specified in Summary Section 14 (Brokers) and that they know of no other real estate broker or agent who is entitled to a commission or finder's fee in connection with this Lease. Tenant acknowledges that Sean Cooley, Vice President of Cornish & Carey Commercial, is the acting broker for Landlord in this transaction as well as a principal of Landlord. Tenant consents to Mr. Cooley's role as a principal of Landlord and waives any potential conflict of interest arising therefrom. Each party shall indemnify, protect, defend, and hold harmless the other party against all claims, demands, losses, liabilities, lawsuits, judgments, and costs and expenses (including reasonable attorney fees) for any leasing commission, finder's fee, or equivalent compensation alleged to be owing on account of the indemnifying party's dealings with any real estate broker or agent other than the Brokers. Landlord agrees to pay a commission to the Brokers regarding this transaction pursuant to a separate agreement with such Brokers. The terms of this Section 30.21 shall survive the expiration or earlier termination of the Lease Term. 30.22 Guaranty. National Insurance Group, Tenant's parent company, shall guaranty Tenant's performance and obligations under this Lease during the first three (3) Lease Years in the form attached as Exhibit F (the "Guaranty"). If after the first three (3) Lease Years, Tenant's net worth falls below its level as of the date of execution of this Lease, the Guaranty shall be immediately reinstated for an additional three (3) Lease Years. Tenant agrees to provide Landlord with confidential financial statements establishing its net worth on an annual basis, or more frequently as requested by Landlord, but in no event more often than quarterly. Landlord agrees to keep such financial statements confidential and shall not disclose them to any persons other than its attorneys or other professional advisors whose review may be reasonably necessary to assist Landlord in evaluating Tenant's financial status. For purposes of this Section 30.22, "net worth" shall be calculated according to Generally Accepted Accounting Principles. Executed as of the date stated in Summary Section 1. Landlord: Tenant: Systron Business Center, LLC Pinnacle Data Corporation a California limited liability company a California corporation By: /s/ Sean M. Cooley By: /s/ Donald S. Grant ----------------------------------- ---------------------------------- Sean M. Cooley Name: Donald S. Grant Title: Vice President/Facilities By: /s/ Jeff Wilcox ---------------------------------- Jeff Wilcox -32- EX-10.30 5 LETTER AMENDMENT DATED MARCH 20, 1997 1 Exhibit 10.30 [IMPERIAL BANK LETTERHEAD] March 20, 1998 Mr. Gregory S. Saunders Executive Vice President National Insurance Group 395 Oyster Point Blvd., Suite 500 South San Francisco, CA 94080 Re: Loan #716065529/#250 - $1,000,000 revolving line of credit Dear Greg: Imperial Bank has approved an extension of your credit facility shown above as evidenced by that Note dated September 11, 1997 from its current maturity date of May 31, 1998 to March 31, 1999. Except as modified and extended hereby, the existing documentation as amended concerning your obligation remains in full force and effect. Please acknowledge your acceptance in the space provided below and return this letter to the undersigned no later than March 30,1998. Best personal regards, /s/ Joseph J. McCarthy - --------------------------- Joseph J. McCarthy Vice President Acknowledged and Agreed to: National Insurance Group By: /s/ Greg Saunders -------------------------- Gregory S. Saunders Date: March 20, 1998 EX-10.34 6 401(K) PLAN, AS AMENDED, DATED AS OF OCT. 1, 1997 1 EXHIBIT 10.34 FRANKLIN TEMPLETON VALUSELECT DEFINED CONTRIBUTION PLAN Copyright 1996 Franklin Templeton Investor Services, Inc. [LOGO] 2 TABLE OF CONTENTS ARTICLE I DEFINITIONS ARTICLE II TOP HEAVY PROVISIONS AND ADMINISTRATION 2.1 TOP HEAVY PLAN REQUIREMENTS ........................................13 2.2 DETERMINATION OF TOP HEAVY STATUS ..................................13 2.3 POWERS AND RESPONSIBILITIES OF THE EMPLOYER ........................16 2.4 DESIGNATION OF ADMINISTRATIVE AUTHORITY ............................16 2.5 ALLOCATION AND DELEGATION OF RESPONSIBILITIES ......................16 2.6 POWERS AND DUTIES OF THE ADMINISTRATOR .............................17 2.7 RECORDS AND REPORTS ................................................18 2.8 APPOINTMENT OF ADVISERS ............................................18 2.9 INFORMATION FROM EMPLOYER ..........................................18 2.10 PAYMENT OF EXPENSES ................................................18 2.11 MAJORITY ACTIONS ...................................................18 2.12 CLAIMS PROCEDURE ...................................................18 2.13 CLAIMS REVIEW PROCEDURE ............................................18 ARTICLE III ELIGIBILITY 3.1 CONDITIONS OF ELIGIBILITY ..........................................19 3.2 EFFECTIVE DATE OF PARTICIPATION ....................................19 3.3 DETERMINATION OF ELIGIBILITY .......................................19
3 3.4 TERMINATION OF ELIGIBILITY .........................................20 3.5 OMISSION OF ELIGIBLE EMPLOYEE ......................................20 3.6 INCLUSION OF INELIGIBLE EMPLOYEE ...................................20 3.7 ELECTION NOT TO PARTICIPATE ........................................20 3.8 CONTROL OF ENTITIES BY OWNER-EMPLOYEE ..............................20 ARTICLE IV CONTRIBUTION AND ALLOCATION 4.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION ....................21 4.2 TIME OF PAYMENT OF EMPLOYER'S CONTRIBUTION .........................22 4.3 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS ...............22 4.4 MAXIMUM ANNUAL ADDITIONS ...........................................26 4.5 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS ..........................32 4.6 TRANSFERS FROM QUALIFIED PLANS .....................................32 4.7 VOLUNTARY CONTRIBUTIONS ............................................33 4.8 DIRECTED INVESTMENT ACCOUNT ........................................34 4.9 QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTIONS .........................34 4.10 ACTUAL CONTRIBUTION PERCENTAGE TESTS ...............................35 4.11 INTEGRATION IN MORE THAN ONE PLAN ..................................35 ARTICLE V VALUATIONS 5.1 VALUATION OF THE TRUST FUND ........................................35 5.2 METHOD OF VALUATION ................................................35
4 ARTICLE VI DETERMINATION AND DISTRIBUTION OF BENEFITS 6.1 DETERMINATION OF BENEFITS UPON RETIREMENT ..........................36 6.2 DETERMINATION OF BENEFITS UPON DEATH ...............................36 6.3 DETERMINATION OF BENEFITS IN EVENT OF DISABILITY ...................37 6.4 DETERMINATION OF BENEFITS UPON TERMINATION .........................37 6.5 DISTRIBUTION OF BENEFITS ...........................................40 6.6 DISTRIBUTION OF BENEFITS UPON DEATH ................................43 6.7 TIME OF SEGREGATION OR DISTRIBUTION ................................47 6.8 DISTRIBUTION FOR MINOR BENEFICIARY .................................47 6.9 LOCATION OF PARTICIPANT OR BENEFICIARY UNKNOWN .....................47 6.10 PRE-RETIREMENT DISTRIBUTION ........................................47 6.11 ADVANCE DISTRIBUTION FOR HARDSHIP ..................................47 6.12 LIMITATIONS ON BENEFITS AND DISTRIBUTIONS ..........................48 6.13 SPECIAL RULE FOR NON-ANNUITY PLANS .................................48 ARTICLE VII TRUSTEE 7.1 BASIC RESPONSIBILITIES OF THE TRUSTEE ..............................49 7.2 INVESTMENT POWERS AND DUTIES OF THE TRUSTEE ........................49 7.3 OTHER POWERS OF THE TRUSTEE ........................................51 7.4 LOANS TO PARTICIPANTS ..............................................54 7.5 DUTIES OF THE TRUSTEE REGARDING PAYMENTS ...........................55 7.6 TRUSTEE'S COMPENSATION AND EXPENSES AND TAXES ......................55 7.7 ANNUAL REPORT OF THE TRUSTEE .......................................56 7.8 AUDIT ..............................................................56
5 7.9 RESIGNATION, REMOVAL AND SUCCESSION OF TRUSTEE .....................57 7.10 TRANSFER OF INTEREST ...............................................57 7.11 TRUSTEE INDEMNIFICATION ............................................58 7.12 EMPLOYER SECURITIES AND REAL PROPERTY ..............................58 ARTICLE VIII AMENDMENT, TERMINATION, AND MERGERS 8.1 AMENDMENT ..........................................................58 8.2 TERMINATION ........................................................59 8.3 MERGER OR CONSOLIDATION ............................................59 ARTICLE IX MISCELLANEOUS 9.1 EMPLOYER ADOPTIONS .................................................60 9.2 PARTICIPANT'S RIGHTS ...............................................60 9.3 ALIENATION .........................................................60 9.4 CONSTRUCTION OF PLAN ...............................................61 9.5 GENDER AND NUMBER ..................................................61 9.6 LEGAL ACTION .......................................................61 9.7 PROHIBITION AGAINST DIVERSION OF FUNDS .............................61 9.8 BONDING ............................................................61 9.9 EMPLOYER'S AND TRUSTEE'S PROTECTIVE CLAUSE .........................62 9.10 INSURER'S PROTECTIVE CLAUSE ........................................62 9.11 RECEIPT AND RELEASE FOR PAYMENTS ...................................62 9.12 ACTION BY THE EMPLOYER .............................................62 9.13 NAMED FIDUCIARIES AND ALLOCATION OF RESPONSIBILITY .................62
6 9.14 HEADINGS ...........................................................63 9.15 APPROVAL BY INTERNAL REVENUE SERVICE ...............................63 9.16 UNIFORMITY .........................................................63 9.17 PAYMENT OF BENEFITS ................................................63 ARTICLE X PARTICIPATING EMPLOYERS 10.1 ELECTION TO BECOME A PARTICIPATING EMPLOYER ........................63 10.2 REQUIREMENTS OF PARTICIPATING EMPLOYERS ............................63 10.3 DESIGNATION OF AGENT ...............................................64 10.4 EMPLOYEE TRANSFERS .................................................64 10.5 PARTICIPATING EMPLOYER'S CONTRIBUTION AND FORFEITURES ..............64 10.6 AMENDMENT ..........................................................64 10.7 DISCONTINUANCE OF PARTICIPATION ....................................65 10.8 ADMINISTRATOR'S AUTHORITY ..........................................65 10.9 PARTICIPATING EMPLOYER CONTRIBUTION FOR AFFILIATE ..................65 ARTICLE XI CASH OR DEFERRED PROVISIONS 11.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION ....................65 11.2 PARTICIPANT'S SALARY REDUCTION ELECTION ............................66 11.3 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS ...............69 11.4 ACTUAL DEFERRAL PERCENTAGE TESTS ...................................71 11.5 ADJUSTMENT TO ACTUAL DEFERRAL PERCENTAGE TESTS .....................73 11.6 ACTUAL CONTRIBUTION PERCENTAGE TESTS ...............................76
7 11.7 ADJUSTMENT TO ACTUAL CONTRIBUTION PERCENTAGE TESTS .................78 11.8 ADVANCE DISTRIBUTION FOR HARDSHIP ..................................81
8 ARTICLE I DEFINITIONS As used in this Plan, the following words and phrases shall have the meanings set forth herein unless a different meaning is clearly required by the context: 1.1 "ACT" means the Employee Retirement Income Security Act of 1974, as it may be amended from time to time. 1.2 "ADMINISTRATOR" means the person(s) or entity designated by the Employer pursuant to Section 2.4 to administer the Plan on behalf of the Employer. 1.3 "ADOPTION AGREEMENT" means the separate Agreement which is executed by the Employer and accepted by the Trustee which sets forth the elective provisions of this Plan and Trust as specified by the Employer. 1.4 "AFFILIATED EMPLOYER" means the Employer and any corporation which is a member of a controlled group of corporations (as defined in Code Section 414(b)) which includes the Employer; any trade or business (whether or not incorporated) which is under common control (as defined in Code Section 414(c)) with the Employer; any organization (whether or not incorporated) which is a member of an affiliated service group (as defined in Code Section 414(m)) which includes the Employer; and any other entity required to be aggregated with the Employer pursuant to Regulations under Code Section 414(o). 1.5 "AGGREGATE ACCOUNT" means with respect to each Participant, the value of all accounts maintained on behalf of a Participant, whether attributable to Employer or Employee contributions, subject to the provisions of Section 2.2. 1.6 "ANNIVERSARY DATE" means the anniversary date specified in C3 of the Adoption Agreement. 1.7 "BENEFICIARY" means the person to whom a share of a deceased Participant's interest in the Plan is payable, subject to the restrictions of Sections 6.2 and 6.6. 1.8 "CODE" means the Internal Revenue Code of 1986, as amended or replaced from time to time. 1.9 "COMPENSATION" with respect to any Participant means one of the following as elected in the Adoption Agreement. However, Compensation for any Self-Employed Individual shall be equal to his Earned Income. (a) Information required to be reported under Sections 6041, 6051 and 6052 (wages, tips and Other Compensation Box on Form W-2). Compensation is defined as wages, as defined in Code Section 3401(a) and all other payments of Compensation to an Employee by the Employer (in the course of the Employer's trade or business) for which the Employer is required to furnish the Employee a written statement under Code Sections 6041 (d) and 6051(a)(3). Compensation must be determined without regard to any rules under Code Section 3401(a) that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Section 3401(a)(2)). (b) Section 3401 (a) wages. Compensation is defined as wages within the meaning of Code Section 3401 (a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location 1 9 of the employment or the services performed (such as the exception for agricultural labor in Code Section 3401 (a)(2)). (c) 415 safe-harbor compensation. Compensation is defined as wages, salaries, and fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the Employer maintaining the Plan to the extent that the amounts are includible in gross income (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements, or other expense allowances under a nonaccountable plan (as described in Regulation Section 1.62-2(c)), and excluding the following: (1) Employer contributions to a plan of deferred compensation which are not includible in the Employee's gross income for the taxable year in which contributed, or Employer contributions under a simplified employee pension plan to the extent such contributions are deductible by the Employee, or any distributions from a plan of deferred compensation; (2) Amounts realized from the exercise of a nonqualified stock option, or when restricted stock (or property) held by the Employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture; (3) Amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option; and (4) Other amounts which received special tax benefits, or contributions made by the Employer (whether or not under a salary reduction agreement) towards the purchase of an annuity contract described in section 403(b) of the Internal Revenue Code (whether or not the contributions are actually excludable from the gross income of the Employee). If, in connection with the adoption of any amendment, the definition of Compensation has been modified, then, for Plan Years prior to the Plan Year which includes the adoption date of such amendment, Compensation means compensation determined pursuant to the Plan then in effect. In addition, if specified in the Adoption Agreement, Compensation for all Plan purposes shall also include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). Compensation in execs of $200.00 shall be disregarded. Such amount shall be adjusted at the same time and in such manner as permitted under Code Section 415(d). In applying this limitation, the family group of a Highly Compensated Participant who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Participant is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, shall be treated as a single Participant, except that for this purpose Family Members shall include only the affected Participant's spouse and any lineal descendants who have not attained age nineteen (19) before the close of the year. If, as a result of the application of such rules, the adjusted $200,000 limitation is exceeded, then (except for purposes of determining the portion of compensation up to the integration level if this plan is integrated), the limitation shall be prorated among the affected individuals in proportion to each such individual's Compensation as determined under this Section prior to the application of this limitation. For Plan Years beginning prior to January 1, 1989, the $200,000 limit (without regard to Family Member aggregation) shall apply only for Top Heavy Plan Years and shall not be adjusted. 2 10 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 for each Employee taken into account under the Plan shall not exceed the OBRA '93 annual Compensation limit. The OBRA '93 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 that prior determination period is subject to the OBRA '93 Compensation limit in effect for that prior determination period. For this purpose, for determination periods beginning before the first day of the Plan Year beginning on or after January 1, 1994, the OBRA '93 annual Compensation limit is $150,000. 1.10 "CONTRACT" or "POLICY" means any life insurance policy, retirement income policy, or annuity contract (group or individual) issued by the Insurer. In the event of any conflict between the terms of this Plan and the terms of any insurance contract purchased hereunder, the Plan provisions shall control. 1.11 "DEFERRED COMPENSATION" means, with respect to any Participant, that portion of the Participant's total Compensation which has been contributed to the Plan in accordance with the Participant's deferral election pursuant to Section 11.2. 1.12 "EARLY RETIREMENT DATE" means the date specified in the Adoption Agreement on which a Participant or Former Participant has satisfied the age and service requirements specified in the Adoption Agreement (Early Retirement Age). A Participant shall become fully Vested upon satisfying this requirement if still employed at his Early Retirement Age. A Former Participant who terminates employment after satisfying the service requirement for Early Retirement and who thereafter reaches the age requirement contained herein shall be entitled to receive his benefits under this Plan. 1.13 "EARNED INCOME" means with respect to a Self-Employed Individual, the net earnings from self-employment in the trade or business with respect to which the Plan is established, for which the personal services of the individual are a material income-producing factor. Net earnings will be determined without regard for items not included in gross income and the deductions allocable to such items. Net earnings are reduced by contributions by the Employer to a qualified Plan For the extent deductible under Code Section 404. In addition, for Plan Years beginning after December 31, 1989, net earnings shall be determined with regard to the deduction allowed For the Employer by Code Section 164(f). 1.14 "ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan that are made pursuant to the Participant's deferral election pursuant to Section 11.2, excluding any such amounts distributed as "excess annual additions" pursuant to Section 4.4. In addition, if selected in E3 of the Adoption Agreement, the Employer's matching contribution made pursuant to Section 11.1 (b) shall or shall not be considered an Elective Contribution for purposes of the Plan, as provided in Section 11.1(b). Elective Contributions shall be subject to the requirements of Sections 11.2(b) and 11.2(c) and shall further be required For satisfy the 3 11 discrimination requirements of Regulation 1.401(k)-1(b)(3), the provisions of which are specifically incorporated herein by reference. 1.15 "ELIGIBLE EMPLOYEE" means any Employee specified in DI of the Adoption Agreement. 1.16 "EMPLOYEE" means any person who is employed by the Employer, but excludes any person who is employed as an independent contractor. The term Employee shall also include Leased Employees as provided in Code Section 414(n) or (o). Except as provided in the Non-Standardized Adoption Agreement, all Employees of all entities which are an Affiliated Employer will be treated as employed by a single employer 1.17 "EMPLOYER" means the entity specified in the Adoption Agreement, any Participating Employer (as defined in Section 10.1) which shall adopt this Plan, any successor which shall maintain this Plan and any predecessor which has maintained this Plan. 1.18 "EXCESS COMPENSATION" means, with respect to a Plan that is integrated with Social Security, a Participant's Compensation which is in excess of the amount set forth in the Adoption Agreement. 1.19 "EXCESS CONTRIBUTIONS" means, with respect to a Plan Year, the excess of Elective Contributions and Qualified Non-Elective Contributions made on behalf of Highly Compensated Participants for the Plan Year over the maximum amount of such contributions permitted under Section 11.4(a). 1.20 "EXCESS DEFERRED COMPENSATION" means, with respect to any taxable year of a Participant, the excess of the aggregate amount of such Participant's Deferred Compensation and the elective deferrals pursuant to Section 11.2(f) actually made on behalf of such Participant for such taxable year, over the dollar limitation provided for in Code Section 402(g), which is incorporated herein by reference. Excess Deferred Compensation shall be treated as an "annual addition" pursuant to Section 4.4 when contributed to the Plan unless distributed to the affected Participant not later than the first April l5th following the close of the Participant's taxable year. 1.21 "FAMILY MEMBER" means, with respect to an affected Participant, such Participant's spouse, and such Participant's lineal descendants and ascendants and their spouses, all as described in Code Section 414(q)(6)(B). 1.22 "FIDUCIARY" means any person who (a)exercises any discretionary authority or discretionary control respecting management of the Plan or exercises any authority or control respecting management or disposition of its assets, (b) renders investment advice for a fee or other compensation, direct or indirect, with respect to any monies or other property of the Plan or has any authority or responsibility to do so, or (c) has any discretionary authority or discretionary responsibility in the administration of the Plan, including, but not limited to, the Trustee, the Employer and its representative body, and the Administrator. 1.23 "FISCAL YEAR" means the Employer's accounting year as specified in the Adoption Agreement. 1.24 "FORFEITURE" means that portion of a Participant's Account that is not Vested, and occurs on the earlier of: (a) the distribution of the entire Vested portion of a Participant's Account, or (b) the last day of the Plan Year in which the Participant incurs five (5) consecutive 1-Year Breaks in Service. 4 12 Furthermore, for purposes of paragraph (a) above, in the case of a Terminated Participant whose Vested benefit is zero, such Terminated Participant shall be deemed to have received a distribution of his Vested benefit upon his termination of employment. In addition, the term Forfeiture shall also include amounts deemed to be Forfeitures pursuant to any other provision of this Plan. 1.25 "FORMER PARTICIPANT" means a person who has been a Participant, but who has ceased to be a Participant for any reason. 1.26 "414(S) COMPENSATION" with respect to any Employee means his Compensation as defined in Section 1.9. However, for purposes of this Section, Compensation shall be Compensation paid and, if selected in the Adoption Agreement, shall only be recognized as of an Employee's effective date of participation. If, in connection with the adoption of any amendment, the definition of "414(s) Compensation" has been modified, then for Plan Years prior to the Plan Year which includes the adoption date of such amendment, "414(s) Compensation" means compensation determined pursuant to the Plan Year in effect. In addition, if specified in the Adoption Agreement, "414(s) Compensation" shall also include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b), plus Elective Contributions attributable to Deferred Compensation recharacterized as voluntary Employee contributions pursuant to 11.5(a). 1.27 "415 COMPENSATION" means compensation as defined in Section 4.4(f)(2). If, in connection with the adoption of any amendment, the definition of "415 Compensation" has been modified, then, for Plan Years prior to the Plan Year which includes the adoption date of such amendment, "415 Compensation" means compensation determined pursuant to the Plan then in effect. 1.28 "HIGHLY COMPENSATED EMPLOYEE" means an Employee described in Code Section 414(q) and the Regulations thereunder and generally means an Employee who performed services for the Employer during the "determination year" and is in one or more of the following groups: (a) Employees who at any time during the "determination year" or "look-back year" were "Five percent owners" as defined in Section 1.35(c). (b) Employees who received "415 Compensation" during the "look-back year" from the Employer in excess of $75,000. (c) Employees who received "415 Compensation" during the "look-back year" from the Employer in excess of $50,000 and were in the Top Paid Group of Employees for the Plan Year. (d) Employees who during the "look-back year" were officers of the Employer (as that term is defined within the meaning of the Regulations under Code Section 416) and received "415 Compensation" during the "look-back year" from the Employer greater than 50 percent of the limit in effect under Code Section 415(b)(1)(A) for any such Plan Year. The number of officers shall be limited For the lesser of (i) 50 employees, or (ii) the greater of 3 employees or 10 percent of all employees. If the Employer does not have at least one officer whose annual "415 Compensation" is in excess of 50 percent of the Code Section 415(b)(1)(A) limit, then the highest paid officer of the Employer will be treated as a Highly Compensated Employee. (e) Employees who are in the group consisting of the 100 Employees paid the greatest "415 Compensation" during the "determination year" and are also described in (b), (c) or (d) above when these paragraphs are modified to substitute "determination year" for "look-back year." 5 13 The "determination year" shall be the Plan Year for which testing is being performed, and the "look-back year" shall be the immediately preceding twelve-month period. However, if the Plan Year is a calendar year, or if another Plan of the Employer so provides, then the "look-back year" shall be the calendar year ending with or within the Plan Year for which testing is being performed, and the "determination year" (if applicable) shall be the period of time, if any, which extends beyond the "look-back year" and ends on the last day of the Plan Year for which testing is being performed (the "lag period"). With respect to this election, it shall be applied on a uniform and consistent basis to all plans, entities, and arrangements of the Employer. For purposes of this Section, the determination of "415 Compensation" shall be made by including amounts that would otherwise be excluded from a Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B) and, in the case of Employer contributions made pursuant to a salary reduction agreement, Code Section 403(b). Additionally, the dollar threshold amounts specified in (b) and (c) above shall be adjusted at such time and in such manner as is provided in Regulations. In the case of such an adjustment, the dollar limits which shall be applied are those for the calendar year in which the "determination year" or "look back year" begins. In determining who is a Highly Compensated Employee, Employees who are nonresident aliens and who received no earned income (within the meaning of Code Section 911 (d)) from the Employer constituting United States source income within the meaning of Code Section 861(a)(3) shall not be treated as Employees. Additionally, all Affiliated Employers shall be taken into account as a single employer and Leased Employees within the meaning of Code Sections 414(n)(2) and 414(o)(2) shall be considered Employees unless such Leased Employees are covered by a plan described in Code Section 414(n)(5) and are not covered in any qualified plan maintained by the Employer. The exclusion of Leased Employees for this purpose shall be applied on a uniform and consistent basis for all of the Employer's retirement plans. In addition, Highly Compensated Former Employees shall be treated as Highly Compensated Employees without regard to whether they performed services during the "determination year," 1.29 "HIGHLY COMPENSATED FORMER EMPLOYEE" means a former Employee who had a separation year prior to the "determination year" and was a Highly Compensated Employee in the year of separation from service or in any "determination year" after attaining age 55. Notwithstanding the foregoing, an Employee who separated from service prior to 1987 will be treated as a Highly Compensated Former Employee only if during the separation year (or year preceding the separation year) or any year after the Employee attains age 55 (or the last year ending before the Employee's 55th birthday), the Employee either received `415 Compensation" in excess of $50,000 or was a "Five percent owner." For purposes of this Section, "determination year," "415 Compensation" and "five percent owner" shall be determined in accordance with Section 1.28. Highly Compensated Former Employees shall be treated as Highly Compensated Employees. The method set forth in this Section for determining who is a "Highly Compensated Former Employee" shall be applied on a uniform and consistent basis for all purposes for which the Code Section 414(q) definition is applicable. 1.30 "HIGHLY COMPENSATED PARTICIPANT" means any Highly Compensated Employee who is eligible to participate in the Plan. 1.31 "HOUR OF SERVICE" means (1) each hour for which an Employee is directly or indirectly compensated or entitled to compensation by the Employer for the performance of duties during the applicable computation period; (2) each hour for which an Employee is directly or indirectly compensated or entitled to compensation by the Employer (irrespective of whether the employment relationship has terminated) for reasons other than performance of duties (such as vacation, holidays, sickness, jury duty, disability, lay-off, military duty or leave of absence) during the applicable computation period; (3) each hour for which back pay is awarded or agreed to by the Employer without regard For mitigation of damages. The same Hours of Service shall not he credited both under (1) or (2), as the case may be, and under (3). 6 14 Notwithstanding the above, (i) no more than 501 Hours of Service are required to be credited 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 computation period); (ii) an hour for which an Employee is directly or indirectly paid, or entitled to payment, on account of a period during which no duties are performed is not required to be credited to the Employee if such payment is made or due under a plan maintained solely for the purpose of complying with applicable worker's compensation, or unemployment compensation or disability insurance laws; and (iii) Hours of Service are not required to be credited for a payment which solely reimburses an Employee for medical or medically related expenses incurred by the Employee. For purposes of this Section, a payment shall be deemed to be made by or due from the Employer regardless of whether such payment is made by or due from the Employer directly, or indirectly through, among others, a trust fund, or insurer, to which the Employer contributes or pays premiums and regardless of whether contributions made or due to the trust fund, insurer, or other entity are for the benefit of particular Employees or are on behalf of a group of Employees in the aggregate. An Hour of Service must be counted for the purpose of determining a Year of Service, a year of participation for purposes of accrued benefits, a 1-Year Break in Service, and employment commencement date (or reemployment commencement date). The provisions of Department of Labor regulations 2530.200b-2(b) and (c) are incorporated herein by reference. Hours of Service will be credited for employment with all Affiliated Employers and for any individual considered to be a Leased Employee pursuant to Code Sections 414(n) or 414(o) and the Regulations thereunder. Hours of Service will be determined on the basis of the method selected in the Adoption Agreement. 1.32 "INSURER" means any legal reserve insurance company which shall issue one or more policies under the Plan. 1.33 "INVESTMENT MANAGER" means an entity that (a) has the power to manage, acquire, or dispose of Plan assets and (b) acknowledges fiduciary responsibility to the Plan in writing. Such entity must be a person, firm, or corporation registered as an investment adviser under the Investment Advisers Act of 1940, a bank, or an insurance company. 1.34 "JOINT AND SURVIVOR ANNUITY" means an annuity for the life of a Participant with a survivor annuity for the life of the Participant's spouse which is not less than 1/2, nor greater than the amount of the annuity payable during the joint lives of the Participant and the Participant's spouse. The Joint and Survivor Annuity will be the amount of benefit which can be purchased with the Participant's Vested interest in the Plan. 1.35 "KEY EMPLOYEE" means an Employee as defined in Code Section 416(i) and the Regulations thereunder. Generally, any Employee or former Employee (as well as each of his Beneficiaries) is considered a Key Employee if he, at any time during the Plan Year that contains the "Determination Date" or any of the preceding four (4) Plan Years, has been included in one of the following categories: (a) an officer of the Employer (as that term is defined within the meaning of the Regulations under Code Section 416) having annual "415 Compensation" greater than 50 percent of the amount in effect under Code Section 415(b)(1)(A) for any such Plan Year. (b) one of the ten employees having annual "415 Compensation" from the Employer for a Plan Year greater than the dollar limitation in effect under Code Section 415(c)(1)(A) for the calendar year in which such Plan Year ends and owning (or considered as owning within the 7 15 meaning of Code Section 318) both more than one-half percent interest and the largest interests in the Employer. (c) a "five percent owner" of the Employer. "Five percent owner" means any person who owns (or is considered as owning within the meaning of Code Section 318) more than five percent (5%) of the outstanding stock of the Employer or stock possessing more than Eve percent (5%) of the tool combined voting power of all stock of the Employer or, in the case of an unincorporated business, any person who owns more than five percent (5%) of the capital or profits interest in the Employer. In determining percentage ownership hereunder, employers that would otherwise be aggregated under 'Code Sections 414(b) (c) !(m) and (o) shall be treated as separate employers. (d) a "one percent owner" of the Employer having an annual "415 Compensation" from the Employer of more than $150,000. "One percent owner" means any person who owns (or is considered as owning within the meaning of Code Section 318) more than one percent (1%) of the outstanding stock of the Employer or stock possessing more than one percent (1%) of the total combined voting power of all stock of the Employer or, in the case of an unincorporated business, any person who owns more than one percent (1%) of the capital or profits interest in the Employer. In determining percentage ownership hereunder, employers that would otherwise be aggregated under Code Sections 414(b), (c), (m) and (o) shall be treated as separate employers. However, in determining whether an individual has "415 Compensation" of more than $150,000, "415 Compensation" from each employer required to be aggregated under Code Sections 414(b), (c), (m) and (o) shall be taken into account. For purposes of this Section, the determination of "415 Compensation" shall be made by including amounts that would otherwise be excluded from a Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B) and, in the case of Employer contributions made pursuant to a salary reduction agreement, Code Section 403(b). 1.36 "LATE RETIREMENT DATE" means the date of, or the first day of the month or the Anniversary Date coinciding with or next following, whichever corresponds to the election made for the Normal Retirement Date, a Participant's actual retirement after having reached his Normal Retirement Date. 1.37 "LEASED EMPLOYEE" means any person (other than an Employee of the recipient) who pursuant to an agreement between the recipient and any other person ("leasing organization") has performed services for the recipient (or for the recipient and related persons determined in accordance with Code Section 414(n)(6)) on a substantially full time basis for a period of at least one year, and such services are of a type historically performed by employees in the business field of the recipient employer. Contributions or benefits provided a leased employee by the leasing organization which are attributable to services performed for the recipient employer shall be treated as provided by the recipient employer. A leased employee shall not be considered an Employee of the recipient if: (i) such employee is covered by a money purchase pension plan providing: (1) a nonintegrated employer contribution rate of at least 10 percent of compensation, as defined in Code Section 415(c)(3), but including amounts contributed pursuant to a salary reduction agreement which are excludable from the employee's gross income under Code Sections 125, 402(a)(8), 402(h), or 403(b), (2) immediate participation, and (3) full and immediate vesting; and (ii) leased employees do not constitute more than 20 percent of the recipient's nonhighly compensated workforce. 1.38 "NET PROFIT" means with respect to any Fiscal Year the Employer's net income or profit for such Fiscal Year determined upon the basis of the Employer's books of account in accordance with generally accepted accounting principles, without any reduction for taxes based upon income, or for contributions made by the Employer to this Plan and any other qualified plan. 8 16 1.39 "NON-ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan other than those made pursuant to the Participant's deferral election made pursuant to Section 11.2 and any Qualified Non-Elective Contribution. In addition, if selected in E3 of the Adoption Agreement, the Employer's Matching Contribution made pursuant to Section 4.3(b) shall be considered a Non-Elective Contribution for purposes of the Plan. 1.40 "NON-HIGHLY COMPENSATED PARTICIPANT" means any Participant who is neither a Highly Compensated Employee nor a Family Member. 1.41 "NON-KEY EMPLOYEE" means any Employee or former Employee (and his Beneficiaries) who is not a Key Employee. 1.42 "NORMAL RETIREMENT AGE" means the age specified in the Adoption Agreement at which time a Participant shall become fully Vested in his Participant's Account. 1.43 "NORMAL RETIREMENT DATE" means the date specified in the Adoption Agreement on which a Participant shall become eligible to have his benefits distributed to him. 1.44 "1-YEAR BREAK IN SERVICE" means the applicable computation period during which an Employee has not completed more than 500 Hours of Service with the Employer, Further, solely for the purpose of determining whether a Participant has incurred a 1-Year Break in Service, Hours of Service shall be recognized for "authorized leaves of absence" and "maternity and paternity leaves of absence." "Authorized leave of absence" means an unpaid, temporary cessation from active employment with the Employer pursuant to an established nondiscriminatory policy, whether occasioned by illness, military service, or any other reason. A "maternity or paternity leave of absence" means, for Plan Years beginning after December 31, 1984, an absence from work for any period by reason of the Employee's pregnancy, birth of the Employee's child, placement of a child with the Employee in connection with the adoption of such child, or any absence for the purpose of caring for such child for a period immediately following such birth or placement. For this purpose, Hours of Service shall be credited for the computation period in which the absence from work begins, only if credit therefore is necessary to prevent the Employee from incurring a 1-Year Break in Service, or, in any other case, in the immediately following computation period. The Hours of Service credited for a maternity or paternity leave of absence" shall be those which would normally have been credited but for such absence, or, in any case in which the Administrator is unable to determine such hours normally credited, eight (8) Hours of Service per day. The total Hours of Service required to be credited for a "maternity or paternity leave of absence" shall not exceed 501. 1.45 "OWNER-EMPLOYEE" means a sole proprietor who owns the entire interest in the Employer or a partner who owns more than 10% of either the capital interest or the profit-its interest in the Employer and who receives income for personal services from the Employer. 1.46 "PARTICIPANT" means any Eligible Employee who participates in the Plan as provided in Section 3.2 and has not for any reason become ineligible to participate further in the Plan. 1.47 "PARTICIPANT'S ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest under the Plan resulting from (a) the Employer's contributions in the case of a Profit Sharing Plan or Money Purchase Plan, and (b) the Employer's Non-Elective Contributions in the case of a 401(k) Profit Sharing Plan. 9 17 1.48 "PARTICIPANT'S COMBINED ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest under the Plan resulting from the Employer's contributions. 1.49 "PARTICIPANT'S ELECTIVE ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan and Trust resulting from the Employer's Elective Contributions and Qualified Non-Elective Contributions. A separate accounting shall be maintained with respect to that portion of the Participant's Elective Account attributable to Elective Contributions made pursuant to Section 11.2, Employer matching contributions if they are deemed to be Elective Contributions, and any Qualified Non-Elective Contributions. 1.50 "PARTICIPANT'S Rollover Account" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan resulting from amounts transferred from another qualified plan or "conduit" Individual Retirement Account in accordance with Section 4.6. 1.51 "Plan means this instrument (hereinafter referred to as Franklin Templeton ValueSelect Defined Contribution Plan Basic Plan Document #01) including all amendments thereto, and the Adoption Agreement as adopted by the Employer. 1.52 "PLAN YEAR" means the Plan's accounting year as specified in C2 of the Adoption Agreement. 1.53 "PRE-RETIREMENT SURVIVOR ANNUITY" means an immediate annuity for the life of the Participant's spouse, the payments under which must be equal to the actuarial equivalent of 50% of the Participant's Vested interest in the Plan as of the date of death. 1.54 "QUALIFIED NON-ELECTIVE ACCOUNT" means the account established hereunder to which Qualified Non-Elective Contributions are allocated. 1.55 "QUALIFIED NON-ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan that are made pursuant to E5 of the Adoption Agreement and Section 11.1(d) which are used to satisfy the "Actual Deferral Percentage" tests. Qualified Non-Elective Contributions are nonforfeitable when made and are distributable only as specified in Sections 11.2(c) and 11.8. In addition, the Employer's contributions to the Plan that are made pursuant to Section 11.7(h) and which are used to satisfy the "Actual Contribution Percentage" tests shall be considered Qualified Non-Elective Contributions. 1.56 "QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTION ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest under the Plan resulting from the Participant's tax deductible qualified voluntary employee contributions made pursuant to Section 4.9. 1.57 "REGULATION" means the Income Tax Regulations as promulgated by the Secretary of the Treasury or his delegate, and as amended from time to time. 1.58 "RETIRED PARTICIPANT" means a person who has been a Participant, but who has become entitled to retirement benefits under the Plan. 1.59 "RETIREMENT DATE" means the date as of which a Participant retires for reasons other than Total and Permanent Disability, whether such retirement occurs on a Participant's Normal Retirement Date, Early or Late Retirement Date (see Section 6.1). 1.60 "SELF-EMPLOYED INDIVIDUAL" means an individual who has earned income for the taxable year from the trade or business for which the Plan is established, and, also, an individual who would have had earned 10 18 income but for the fact that the trade or business had no net profits for the taxable year. A Self-Employed Individual shall be treated as an Employee. 1.61 "SHAREHOLDER-EMPLOYEE" means a Participant who owns more than five percent (5%) of the Employer's outstanding capital stock during any year in which the Employer elected to be taxed as a Small Business Corporation under the applicable Code Section. 1.62 "SHORT PLAN YEAR" means, if specified in the Adoption Agreement, that the Plan Year shall be less than a 12 month period. If chosen, the following rules shall apply in the administration of this Plan. In determining whether an Employee has completed a Year of Service for benefit accrual purposes in the Short Plan Year, the number of the Hours of Service required shall be proportionately reduced based on the number of days in the Short Plan Year. The determination of whether an Employee has completed a Year of Service for vesting and eligibility purposes shall be made in accordance with Department of Labor Regulation 2530.2030(c). In addition, if this Man is integrated with Social Security, the integration level shall also be proportionately reduced based on the number of days in the Short Plan Year. 1.63 "SUPER TOP HEAVY PLAN" means a plan described in Section 2.2(b). 1.64 "TAXABLE WAGE BASE" means, with respect to any year, the maximum amount of earnings which may be considered wages for such year under Code Section 3121(a)(1). 1.65 "TERMINATED PARTICIPANT" means a person who has been a Participant, but whose employment has been terminated other than by death, Total and Permanent Disability or retirement. 1.66 "TOP HEAVY PLAN" means a plan described in Section 2.2(a). 1.67 "TOP HEAVY PLAN YEAR" means a Plan Year commencing after December 31, 1983 during which the Plan is a Top Heavy Plan. 1.68 "TOP PAID GROUP" shall be determined pursuant to Code Section 414(q) and the Regulations thereunder and generally means the top 20 percent of Employees who performed services for the Employer during the applicable year, ranked according to the amount of "415 Compensation" (as determined pursuant to Section 1.28) received from the Employer during such year. All Affiliated Employers shall be taken into account as a single employer, and Leased Employees shall be treated as Employees pursuant to Code Section 414(n) or (o). Employees who are non-resident aliens who received no earned income (within the meaning of Code Section 911(d)(2)) from the Employer constituting United States source income within the meaning of Code Section 864a(3) shall not be treated as Employees. Additionally, for the purpose of determining the number of active Employees in any year, the following additional Employees shall also he excluded, however, such Employees shall still be considered for the purpose of identifying the particular Employees in the Top Paid Group: (a) Employees with less than six (6) months of service; (b) Employees who normally work less than 17 1/2 hours per week; (c) Employees who normally work less than six (6) months during a year; and (d) Employees who have not yet attained age 21. In addition, if 90 percent or more of the Employees of the Employer are covered under agreements the Secretary of Labor finds to be collective bargaining agreements between Employee representatives and the Employer, and the Plan covers only Employees who are not covered under such agreements, then Employees 11 19 covered by such agreements shall be excluded from both the total number of active Employees as well as from the identification of particular Employees in the Top Paid Group. The foregoing exclusions set forth in this Section shall be applied on a uniform and consistent basis for all purposes for which the Code Section 414(q) definition is applicable. 1.69 "TOTAL AND PERMANENT DISABILITY" means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. The disability of a Participant shall be determined by a licensed physician chosen by the Administrator. However, if the condition constitutes total disability under the federal Social Security Acts, the Administrator may rely upon such determination that the Participant is Totally and Permanently Disabled for the purposes of this Plan. The determination shall be applied uniformly to all Participants. 1.70 "TRUSTEE" means the person or entity named in B6 of the Adoption Agreement or named in any trust forming a part of this Plan, and any successors. 1.71 "TRUST FUND" means the assets of the Plan and Trust as the same shall exist from time to time. 1.72 "VESTED" means the nonforfeitable portion of any account maintained on behalf of a Participant. 1.73 "VOLUNTARY CONTRIBUTION ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan resulting from the Participant's nondeductible voluntary contributions made pursuant to Section 4.7. 1.74 "YEAR OF SERVICE" means the computation period of twelve (12) consecutive months, herein set forth, and during which an Employee has completed at least 1000 Hours of Service. For purposes of eligibility for participation, the initial computation period shall begin with the date on which the Employee first performs an Hour of Service (employment commencement date). The computation period beginning after a 1-Year Break in Service shall be measured from the date on which an Employee again performs an Hour of Service. The succeeding computation periods shall begin with the first anniversary of the Employee's employment commencement date. However, if one (1) Year of Service or less is required as a condition of eligibility, then after the initial eligibility computation period, the eligibility computation period shall shift to the current Plan Year which includes the anniversary of the date on which the Employee first performed an Hour of Service. An Employee who is credited with 1,000 Hours of Service in both the initial eligibility computation period and the first Plan Year which commences prior to the first anniversary of the Employee's initial eligibility computation period will be credited with two Years of Service for purposes of eligibility to participate. For vesting purposes, and all other purposes not specifically addressed in this Section, the computation period shall be the Plan Year, including periods prior to the Effective Date of the Plan unless specifically excluded pursuant to the Adoption Agreement. Years of Service and breaks in service will be measured on the same computation period. Years of Service with any predecessor Employer which maintained this Plan shall be recognized. Years of Service with any other predecessor Employer shall be recognized as specified in the Adoption Agreement. Years of Service with any Affiliated Employer shall be recognized. 12 20 ARTICLE II TOP HEAVY PROVISIONS AND ADMINISTRATION 2.1 TOP HEAVY PLAN REQUIREMENTS For any Top Heavy Plan Year, the Plan shall provide the special vesting requirements of Code Section 416(b) pursuant to Section 6.4 of the Plan and the special minimum allocation requirements of Code Section 416(c) pursuant to Section 4.3(i) of the Plan. 2.2 DETERMINATION OF TOP HEAVY STATUS (a) This Plan shall be a Top Heavy Plan for any Plan Year beginning after December 31, 1983, in which, as of the Determination Date, (1) the Present Value of Accrued Benefits of Key Employees and (2) the sum of the Aggregate Accounts of Key Employees under this Plan and all plans of an Aggregation Group, exceeds sixty percent (60%) of the Present Value of Accrued Benefits and the Aggregate Accounts of all Key and Non-Key Employees under this Plan and all plans of an Aggregation Group. If any Participant is a Non-Key Employee for any Plan Year, but such Participant was a Key Employee for any prior Plan Year, such Participant's Present Value of Accrued Benefit and/or Aggregate Account balance shall not be taken into account for purposes of determining whether this Plan is a Top Heavy or Super Top Heavy Plan (or whether any Aggregation Group which includes this Plan is a Top Heavy Group). In addition, if a Participant or Former Participant has not performed any services for any Employer maintaining the Plan at any time during the five year period ending on the Determination Date, any accrued benefit-it for such Participant or Former Participant shall not be taken into account for the purposes of determining whether this Plan is a Top Heavy or Super Top Heavy Plan. (b) This Plan shall be a Super Top Heavy Plan for any Plan Year beginning after December 31, 1983, in which, as of the Determination Date, (1) the Present Value of Accrued Benefits of Key Employees and (2) the sum of the Aggregate Accounts of Key Employees under this Plan and all plans of an Aggregation Group, exceeds ninety percent (90%) of the Present Value of Accrued Benefits and the Aggregate Accounts of all Key and Non-Key Employees under this Plan and all plans of an Aggregation Group. (c) Aggregate Account: A Participant's Aggregate Account as of the Determination Date is the sum of: (1) his Participant's Combined Account balance as of the most recent valuation occurring within a twelve (12) month period ending on the Determination Date; (2) for a Profit Sharing Plan, an adjustment for any contributions due as of the Determination Date. Such adjustment shall be the amount of any contributions actually made after the valuation date but before the Determination Date, except for the first Plan Year when such adjustment shall also reflect the amount of any contributions made after the Determination Date that are allocated as of a date in that first Plan Year; (3) for a Money Purchase Plan, contributions that would be allocated as of a date not later than the Determination Date, even though those amounts are not yet made or required to be made. 13 21 (4) any Plan distributions made within the Plan Year that includes the Determination Date or within the four (4) preceding Plan Years. However, in the case of distributions made after the valuation date and prior to the Determination Date, such distributions are not included as distributions for top heavy purposes to the extent that such distributions are already included in the Participant's Aggregate Account balance as of the valuation date. In the case of a distribution of an annuity Contract, the amount of such distribution is deemed to be the current actuarial value of the Contract, determined on the date of the distribution. Notwithstanding anything herein to the contrary, all distributions, including distributions made prior to January 1, 1984, and distributions under a terminated plan which if it had not been terminated would have been required to be included in an Aggregation Group, will be counted. Further, distributions from the Plan (including the cash value of life insurance policies) of a Participant's account balance because of death shall be treated as a distribution for the purpose of this paragraph. (5) any Employee contributions, whether voluntary or mandatory. However, amounts attributable to tax deductible qualified voluntary employee contributions shall not be considered to be a part of the Participant's Aggregate Account balance. (6) with respect to unrelated rollovers and plan-to-plan transfers (ones which are both initiated by the Employee and made from a plan maintained by one employer to a plan maintained by another employer), if this Plan provides the rollovers or plan-to-plan transfers, it shall always consider such rollovers or plan-to-plan transfers as a distribution for the purposes of this Section. If this Plan is the plan accepting such rollovers or plan-to-plan transfers, it shall not consider such rollovers or plan-to-plan transfers accepted after December 31, 1983 as part of the Participant's Aggregate Account balance. However, rollovers or plan-to-plan transfers accepted prior to January 1, 1984 shall be considered as part of the Participant's Aggregate Account balance. (7) with respect to related rollovers and plan-to-plan transfers (ones either not initiated by the Employee or made to a plan maintained by the same employer), if this Plan provides the rollover or plan-to-plan transfer, it shall not be counted as a distribution for purposes of this Section. If this Plan is the plan accepting such rollover or plan-to-plan transfer, it shall consider such rollover or plan-to-plan transfer as part of the Participant's Aggregate Account balance, irrespective of the date on which such rollover or plan-to-plan transfer is accepted. (8) For the purposes of determining whether two employers are to be treated as the same employer in 2.2(c)(6) and 2.2(c)(7) above, all employers aggregated under Code Section 414(b), (c), (m) and (o) are treated as the same employer. (d) "Aggregation Group" means either a Required Aggregation Group or a Permissive Aggregation Group as hereinafter determined. (1) Required Aggregation Group: In determining a Required Aggregation Group hereunder, each qualified plan of the Employer, including any Simplified Employee Pension Plan, in which a Key Employee is a participant in the Plan Year containing the Determination Date or any of the four preceding Plan Years, and each other qualified plan of the Employer which enables any qualified plan in which a Key Employee participates to meet the requirements of Code Sections 401 (a)(4) or 410, will be required to be aggregated. Such group shall be known as a Required Aggregation Group. In the case of a Required Aggregation Group, each plan in the group will be considered a Top Heavy Plan if the Required Aggregation Group is a Top Heavy Group. No plan in the 14 22 Required Aggregation Group will be considered a Top Heavy Plan if the Required Aggregation Group is not a Top Heavy Group. (2) Permissive Aggregation Group: The Employer may also include any other plan of the Employer, including any Simplified Employee Pension Plan, not required to be included in the Required Aggregation Group, provided the resulting group, taken as a whole, would continue to satisfy the provisions of Code Sections 401(a)(4) and 410. Such group shall be known as a Permissive Aggregation Group. In the case of a Permissive Aggregation Group, only a plan that is part of the Required Aggregation Group will be considered a Top Heavy Plan if the Permissive Aggregation Group is a Top Heavy Group. No plan in the Permissive Aggregation Group will be considered a Top Heavy Plan if the Permissive Aggregation Group is not a Top Heavy Group. (3) Only those plans of the Employer in which the Determination Dates fall within the same calendar year shall be aggregated in order to determine whether such plans are Top Heavy Plans. (4) An Aggregation Group shall include any terminated plan of the Employer if it was maintained within the last five (5) years ending on the Determination Date. (e) "Determination Date" means (a) the last day of the preceding Plan Year, or (b) in the case of the first Plan Year, the last day of such Plan Year. (f) Present Value of Accrued Benefit: In the case of a defined benefit plan, the Present Value of Accrued Benefit for a Participant other than a Key Employee shall be as determined using the single accrual method used for all plans of the Employer and Affiliated Employers, or if no such single method exists, using a method which results in benefits accruing not more rapidly than the slowest accrual rate permitted under Code Section 41l(b)(1)(C). The determination of the Present Value of Accrued Benefit shall be determined as of the most recent valuation date that falls within or ends with the 12-month period ending on the Determination Date, except as provided in Code Section 416 and the Regulations thereunder for the first and second plan years of a defined benefit Plan. However, any such determination must include present value of accrued benefit attributable to any Plan distributions referred to in Section 2.2(c)(4) above, any Employee contributions referred to in Section 2.2(c)(5) above or any related or unrelated rollovers referred to in Sections 2.2(c)(6) and 2.2(c)(7) above. (g) "Top Heavy Group" means an Aggregation Group in which, as of the Determination Date, the sum of: (1) the Present Value of Accrued Benefits of Key Employees under all defined benefit plans included in the group, and (2) the Aggregate Accounts of Key Employees under all defined contribution plans included in the group, exceeds sixty percent (60%) of a similar sum determined for all Participants. 15 23 (h) The Administrator shall determine whether this Plan is a Top Heavy Plan on the Anniversary Date specified in the Adoption Agreement. Such determination of the top heavy ratio shall be in accordance with Code Section 416 and the Regulations thereunder. 2.3 POWERS AND RESPONSIBILITIES OF THE EMPLOYER (a) The Employer shall be empowered to appoint and remove the Trustee and the Administrator from time For time as it deems necessary for the proper administration of the Plan to assure that the Plan is being operated for the exclusive benefit of the Participants and their Beneficiaries in accordance with the terms of the Plan, the Code, and the Act. (b) The Employer shall establish a "funding policy and method," i.e., it shall determine whether the Plan has a short run need for liquidity (e.g., to pay benefits) or whether liquidity is a long run goal and investment growth (and stability of same) is a more current need, or shall appoint a qualified person to do so. The Employer or its delegate shall communicate such needs and goals to the Trustee, who shall coordinate such Plan needs with its investment policy. The communication of such a "funding policy and method" shall not, however, constitute a directive to the Trustee as to investment of the Trust Funds. Such "funding policy and method" shall be consistent with the objectives of this Plan and with the requirements of Title 1 of the Act. (c) If a separate trust is not being used pursuant to the election in the Adoption Agreement, the Employer may, in its discretion, appoint an Investment Manager to manage all or a designated portion of the assets of the Plan. In such event, the Trustee shall follow the directive of the Investment Manager in investing the assets of the Plan managed by the Investment Manager. (d) The Employer shall periodically review the performance of any Fiduciary or other person to whom duties have been delegated or allocated by it under the provisions of this Plan or pursuant to procedures established hereunder. This requirement may be satisfied by formal periodic review by the Employer or by a qualified person specifically designated by the Employer, through day-to-day conduct and evaluation, or through other appropriate ways. 2.4 DESIGNATION OF ADMINISTRATIVE AUTHORITY The Employer shall appoint one or more Administrators. Any person, including, but not limited to, the Employees of the Employer, shall be eligible to serve as an Administrator. Any person so appointed shall signify his acceptance by filing written acceptance with the Employer. An Administrator may resign by delivering his written resignation to the Employer or be removed by the Employer by delivery of written notice of removal, to take effect at a date specified therein, or upon delivery to the Administrator if no date is specified. The Employer, upon the resignation or removal of an Administrator, shall promptly designate in writing a successor to this position. If the Employer does not appoint an Administrator, the Employer will function as the Administrator. 2.5 ALLOCATION AND DELEGATION OF RESPONSIBILITIES If more than one person is appointed as Administrator, the responsibilities of each Administrator may be specified by the Employer and accepted in writing by each Administrator. In the event that no such delegation is made by the Employer, the Administrators may allocate the responsibilities among themselves, in which event the Administrators shall notify the Employer and the Trustee in writing of such action and specify the responsibilities of each Administrator. The Trustee thereafter shall accept and rely upon any 16 24 documents executed by the appropriate Administrator until such time as the Employer or the Administrators file with the Trustee a written revocation of such designation. 2.6 POWERS AND DUTIES OF THE ADMINISTRATOR The primary responsibility of the Administrator is to administer the Plan for the exclusive benefit of the Participants and their Beneficiaries, subject to the specific terms of the Plan. The Administrator shall administer the Plan in accordance with its terms and shall have the power and discretion to construe the terms of the Plan and determine all questions arising in connection with the administration, interpretation, and application of the Plan. Any such determination by the Administrator shall be conclusive and binding upon all persons. The Administrator may establish procedures, correct any defect, supply any information, or reconcile any inconsistency in such manner and to such extent as shall be deemed necessary or advisable to carry out the purpose of the Plan; provided, however, that any procedure, discretionary act, interpretation or construction shall be done in a nondiscriminatory manner based upon uniform principles consistently applied and shall be consistent with the intent that the Plan shall continue to be deemed a qualified plan under the terms of Code Section 401(a), and shall comply with the terms of the Act and all regulations issued pursuant thereto. The Administrator shall have all powers necessary or appropriate to accomplish his duties under this Plan. The Administrator shall be charged with the duties of the general administration of the Plan, including, but not limited to, the following: (a) the discretion to determine all questions relating to the eligibility of Employees to participate or remain a Participant hereunder and to receive benefits under the Plan; (b) to compute, certify, and direct the Trustee with respect to the amount and the kind of benefit to which any Participant shall be entitled hereunder; (c) to authorize and direct the Trustee with respect to all nondiscretionary or otherwise directed disbursements from the Trust Fund; (d) to maintain all necessary records for the administration of the Plan; (e) to interpret the provisions of the Plan and to make and publish such rules for regulation of the Plan as are consistent with the terms hereof; (f) For determine the size and type of any Contract to be purchased from any Insurer, and to designate the Insurer from which such Contract shall be purchased; (g) For compute and certify to the Employer and to the Trustee from time to time the sums of money necessary or desirable to be contributed For the Trust Fund; (h) to consult with the Employer and the Trustee regarding the short and long-term liquidity needs of the Plan in order that the Trustee can exercise any investment discretion in a manner designed to accomplish specific objectives; (i) For prepare and distribute to Employees a procedure for notifying Participants and Beneficiaries of their rights to elect Joint and Survivor Annuities and Pre-Retirement Survivor Annuities if required by the Code and Regulations thereunder; (j) to assist any Participant regarding his rights, benefits, or elections available under the Plan. 17 25 2.7 RECORDS AND REPORTS The Administrator shall keep a record of all actions taken and shall keep all other books of account, records, and other data that may be necessary for proper administration of the Plan and shall be responsible for supplying all information and reports to the Internal Revenue Service, Department of Labor, Participants, Beneficiaries and others as required by law. 2.8 APPOINTMENT OF ADVISERS The Administrator, or the Trustee with the consent of the Administrator, may appoint counsel, specialists, advisers, and other persons as the Administrator or the Trustee deems necessary or desirable in connection with the administration of this Plan. 2.9 INFORMATION FROM EMPLOYER To enable the Administrator to perform his functions, the Employer shall supply full and timely information to the Administrator on all matters relating to the Compensation of all Participants, their Hours of Service, their Years of Service, their retirement, death, disability, or termination of employment, and such other pertinent facts as the Administrator may require; and the Administrator shall advise the Trustee of such of the foregoing facts as may be pertinent to the Trustee's duties under the Plan. The Administrator may rely upon such information as is supplied by the Employer and shall have no duty or responsibility to verify such information. 2.10 PAYMENT OF EXPENSES All expenses of administration may be paid out of the Trust Fund unless paid by the Employer. Such expenses shall include any expenses incident to the functioning of the Administrator, including, but not limited to, fees of accountants, counsel, and other specialists and their agents, and other costs of administering the Plan. Until paid, the expenses shall constitute a liability of the Trust Fund. However, the Employer may reimburse the Trust Fund for any administration expense incurred. Any administration expense paid to the Trust Fund as a reimbursement shall not be considered an Employer contribution. 2.11 MAJORITY ACTIONS Except where there has been an allocation and delegation of administrative authority pursuant to Section 2.5, if there shall be more than one Administrator, they shall act by a majority of their number, but may authorize one or more of them to sign all papers on their behalf. 2.12 CLAIMS PROCEDURE Claims for benefits under the Plan may be filed in writing with the Administrator. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the application is filed. In the event the claim is denied, the reasons for the denial shall be specifically set forth in the notice in language calculated to be understood by the claimant, pertinent provisions of the Plan shall be cited, and, where appropriate, an explanation as to how the claimant can perfect the claim will be provided. In addition, the claimant shall be furnished with an explanation of the Plan's claims review procedure. 2.13 CLAIMS REVIEW PROCEDURE Any Employee, former Employee, or Beneficiary of either, who has been denied a benefit by a decision of the Administrator pursuant For Section 2.12 shall be entitled to request the Administrator to give further consideration to his claim by filing with the Administrator a written request for a hearing. Such request, 18 26 together with a written statement of the reasons why the claimant believes his claim should be allowed, shall be filed with the Administrator no later than 60 days after receipt of the written notification provided for in Section 2.12. The Administrator shall then conduct a hearing within the next 60 days, at which the claimant may be represented by an attorney or any other representative of his choosing and expense and at which the claimant shall have an opportunity to submit written and oral evidence and arguments in support of his claim. At the hearing (or prior thereto upon 5 business days written notice to the Administrator) the claimant or his representative shall have an opportunity to review all documents in the possession of the Administrator which are pertinent to the claim at issue and its disallowance. Either the claimant or the Administrator may cause a court reporter to attend the hearing and record the proceedings. In such event, a complete written transcript of the proceedings shall be furnished to both parties by the court reporter. The full expense of any such court reporter and such transcripts shall be done by the party causing the court reporter to attend the hearing. A final decision as to the allowance of the claim shall be made by the Administrator within 60 days of receipt of the appeal (unless there has been an extension of 60 days due to special circumstances, provided the delay and the special circumstances occasioning it are communicated to the claimant within the 60 day period). Such communication shall be written in a manner calculated to be understood by the claimant and shall include specific reasons for the decision and specific references to the pertinent Plan provisions on which the decision is based. ARTICLE III ELIGIBILITY 3.1 CONDITIONS OF ELIGIBILITY Any Eligible Employee shall be eligible to participate hereunder on the date he has satisfied the requirements specified in the Adoption Agreement. 3.2 EFFECTIVE DATE OF PARTICIPATION An Eligible Employee who has become eligible to be a Participant shall become a Participant effective as of the day specified in the Adoption Agreement. In the event an Employee who has satisfied the Plan's eligibility requirements and would otherwise have become a Participant shall go from a classification of a noneligible Employee to an Eligible Employee, such Employee shall become a Participant as of the date he becomes an Eligible Employee. In the event an Employee who has satisfied the Plan's eligibility requirements and would otherwise become a Participant shall go from a classification of an Eligible Employee to a noneligible Employee and becomes ineligible to participate and has not incurred a 1-Year Break in Service, such Employee shall participate in the Plan as of the date he returns to an eligible class of Employees. If such Employee does incur a 1-Year Break in Service, eligibility will be determined under the Break in Service rules of the Plan. 3.3 DETERMINATION OF ELIGIBILITY The Administrator shall determine the eligibility of each Employee for participation in the Plan based upon information furnished by the Employer. Such determination shall be conclusive and binding upon all persons, as long as the same is made pursuant to the Plan and the Act. Such determination shall be subject to review per Section 2.13 19 27 3.4 TERMINATION OF ELIGIBILITY In the event a Participant shall go from a classification of an Eligible Employee to an ineligible Employee, such Former Participant shall continue to vest in his interest in the Plan for each Year of Service completed while a noneligible Employee, until such time as his Participant's Account shall be forfeited or distributed pursuant to the terms of the Plan. Additionally, his interest in the Plan shall continue to share in the earnings of the Trust Fund. 3.5 OMISSION OF ELIGIBLE EMPLOYEE If, in any Plan Year, any Employee who should be included as a Participant in the Plan is erroneously omitted and discovery of such omission is not made until after a contribution by his Employer for the year has been made, the Employer shall make a subsequent contribution, if necessary after the application of Section 4.3(c), so that the omitted Employee receives a total amount which the said Employee would have received had he not been omitted. Such contribution shall be made regardless of whether or not it is deductible in whole or in part in any taxable year under applicable provisions of the Code. 3.6 INCLUSION OF INELIGIBLE EMPLOYEE If, in any Plan Year, any person who should not have been included as a Participant in the Plan is erroneously included and discovery of such incorrect inclusion is not made until after a contribution for the year has been made, the Employer shall not be entitled to recover the contribution made with respect to the ineligible person regardless of whether or not a deduction is allowable with respect to such contribution. In such event, the amount contributed with respect to the ineligible person shall constitute a Forfeiture for the Plan Year in which the discovery is made. 3.7 ELECTION NOT TO PARTICIPATE An Employee may, subject to the approval of the Employer, elect voluntarily not to participate in the Plan. The election not to participate must be communicated to the Employer, in writing, at least thirty (30) days before the beginning of a Plan Year. For Standardized Plans, a Participant or an Eligible Employee may not elect not to participate. Furthermore, the foregoing election not to participate shall not be available with respect to partners in a partnership. 3.8 CONTROL OF ENTITIES BY OWNER-EMPLOYEE (a) 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 entities, this Plan and the plan established for other trades or businesses must, when looked at as a single Plan, satisfy Code Sections 401(a) and (d) for the Employees of this and all other entities. (b) If the Plan provides contributions or benefit 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 Sections 401(a) and (d) and which provides contributions and benefits not less favorable than provided for Owner-Employees under this Plan. (c) If an individual is covered as an Owner-Employee under the plans of two or more trades or businesses which are not controlled and the individual controls a trade or business, then the benefits or contributions of the employees under the plan of the trades or businesses which are controlled must be as favorable as those provided for him under the most favorable plan of the trade or business which is not controlled. 20 28 (d) For purposes of the preceding paragraphs, an Owner-Employee, or two or more Owner-Employees, will be considered to control an entity if the Owner-Employee, or two or more Owner-Employees together: (1) own the entire interest in an unincorporated entity, or (2) in the case of a partnership, own more than 50 percent of either the capital interest or the profits interest in the partnership. (c) For purposes of the preceding sentence, an Owner-Employee, or two or more Owner-Employees shall be treated as owning any interest in a partnership which is owned, directly or indirectly, by a partnership which such Owner-Employee, or such two or more Owner-Employees, are considered to control within the meaning of the preceding sentence. ARTICLE IV CONTRIBUTION AND ALLOCATION 4.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION (a) For a Money Purchase Plan - (1) The Employer shall make contributions over such period of years as the Employer may determine on the following basis. On behalf of each Participant eligible to share in allocations, for each year of his participation in this Plan, the Employer shall contribute the amount specified in the Adoption Agreement. All contributions by the Employer shall be made in cash or in such property as is acceptable to the Trustee. The Employer shall be required to obtain a waiver from the Internal Revenue Service for any Plan Year in which it is unable to make the full required contribution to the Plan. In the event a waiver is obtained, this Plan shall be deemed to be an individually designed plan. (2) For any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, the Employer shall not contribute on behalf of a Participant who performs less than a Year of Service during any Plan Year, unless there is a Short Plan Year or a contribution is required pursuant to 4.3(h). (3) Notwithstanding the foregoing, the Employer's contribution for any Fiscal Year shall not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. However, to the extent necessary to provide the top heavy minimum allocations, the Employer shall make a contribution even if it exceeds the amount which is deductible under Code Section 404. (b) For a Profit Sharing Plan - (1) For each Plan Year, the Employer shall contribute to the Plan such amount as specified by the Employer in the Adoption Agreement. Notwithstanding the foregoing, however, the Employer's contribution for any Fiscal Year shall not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. All contributions by the Employer shall be made in cash or in such property as is acceptable to the Trustee. 21 29 (2) Except, however, to the extent necessary to provide the top heavy minimum allocations, the Employer shall make a contribution even if it exceeds current or accumulated Net Profit or the amount which is deductible under Code Section 404. 4.2 TIME OF PAYMENT OF EMPLOYER'S CONTRIBUTION The Employer shall generally pay to the Trustee its contribution to the Plan for each Plan Year within the time prescribed by law, including extensions of time, for the filing of the Employer's federal income tax return for the Fiscal Year. 4.3 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS (a) The Administrator shall establish and maintain an account in the name of each Participant to which the Administrator shall credit as of each Anniversary Date, or other valuation date, all amounts allocated to each such Participant as set forth herein. (b) The Employer shall provide the Administrator with all information required by the Administrator to make a proper allocation of the Employer's contributions for each Plan Year. Within a reasonable period of time after the date of receipt by the Administrator of such information, the Administrator shall allocate such contribution as follows: (1) For a Money Purchase Plan: (i) The Employer's Contribution shall be allocated to each Participant's Combined Account in the manner set forth in Section 4.1 herein and as specified in Section E2 of the Adoption Agreement. (2) For an Integrated Profit Sharing Plan: (i) The Employer's contribution shall be allocated to each Participant's Account, except as provided in Section 4.3(f), in a dollar amount equal to 5.7% of the sum of each Participant's total Compensation plus Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his total Compensation plus his total Excess Compensation for the Plan Year bears to the total Compensation plus the total Excess Compensation of all Participants for that year. Regardless of the preceding, 4.3% shall be substituted for 5.7% above if Excess Compensation is based on more than 20% and less than or equal to 80% of the Taxable Wage Base. If Excess Compensation is based on less than 100% and more than 80% of the Taxable Wage Base, then 5.4% shall be substituted for 5.7% above. (ii) The balance Of the Employer's contribution over the amount allocated above, if any, shall be allocated to each Participant's Combined Account in the same proportion that his total Compensation for the Year bears to the total Compensation of all Participants for such year. (iii) Except, however, for any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, a Participant who performs less than a Year of Service during any Plan Year shall not share in the Employer's contribution for that year, unless there is a Short Plan Year or a contribution is required pursuant to Section 4.3(h). 22 30 (3) For a Non-Integrated Profit Sharing Plan: (i) The Employer's contribution shall be allocated to each Participant's Account in the same proportion that each such Participant's Compensation for the year bears to the total Compensation of all Participants for such year. (ii) Except, however, for any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, a Participant who performs less than a Year of Service during any Plan Year shall not share in the Employer's contribution for that year, unless there is a Short Plan Year or a contribution is required pursuant to Section 4.3(h). (c) As of each Anniversary Date or other valuation date, before allocation of Employer contributions and Forfeitures, any earnings or losses (net appreciation or net depreciation) of the Trust Fund shall be allocated in the same proportion that each Participant's and Former Participant's nonsegregated accounts bear to the total of all Participants' and Former Participants' nonsegregated accounts as of such date. If any nonsegregated account of a Participant has been distributed prior to the Anniversary Date or other valuation date subsequent to a Participant's termination of employment, no earnings or losses shall be credited to such account. Notwithstanding the above, with respect to contributions made to a 401(k) Plan after the previous Anniversary Date or allocation date, the method specified in the Adoption Agreement shall be used. (d) Participants' Accounts shall be debited for any insurance or annuity premiums paid, if any, and credited with any dividends or interest received on insurance contracts. (e) As of each Anniversary Date any amounts which became Forfeitures since the last Anniversary Date shall first be made available to reinstate previously forfeited account balances of Former Participants, if any, in accordance with Section 6.4(g)(2) or be used to satisfy any contribution that may be required pursuant to Section 3.5 and/or 6.9. The remaining Forfeitures, if any, shall be treated in accordance with the Adoption Agreement. Provided, however, that in the event the allocation of Forfeitures provided herein shall cause the "annual addition" (as defined in Section 4.4) to any Participant's Account to exceed the amount allowable by the Code, the excess shall be reallocated in accordance with Section 4.5. Except, however, for any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, a Participant who performs less than a Year of Service during any Plan Year shall not share in the Plan Forfeitures for that year, unless there is a Short Plan Year or a contribution required pursuant to Section 4.3(h). (f) Minimum Allocations Required for Top Heavy Plan Years: Notwithstanding the foregoing, for any Top Heavy Plan Year, the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each Non-Key Employee shall be equal to at least three percent (3%) of such Non-Key Employee's "415 Compensation" (reduced by contributions and forfeitures, if any, allocated to each Non-Key Employee in any defined contribution plan included with this plan in a Required Aggregation Group). However, if (i) the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each Key Employee for such Top Heavy Plan Year is less than three percent (3%) of each Key Employee's "415 Compensation" and (ii) this Plan is not required to be included in an Aggregation Group to enable a defined benefit plan For meet the requirements of Code Section 401(a)(4) or 410, the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each 23 31 Non-Key Employee shall be equal to the largest percentage allocated to the Participant's Combined Account of any Key Employee. However, for each Non-Key Employee who is a Participant in a paired Profit Sharing Plan or 401(k) Profit Sharing Plan and a paired Money Purchase Plan, the minimum 3% allocation specified above shall be provided in the Money Purchase Plan. If this is an integrated Plan, then for any Top Heavy Plan Year the Employer's contribution shall be allocated as follows: (1) An amount equal to 3% multiplied by each Participant's Compensation for the Plan Year shall be allocated to each Participant's Account. If the Employer does not contribute such amount for all Participants, the amount shall be allocated to each Participant's Account in the same proportion that his total Compensation for the Plan Year bears to the total Compensation of all Participants for such year. (2) The balance of the Employer's contribution over the amount allocated under subparagraph (1) hereof shall be allocated to each Participant's Account in a dollar amount equal to 3% multiplied by a Participant's Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his Excess Compensation bears to the total Excess Compensation of all Participants for that year. (3) The balance of the Employer's contribution over the amount allocated under subparagraph (2) hereof shall be allocated to each Participant's Account in a dollar amount equal to 2.7% multiplied by the sum of each Participant's total Compensation plus Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his total Compensation plus his total Excess Compensation for the Plan Year bears to the total Compensation plus the total Excess Compensation of all Participants for that year. Regardless of the preceding, 1.3% shall be substituted for 2.7% above if Excess Compensation is based on more than 20% and less than or equal to 80% of the Taxable Wage Base. If Excess Compensation is based on less than 100% and more than 80% of the Taxable Wage Base, then 2.4% shall be substituted for 2.7% above. (4) The balance of the Employer's contributions over the amount allocated above, if any, shall be allocated to each Participant's Account in the same proportion that his total Compensation for the Plan Year bears to the total Compensation of all Participants for such year. For each Non-Key Employee who is a Participant in this Plan and another non-paired defined contribution plan maintained by the Employer, the minimum 3% allocation specified above shall be provided as specified in F3 of the Adoption Agreement. (g) For purposes of the minimum allocations set forth above, the percentage allocated to the Participant's Combined Account of any Key Employee shall be equal to the ratio of the sum of the Employer's contributions and Forfeitures allocated on behalf of such Key Employee divided by the "415 Compensation" for such Key Employee. (h) For any Top Heavy Plan Year, the minimum allocations Set forth in this Section shall be allocated to the Participant's Combined Account of all Non-Key Employees who are Participants and 24 32 who are employed by the Employer on the last day of the Plan Year, including Non-Key Employees who have (1) failed the complete a Year of Service; or (2) declined to make mandatory contributions (if required) or, in the case of a cash or deferred arrangement, elective contributions to the Plan. (i) Notwithstanding anything herein to the contrary, in any Plan Year in which the Employer maintains both this Plan and a defined benefit pension plan included in a Required Aggregation Group which is top heavy, the Employer shall not be required to provide a Non-Key Employee with both the full separate minimum defined benefit plan benefit and the full separate defined contribution plan allocations. Therefore, if the Employer maintains both a Defined Benefit and a Defined Contribution Plan that are a Top Heavy Group, the top heavy minimum benefits shall be provided as follows: (1) Applies if F1b of the Adoption Agreement is Selected: (i) The requirements of Section 2.1 shall apply except that each Non-Key Employee who is a Participant in the Profit Sharing Plan or Money Purchase Plan and who is also a Participant in the Defined Benefit Plan shall receive a minimum allocation of five percent (5%) of such Participant's "415 Compensation" from the applicable Defined Contribution Plan(s). (ii) For each Non-Key Employee who is a Participant only in the Defined Benefit Plan the Employer will provide a minimum non-integrated benefit equal to 2% of his highest five consecutive year average "415 Compensation" for each Year of Service while a Participant in the Plan, in which the Plan is top heavy, not to exceed ten. (iii) For each Non-Key Employee who is a Participant only in this Defined Contribution Plan, the Employer shall provide a contribution equal to 3% of his "415 Compensation." (2) Applies if F1c of the Adoption Agreement is Selected: (i) The minimum allocation specified in Section 4.3(i)(1)(i) shall be 7 1/2% if the Employer elects in the Adoption Agreement for years in which the Plan is Top Heavy, but not Super Top Heavy. (ii) The minimum benefit specified in Section 4.3(i)(1)(ii) shall be 3% if the Employer elects in the Adoption Agreement for years in which the Plan is Top Heavy, but not Super Top Heavy. (iii) The minimum allocation specified in Section 4.3(i)(1)(iii) shall be 4% if the Employer elects in the Adoption Agreement for years in which the Plan is Top Heavy, but not Super Top Heavy. (j) For the purposes of this Section, "415 Compensation" shall be limited to $200,000 (unless adjusted in such manner as permitted under Code Section 415(d)). However, for Plan Years beginning prior to January 1, 1989, the $200,000 limit shall apply only for Top Heavy Plan Years and shall not be adjusted. (k) Notwithstanding anything herein to the contrary, any Participant who terminated employment during the Plan Year for reasons other than death, Total and Permanent Disability, or retirement shall or shall not share in the allocations of the Employer's Contributions and Forfeitures as provided in the Adoption Agreement. Notwithstanding the foregoing, for Plan Years beginning 25 33 after 1989, if this is a standardized Plan, any such terminated Participant shall share in the allocations as provided in this Section provided such Participant completed more than 500 Hours of Service. (l) Notwithstanding anything herein to the contrary, Participants terminating for reasons of death, Total and Permanent Disability, or retirement shall share in the allocations as provided in this Section regardless of whether they completed a Year of Service during the Plan Year. (m) If a Former Participant is reemployed after five (5) consecutive 1-Year Breaks in Service, then separate accounts shall be maintained as follows: (1) one account for nonforfeitable benefits attributable to pre-break service; and (2) one account representing his employer derived account balance in the Plan attributable to post-break service. (n) Notwithstanding any election in the Adoption Agreement to the contrary, if this is a non-standardized Plan that would otherwise fail to meet the requirements of Code Sections 401(a)(26), 410(b)(1), or 410(b)(2)(A)(i) and the Regulations thereunder because Employer Contributions have not been allocated to a sufficient number or percentage of Participants for a Plan Year, then the following rules shall apply: (1) The group of Participants eligible to share in the Employer's contribution and Forfeitures for the Plan Year shall be expanded to include the minimum number of Participants who would not otherwise be eligible as are necessary to satisfy the applicable test specified above. The specific participants who shall become eligible under the terms of this paragraph shall be those who are actively employed on the last day of the Plan Year and, when compared to similarly situated Participants, have completed the greatest number of Hours of Service in the Plan Year. (2) If after application of paragraph (1) above, the applicable test is still not satisfied, then the group of Participants eligible to share in the Employer's contribution and Forfeitures for the Plan Year shall be further expanded to include the minimum number of Participants who are not actively employed on the last day of the Plan Year as are necessary to satisfy the applicable test. The specific Participants who shall become eligible to share shall be those Participants, when compared to similarly situated Participants, who have completed the greatest number of Hours of Service in the Plan Year before terminating employment. Nothing in this Section shall permit the reduction of a Participant's accrued benefit. Therefore any amounts that have previously been allocated to Participants may not be reallocated to satisfy these requirements. In such event, the Employer shall make an additional contribution equal to the amount such affected Participants would have received had they been included in the allocations, even if it exceeds the amount which would be deductible under Code Section 404. Any adjustment to the allocations pursuant to this paragraph shall be considered a retroactive amendment adopted by the last day of the Plan Year. 4.4 MAXIMUM ANNUAL ADDITIONS (a)(1) If the Participant does not participate in, and has never participated in another qualified plan maintained by the Employer, or a welfare benefit fund (as defined in Code Section 419(c)), maintained by the Employer, or an individual medical account (as defined in Code Section 415(i)(2)) maintained by the Employer, which provides Annual Additions, the amount of Annual Additions which may be credited to the Participant's accounts for any Limitation Year shall not exceed the 26 34 lesser of the Maximum Permissible Amount or any other limitation contained in this Plan. If the Employer contribution that would otherwise be contributed or allocated to the Participant's accounts would cause the Annual Additions for the Limitation Year to exceed the Maximum Permissible Amount, the amount contributed or allocated will be reduced so that the Annual Additions for the Limitation Year will equal the Maximum Permissible Amount. (2) Prior to determining the Participant's actual Compensation for the Limitation Year, the Employer may determine the Maximum Permissible Amount for a Participant on the basis of a reasonable estimation of the Participant's Compensation for the Limitation Year, uniformly determined for all Participants similarly situated. (3) As soon as is administratively feasible after the end of the Limitation Year, the Maximum Permissible Amount for such Limitation Year shall be determined on the basis of the Participant's actual compensation for such Limitation Year. (4) If there is an excess amount pursuant to Section 4.4(a)(2) or Section 4.5, the excess will be disposed of in one of the following manners, as uniformly determined by the Plan Administrator for all Participants similarly situated: (i) Any Deferred Compensation or nondeductible Voluntary Employee Contributions, to the extent they would reduce the Excess Amount, will be distributed to the Participant; (ii) If, after the application of subparagraph (i), an Excess Amount still exists, and the Participant is covered by the Plan at the end of the Limitation Year, the Excess Amount in the Participant's account will be used to reduce Employer contributions (including any allocation of Forfeitures) for such Participant in the next Limitation Year, and each succeeding Limitation Year if necessary; (iii) If, after the application of subparagraph (i), an Excess Amount still exists, and the Participant is not covered by the Plan at the end of a Limitation Year, the Excess Amount will be held unallocated in a suspense account. The suspense account will be applied to reduce future Employer contributions (including allocation of any Forfeitures) for all remaining Participants in the next Limitation Year, and each succeeding Limitation Year if necessary; (iv) If a suspense account is in existence at any time during a Limitation Year pursuant to this Section, it will not participate in the allocation of investment gains and losses. If a suspense account is in existence at any time during a particular limitation year, all amounts in the suspense account must be allocated and reallocated to participants' accounts before any employer contributions or any employee contributions may be made to the plan for that limitation year. Excess amounts may not be distributed to participants or former participants. (b)(1) This subsection applies if, in addition to this Plan, the Participant is covered under another qualified Prototype defined contribution plan maintained by the Employer, or a welfare benefit fund (as defined in Code Section 419(e)) maintained by the Employer, or an individual medical account (as defined in Code Section 415(l)(2)) maintained by the Employer, which provides Annual Additions, during any Limitation Year. The Annual Additions which may be credited to a Participant s accounts under this Plan for any such Limitation Year shall not exceed the Maximum Permissible Amount reduced by the Annual Additions credited to a Participant's accounts under the other plans and welfare benefit funds for the same Limitation Year. If the Annual Additions with respect to the Participant under other defined contribution plans and welfare benefit funds maintained 27 35 by the Employer are less than the Maximum Permissible Amount and the Employer contribution that would otherwise be contributed or allocated to the Participant's accounts under this Plan would cause the Annual Additions for the Limitation Year to exceed this limitation, the amount contributed or allocated will be reduced so that the Annual Additions under all such plans and welfare benefit funds for the Limitation Year will equal the Maximum Permissible Amount. If the Annual Additions with respect to the Participant under such other defined contribution plans and welfare benefit funds in the aggregate are equal to or greater than the Maximum Permissible Amount, no amount will be contributed or allocated to the Participant's account under this Plan for the Limitation Year. (2) Prior to determining the Participant's actual Compensation for the Limitation Year, the Employer may determine the Maximum Permissible Amount for a Participant in the manner described in Section 4.4(a)(2). (3) As soon as is administratively feasible after the end of the Limitation Year, the Maximum Permissible Amount for the Limitation Year will be determined on the basis of the Participant's actual Compensation for the Limitation Year. (4) If, pursuant to Section 4.4(b)(2) or Section 4.5, a Participant's Annual Additions under this Plan and such other plans would result in an Excess Amount for a Limitation Year, the Excess Amount will be deemed to consist of the Annual Additions last allocated, except that Annual Additions attributable to a welfare benefit fund or individual medical account will be deemed to have been allocated first regardless of the actual allocation date. (5) If an Excess Amount was allocated to a Participant on an allocation date of this Plan which coincides with an allocation date of another plan, the Excess Amount attributed to this Plan will be the product of: (i) the total Excess Amount allocated as of such date, times (ii) the ratio of (1) the Annual Additions allocated to the Participant for the Limitation Year as of such date under this Plan to (2) the total Annual Additions allocated to the Participant for the Limitation Year as of such date under this and all the other qualified defined contribution plans. (6) Any Excess Amount attributed to this Plan will be disposed in the manner described in Section 4.4(a)(4). (c) If the Participant is covered under another qualified defined contribution plan maintained by the Employer which is not a Prototype Plan, Annual Additions which may be credited to the Participant's account under this Plan for any Limitation Year will be limited in accordance with Section 4.4(b), unless the Employer provides other limitations in the Adoption Agreement. (d) If the Employer maintains, or at any time maintained, a qualified defined benefit plan covering any Participant in this Plan the sum of the Participant's Defined Benefit Plan Fraction and Defined Contribution Plan Fraction will not exceed 1.0 in any Limitation Year. The Annual Additions which may be credited to the Participant's account under this Plan for any Limitation Year will be limited in accordance with the Limitation on Allocations Section of the Adoption Agreement. Except, however, if the Plans are standardized paired plans, the rate of accrual in the defined benefit plan will be reduced to the extent necessary so that the sum of the Defined Contribution Fraction and Defined Benefit Fraction will equal 1.0. 28 36 (e) For purposes of applying the limitations of Code Section 415, the transfer of funds from one qualified plan to another is not an "annual addition." In addition, the following are not Employee contributions for the purposes of Section 4.4(f)(1)(2): (1) rollover contributions (as defined in Code Sections 402(a)(5), 403(a)(4), 403(b)(8) and 408(d)(3)); (2) repayments of loans made to a Participant from the Plan; (3) repayments of distributions received by an Employee pursuant to Code Section 41 I (a)(7)(B) (cash-outs); (4) repayments of distributions received by an Employee pursuant to Code Section 41 1(a)(3)(D) (mandatory contributions); and (5) Employee contributions to a simplified employee pension excludable from gross income under Code Section 408(k)(6). (f) For purposes of this Section, the following terms shall be defined as follows: (1) Annual Additions means the sum credited to a Participant's accounts for any Limitation Year of (1) Employer contributions, (2) effective with respect to "limitation years" beginning after December 31, 1986, Employee contributions, (3) forfeitures, (4) amounts allocated, after Mareh 31, 1984, to an individual medical account, as defined in Code Section 415(l)(2), which is part of a pension or annuity plan maintained by the Employer and (5) amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date, which are attributable to post-retirement medical benefits allocated to the separate account of a key employee (as defined in Code Section 419A(d)(3)) under a welfare benefit fund (as defined in Code Section 419(e)) maintained by the Employer. Except, however, the "415 Compensation" percentage limitation referred to in paragraph (a)(2) above shall not apply to: (1) any contribution for medical benefits (within the meaning of Code Section 419A(f)(2)) after separation from service which is otherwise treated as an "annual addition," or (2) any amount otherwise treated as an "annual addition" under Code Section 415(l)(1). Notwithstanding the foregoing, for "limitation years" beginning prior to January 1, 1987, only that portion of Employee contributions equal to the lesser of Employee contributions in excess of six percent (6%) of "415 Compensation" or one-half of Employee contributions shall be considered an "annual addition." For this purpose, any Excess Amount applied under Sections 4.4(a)(4) and 4.4(b)(6) in the Limitation Year to reduce Employer contributions shall be considered Annual Additions for such Limitation Year. (2) Compensation means a Participant's Compensation as elected in the Adoption Agreement. However, regardless of any selection made in the Adoption Agreement, "415 Compensation" shall exclude compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). For limitation years beginning after December 31, 1991, for purposes of applying the limitations of this article, compensation for a limitation year is the compensation actually paid or made available during such limitation year. Notwithstanding the preceding sentence, compensation for a participant in a defined contribution plan who is permanently and totally disabled (as defined in section 22(e)(3) of the Internal Revenue Code) is the compensation such participant would have received for the limitation year if the participant had been paid at the rate of compensation paid immediately before becoming permanently and totally disabled; such imputed compensation for the disabled participant may be taken into account only if the participant is not a Highly Compensated Employee and contributions made on behalf of such participant are nonforfeitable when made. 29 37 (3) Defined Benefit Fraction means a fraction, the numerator of which is the sum of the Participant's Projected Annual Benefits under all the defined benefit plans (whether or not terminated) maintained by the Employer, and the denominator of which is the lesser of 125 percent of the dollar limitation determined for the Limitation Year under Code Sections 415(b) and (d) or 140 percent of his Highest Average Compensation including any adjustments under Code Section 415(b). Notwithstanding the above, if the Participant was a Participant as of the first day of the first Limitation Year beginning after December 31, 1986, in one or more defined benefit plans maintained by the Employer which were in existence on May 6, 1986, the denominator of this fraction will not be less than 125 percent of the sum of the annual benefits under such plans which the Participant had accrued as of the end of the close of the last Limitation Year beginning before January 1, 1987, disregarding any changes in the terms and conditions of the plan after May 5, 1986. The preceding sentence applies only if the defined benefit plans individually and in the aggregate satisfied the requirements of Code Section 415 for all Limitation Years beginning before January 1, 1987. Notwithstanding the foregoing, for any Top Heavy Plan Year, 100 shall be substituted for 125 unless the extra minimum allocation is being made pursuant to the Employer's election in F1 of the Adoption Agreement. However, for any Plan Year in which this Plan is a Super Top Heavy Plan, 100 shall be substituted for 125 in any event. (4) Defined Contribution Dollar Limitation means $30,000, or, if greater, one-fourth of the defined benefit dollar limitation set forth in Code Section 415(b)(1) as in effect for the Limitation Year. (5) Defined Contribution Fraction means a fraction, the numerator of which is the sum of the Annual Additions to the Participant's account under all the defined contribution plans (whether or not terminated) maintained by the Employer for the current and all prior Limitation Years, (including the Annual Additions attributable to the Participant's nondeductible voluntary employee contributions to any defined benefit plans, whether or not terminated, maintained by the Employer and the annual additions attributable to all welfare benefit funds, as defined in Code Section 419(c), and individual medical accounts, as defined in Code Section 415(l)(2), maintained by the Employer), and the denominator of which is the sum of the maximum aggregate amounts for the current and all prior Limitation Years of Service with the Employer (regardless of whether a defined contribution plan was maintained by the Employer). The maximum aggregate amount in any Limitation Year is the lesser of 125 percent of the Defined Contribution Dollar Limitation or 35 percent of the Participant's Compensation for such year. For Limitation Years beginning prior to January 1, 1987, the annual addition" shall not be recomputed to treat all Employee contributions as an Annual Addition. If the Employee was a Participant as of the end of the first day of the first Limitation Year beginning after December 31, 1986, in one or more defined contribution plans maintained by the Employer which were in existence on May 5, 1986, the numerator of this fraction will be adjusted if the sum of this fraction and the Defined Benefit Fraction would otherwise exceed 1.0 under the terms of this Plan. Under the adjustment, an amount equal to the product of (1) the excess of the sum of the fractions over 1.0 times (2) the denominator of this fraction, will be permanently subtracted from the numerator of this fraction. The adjustment is calculated using the fractions as they would be computed as of the end of the last Limitation Year beginning before January 1, 1987, and disregarding any changes in the terms and conditions 30 38 of the plan made after May 5, 1986, but using the Code Section 415 limitation applicable to the first Limitation Year beginning on or after January 1, 1987. Notwithstanding the foregoing, for any Top Heavy Plan Year, 100 shall be substituted for 125 unless the extra minimum allocation is being made pursuant to the Employer's election in F1 of the Adoption Agreement. However, for any Plan Year in which this Plan is a Super Top Heavy Plan, 100 shall be substituted for 125 in any event. (6) Employer means the Employer that adopts this Plan and all Affiliated Employers, except that for purposes of this Section, Affiliated Employers shall be determined pursuant to the modification made by Code Section 415(h). (7) Excess Amount means the excess of the Participant's Annual Additions for the Limitation Year over the Maximum Permissible Amount. (8) Highest Average Compensation means the average Compensation for the three consecutive Years of Service with the Employer that produces the highest average. A Year of Service with the Employer is the 12 consecutive month period defined in Section El of the Adoption Agreement which is used to determine Compensation under the Plan. (9) Limitation Year means the Compensation Year (a 12 consecutive month period) as elected by the Employer in the Adoption Agreement. All qualified plans maintained by the Employer must use the same Limitation Year. If the Limitation Year is amended to a different 12 consecutive month period, the new Limitation Year must begin on a date within the Limitation Year in which the amendment is made. (10) Master or Prototype Plan means a plan the form of which is the subject of a favorable opinion letter from the Internal Revenue Service. (11) Maximum Permissible Amount means the maximum Annual Addition that may be contributed or allocated to a Participant's account under the plan for any Limitation Year, which shall not exceed the lesser of: (i) the Defined Contribution Dollar Limitation, or (ii) 25 percent of the Participant's Compensation for the Limitation Year. The Compensation Limitation referred to in (ii) shall not apply to any contribution for medical benefits (within the meaning of Code Sections 401(h) or 419A(f)(2)) which is otherwise treated as an annual addition under Code Sections 415(l)(1) or 419A(d)(2). If a short Limitation Year is created because of an amendment changing the Limitation Year to a different 12 consecutive month period, the Maximum Permissible Amount will not exceed the Defined Contribution Dollar Contribution multiplied by the following fraction: number of months in the short Limitation Year --------------------------------------------- 12 (12) Projected Annual Benefit means the annual retirement benefit (adjusted to an actuarially equivalent Straight life annuity if such benefit is expressed in a form other than a straight life annuity or qualified Joint and Survivor Annuity) to which the Participant would be entitled under the terms of the plan assuming: 31 39 (i) the Participant will continue employment until Normal Retirement Age (or current age, if later), and (ii) the Participant's Compensation for the current Limitation Year and all other relevant factors used to determine benefits under the Plan will remain constant for all future Limitation Years. (g) Notwithstanding anything contained in this Section to the contrary, the limitations, adjustments and other requirements prescribed in this Section shall at all times comply with the provisions of Code Section 415 and the Regulations thereunder, the terms of which are specifically incorporated herein by reference. 4.5 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS (a) If as a result of the allocation of Forfeitures, a reasonable error in estimating a Participant's annual Compensation, a reasonable error in determining the amount of elective deferrals (within the meaning of Code Section 402(g)(3)) that may be made with respect to any Participant under the limits of Section 4.4, or other facts and circumstances to which Regulation 1.415-6(b)(6) shall be applicable, the "annual additions" under this Plan would cause the maximum provided in Section 4.4 to be exceeded, the Administrator shall treat the excess in accordance with Section 4.4(a)(4). 4.6 TRANSFERS FROM QUALIFIED PLANS (a) If specified in the Adoption Agreement and with the consent of the Administrator, amounts may be transferred from other qualified plans, provided that the trust from which such funds are transferred permits the transfer to be made and the transfer will not jeopardize the tax exempt status of the Plan or create adverse tax consequences for the Employer. The amounts transferred shall be set up in a separate account herein referred to as a "Participant's Rollover Account." Such account shall be fully Vested at all times and shall not be subject to forfeiture for any reason. (b) Amounts in a Participant's Rollover Account shall be held by the Trustee pursuant to the provisions of this Plan and may not be withdrawn by, or distributed to the Participant, in whole or in part, except as provided in Paragraphs (c) and (d) of this Section. (c) Amounts attributable to elective contributions (as defined in Regulation 1.40 l(k)-I(g)(4)), including amounts treated as elective contributions, which are transferred from another qualified plan in a plan-to-plan transfer shall be subject to the distribution limitations provided for in Regulation 1.401 (k)-I(d). (d) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Participant's Rollover Account shall be used to provide additional benefits to the Participant or his Beneficiary. Any distributions of amounts held in a Participant's Rollover Account shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. Furthermore, such amounts shall be considered as part of a Participant's benefit in determining whether an involuntary cash-out of benefits without Participant consent may be made. (e) The Administrator may direct that employee transfers made after a valuation date be segregated into a separate account for each Participant until such time as the allocations pursuant to 32 40 this Plan have been made, at which time they may remain segregated or be invested as part of the general Trust Fund, to be determined by the Administrator. (f) For purposes of this Section, the term "qualified plan" shall mean any tax qualified plan under Code Section 401(a). The term "amounts transferred from other qualified plans" shall mean: (i) amounts transferred to this Plan directly from another qualified plan; (ii) lump-sum distributions received by an Employee from another qualified plan which are eligible for tax free rollover to a qualified plan and which are transferred by the Employee to this Plan within sixty (60) days following his receipt thereof; (iii) amounts transferred to this Plan from a conduit individual retirement account provided that the conduit individual retirement account has no assets other than assets which (A) were previously distributed to the Employee by another qualified plan as a lump-sum distribution B were eligible for tax-free rollover to a qualified plan and (C) were deposited in such conduit individual retirement account within sixty (60) days of receipt thereof and other than earnings on said assets; and (iv) amounts distributed to the Employee from a conduit individual retirement account meeting the requirements of clause (iii) above, and transferred by the Employee to this Plan within sixty (60) days of his receipt thereof from such conduit individual retirement account. (g) Prior to accepting any transfers to which this Section applies, the Administrator may require the Employee to establish that the amounts to be transferred to this Plan meet the requirements of this Section and may also require the Employee to provide an opinion of counsel satisfactory to the Employer that the amounts to be transferred meet the requirements of this Section. (h) Notwithstanding anything herein to the contrary, a transfer directly to this Plan from another qualified plan (or a transaction having the effect of such a transfer) shall only be permitted if it will not result in the elimination or reduction of any "Section 411(d)(6) protected benefit" as described in Section 8.1. 4.7 VOLUNTARY CONTRIBUTIONS (a) If this is an amendment to a Plan that had previously allowed voluntary Employee contributions, then, except as provided in 4.7(b) below, this Plan will not accept voluntary Employee contributions for Plan Years beginning after the Plan Year in which this Plan is adopted by the Employer. (b) For 401(k) Plans, if elected in the Adoption Agreement, each Participant may, at the discretion of the Administrator in a nondiscriminatory manner, elect to voluntarily contribute a portion of his compensation earned while a Participant under this Plan. Such contributions shall be paid to the Trustee within a reasonable period of time but in no event later than 90 days after the receipt of the contribution. (c) The balance in each Participant's Voluntary Contribution Account shall be fully Vested at all times and shall not be subject to Forfeiture for any reason. (d) A Participant may elect to withdraw his voluntary contributions from his Voluntary Contribution Account and the actual earnings thereon in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. If the Administrator maintains sub-accounts with respect to voluntary contributions (and earnings thereon) which were made on or before a specified date, a Participant shall be permitted to designate which sub-account shall be the source for his withdrawal. No Forfeitures shall occur solely as a result of an Employee's withdrawal of Employee contributions. 33 41 In the event such a withdrawal is made, or in the event a Participant has received a hardship distribution pursuant to Regulation 1.401 (k)-1 (d)(2)(iii)(B) from any plan maintained by the Employer, then such Participant shall be barred from making any voluntary contributions for a period of twelve (12) months after receipt of the withdrawal or distribution. (e) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Voluntary Contribution Account shall be used to provide additional benefits to the Participant or his Beneficiary. (f) The Administrator may direct that voluntary contributions made after a valuation date be segregated into a separate account until such time as the allocations pursuant to this Plan have been made, at which time they may remain segregated or be invested as part of the general Trust Fund, to be determined by the Administrator. 4.8 DIRECTED INVESTMENT ACCOUNT (a) If elected in the Adoption Agreement, all Participants shall direct the Trustee as to the investment of all of their individual account balances. Participants shall direct the Trustee in writing to invest their account in specific assets as permitted by the Administrator provided such investments are in accordance with the Department of Labor regulations and are permitted by the Plan. That portion of the account of any Participant so directing will thereupon be considered a Directed Investment Account. (b) A separate Directed Investment Account shall be established for each Participant who has directed an investment. Transfers between the Participant's regular account and their Directed Investment Account shall be charged and credited as the case may be to each account. The Directed Investment Account shall not share in Trust Fund Earnings, but it shall be charged or credited as appropriate with the net earnings, gains, losses and expenses as well as any appreciation or depreciation in market value during each Plan Year attributable to such account. (c) The Administrator shall establish a procedure, to be applied in a uniform and nondiscriminatory manner, setting forth the permissible investment options under this Section, how often changes between investments may be made, and any other limitations that the Administrator shall impose on a Participant's right to direct investments. 4.9 QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTIONS (a) If this is an amendment to a Plan that previously permitted deductible voluntary contributions, then each Participant who made a "Qualified Voluntary Employee Contribution" within the meaning of Code Section 219(e)(2) as it existed prior to the enactment of the Tax Reform Act of 1986, shall have his contribution held in a separate Qualified Voluntary Employee Contribution Account which shall be fully Vested at all times. Such contributions, however, shall not be permitted if they are attributable to taxable years beginning after December 31, 1986. (b) A Participant may, upon written request delivered to the Administrator, make withdrawals from his Qualified Voluntary Employee Contribution Account. Any distribution shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. (c) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Qualified Voluntary Employee 34 42 Contribution Account shall be used to provide additional benefits to the Participant or his Beneficiary. (d) Unless the Administrator directs Qualified Voluntary Employee Contributions made pursuant to this Section be segregated into a separate account for each Participant, they shall be invested as part of the general Trust Fund and share in earnings and losses. 4.10 ACTUAL CONTRIBUTION PERCENTAGE TESTS In the event this Plan previously provided for voluntary or mandatory Employee contributions, then, with respect to Plan Years beginning after December 31, 1986, such contributions must satisfy the provisions of Code Section 401(m) and the Regulations thereunder. 4.11 INTEGRATION IN MORE THAN ONE PLAN If the Employer and/or an Affiliated Employer maintain qualified retirement plans integrated with Social Security such that any Participant in this Plan is covered under more than one of such plans, then such plans will be considered to be one plan and will be considered to be integrated if the extent of the integration of all such plans does not exceed 100%. For purposes of the preceding sentence, the extent of integration of a plan is the ratio, expressed as a percentage, which the actual benefits, benefit rate, offset rate, or employer contribution rate, whatever is applicable under the Plan bears to the limitation applicable to such Plan. If the Employer maintains two or more standardized paired plans, only one plan may be integrated with Social Security. ARTICLE V VALUATIONS 5.1 VALUATION OF THE TRUST FUND The Administrator shall direct the Trustee, as of each Anniversary Date, and at such other date or dates deemed necessary by the Administrator, herein called "valuation date," to determine the net worth of the assets comprising the Trust Fund as it exists on the "valuation date." In determining such net worth, the Trustee shall value the assets comprising the Trust Fund at their fair market value as of the "valuation date" and shall deduct all expenses from which the Trustee has not yet obtained reimbursement from the Employer or the Trust Fund. 5.2 METHOD OF VALUATION In determining the fair market value of securities held in the Trust Fund which are listed on a registered stock exchange, the Administrator shall direct the Trustee to value the same at the prices they were last traded on such exchange preceding the close of business on the "valuation date." If such securities were not traded on the "valuation date," or if the exchange on which they are traded was not open for business on the "valuation date," then the securities shall be valued at the prices at which they were last traded prior to the valuation date. Any unlisted security held in the Trust Fund shall be valued at its bid price next preceding the close of business on the "valuation date," which bid price shall be obtained from a registered broker or an investment banker. In determining the fair market value of assets other than securities for which trading or bid prices can be obtained, the Trustee may appraise such assets itself, or in its discretion, employ one or more appraisers for that purpose and rely on the values established by such appraiser or appraisers. 35 43 ARTICLE VI DETERMINATION AND DISTRIBUTION OF BENEFITS 6.1 DETERMINATION OF BENEFITS UPON RETIREMENT Every Participant may terminate his employment with the Employer and retire for the purposes hereof on or after his Normal Retirement Date or Early Retirement Date. Upon such Normal Retirement Date or Early Retirement Date, all amounts credited to such Participant's Combined Account shall become distributable. However, a Participant may postpone the termination of his employment with the Employer to a later date, in which event the participation of such Participant in the Plan, including the right to receive allocations pursuant to Section 4.3, shall continue until his Late Retirement Date. Upon a Participant's Retirement Date, or as soon thereafter as is practicable, the Administrator shall direct the distribution of all amounts credited to such Participant's Combined Account in accordance with Section 6.5. 6.2 DETERMINATION OF BENEFITS UPON DEATH (a) Upon the death of a Participant before his Retirement Date or other termination of his employment, all amounts credited to such Participant's Combined Account shall become fully Vested. The Administrator shall direct, in accordance with the provisions of Sections 6.6 and 6.7, the distribution of the deceased Participant's accounts to the Participant's Beneficiary. (b) Upon the death of a Former Participant, the Administrator shall direct, in accordance with the provisions of Sections 6.6 and 6.7, the distribution of any remaining amounts credited to the accounts of such deceased Former Participant to such Former Participant's Beneficiary. (c) The Administrator may require such proper proof of death and such evidence of the right of any person to receive payment of the value of the account of a deceased Participant or Former Participant as the Administrator may deem desirable. The Administrator's determination of death and of the right of any person to receive payment shall be conclusive. (d) Unless otherwise elected in the manner prescribed in Section 6.6, the Beneficiary of the Pre-Retirement Survivor Annuity shall be the Participant's spouse. Except, however, the Participant may designate a Beneficiary other than his spouse for the Pre-Retirement Survivor Annuity if: (1) the Participant and his spouse have validly waived the Pre-Retirement Survivor Annuity in the manner prescribed in Section 6.6, and the spouse has waived his or her fight to be the Participant's Beneficiary, or (2) the Participant is legally separated or has been abandoned (within the meaning of local law) and the Participant has a court order to such effect (and there is no "qualified domestic relations order" as defined in Code Section 414(p) which provides otherwise), or (3) the Participant has no spouse, or (4) the spouse cannot be located. In such event, the designation of a Beneficiary shall be made on a form satisfactory to the Administrator. A Participant may at any time revoke his designation of a Beneficiary or change his Beneficiary by filing written notice of such revocation or change with the Administrator. However, the Participant's spouse must again consent in writing to any change in Beneficiary unless the original consent acknowledged that the spouse had the right to limit consent only to a specific Beneficiary and that the spouse voluntarily elected to relinquish such right. The Participant may, at 36 44 any time, designate a Beneficiary for death benefits payable under the Plan that are in excess of the Pre-Retirement Survivor Annuity. In the event no valid designation of Beneficiary exists at the time of the Participant's death, the death benefit shall be payable to his estate. (e) If the Plan provides an insured death benefit and a Participant dies before any insurance coverage to which he is entitled under the Plan is effected, his death benefit from such insurance coverage shall be limited to the standard rated premium which was or should have been used for such purpose. (f) In the event of any conflict between the terms of this Plan and the terms of any Contract issued hereunder, the Plan provisions shall control. 6.3 DETERMINATION OF BENEFITS IN EVENT OF DISABILITY In the event of a Participant's Total and Permanent Disability prior to his Retirement Date or other termination of his employment, all amounts credited to such Participant's Combined Account shall become fully Vested. In the event of a Participant's Total and Permanent Disability, the Administrator, in accordance with the provisions of Sections 6.5 and 6.7, shall direct the distribution to such Participant of all amounts credited to such Participant's Combined Account as though he had retired. 6.4 DETERMINATION OF BENEFITS UPON TERMINATION (a) On or before the Anniversary Date, or other valuation date, coinciding with or subsequent to the termination of a Participant's employment for any reason other than retirement, death, or Total and Permanent Disability, the Administrator may direct that the amount of the Vested portion of such Terminated Participant's Combined Account be segregated and invested separately. In the event the Vested portion of a Participant's Combined Account is not segregated, the amount shall remain in a separate account for the Terminated Participant and share in allocations pursuant to Section 4.3 until such time as a distribution is made to the Terminated Participant. The amount of the portion of the Participant's Combined Account which is not Vested may be credited to a separate account (which will always share in gains and losses of the Trust Fund) and at such time as the amount becomes a Forfeiture shall be treated in accordance with the provisions of the Plan regarding Forfeitures. Regardless of whether distributions in kind are permitted, in the event that the amount of the Vested portion of the Terminated Participant's Combined Account equals or exceeds the fair market value of any insurance Contracts, the Trustee, when so directed by the Administrator and agreed to by the Terminated Participant, shall assign, transfer, and set over to such Terminated Participant all Contracts on his life in such form or with such endorsements, so that the settlement options and forms of payment are consistent with the provisions of Section 6.5. In the event that the Terminated Participant's Vested portion does not at least equal the fair market value of the Contracts, if any, the Terminated Participant may pay over to the Trustee the sum needed to make the distribution equal to the value of the Contracts being assigned or transferred, or the Trustee, pursuant to the Participant's election, may borrow the cash value of the Contracts from the Insurer so that the value of the Contracts is equal to the Vested portion of the Terminated Participant's Combined Account and then assign the Contracts to the Terminated Participant. Distribution of the funds due to a Terminated Participant shall be made on the occurrence of an event which would result in the distribution had the Terminated Participant remained in the employ of the Employer (upon the Participant's death, Total and Permanent Disability, Early or Normal Retirement). However, at the election of the Participant, the Administrator shall direct that the entire Vested portion of the Terminated Participant's Combined Account to be payable to such 37 45 Terminated Participant provided the conditions, if any, set forth in the Adoption Agreement have been satisfied. Any distribution under this paragraph shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including but not limited to, all notice and consent requirements of Code Sections 41l(a)(11) and 417 and the Regulations thereunder. Notwithstanding the above, if the value of a Terminated Participant's Vested benefit derived from Employer and Employee contributions does not exceed, and at the time of any prior distribution, has never exceeded $3,500, the Administrator shall direct that the entire Vested benefit be paid to such Participant in a single lump-sum without regard to the consent of the Participant or the Participant's spouse. A Participant's Vested benefit shall not include Qualified Voluntary Employee Contributions within the meaning of Code Section 72(o)(5)(B) for Plan Years beginning prior to January 1, 1989. (b) The Vested portion of any Participant's Account shall be a percentage of such Participant's Account determined on the basis of the Participant's number of Years of Service according to the vesting schedule specified in the Adoption Agreement. (c) For any Top Heavy Plan Year, one of the minimum top heavy vesting schedules as elected by the Employer in the Adoption Agreement will automatically apply to the Plan. The minimum top heavy vesting schedule applies to all benefits within the meaning of Code Section 411(a)(7) except those attributable to Employee contributions, including benefits accrued before the effective date of Code Section 416 and benefits accrued before the Plan became top heavy. Further, no decrease in a Participant's Vested percentage may occur in the event the Plan's status as top heavy changes for any Plan Year. However, this Section does not apply to the account balances of any Employee who does not have an Hour of Service after the Plan has initially become top heavy and the Vested percentage of such Employee's Participant's Account shall be determined without regard to this Section 6.4(c). If in any subsequent Plan Year, the Plan ceases to be a Top Heavy Plan, the Administrator shall continue to use the vesting schedule in effect while the Plan was a Top Heavy Plan for each Employee who had an Hour of Service during a Plan Year when the Plan was Top Heavy. (d) Notwithstanding the vesting schedule above, upon the complete discontinuance of the Employer's contributions to the Plan or upon any full or partial termination of the Plan, all amounts credited to the account of any affected Participant shall become 100% Vested and shall not thereafter be subject to Forfeiture. (e) If this is an amended or restated Plan, then notwithstanding the vesting schedule specified in the Adoption Agreement, the Vested percentage of a Participant's Account shall not be less than the Vested percentage attained as of the later of the effective date or adoption date of this amendment and restatement. The computation of a Participant's nonforfeitable percentage of his interest in the Plan shall not be reduced as the result of any direct or indirect amendment to this Article, or due to changes in the Plan's status as a Top Heavy Plan. (f) If the Plan's vesting schedule is amended, or if the Plan is amended in any way that directly or indirectly affects the computation of the Participant's nonforfeitable percentage or if the Plan is deemed amended by an automatic change to a top heavy vesting schedule, then each Participant with at least 3 Years of Service as of the expiration date of the election period may elect to have his nonforfeitable percentage computed under the Plan without regard to such amendment or change. Notwithstanding the foregoing, for Plan Years beginning before January 1, 1989, or with respect to Employees who fail to complete at least one ( 1) Hour of Service in a Plan Year beginning after December 31, 1988, five (5) shall be substituted for three (3) in the preceding sentence. If a 38 46 Participant fails to make such election, then such Participant shall be subject to the new vesting schedule. The Participant's election period shall commence on the adoption date of the amendment and shall end 60 days after the latest of: (1) the adoption date of the amendment, (2) the effective date of the amendment, or (3) the date the Participant receives written notice of the amendment from the Employer or Administrator. (g)(1) If any Former Participant shall be reemployed by the Employer before a 1-Year Break in Service occurs, he shall continue to participate in the Plan in the same manner as if such termination had not occurred. (2) If any Former Participant shall be reemployed by the Employer before five (5) consecutive 1-Year Breaks in Service, and such Former Participant had received a distribution of his entire Vested interest prior to his reemployment, his forfeited account shall be reinstated only if he repays the full amount distributed to him before the earlier of five (5) years after the first date on which the Participant is subsequently reemployed by the Employer or the close of the first period of 5 consecutive 1-Year Breaks in Service commencing after the distribution. If a distribution occurs for any reason other than a separation from service, the time for repayment may not end earlier than five (5) years after the date of separation. In the event the Former Participant does repay the full amount distributed to him, the undistributed portion of the Participant's Account must be restored in full, unadjusted by any gains or losses occurring subsequent to the Anniversary Date or other valuation date preceding his termination. If an employee receives a distribution pursuant to this section and the employee resumes employment covered under this plan, the employee's employer-derived account balance will be restored to the amount on the date of distribution if the employee repays to the plan the full amount of the distribution attributable to employer contributions before the earlier of 5 years after the first date on which the participant is subsequently re-employed by the employer, or the date the participant incurs 5 consecutive 1-year breaks in service following the date of the distribution. If a non-Vested Former Participant was deemed to have received a distribution and such Former Participant is reemployed by the Employer before five (5) consecutive 1-Year Breaks in Service, then such Participant will be deemed to have repaid the deemed distribution as of the date of reemployment. (3) If any Former Participant is reemployed after a I-Year Break in Service has occurred, Years of Service shall include Years of Service prior to his I-Year Break in Service subject to the following rules: (i) Any Former Participant who under the Plan does not have a nonforfeitable right to any interest in the Plan resulting from Employer contributions shall lose credits if his consecutive 1-Year Breaks in Service equal or exceed the greater of (A) five (5) or (B) the aggregate number of his pre-break Years of Service; (ii) After five (5) consecutive 1-Year Breaks in Service, a Former Participant's Vested Account balance attributable to pre-break service shall not be increased as a result of post-break service; 39 47 (iii) A Former Participant who is reemployed and who has not had his Years of Service before a 1-Year Break in Service disregarded pursuant to (i) above, shall participate in the Plan as of his date of reemployment; (iv) If a Former Participant completes a Year of Service (a 1-Year Break in Service previously occurred, but employment had not terminated), he shall participate in the Plan retroactively from the first day of the Plan Year during which he completes one (1) Year of Service. (h) In determining Years of Service for purposes of vesting under the Plan, Years of Service shall be excluded as specified in the Adoption Agreement. 6.5 DISTRIBUTION OF BENEFITS (a)(1) Unless otherwise elected as provided below, a Participant who is married on the "annuity starting date" and who does not die before the "annuity starting date" shall receive the value of all of his benefits in the form of a Joint and Survivor Annuity. The Joint and Survivor Annuity is an annuity that commences immediately and shall be equal in value to a single life annuity. Such joint and survivor benefits following the Participant's death shall continue to the spouse during the spouse's lifetime at a rate equal to 50% of the rate at which such benefits were payable to the Participant. This Joint and Survivor Annuity shall be considered the designated qualified Joint and Survivor Annuity and automatic form of payment for the purposes of this Plan. However, the Participant may elect to receive a smaller annuity benefit with continuation of payments to the spouse at a rate of seventy-five percent (75%) or one hundred percent (100%) of the rate payable to a Participant during his lifetime which alternative Joint and Survivor Annuity shall be equal in value to the automatic Joint and 50% Survivor Annuity. An unmarried Participant shall receive the value of his benefit in the form of a life annuity. Such unmarried Participant, however, may elect in writing to waive the life annuity. The election must comply with the provisions of this Section as if it were an election to waive the Joint and Survivor Annuity by a married Participant, but without the spousal consent requirement. The Participant may elect to have any annuity provided for in this Section distributed upon the attainment of the "earliest retirement age" under the Plan. The "earliest retirement age" is the earliest date on which, under the Plan, the Participant could elect to receive retirement benefits. (2) Any election to waive the Joint and Survivor Annuity must be made by the Participant in writing during the election period and be consented to by the Participant's spouse. If the spouse is legally incompetent to give consent, the spouse's legal guardian, even if such guardian is the Participant, may give consent. Such election shall designate a Beneficiary (or a form of benefits) that may not be changed without spousal consent (unless the consent of the spouse expressly permits designations by the Participant without the requirement of further consent by the spouse). Such spouse's consent shall be irrevocable and must acknowledge the effect of such election and be witnessed by a Plan representative or a notary public. Such consent shall not be required if it is established to the satisfaction of the Administrator that the required consent cannot be obtained because there is no spouse, the spouse cannot be located, or other circumstances that may be prescribed by Regulations. The election made by the Participant and consented to by his spouse may be revoked by the Participant in writing without the consent of the spouse at any time during the election period. The number of revocations shall not be limited. Any new election must comply with the requirements of this paragraph. A former spouse's waiver shall not be binding on a new spouse. (3) The election period to waive the Joint and Survivor Annuity shall be the 90 day period ending on the "annuity starting date." 40 48 (4) For purposes of this Section and Section 6.6, the "annuity Starting date" means the first day Of the first period for which an amount is paid as an annuity, or, in the case of a benefit not payable in the form of an annuity, the first day on which all events have occurred which entities the Participant to such benefit. (5) With regard to the election, the Administrator shall provide to the Participant no less than 30 days and no more than 90 days before the "annuity starting date" a written explanation of: (i) the terms and conditions of the Joint and Survivor Annuity, and (ii) the Participant's right to make and the effect of an election to waive the Joint and Survivor Annuity, and (iii) the right of the Participant's spouse to consent to any election to waive the Joint and Survivor Annuity, and (iv) the right of the Participant to revoke such election, and the effect of such revocation. (b) In the event a married Participant duly elects pursuant to paragraph (a)(2) above not to receive his benefit in the form of a Joint and Survivor Annuity, or if such Participant is not married, in the form of a life annuity, the Administrator, pursuant to the election of the Participant, shall direct the distribution to a Participant or his Beneficiary any amount to which he is entitled under the Plan in one or more of the following methods which are permitted pursuant to the Adoption Agreement: (1) One lump-sum payment in cash or in property; (2) Payments over a period certain in monthly, quarterly, semiannual, or annual cash installments. In order to provide such installment payments, the Administrator may direct that the Participant's interest in the Plan be segregated and invested separately, and that the funds in the segregated account be used for the payment of the installments. The period over which such payment is to be made shall not extend beyond the Participant's life expectancy (or the life expectancy of the Participant and his designated Beneficiary); (3) Purchase of or providing an annuity. However, such annuity may not be in any form that will provide for payments over a period extending beyond either the life of the Participant (or the lives of the Participant and his designated Beneficiary) or the life expectancy of the Participant (or the life expectancy of the Participant and his designated Beneficiary). (c) The present value of a Participant's Joint and Survivor Annuity derived from Employer and Employee contributions may not be paid without his written consent if the value exceeds, or has ever exceeded at the time of any prior distribution, $3,500. Further, the spouse of a Participant must consent in writing to any immediate distribution. If the value of the Participant's benefit derived from Employer and Employee contributions does not exceed $3,500 and has never exceeded $3,500 at the time of any prior distribution, the Administrator may immediately distribute such benefit without such Participant's consent. No distribution may be made under the preceding sentence after the "annuity starting date" unless the Participant and his spouse consent in writing to such distribution. Any written consent required under this paragraph must be obtained not more than 90 days before commencement of the distribution and shall be made in a manner consistent with Section 6.5(a)(2). (d) Any distribution to a Participant who has a benefit which exceeds, or has ever exceeded at the time of any prior distribution, S3,500 shall require such Participant's consent if such 41 49 distribution commences prior to the later of his Normal Retirement Age or age 62. With regard to this required consent: (1) No consent shall be valid unless the Participant has received a general description of the material features and an explanation of the relative values of the optional forms of benefit available under the Plan that would satisfy the notice requirements of Code Section 417. (2) The Participant must be informed of his right to defer receipt of the distribution. If a Participant fails to consent, it shall be deemed an election to defer the commencement of payment of any benefit. However, any election to defer the receipt of benefits shall not apply with respect to distributions which are required under Section 6.5(e). (3) Notice of the rights specified under this paragraph shall be provided no less than 30 days and no more than 90 days before the "annuity starting date." (4) Written consent of the Participant to the distribution must not be made before the Participant receives the notice and must not be made more than 90 days before the "annuity starting date." (5) No consent shall be valid if a significant detriment is imposed under the Plan on any Participant who does not consent to the distribution. (e) Notwithstanding any provision in the Plan to the contrary, the distribution of a Participant's benefits, made on or after January 1, 1985, whether under the Plan or through the purchase of an annuity Contract, shall be made in accordance with the following requirements and shall otherwise comply with Code Section 401(a)(9) and the Regulations thereunder (including Regulation Section 1.401(a)(9)-2), the provisions of which are incorporated herein by reference: (1) A Participant's benefits shall be distributed to him not later than April 1st of the calendar year following the later of (i) the calendar year in which the Participant attains age 70 1/2 or (ii) the calendar year in which the Participant retires, provided, however, that this clause (ii) shall not apply in the case of a Participant who is a "five (5) percent owner" at any time during the five (5) Plan Year period ending in the calendar year in which he attains age 70 1/2 or, in the case of a Participant who becomes a "ive (5) percent owner" during any subsequent Plan Year, clause (ii) shall no longer apply and the required beginning date shall be the April 1st of the calendar year following the calendar year in which such subsequent Plan Year ends. Alternatively, distributions to a Participant must begin no later than the applicable April 1st as determined under the preceding sentence and must be made over the life of the Participant (or the lives of the Participant and the Participant's designated Beneficiary) or, if benefits are paid in the form of a Joint and Survivor Annuity, the life expectancy of the Participant (or the life expectancies of the Participant and his designated Beneficiary) in accordance with Regulations. For Plan Years beginning after December 31, 1988, clause (ii) above shall not apply to any Participant unless the Participant had attained age 70 1/2 before January 1, 1988 and was not a "five (5) percent owner" at any time during the Plan Year ending with or within the calendar year in which the Participant attained age 66 1/2 or any subsequent Plan Year. (2) Distributions to a Participant and his Beneficiaries shall only be made in accordance with the incidental death benefit requirements of Code Section 401(a)(9)(G) and the Regulations thereunder. 42 50 Additionally, for calendar years beginning before 1989, distributions may also be made under an alternative method which provides that the then present value of the payments to be made over the period of the Participant's life expectancy exceeds fifty percent (50%) of the then present value of the total payments to be made to the Participant and his Beneficiaries. (f) For purposes of this Section, the life expectancy of a Participant and a Participant's spouse (other than in the case of a life annuity) shall be redetermined annually in accordance with Regulations if permitted pursuant to the Adoption Agreement. If the Participant or the Participant's spouse may elect whether recalculations will be made, then the election, once made, shall be irrevocable. If no election is made by the time distributions must commence, then the life expectancy of the Participant and the Participant's spouse shall not be subject to recalculation. Life expectancy and joint and last survivor expectancy shall be computed using the return multiples in Tables V and VI of Regulation 1.72-9. (g) All annuity Contracts under this Plan shall be non-transferable when distributed. Furthermore, the terms of any annuity Contract purchased and distributed to a Participant or spouse shall comply with all of the requirements of this Plan. (h) Subject to the spouse's right of consent afforded under the Plan, the restrictions imposed by this Section shall not apply if a Participant has, prior to January 1, 1984, made a written designation to have his retirement benefit paid in an alternative method acceptable under Code Section 401(a) as in effect prior to the enactment of the Tax Equity and Fiscal Responsibility Act of 1981. (i) If a distribution is made at a time when a Participant who has not terminated employment is not fully Vested in his Participant's Account and the Participant may increase the Vested percentage in such account: (1) A separate account shall be established for the Participant's interest in the Plan as of the time of the distribution, and (2) At any relevant time the Participant's Vested portion of the separate account shall be equal to an amount ("X") determined by the formula: X equals P(AB plus (RxD)) - (R x D) For purposes of applying the formula: P is the Vested percentage at the relevant time, AB is the account balance at the relevant time, D is the amount of distribution, and R is the ratio of the account balance at the relevant time to the account balance after distribution. 6.6 DISTRIBUTION OF BENEFITS UPON DEATH (a) Unless otherwise elected as provided below, a Vested Participant who dies before the annuity starting date and who has a surviving spouse shall have the Pre-Retirement Survivor Annuity paid to his surviving spouse. The Participant's spouse may direct that payment of the Pre-Retirement Survivor Annuity commence within a reasonable period after the Participant's death. If the spouse does not so direct, payment of such benefit will commence at the time the Participant would have attained the later of his Normal Retirement Age or age 62. However, the spouse may elect a later commencement date. Any distribution to the Participant's spouse shall be subject to the rules specified in Section 6.6(h). 43 51 (b) Any election to waive the Pre-Retirement Survivor Annuity before the Participant's death must be made by the Participant in writing during the election period and shall require the spouse's irrevocable consent in the same manner provided for in Section 6.5(a)(2). Further, the spouse's consent must acknowledge the specific nonspouse Beneficiary. Notwithstanding the foregoing, the nonspouse Beneficiary need not be acknowledged, provided the consent of the spouse acknowledges that the spouse has the right to limit consent only to a specific Beneficiary and that the spouse voluntarily elects to relinquish such right. (c) The election period to waive the Pre-Retirement Survivor Annuity shall begin on the first day of the Plan Year in which the Participant attains age 35 and end on the date of the Participant's death. An earlier waiver (with spousal consent) may be made provided a written explanation of the Pre-Retirement Survivor Annuity is given to the Participant and such waiver becomes invalid at the beginning of the Plan Year in which the Participant turns age 35. In the event a Vested Participant separates from service prior to the beginning of the election period, the election period shall begin on the date of such separation from service. (d) With regard to the election, the Administrator shall provide each Participant within the applicable period, with respect to such Participant (and consistent with Regulations), a written explanation of the Pre-Retirement Survivor Annuity containing comparable information to that required pursuant to Section 6.5(a)(4). For the purposes of this paragraph, the term "applicable period" means, with respect to a Participant, whichever of the following periods ends last: (1) The period beginning with the first day of the Plan Year in which the Participant attains age 32 and ending with the close of the Plan Year preceding the Plan Year in which the Participant attains age 35; (2) A reasonable period after the individual becomes a Participant. For this purpose, in the case of an individual who becomes a Participant after age 32, the explanation must be provided by the end of the three-year period beginning with the first day of the first Plan Year for which the individual is a Participant; (3) A reasonable period ending after the Plan no longer fully subsidizes the cost of the Pre-Retirement Survivor Annuity with respect to the Participant; (4) A reasonable period ending after Code Section 401(a)X 11) applies to the Participant; or (5) A reasonable period after separation from service in the case of a Participant who separates before attaining age 35. For this purpose, the Administrator must provide the explanation beginning one year before the separation from service and ending one year after separation. (e) The Pre-Retirement Survivor Annuity provided for in this Section shall apply only to Participants who are credited with an Hour of Service on or after August 23, 1984. Former Participants who are not credited with an Hour of Service on or after August 23, 1984 shall be provided with Tights to the Pre-Retirement Survivor Annuity in accordance with Section 303(e)(2) of the Retirement Equity Act of 1984. (f) If the value of the Pre-retirement Survivor Annuity derived from Employer and Employee contributions does not exceed S3,500 and has never exceeded $3,500 at the time of any prior distribution, the Administrator shall direct the immediate distribution of such amount to the Participant's spouse. No distribution may be made under the preceding sentence after the annuity starting date unless the spouse consents in writing. If the value exceeds, or has ever exceeded at the 44 52 time of any prior distribution, $3,500, an immediate distribution of the entire amount may be made to the surviving spouse, provided such surviving spouse consents in writing to such distribution. Any written consent required under this paragraph must be obtained not more than 90 days before commencement of the distribution and shall be made in a manner consistent with Section 6.5(a)(2). (g)(1) In the event there is an election to waive the Pre-Retirement Survivor Annuity, and for death benefits in excess of the Pre-Retirement Survivor Annuity, such death benefits shall be paid to the Participant's Beneficiary by either of the following methods, as elected by the Participant (or if no election has been made prior to the Participant's death, by his Beneficiary) subject to the rules specified in Section 6.6(h) and the selections made in the Adoption Agreement: (i) One lump-sum payment in cash or in property; (ii)Payment in monthly, quarterly, semi-annual, or annual cash installments over a period to be determined by the Participant or his Beneficiary. After periodic installments commence, the Beneficiary shall have the right to reduce the period over which such periodic installments shall be made, and the cash amount of such periodic installments shall be adjusted accordingly. (iii) If death benefits in excess of the Pre-Retirement Survivor Annuity are to be paid to the surviving spouse, such benefit-its may be paid pursuant to (i) or (ii) above, or used to purchase an annuity so as to increase the payments made pursuant to the Pre-Retirement Survivor Annuity; (2) In the event the death benefit payable pursuant to Section 6.2 is payable in installments, then, upon the death of the Participant, the Administrator may direct that the death benefit be segregated and invested separately, and that the funds accumulated in the segregated account be used for the payment of the installments. (h) Notwithstanding any provision in the Plan to the contrary, distributions upon the death of a Participant made on or after January 1, 1985, shall be made in accordance with the following requirements and shall otherwise comply with Code Section 401(a)(9) and the Regulations thereunder. (1) If it is determined, pursuant to Regulations, that the distribution of a Participant's interest has begun and the Participant dies before his entire interest has been distributed to him, the remaining portion of such interest shall be distributed at least as rapidly as under the method of distribution selected pursuant to Section 6.5 as of his date of death. (2) If a Participant dies before he has begun to receive any distributions of his interest in the Plan or before distributions are deemed to have begun pursuant to Regulations, then his death benefit shall be distributed to his Beneficiaries in accordance with the following rules subject to the selections made in the Adoption Agreement and Subsections 6.6(h)(3) and 6.6(i) below: (i) The entire death benefit shall be distributed to the Participant's Beneficiaries by December 31st of the calendar year in which the fifth anniversary of the Participant's death occurs; (ii) The 5-year distribution requirement of (i) above shall not apply to any portion of the deceased Participant's interest which is payable to or for the benefit of a designated Beneficiary. In such event, such portion shall be distributed over the life of such designated Beneficiary (or over a period not extending beyond the life expectancy of such 45 53 designated Beneficiary) provided such distribution begins not later than December 31st of the calendar year immediately following the calendar year in which the Participant died; (iii) However, in the event the Participant's spouse (determined as of the date of the Participant's death) is his designated Beneficiary, the provisions of (ii) above shall apply except that the requirement that distributions commence within one year of the Participant's death shall not apply. In lieu thereof, distributions must commence on or before the later of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died; or (2) December 31st of the calendar year in which the Participant would have attained age 70 1/2. If the surviving spouse dies before distributions to such spouse begin, then the 5-year distribution requirement of this Section shall apply as if the spouse was the Participant. (3) Notwithstanding subparagraph (2) above, or any selections made in the Adoption Agreement, if a Participant's death benefits are to be paid in the form of a Pre-Retirement Survivor Annuity, then distributions to the Participant's surviving spouse must commence on or before the later of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died; or (2) December 31st of the calendar year in which the Participant would have attained age 70 1/2. (i) For purposes of Section 6.6(h)(2), the election by a designated Beneficiary to be excepted from the 5-year distribution requirement (if permitted in the Adoption Agreement) must be made no later than December 31st of the calendar year following the calendar year of the Participant's death. Except, however, with respect to a designated Beneficiary who is the Participant's surviving spouse, the election must be made by the earlier of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died or, if later, the calendar year in which the Participant would have attained age 70 1/2; or (2) December 31st of the calendar year which contains the fifth anniversary of me date of me Participant's death. An election by a designated Beneficiary must be in writing and shall be irrevocable as of the last day of the election period stated herein. In the absence of an election by the Participant or a designated Beneficiary, the 5-year distribution requirement shall apply. (j) For purposes of this Section, the life expectancy of a Participant and a Participant's spouse (other than in the case of a life annuity) shall or shall not be redetermined annually as provided in the Adoption Agreement and in accordance with Regulations. If the Participant or the Participant's spouse may elect, pursuant to the Adoption Agreement, to have life expectancies recalculated, then the election, once made shall be irrevocable. If no election is made by the time distributions must commence, then the life expectancy of the Participant and the Participant's spouse shall not be subject to recalculation. Life expectancy and joint and last survivor expectancy shall be computed using the return multiples in Tables V and VI of Regulation Section 1.72-9. (k) In the event that less than 100% of a Participant's interest in the Plan is distributed To such Participant's spouse, the portion of the distribution attributable to the Participant's Voluntary Contribution Account shall be in the same proportion that the Participant's Voluntary Contribution Account bears to the Participant's total interest in the Plan. (l) Subject to the spouse's right of consent afforded under the Plan, the restrictions imposed by this Section shall not apply if a Participant has, prior to January 1, 1984, made a written designation to have his death benefits paid in an alternative method acceptable under Code Section 401 (a) as in effect prior to the enactment of the Tax Equity and Fiscal Responsibility Act of 1982. 46 54 6.7 TIME OF SEGREGATION OR DISTRIBUTION Except as limited by Sections 6.5 and 6.6, whenever a distribution is to be made, or a series of payments are to commence, on or as of an Anniversary Date, the distribution or series of payments may be made or begun on such date or as soon thereafter as is practicable, but in no event later than 180 days after the Anniversary Date. However, unless a Former Participant elects in writing to defer the receipt of benefits (such election may not result in a death benefit that is more than incidental), the payment of benefits shall begin not later than the 60th day after the close of the Plan Year in which the latest of the following events occurs: (a) the date on which the Participant attains the earlier of age 65 or the Normal Retirement Age specified herein; (b) the 10th anniversary of the year in which the Participant commenced participation in the Plan; or (c) the date the Participant terminates his service with the Employer. Notwithstanding the foregoing, the failure of a Participant and, if applicable, the Participant's spouse, to consent to a distribution pursuant to Section 6.5(d), shall be deemed to be an election to defer the commencement of payment of any benefit sufficient to satisfy this Section. 6.8 DISTRIBUTION FOR MINOR BENEFICIARY In the event a distribution is to be made to a minor, then the Administrator may direct that such distribution be paid to the legal guardian, or if none, to a parent of such Beneficiary or a responsible adult with whom the Beneficiary maintains his residence, or to the custodian for such Beneficiary under the Uniform Gift to Minors Act or Gift to Minors Act, if such is permitted by the laws of the state in which said Beneficiary resides. Such a payment to the legal guardian, custodian or parent of a minor Beneficiary shall fully discharge the Trustee, Employer, and Plan from further liability on account thereof. 6.9 LOCATION OF PARTICIPANT OR BENEFICIARY UNKNOWN In the event that all, or any portion, of the distribution payable to a Participant or his Beneficiary hereunder shall, at the later of the Participant's attainment of age 62 or his Normal Retirement Age, remain unpaid solely by reason of the inability of the Administrator, after sending a registered letter, return receipt requested, to the last known address, and after further diligent effort, to ascertain the whereabouts of such Participant or his Beneficiary, the amount so distributable shall be treated as a Forfeiture pursuant to the Plan. In the event a Participant or Beneficiary is located subsequent to his benefit being reallocated, such benefit shall be restored, first from Forfeitures, if any, and then from an additional Employer contribution if necessary. 6.10 PRE-RETIREMENT DISTRIBUTION For Profit Sharing Plans and 401(k) Profit Sharing Plans, if elected in the Adoption Agreement, at such time as a Participant shall have attained the age specified in the Adoption Agreement, the Administrator, at the election of the Participant, shall direct the distribution of up to the entire amount then credited to the accounts maintained on behalf of the Participant. However, no such distribution from the Participant's Account shall occur prior to 100% Vesting. In the event that the Administrator makes such a distribution, the Participant shall continue to be eligible to participate in the Plan on the same basis as any other Employee. Any distribution made pursuant to this Section shall be made in a manner consistent with Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. 6.11 ADVANCE DISTRIBUTION FOR HARDSHIP (a) For Profit Sharing Plans, if elected in the Adoption Agreement, the Administrator, at the election of the Participant, shall direct the distribution to any Participant in any one Plan Year up to the lesser of 100% of his Participant's Combined Account valued as of the last Anniversary Date 47 55 or other valuation date or the amount necessary to satisfy the immediate and heavy Financial need of the Participant. Any distribution made pursuant to this Section shall be deemed to be made as of the first day of the Plan Year or, if later, the valuation date immediately preceding the date of distribution, and the account from which the distribution is made shall be reduced accordingly. Withdrawal under this Section shall be authorized only if the distribution is on account of: (1) Medical expenses described in Code Section 213(d) incurred by the Participant, his spouse, or any of his dependents (as defined in Code Section 152) or expenses necessary for these persons to obtain medical care; (2) The purchase (excluding mortgage payments) of a principal residence for the Participant; (3) Funeral expenses for a member of the Participant's family; (4) Payment of tuition and related educational fees for the next 12 months of post-secondary education for the Participant, his spouse, children, or dependents; or (5) The need to prevent the eviction of the Participant from his principal residence or foreclosure on the mortgage of the Participant's principal residence. (b) No such distribution shall be made from the Participant's Account until such Account has become fully Vested. (c) Any distribution made pursuant to this Section shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. 6.12 LIMITATIONS ON BENEFITS AND DISTRIBUTIONS All rights and benefits, including elections, provided to a Participant in this Plan shall be subject to the rights afforded to any "alternate payee" under a "qualified domestic relations order." Furthermore, a distribution to an "alternate payee" shall be permitted if such distribution is authorized by a "qualified domestic relations order," even if the affected Participant has not reached the "earliest retirement age" under the Plan. For the purposes of this Section, "alternate payee," "qualified domestic relations order" and "earliest retirement age" shall have the meaning set forth under Code Section 414(p). 6.13 SPECIAL RULE FOR NON-ANNUITY PLANS If elected in the Adoption Agreement, the following shall apply to a Participant in a Profit Sharing Plan or 401(k) Profit Sharing Plan and To any distribution, made on or after the First day of the first plan year beginning after December 31, 1988, from or under a separate account attributable solely to accumulated deductible employee contributions, as defined in Code Section 72(o)(5)(B), and maintained on behalf of a participant in a money purchase pension plan, (including a target benefit plan): (a) The Participant shall be prohibited from electing benefits in the form of a life annuity; (b) Upon the death of the Participant, the Participant's entire Vested account balances will be paid to his or her surviving spouse, or, if there is no surviving spouse or the surviving spouse has already consented to waive his or her benefit, in accordance with Section 6.6, to his designated Beneficiary; 48 56 (c) Except to the extent otherwise provided in this Section and Section 6.5(h), the other provisions of Sections 6.2, 6.5 and 6.6 regarding spousal consent and the forms of distributions shall be inoperative with respect to this Plan. (d) If a distribution is one to which Sections 401(a)(11) and 417 of the Internal Revenue Code do not apply, such distribution may commence less than 30 days after the notice required under Section 1.411(a)-11(c) of the Income Tax Regulations is given, provided that: (1) the Plan Administrator clearly informs the Participant that the Participant has a right to a period of at least 30 days after the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option), and (2) the Participant, after receiving the notice, affirmatively elects a distribution. This Section shall not apply to any Participant if it is determined that this Plan is a direct or indirect transferee of a defined benefit plan or money purchase plan, or a target benefit plan, stock bonus or profit sharing plan which would otherwise provide for a life annuity form of payment to the Participant. ARTICLE VII TRUSTEE 7.1 BASIC RESPONSIBILITIES OF THE TRUSTEE The Trustee shall have the following categories of responsibilities except that if selected in the Adoption Agreement, the separate trust document shall apply in lieu of the Sections set forth in this Article VII other than Sections 7.2(e) and (f), 7.3(r), 7.4 and 7.10: (a) Consistent with the "funding policy and method" determined by the Employer to invest, manage, and control the Plan assets subject, however, to the direction of an Investment Manager if the Employer should appoint such manager as to all or a portion of the assets of the Plan; (b) At the direction of the Administrator, to pay benefits required under the Plan to be paid to Participants, or, in the event of their death, to their Beneficiaries (c) To maintain records of receipts and disbursements and furnish to the Employer and/or Administrator for each Plan Year a written annual report per Section 7.7; and (d) If there shall be more than one Trustee, they shall act by a majority of their number, but may authorize one or more of them to sign papers on their behalf. 7.2 INVESTMENT POWERS AND DUTIES OF THE TRUSTEE (a) The Trustee shall invest and reinvest the Trust Fund to keep the Trust Fund invested without distinction between principal and income and in such securities or property, real or personal, wherever situated, as the Trustee shall deem advisable, including, but not limited to, stocks, common or preferred, bonds and other evidences of indebtedness or ownership, and real estate or any interest therein. The Trustee shall at all times in making investments of the Trust Fund consider, among other factors, the short and long-term financial needs of the Plan on the basis of information furnished by the Employer. In making such investments, the Trustee shall not be restricted to securities or other property of the character expressly authorized by the applicable law for trust investments; however, the Trustee shall give due regard to any limitations imposed by the Code or the Act so that at all times this Plan may qualify as a qualified Plan and Trust. 49 57 (b) The Trustee may employ a bank or trust company pursuant to the terms of its usual and customary bank agency agreement, under which the duties of such bank or trust company shall be of a custodial, clerical and record-keeping nature. (c) Notwithstanding Section 7.2(a), the Employer, in writing to the Trustee, may delegate investment responsibility to the Administrator. If the Administrator has been delegated such authority, the Trustee shall invest trust assets in accordance with the Administrator's direction, unless the Trustee determines, in the exercise of its responsibility under ERISA as a co-fiduciary of the Plan, that such investments are not permitted under the terms of the Plan, Trust, or the Act. The Trustee shall not be liable or responsible for losses or unfavorable results arising from the Trustee's compliance with directions received from the Administrator. (d) The Trustee may from time to time transfer to a common, collective, or pooled trust fund maintained by any corporate Trustee hereunder pursuant to Revenue Ruling 81-100, all or such part of the Trust Fund as the Trustee may deem advisable, and such part or all of the Trust Fund so transferred shall be subject to all the terms and provisions of the common, collective, or pooled trust fund which contemplate the commingling for investment purposes of such trust assets with trust assets of other trusts. The Trustee may withdraw from such common, collective, or pooled trust fund all or such part of the Trust Fund as the Trustee may deem advisable. (e) The Trustee, at the direction of the Administrator and pursuant to instructions from the individual designated in the Adoption Agreement for such purpose shall ratably apply for, own, and pay all premiums on Contracts on the lives of the Participants. Any initial or additional Contract purchased on behalf of a Participant shall have a face amount of not less than $1,000 or the limitation of the Insurer, whichever is greater. If a life insurance Contract is to be purchased for a Participant, the aggregate premium for ordinary life insurance for each Participant must be less than 50% of the aggregate contributions and Forfeitures allocated to a Participant's Combined Account. For purposes of this limitation, ordinary life insurance Contracts are Contracts with both non-decreasing death benefits and non-increasing premiums. If term insurance or universal life insurance is purchased with such contributions, the aggregate premium must be 25% or less of the aggregate contributions and Forfeitures allocated to a Participant's Combined Account. If both term insurance and ordinary life insurance are purchased with such contributions, the amount expended for term insurance plus one-half of the premium for ordinary life insurance may not in the aggregate exceed 25% of the aggregate Employer contributions and Forfeitures allocated to a Participant's Combined Account. The Trustee must distribute the Contracts to the Participant or convert the entire value of the Contracts at or before retirement into cash or provide for a periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement. Notwithstanding the above, the limitations imposed herein with respect to the purchase of life insurance shall not apply, in the case of a Profit Sharing Plan, to the portion of a Participant's Account that has accumulated for at least two (2) Plan Years. Notwithstanding anything hereinabove to the contrary, amounts credited to a Participant's Qualified Voluntary Employee Contribution Account pursuant to Section 4.9, shall not be applied to the purchase of life insurance contracts. (f) The Trustee will be the owner of any life insurance Contract purchased under the terms of this Plan. The Contract must provide that the proceeds will be payable to the Trustee; however, the Trustee shall be required to pay over all proceeds of the Contract to the Participant's designated Beneficiary in accordance with the distribution provisions of Article VI. A Participant's spouse will be the designated Beneficiary pursuant to Section 6.2, unless a qualified election has been made in accordance with Sections 6.5 and 6.6 of the Plan, if applicable. Under no circumstances shall the Trust retain any part of the proceeds. However, the Trustee shall not pay the proceeds in a method 50 58 that would violate the requirements of the Retirement Equity Act, as stated in Article VI of the Plan, or Code Section 401(a)(9) and the Regulations thereunder. 7.3 OTHER POWERS OF THE TRUSTEE The Trustee, in addition to all powers and authorities under common law, statutory authority, including the Act, and other provisions of this Plan, shall have the following powers and authorities to be exercised in the Trustee's sole discretion: (a) To purchase, or subscribe for, any securities or other property and to retain the same. In conjunction with the purchase of securities, margin accounts may be opened and maintained; (b) To sell, exchange, convey, transfer, grant options to purchase, or otherwise dispose of any securities or other property held by the Trustee, by private contract or at public auction. No person dealing with the Trustee shall be bound to see to the application of the purchase money or to inquire into the validity, expediency, or propriety of any such sale or other disposition, with or without advertisement; (c) To vote upon any stocks, bonds, or other securities; to give general or special proxies or powers of attorney with or without power of substitution; to exercise any conversion privileges, subscription rights or other options, and to make any payments incidental thereto; to oppose, or to consent to, or otherwise participate in, corporate reorganizations or other changes affecting corporate securities, and to delegate discretionary powers, and to pay any assessments or charges in connection therewith; and generally to exercise any of the powers of an owner with respect to stocks, bonds, securities, or other property. However, the Trustee shall not vote proxies relating to securities for which it has not been assigned full investment management responsibilities. In those cases where another party has such investment authority or discretion, be it the Administrator or an outside Investment Manager, the Trustee will deliver all proxies to said party who will then have full responsibility for voting those proxies; (d) To cause any securities or other property to be registered in the Trustee's own name or in the name of one or more of the Trustee's nominees, and to hold any investments in bearer form, but the books and records of the Trustee shall at all times show that all such investments are part of the Trust Fund; (e) To borrow or raise money for the purposes of the Plan in such amount, and upon such terms and conditions, as the Trustee shall deem advisable; and for any sum so borrowed, to issue a promissory note as Trustee, and to secure the repayment thereof by pledging all, or any part, of the Trust Fund; and no person lending money to the Trustee shall be bound to see To the application of the money lent or to inquire into the validity, expediency, or propriety of any borrowing; (f) To keep such portion of the Trust Fund in cash or cash balances as the Trustee may, from time to time, deem to be in the best interests of the Plan, without liability for interest thereon; (g) To accept and retain for such time as it may deem advisable any securities or other property received or acquired by it as Trustee hereunder, whether or not such securities or other property would normally be purchased as investments hereunder; (h) To make, execute, acknowledge, and deliver any and all documents of transfer and conveyance and any and all other instruments that may be necessary or appropriate to carry out the powers herein granted; 51 59 (i) To settle, compromise, or submit to arbitration any claims, debts, or damages due or owing to or from the Plan, to commence or defend suits or legal or administrative proceedings, and to represent the Plan in all suits and legal and administrative proceedings; (j) To employ suitable agents and counsel and to pay their reasonable expenses and compensation, and such agent or counsel may or may not be agent or counsel for the Employer; (k) To apply for and procure from the Insurer as an investment of the Trust Fund such annuity, or other Contracts (on the life of any Participant) as the Administrator shall deem proper; to exercise, at any time or from time to time, whatever rights and privileges may be granted under such annuity, or other Contracts; to collect, receive, and settle for the proceeds of all such annuity, or other Contracts as and when entitled to do so under the provisions thereof; (l) To invest funds of the Trust in time deposits or savings accounts bearing a reasonable rate of interest in the Trustee's bank; (m) To invest in Treasury Bills and other forms of United States government obligations; (n) To sell, purchase and acquire put or call options if the options are traded on and purchased through a national securities exchange registered under the Securities Exchange Act of 1934, as amended, or, if the options are not traded on a national securities exchange, are guaranteed by a member firm of the New York Stock Exchange; (o) To deposit monies in federally insured savings accounts or certificates of deposit in banks or savings and loan associations; (p) To pool all or any of the Trust Fund, from time to time, with assets belonging to any other qualified employee pension benefit trust created by the Employer or any Affiliated Employer, and to commingle such assets and make joint or common investments and carry joint accounts on behalf of this Plan and such other trust or trusts, allocating undivided shares or interests in such investments or accounts or any pooled assets of the two or more trusts in accordance with their respective interests; (q) To do all such acts and exercise all such rights and privileges, although not specifically mentioned herein, as the Trustee may deem necessary to carry out the purposes of the Plan. (r) Directed Investment Account. The powers granted to the Trustee shall be exercised in the sole fiduciary discretion of the Trustee. However, if elected in the Adoption Agreement, each Participant shall direct the Trustee to separate and keep separate all or a portion of his interest in the Plan-, and further each Participant is authorized and empowered, in his sole and absolute discretion, to give directions to the Trustee in such form as the Trustee may require concerning the investment of the Participant's Directed Investment Account, which directions must be followed by the Trustee subject, however, to restrictions on payment of life insurance premiums. Neither the Trustee nor any other persons including the Administrator or otherwise shall be under any duty to question any such direction of the Participant or to review any securities or other property, real or personal, or to make any suggestions to the Participant in connection therewith, and the Trustee shall comply as promptly as practicable with directions given by the Participant hereunder. Any such direction may be of a continuing nature or otherwise and may be revoked by the Participant at any time in such form as the Trustee may require. The Trustee may refuse to comply with any direction from the Participant in the event the Trustee, in its sole and absolute discretion, deems such directions improper by virtue of applicable law, and in such event, the Trustee shall not be responsible or liable for any loss or 52 60 expense which may result. Any costs and expenses related to compliance with the Participant's directions shall be borne by the Participant's Directed Investment Account. (s) Notwithstanding anything in this Section, if this Plan is used in conjunction with a separate trust, the separate trust shall control with respect to the powers and duties of the Trustee. 53 61 7.4 LOANS TO PARTICIPANTS (a) If specified in the Adoption Agreement, the Trustee (or, if loans are treated as Directed Investment pursuant to the Adoption Agreement, the Administrator) may, in the Trustee's (or, if applicable, the Administrator's) sole discretion, make loans to Participants or Beneficiaries under the following circumstances: (1) loans shall be made available to all Participants and Beneficiaries on a reasonably equivalent basis; (2) loans shall not be made available to Highly Compensated Employees in an amount greater than the amount made available to other Participants; (3) loans shall bear a reasonable rate of interest; (4) loans shall be adequately secured; and (5) shall provide for periodic repayment over a reasonable period of time. (b) Loans shall not be made to any Shareholder-Employee or Owner-Employee unless an exemption for such loan is obtained pursuant to Act Section 408 and further provided that such loan would not be subject to tax pursuant to Code Section 4975. (c) Loans shall not be granted to any Participant that provide for a repayment period extending beyond such Participant's Normal Retirement Date. (d) Loans made pursuant to this Section (when added to the outstanding balance of all other loans made by the Plan to the Participant) shall be limited to the lesser of: (1) $50,000 reduced by the excess (if any) of the highest outstanding balance of loans from the Plan to the Participant during the one year period ending on the day before the date on which such loan is made, over the outstanding balance of loans from the Plan to the Participant on the date on which such loan was made, or (2) one-half (1/2) of the present value of the non-forfeitable accrued benefit of the Employee under the Plan. For purposes of this limit, all plans of the Employer shall be considered one plan. Additionally, with respect to any loan made prior to January 1, 1987, the $50,000 limit specified in (1) above shall be unreduced. (e) No Participant loan shall take into account the present value of such Participant's Qualified Voluntary Employee Contribution Account. (f) Loans shall provide for level amortization with payments to be made not less frequently than quarterly over a period not to exceed five (5) years. However, loans used to acquire any dwelling unit which, within a reasonable time, is to be used (determined at the time the loan is made) as a principal residence of the Participant shall provide for periodic repayment over a reasonable period of time that may exceed five (5) years. Notwithstanding the foregoing, loans made prior to January 1, 1987 which are used to acquire, construct, reconstruct or substantially rehabilitate any dwelling unit which, within a reasonable period of time is to be used (determined at the time the loan is made) as a principal residence of the Participant or a member of his family (within the meaning of Code Section 267(c)(4)) may provide for periodic repayment over a reasonable period of time that may exceed five (5) years. Additionally, loans made prior to January 1, 1987, may provide for periodic payments which are made less frequently than quarterly and which do not necessarily result in level amortization. 54 62 (g) An assignment or pledge of any portion of a Participant's interest in the Plan and a loan, pledge, or assignment with respect to any insurance Contract purchased under the Plan, shall be treated as a loan under this Section. (h) Any loan made pursuant to this Section after August 18, 1985 where the Vested interest of the Participant is used to secure such loan shall require the written consent of the Participant's spouse in a manner consistent with Section 6.5(a) provided the spousal consent requirements of such Section apply to the Plan. Such written consent must be obtained within the 90-day period prior to the date the loan is made. Any security interest held by the Plan by reason of an outstanding loan to the Participant shall be taken into account in determining the amount of the death benefit or Pre-Retirement Survivor Annuity. However, no spousal consent shall be required under this paragraph if the total accrued benefit subject to the security is not in excess of $3,500. (i) With regard to any loans granted or renewed on or after the last day of the first Plan Year beginning after December 31, 1988, a Participant loan program shall be established which must include, but need not be limited to, the following: (1) the identity of the person or positions authorized to administer the Participant loan program; (2) a procedure for applying for loans; (3) the basis on which loans will be approved or denied; (4) limitations, if any, on the types and amounts of loans offered, including what constitutes a hardship or financial need if selected in the Adoption Agreement; (5) the procedure under the program for determining a reasonable rate of interest; (6) the types of collateral which may secure a Participant loan; and (7) the events constituting default and the steps that will be taken to preserve plan assets. Such Participant loan program shall be contained in a separate written document which, when properly executed, is hereby incorporated by reference and made a part of this plan. Furthermore, such Participant loan program may be modified or amended in writing from time to time without the necessity of amending this Section of the Plan. 7.5 DUTIES OF THE TRUSTEE REGARDING PAYMENTS At the direction of the Administrator, the Trustee shall, from time to time, in accordance with the terms of the Plan, make payments out of the Trust Fund. The Trustee shall not be responsible in any way for the application of such payments. 7.6 TRUSTEE'S COMPENSATION AND EXPENSES AND TAXES The Trustee shall be paid such reasonable compensation as set forth in the Trustee's fee schedule (if the Trustee has such a schedule) or as agreed upon in writing by the Employer and the Trustee. An individual serving as Trustee who already receives full-time pay from the Employer shall not receive compensation from this Plan. In addition, the Trustee shall be reimbursed for any reasonable expenses, including reasonable counsel fees incurred by it as Trustee. Such compensation and expenses shall be paid from the Trust Fund unless paid or advanced by the Employer. All taxes of any kind and all kinds whatsoever that 55 63 may be levied or assessed under existing or future laws upon, or in respect of, the Trust Fund or the income thereof, shall be paid from the Trust Fund. 7.7 ANNUAL REPORT OF THE TRUSTEE Within a reasonable period of time after the later of the Anniversary Date or receipt of the Employer's contribution for each Plan Year, the Trustee, or its agent, shall furnish to the Employer and Administrator a written statement of account with respect to the Plan Year for which such contribution was made setting forth: (a) the net income, or loss, of the Trust Fund; (b) the gains, or losses, realized by the Trust Fund upon sales or other disposition of the assets; (c) the increase, or decrease, in the value of the Trust Fund; (d) all payments and distributions made from the Trust Fund; and (e) such further information as the Trustee and/or Administrator deems appropriate. The Employer, forthwith upon its receipt of each such statement of account, shall acknowledge receipt thereof in writing and advise the Trustee and/or Administrator of its approval or disapproval thereof. Failure by the Employer to disapprove any such statement of account within thirty (30) days after its receipt thereof shall be deemed an approval thereof. The approval by the Employer of any statement of account shall be binding as to all matters embraced therein as between the Employer and the Trustee to the same extent as if the account of the Trustee had been settled by judgment or decree in an action for a judicial settlement of its account in a court of competent jurisdiction in which the Trustee, the Employer and all persons having or claiming an interest in the Plan were parties; provided, however, that nothing herein contained shall deprive the Trustee of its right to have its accounts judicially settled if the Trustee so desires. 7.8 AUDIT (a) If an audit of the Plan's records shall be required by the Act and the regulations thereunder for any Plan Year, the Administrator shall direct the Trustee to engage on behalf of all Participants an independent qualified public accountant for that purpose. Such accountant shall, after an audit of the books and records of the Plan in accordance with generally accepted auditing standards, within a reasonable period after the close of the Plan Year, furnish to the Administrator and the Trustee a report of his audit setting forth his opinion as to whether any statements, schedules or lists, that are required by Act Section 103 or the Secretary of Labor to be filed with the Plan's annual report, are presented fairly in conformity with generally accepted accounting principles applied consistently. (b) All auditing and accounting fees shall be an expense of and may, at the election of the Administrator, be paid from the Trust Fund. (c) If some or all of the information necessary to enable the Administrator to comply With Act Section 103 is maintained by a bank, insurance company, or similar institution, regulated and supervised and subject to periodic examination by a state or federal agency, it shall transmit and certify the accuracy of that information to the Administrator as provided in Act Section 103(b) within one hundred twenty ( 120) days after the end of the Plan Year or such other date as may be prescribed under regulations of the Secretary of Labor. 56 64 7.9 RESIGNATION, REMOVAL AND SUCCESSION OF TRUSTEE (a) The Trustee may resign at any time by delivering to the Employer, at least thirty (30) days before its effective date, a written notice of his resignation. (b) The Employer may remove the Trustee by mailing by registered or certified mail, addressed to such Trustee at his last known address, at least thirty (30) days before its effective date, a written notice of his removal. (c) Upon the death, resignation, incapacity, or removal of any Trustee, a successor may be appointed by the Employer; and such successor, upon accepting such appointment in writing and delivering same to the Employer, shall, without further act, become vested with all the estate, rights, powers, discretions, and duties of his predecessor with like respect as if he were originally named as a Trustee herein. Until such a successor is appointed, the remaining Trustee or Trustees shall have full authority to act under the terms of the Plan. (d) The Employer may designate one or more successors prior to the death, resignation, incapacity, or removal of a Trustee, In the event a successor is so designated by the Employer and accepts such designation, the successor shall, without further act, become vested with all the estate, rights, powers, discretions, and duties of his predecessor with the like effect as if he were originally named as Trustee herein immediately upon the death, resignation, incapacity, or removal of his predecessor. (e) Whenever any Trustee hereunder ceases to serve as such, he shall furnish to the Employer and Administrator a written statement of account with respect to the portion of the Plan Year during which he served as Trustee. This statement shall be either (i) included as part of the annual statement of account for the Plan Year required under Section 7.7 or (ii) set forth in a special statement. Any such special statement of account should be rendered to the Employer no later than the due date of the annual statement of account for the Plan Year. The procedures set forth in Section 7.7 for the approval by the Employer of annual statements of account shall apply to any special statement of account rendered hereunder and approval by the Employer of any such special statement in the manner provided in Section 7.7 shall have the same effect upon the statement as the Employer's approval of an annual statement of account. No successor to the Trustee shall have any duty or responsibility to investigate the acts or transactions of any predecessor who has rendered all statements of account required by Section 7.7 and this subparagraph. 7.10 TRANSFER OF INTEREST Notwithstanding any other provision contained in this Plan, the Trustee at the direction of the Administrator shall transfer the Vested interest, if any, of such Participant in his account to another trust forming part of a pension, profit sharing, or stock bonus plan maintained by such Participant's new employer and represented by said employer in writing as meeting the requirements of Code Section 401 (a), provided that the trust to which such transfers are made permits the transfer to be made. (a) Notwithstanding any provision of the plan to the contrary, with respect to distributions made after December 31, 1992, a Participant shall be permitted to elect to have any "eligible rollover distribution" transferred directly To an "eligible retirement plan" specified by the Participant. The Plan provisions otherwise applicable to distributions continue to apply to the direct transfer option. The Participant shall, in the time and manner prescribed by the Administrator, specify the amount to be directly transferred and the "eligible retirement plan" to receive the transfer. Any portion of a distribution which is not transferred shall be distributed to the Participant. 57 65 (b) For purposes of this Section, the term "eligible rollover distribution" means any distribution other than a distribution of substantially equal periodic payments over the life or life expectancy of the Participant (or joint life or joint life expectancies of the Participant and the designated beneficiary) or a distribution over a period certain of ten years or more. Amounts required to be distributed under Code Section 401 (a)(9) are not eligible rollover distributions. The direct transfer option described in subsection (a) applies only to eligible rollover distributions which would otherwise be includible in gross income if not transferred. (c) For purposes of this Section, the term "eligible retirement plan" means an individual retirement account as described in Code Section 408(a), an individual retirement annuity as described in Code Section 408(b), an annuity plan as described in Code Section 403(a), or a defined contribution plan as described in Code Section 401(a) which is exempt from tax under Code Section 501(a) and which accepts rollover distributions. (d) The election described in subsection (a) also applies to the surviving spouse after the Participant's death; however, distributions to the surviving spouse may only be transferred to an individual retirement account or individual retirement annuity. For purposes of subsection (a), a spouse or former spouse who is the alternate payee under a qualified domestic relations order as defined in Code Section 414(p) will be treated as the Participant. 7.11 TRUSTEE INDEMNIFICATION The Employer agrees to indemnify and save harmless the Trustee against any and all claims, losses, damages, expenses and liabilities the Trustee may incur in the exercise and performance of the Trustee's powers and duties hereunder, unless the same are determined to be due to gross negligence or willful misconduct. 7.12 EMPLOYER SECURITIES AND REAL PROPERTY The Trustee shall be empowered to acquire and hold "qualifying Employer securities" and "qualifying Employer real property," as those terms are defined in the Act. However, no more than 100%, in the case of a Profit Sharing Plan or 401(k) Plan or 10%, in the case of a Money Purchase Plan of the fair market value of all the assets in the Trust Fund may be invested in "qualifying Employer securities" and "qualifying Employer real property." ARTICLE VIII AMENDMENT, TERMINATION, AND MERGERS 8.1 AMENDMENT (a) The Employer shall have the right at any time to amend this Plan subject to the limitations of this Section. However, any amendment which affects the rights, duties or responsibilities of the Trustee and Administrator may only be made with the Trustee's and Administrator's written consent. Any such amendment shall become effective as provided therein upon its execution. The Trustee shall not be required to execute any such amendment unless the amendment affects the duties of the Trustee hereunder. (b) The Employer may (1) change the choice of options in the Adoption Agreement, (2) add overriding language in the Adoption Agreement when such language is necessary to satisfy Code Sections 415 or 416 because of the required aggregation of multiple plans, and (3) add certain model amendments published by the Internal Revenue Service which specifically provide that their adoption will not cause the Plan to be treated as an individually designed plan. An Employer that amends the Plan for any other reason, including a waiver of the minimum funding requirement under Code 58 66 Section 412(d), will no longer participate in this Prototype Plan and will be considered to have an individually designed plan. (c) The Employer expressly delegates authority to the sponsoring organization of this Plan, the right to amend this Plan by submitting a copy of the amendment to each Employer who has adopted this Plan after first having received a ruling or favorable determination from the Internal Revenue Service that the Plan as amended qualifies under Code Section 401(a) and the Act. For purposes of this Section, the mass submitter shall be recognized as the agent of the sponsoring organization. If the sponsoring organization does not adopt the amendments made by the mass submitter, it will no longer be identical to or a minor modifier of the mass submitter plan. (d) No amendment to the Plan shall be effective if it authorizes or permits any part of the Trust Fund (other than such part as is required to pay taxes and administration expenses) to be used for or diverted to any purpose other than for the exclusive benefit of the Participants or their Beneficiaries or estates; or causes any reduction in the amount credited to the account of any Participant; or causes or permits any portion of the Trust Fund to revert to or become property of the Employer. (e) Except as permitted by Regulations (including Regulation 1.411(d)-4, no Plan amendment or transaction having the effect of a Plan amendment (such as a merger, plan transfer or similar transaction) shall be effective if it eliminates or reduces any "Section 41l(d)(6) protected benefit" or adds or modifies conditions relating to "Section 411(d)(6) protected benefits" the result of which is a further restriction on such benefit unless such protected benefits are preserved with respect to benefits accrued as of the later of the adoption date or effective date of the amendment. "Section 41l(d)(6) protected benefits" are benefits described in Code Section 41l(d)(6)(A), early retirement benefits and retirement-type subsidies, and optional forms of benefit. 8.2 TERMINATION (a) The Employer shall have the right at any time to terminate the Plan by delivering to the Trustee and Administrator written notice of such termination. Upon any full or partial termination all amounts credited to the affected Participants' Combined Accounts shall I become 100% Vested and shall not thereafter be subject to forfeiture, and all unallocated amounts shall be allocated to the accounts of all Participants in accordance with the provisions hereof. (b) Upon the full termination of the Plan, the Employer shall direct the distribution of the assets to Participants in a manner which is consistent with and satisfies the provisions of Section 6.5. Distributions to a Participant shall be made in cash (or in property if permitted in the Adoption Agreement) or through the purchase of irrevocable nontransferable deferred commitments from the Insurer. Except as permitted by Regulations, the termination of the Plan shall not result in the reduction of "Section 411(d)(6) protected benefits" as described in Section 8.1. 8.3 MERGER OR CONSOLIDATION This Plan may be merged or consolidated with, or its assets and/or liabilities may be transferred to any other plan only if the benefits which would be received by a Participant of this Plan, in the event of a termination of the plan immediately after such transfer, merger or consolidation, are at least equal to the benefits the Participant would have received if the Plan had terminated immediately before the transfer, merger or consolidation and such merger or consolidation does not otherwise result in the elimination or reduction of any "Section 411(d)(6) protected benefits" as described in Section 8.1(c). 59 67 ARTICLE IX MISCELLANEOUS 9.1 EMPLOYER ADOPTIONS (a) Any organization may become the Employer hereunder by executing the Adoption Agreement in form satisfactory to the Trustee, and it shall provide such additional information as the Trustee may require. The consent of the Trustee to act as such shall be signified by its execution of the Adoption Agreement. (b) Except as otherwise provided in this Plan, the affiliation of the Employer and the participation of its Participants shall be separate and apart from that of any other employer and its participants hereunder. 9.2 PARTICIPANT'S RIGHTS This Plan shall not be deemed to constitute a contract between the Employer and any Participant or to be a consideration or an inducement for the employment of any Participant or Employee. Nothing contained in this Plan shall be deemed to give any Participant or Employee the right to be retained in the service of the Employer or to interfere with the right of the Employer to discharge any Participant or Employee at any time regardless of the effect which such discharge shall have upon him as a Participant of this Plan. 9.3 ALIENATION (a) Subject to the exceptions provided below, no benefit which shall be payable to any person (including a Participant or his Beneficiary) shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, or charge the same shall be void; and no such benefit shall in any manner be liable for, or subject to, the debts, contracts, liabilities, engagements, or torts of any such person, nor shall it be subject to attachment or legal process for or against such person, and the same shall not be recognized except to such extent as may be required by law. (b) This provision shall not apply to the extent a Participant or Beneficiary is indebted to the Plan, for any reason, under any provision of this Plan. At the time a distribution is to be made to or for a Participant's or Beneficiary's benefit, such proportion of the amount to be distributed as shall equal such indebtedness shall be paid to the Plan, to apply against or discharge such indebtedness. Prior to making a payment, however, the Participant or Beneficiary must be given written notice by the Administrator that such indebtedness is to be so paid in whole or part from his Participant's Combined Account. If the Participant or Beneficiary does not agree that the indebtedness is a valid claim against his Vested Participant's Combined Account, he shall be entitled to a review of the validity of the claim in accordance with procedures provided in Sections 2.12 and 2.13. (c) This provision shall not apply to a "qualified domestic relations order" defined in Code Section 414(p), and those other domestic relations orders permitted to be so treated by the Administrator under the provisions of the Retirement Equity Act Of 1984. The Administrator shall establish a written procedure to determine the qualified status of domestic relations orders and to administer distributions under such qualified orders. Further, to the extent provided under a "qualified domestic relations order," a former spouse of a Participant shall be treated as the spouse or surviving spouse for all purposes under the Plan. 60 68 9.4 CONSTRUCTION OF PLAN This Plan and Trust shall be construed and enforced according to the Act and the laws of the State or Commonwealth in which the Employer's principal office is located, other than its laws respecting choice of law, to the extent not pre-empted by the Act. 9.5 GENDER AND NUMBER Wherever any words are used herein in the masculine, feminine or neuter gender, they shall be construed as though they were also used in another gender in all cases where they would so apply, and whenever any words are used herein in the singular or plural form, they shall be construed as though they were also used in the other form in all cases where they would so apply. 9.6 LEGAL ACTION In the event any claim, suit, or proceeding is brought regarding the Trust and/or Plan established hereunder to which the Trustee or the Administrator may be a party, and such claim, suit, or proceeding is resolved in favor of the Trustee or Administrator, they shall be entitled to be reimbursed from the Trust Fund for any and all costs, attorney's fees, and other expenses pertaining thereto incurred by them for which they shall have become liable. 9.7 PROHIBITION AGAINST DIVERSION OF FUNDS (a) Except as provided below and otherwise specifically permitted by law, it shall be impossible by operation of the Plan or of the Trust, by termination of either, by power of revocation or amendment, by the happening of any contingency, by collateral arrangement or by any other means, for any part of the corpus or income of any Trust Fund maintained pursuant to the Plan or any funds contributed thereto to be used for, or diverted to, purposes other than the exclusive benefit of Participants, Retired Participants, or their Beneficiaries. (b) In the event the Employer shall make a contribution under a mistake of fact pursuant to Section 403(c)(2)(A) of the Act, the Employer may demand repayment of such contribution at any time within one (1) year following the time of payment and the Trustees shall return such amount to the Employer within the one (1) year period. Earnings of the Plan attributable to the contributions may not be returned to the Employer but any losses attributable thereto must reduce the amount so returned. 9.8 BONDING Every Fiduciary, except a bank or an insurance company, unless exempted by the Act and regulations thereunder, shall be bonded in an amount not less than 10% of the amount of the funds such Fiduciary handles; provided, however, that the minimum bond shall be $1,000 and the maximum bond, $500,000. The amount of funds handled shall be determined at the beginning of each Plan Year by the amount of funds handled by such person, group, or class to be covered and their predecessors, if any, during the preceding Plan Year, or if there is no preceding Plan year, then by the amount of me funds to be handled during the then current year. The bond shall provide protection to the Plan against any loss by reason of acts of fraud or dishonesty by the Fiduciary alone or in connivance with others. The surety shall be a corporate surety company (as such term is used in Act Section 412(a)(2)), and the bond shall be in a form approved by the Secretary of Labor. Notwithstanding anything in the Plan to the contrary, the cost of such bonds shall be an expense of and may, at the election of the Administrator, be paid from the Trust Fund or by the Employer. 61 69 9.9 EMPLOYER'S AND TRUSTEE'S PROTECTIVE CLAUSE Neither the Employer nor the Trustee, nor their successors, shall be responsible for the validity of any Contract issued hereunder or for the failure on the part of the Insurer to make payments provided by any such Contract, or for the action of any person which may delay payment or render a Contract null and void or unenforceable in whole or in part. 9.10 INSURER'S PROTECTIVE CLAUSE The Insurer who shall issue Contracts hereunder shall not have any responsibility for the validity of this Plan or for the tax or legal aspects of this Plan. The Insurer shall be protected and held harmless in acting in accordance with any written direction of the Trustee, and shall have no duty to see to the application of any funds paid to the Trustee, nor be required to question any actions directed by the Trustee. Regardless of any provision of this Plan, the Insurer shall not be required to take or permit any action or allow any benefit or privilege contrary to the terms of any Contract which it issues hereunder, or the rules of the Insurer. 9.11 RECEIPT AND RELEASE FOR PAYMENTS Any payment to any Participant, his legal representative, Beneficiary, or to any guardian or committee appointed for such Participant or Beneficiary in accordance with the provisions of this Plan, shall, to the extent thereof, be in full satisfaction of all claims hereunder against the Trustee and the Employer. 9.12 ACTION BY THE EMPLOYER Whenever the Employer under the terms of the Plan is permitted or required to do or perform any act or matter or thing, it shall be done and performed by a person duly authorized by its legally constituted authority. 9.13 NAMED FIDUCIARIES AND ALLOCATION OF RESPONSIBILITY The "named Fiduciaries" of this Plan are (1) the Employer, (2) the Administrator, (3) the Trustee, and (4) any Investment Manager appointed hereunder. The named Fiduciaries shall have only those specific powers, duties, responsibilities, and obligations as are specifically given them under the Plan. In general, the Employer shall have the sole responsibility for making the contributions provided for under Section 4.1; and shall have the sole authority to appoint and remove the Trustee and the Administrator; to formulate the Plan's "funding policy and method"; and to amend the elective provisions of the Adoption Agreement or terminate, in whole or in part, the Plan. The Administrator shall have the sole responsibility for the administration of the Plan, which responsibility is specifically described in the Plan. The Trustee shall have the sole responsibility of management of the assets held under the Trust, except those assets, the management of which has been assigned to an Investment Manager or Administrator, who shall be solely responsible for the management of the assets assigned to it, all as specifically provided in the Plan. Each named Fiduciary warrants that any directions given, information furnished, or action taken by it shall be in accordance with the provisions of the Plan, authorizing or providing for such direction, information or action. Furthermore, each named Fiduciary may rely upon any such direction, information or action of another named Fiduciary as being proper under the Plan, and is not required under the Plan to inquire into the propriety of any such direction, information or action. It is intended under the Plan that each named Fiduciary shall be responsible for the proper exercise of its own powers, duties, responsibilities and obligations under the Plan. No named Fiduciary shall guarantee the Trust Fund in any manner against investment loss or depreciation in asset value. Any person or group may serve in more than one Fiduciary capacity. 62 70 9.14 HEADINGS The headings and subheadings of this Plan have been inserted for convenience of reference and are to be ignored in any construction of the provisions hereof. 9.15 APPROVAL BY INTERNAL REVENUE SERVICE (a) Notwithstanding anything herein to the contrary, if, pursuant to a timely application filed by or in behalf of the Plan, the Commissioner of Internal Revenue Service or his delegate should determine that the Plan does not initially qualify as a tax-exempt plan under Code Sections 401 and 501, and such determination is not contested, or if contested, is finally upheld, then if the Plan is a new plan, it shall be void av initio and all amounts contributed to the Plan, by the Employer, less expenses paid, shall be returned within one year and the Plan shall terminate, and the Trustee shall be discharged from all further obligations. If the disqualification relates to an amended plan, then the Plan shall operate as if it had not been amended and restated. (b) Except as specifically stated in the Plan, any contribution by the Employer to the Trust Fund is conditioned upon the deductibility of the contribution by the Employer under the Code and, to the extent any such deduction is disallowed, the Employer may within one (1) year following a final determination of the disallowance, whether by agreement with the Internal Revenue Service or by final decision of a court of competent jurisdiction, demand repayment of such disallowed contribution and the Trustee shall return such contribution within one (1) year following the disallowance. Earnings of the Plan attributable to the excess contribution may not be returned to the Employer, but any losses attributable thereto must reduce the amount so returned. 9.16 UNIFORMITY All provisions of this Plan shall be interpreted and applied in a uniform, nondiscriminatory manner. 9.17 PAYMENT OF BENEFITS Benefits under this Plan shall be paid, subject to Section 6.10 and Section 6.11 only upon death, Total and Permanent Disability, normal or early retirement, termination of employment, or upon Plan Termination. ARTICLE X PARTICIPATING EMPLOYERS 10.1 ELECTION TO BECOME A PARTICIPATING EMPLOYER Notwithstanding anything herein to the contrary, with the consent of the Employer and Trustee, any Affiliated Employer may adopt this Plan and all of the provisions hereof, and participate herein and be known as a Participating Employer, by a properly executed document evidencing said intent and will of such Participating Employer. 10.2 REQUIREMENTS OF PARTICIPATING EMPLOYERS (a) Each Participating Employer shall be required to select the same Adoption Agreement provisions as those selected by the Employer other than the Plan Year, the Fiscal Year, and such other items that must, by necessity, vary among employers. 63 71 (b) Each such Participating Employer shall be required to use the same Trustee as provided in this Plan. (c) The Trustee may, but shall not be required to, commingle, hold and invest as one Trust Fund all contributions made by Participating Employers, as well as all increments thereof. (d) The transfer of any Participant from or to an Employer participating in this Plan, whether he be an Employee of the Employer or a Participating Employer, shall not affect such Participant's rights under the Plan, and all amounts credited to such Participant's Combined Account as well as his accumulated service time with the transferor or predecessor, and his length of participation in the Plan, shall continue to his credit. (e) Any expenses of the Plan which are to be paid by the Employer or borne by the Trust Fund shall be paid by each Participating Employer in the same proportion that the total amount standing to the credit of all Participants employed by such Employer bears to the total standing to the credit of all Participants. 10.3 DESIGNATION OF AGENT Each Participating Employer shall be deemed to be a part of this Plan; provided, however, that with respect to all of its relations with the Trustee and Administrator for the purpose of this Plan, each Participating Employer shall be deemed to have designated irrevocably the Employer as its agent. Unless the context of the Plan clearly indicates the contrary, the word "Employer" shall be deemed to include each Participating Employer as related to its adoption of the Plan. 10.4 EMPLOYEE TRANSFERS It is anticipated that an Employee may be transferred between Participating Employers, and in the event of any such transfer, the Employee involved shall carry with him his accumulated service and eligibility. No such transfer shall effect a termination of employment hereunder, and the Participating Employer to which the Employee is transferred shall thereupon become obligated hereunder with respect to such Employee in the same manner as was the Participating Employer from whom the Employee was transferred. 10.5 PARTICIPATING EMPLOYER'S CONTRIBUTION AND FORFEITURES Any contribution or Forfeiture subject to allocation during each Plan Year shall be allocated among all Participants of all Participating Employers in accordance with the provisions of this Plan. On the basis of the information furnished by the Administrator, the Trustee shall keep separate books and records concerning the affairs of each Participating Employer hereunder and as to the accounts and credits of the Employees of each Participating Employer. The Trustee may, but need not, register Contracts so as to evidence that a particular Participating Employer is the interested Employer hereunder, but in the event of an Employee transfer from one Participating Employer to another, the employing Employer shall immediately notify the Trustee thereof. 10.6 AMENDMENT Amendment of this Plan by the Employer at any time when there shall be a Participating Employer hereunder shall only be by the written action of each and every Participating Employer and with the consent of the Trustee where such consent is necessary in accordance with the terms of this Plan. 64 72 10.7 DISCONTINUANCE OF PARTICIPATION Except in the case of a Standardized Plan, any Participating Employer shall be permitted to discontinue or revoke its participation in the Plan at any time. At the time of any such discontinuance or revocation, satisfactory evidence thereof and of any applicable conditions imposed shall be delivered to the Trustee. The Trustee shall thereafter transfer, deliver and assign Contracts and other Trust Fund assets allocable to the Participants of such Participating Employer to such new Trustee as shall have been designated by such Participating Employer, in the event that it has established a separate pension plan for its Employees provided, however, that no such transfer shall be made if the result is the elimination or reduction of any "Section 411(d)(6) protected benefits" in accordance with Section 8.1(e). If no successor is designated, the Trustee shall retain such assets for the Employees of said Participating Employer pursuant to the provisions of Article VII hereof. In no such event shall any part of the corpus or income of the Trust Fund as it relates to such Participating Employer be used for or diverted for purposes other than for the exclusive benefit of the Employees of such Participating Employer. 10.8 ADMINISTRATOR'S AUTHORITY The Administrator shall have authority to make any and all necessary rules or regulations, binding upon all Participating Employers and all Participants, to effectuate the purpose of this Article. 10.9 PARTICIPATING EMPLOYER CONTRIBUTION FOR AFFILIATE If any Participating Employer is prevented in whole or in part from making a contribution which it would otherwise have made under the Plan by reason of having no current or accumulated earnings or profits, or because such earnings or profits are less than the contribution which it would otherwise have made, then, pursuant to Code Section 404(a)(3)(B), so much of the contribution which such Participating Employer was so prevented from making may be made, for the benefit of the participating employees of such Participating Employer, by other Participating Employers who are members of the same affiliated group within the meaning of Code Section 1504 to the extent of their current or accumulated earnings or profits, except that such contribution by each such other Participating Employer shall be limited to the proportion of its total current and accumulated earnings or profits remaining after adjustment for its contribution to the Plan made without regard to this paragraph which the total prevented contribution bears to the total current and accumulated earnings or profits of all the Participating Employers remaining after adjustment for all contributions made to the Plan without regard to this paragraph. A Participating Employer on behalf of whose employees a contribution is made under this paragraph shall not be required to reimburse the contributing Participating Employers. ARTICLE XI CASH OR DEFERRED PROVISIONS Notwithstanding any provisions in the Plan to the contrary, the provisions of this Article shall apply with respect To any 401(k) Profit Sharing Plan. Notwithstanding anything in this Article to the contrary, effective as of the Plan Year in which this amendment becomes effective, the Actual Deferral Percentage Test and the Actual Contribution Percentage Test shall be applied (and adjusted) by applying the Family Member aggregation rules of Code Section 414(q)(6). 11.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION For each Plan Year, the Employer shall contribute to the Plan: 65 73 (a) The amount of the total salary reduction elections of all Participants made pursuant to Section 11.2(a), which amount shall be deemed an Employer's Elective Contribution, plus (b) If specified in E3 of the Adoption Agreement, a matching contribution equal to the percentage specified in the Adoption Agreement of the Deferred Compensation of each Participant eligible to share in the allocations of the matching contribution, which amount shall be deemed an Employer's Non-Elective or Elective Contribution as selected in the Adoption Agreement, plus (c) If specified in E4 of the Adoption Agreement, a discretionary amount, if any, which shall be deemed an Employer's Non-Elective Contribution, plus (d) If specified in E5 of the Adoption Agreement, a Qualified Non-Elective Contribution. (e) Notwithstanding the foregoing, however, the Employer's contributions for any Fiscal Year shall not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. All contributions by the Employer shall be made in cash or in such property as is acceptable to the Trustee. (f) Except, however, to the extent necessary to provide the top heavy minimum allocations, the Employer shall make a contribution even if it exceeds current or accumulated Net Profit or the amount which is deductible under Code Section 404. (g) Employer Elective Contributions accumulated through payroll deductions shall be paid to the Trustee as of the earliest date on which such contributions can reasonably be segregated from the Employer's general assets, but in any event within ninety (90) days from the date on which such amounts would otherwise have been payable to the Participant in cash. The provisions of Department of Labor regulations 2510.3-102 are incorporated herein by reference. Furthermore, any additional Employer contributions which are allocable to the Participant's Elective Account for a Plan Year shall be paid to the Plan no later than the twelve-month period immediately following the close of such Plan Year. 11.2 PARTICIPANT'S SALARY REDUCTION ELECTION (a) If selected in the Adoption Agreement, each Participant may elect to defer his Compensation which would have been received in the Plan Year, but for the deferral election, subject to the limitations of this Section and the Adoption Agreement. A deferral election (or modification of an earlier election) may not be made with respect to Compensation which is currently available on or before the date the Participant executed such election, or if later, the latest of the date the Employer adopts this cash or deferred arrangement, or the date such arrangement first became effective. Any elections made pursuant to this Section shall become effective as soon as is administratively feasible. Additionally, if elected in the Adoption Agreement, each Participant may elect to defer and have allocated for a Plan Year all or a portion of any cash bonus attributable to services performed by the Participant for the Employer during such Plan Year and which would have been received by the Participant on or before two and once-half months following the end of the Plan Year but for the deferral. A deferral election may not be made with respect to cash bonuses which are currently available on or before the date the Participant executed such election. Notwithstanding the foregoing, cash bonuses attributable to services performed by the Participant during a Plan Year but which are to be paid to the Participant later than two and one-half months after the close of such Plan Year will be subjected to whatever deferral election is in effect at the time such cash bonus would have otherwise been received. 66 74 The amount by which Compensation and/or cash bonuses are reduced shall be that Participant's Deferred Compensation and be treated as an Employer Elective Contribution and allocated to that Participant's Elective Account. Once made, a Participant's election to reduce Compensation shall remain in effect until modified or terminated. Modifications may be made as specified in the Adoption Agreement, and terminations may be made at any time. Any modification or termination of an election will become effective as soon as is administratively feasible. (b) The balance in each Participant's Elective Account shall be fully Vested at all times and shall not be subject to Forfeiture for any reason. (c) Amounts held in the Participant's Elective Account and Qualified Non-Elective Account may be distributable as permitted under the Plan, but in no event prior to the earlier of: (1) a Participant's termination of employment, Total and Permanent Disability, or death; (2) a Participant's attainment of age 59 1/2; (3) the proven financial hardship of a Participant, subject to the limitations of Section 11.8; (4) the termination of the Plan without the existence at the time of Plan termination of another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)) or the establishment of a successor defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)) by the Employer or an Affiliated Employer within the period ending twelve months after distribution of all assets from the Plan maintained by the Employer; (5) the date of the sale by the Employer to an entity that is not an Affiliated Employer of substantially all of the assets (within the meaning of Code Section 409(d)(2)) with respect to a Participant who continues employment with the corporation acquiring such assets; or (6) the date of the sale by the Employer or an Affiliated Employer of its interest in a subsidiary (within the meaning of Code Section 409(d)(3)) to an entity that is not an Affiliated Employer with respect to a Participant who continues employment with such subsidiary. (d) In any Plan Year beginning after December 31, 1986, a Participant's Deferred Compensation made under this Plan and all other plans, contracts or arrangements of the Employer maintaining this Plan shall not exceed the limitation imposed by Code Section 402(g), as in effect for the calendar year in which such Plan Year began. If such dollar limitation is exceeded solely from elective deferrals made under this Plan or any other Plan maintained by the Employer, a Participant will be deemed to have notified the Administrator of such excess amount which shall be distributed in a manner consistent with Section 11.2(f). This dollar limitation shall be adjusted annually pursuant to the method provided in Code Section 415(d) in accordance with Regulations. (e) In the event a Participant has received a hardship distribution pursuant to Regulation 1.401(k)-1(d)(2)(iii)(B) from any other plan maintained by the Employer or from his Participant's Elective Account pursuant to Section 11.8, then such Participant shall not be permitted to elect to have Deferred Compensation contributed to the Plan on his behalf for a period of twelve (12) months following the receipt of the distribution. Furthermore, the dollar limitation under Code Section 402(g) shall he reduced, with respect to the Participant's taxable year following the taxable year in which 67 75 the hardship distribution was made, by the amount of such Participant's Deferred Compensation, if any, made pursuant to this Plan (and any other plan maintained by the Employer) for the taxable year of the hardship distribution. (f) If a Participant's Deferred Compensation under this Plan together with any elective deferrals (as defined in Regulation 1.402(g)-1(b)) under another qualified cash or deferred arrangement (as defined in Code Section 401(k)), a simplified employee pension (as defined in Code Section 408(k)), a salary reduction arrangement (within the meaning of Code Section 3121(a)(5)(D)), a deferred compensation plan under Code Section 457, or a trust described in Code Section 501(c)(18) cumulatively exceed the limitation imposed by Code Section 402(g) (as adjusted annually in accordance with the method provided in Code Section 415(d) pursuant to Regulations) for such Participant's taxable year, the Participant may, not later than Mareh 1st following the close of his taxable year, notify the Administrator in writing of such excess and request that his Deferred Compensation under this Plan be reduced by an amount specified by the Participant. In such event, the Administrator shall direct the Trustee to distribute such excess amount (and any Income allocable to such excess amount) to the Participant not later than the first April 15th following the close of the Participant's taxable year. Distributions in accordance with this paragraph may be made for any taxable year of the Participant which begins after December 31, 1986. Any distribution of less than the entire amount of Excess Deferred Compensation and Income shall be treated as a pro rata distribution of Excess Deferred Compensation and Income. The amount distributed shall not exceed the Participant's Deferred Compensation under the Plan for the taxable year. Any distribution on or before the last day of the Participant's taxable year must satisfy each of the following conditions: (1) the Participant shall designate the distribution as Excess Deferred Compensation; (2) the distribution must be made after the date on which the Plan received the Excess Deferred Compensation; and (3) the Plan must designate the distribution as a distribution of Excess Deferred Compensation. Any distribution under this Section shall be made first from unmatched Deferred Compensation and, thereafter, simultaneously from Deferred Compensation which is matched and matching contributions which relate to such Deferred Compensation. However, any such matching contributions which are not Vested shall be forfeited in lieu of being distributed. For the purpose of this Section, "Income" means the amount of income or loss allocable to a Participant's Excess Deferred Compensation and shall be equal to the sum of the allocable gain or loss for the taxable year of the Participant and the allocable gain or loss for the period between the end of the taxable year of the Participant and the date of distribution ("gap period"). The income or loss allocable to each such period is calculated separately and is determined by multiplying the income or loss allocable to the Participant's Deferred Compensation for the respective period by a fraction. The numerator of the fraction is the Participant's Excess Deferred Compensation for the taxable year of the Participant. The denominator is the balance, as of the last day of the respective period, of the Participant's Elective Account that is attributable To the Participant's Deferred Compensation reduced by the gain allocable to such total amount for the respective period and increased by the loss allocable to such total amount for the respective period. In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable income or loss for the "gap period." Under such "safe harbor method," allocable income or loss for the "gap period" shall be deemed to equal ten percent (10%) of the income or loss allocable to a Participant's Excess Deferred Compensation for the taxable year of the 68 76 Participant multiplied by the number of calendar months in the "gap period." For purposes of determining the number of calendar months in the "gap period," a distribution occurring on or before the fifteenth day of the month shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. Income or loss allocable to any distribution of Excess Deferred Compensation on or before the last day of the taxable year of the Participant shall be calculated from the first day of the taxable year of the Participant to the date on which the distribution is made pursuant to either the "fractional method" or the "safe harbor method." Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 4.3(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. Notwithstanding the above, for the 1987 calendar year, Income during the "gap period" shall not be taken into account. (g) Notwithstanding the above, a Participant's Excess Deferred Compensation shall be reduced, but not below zero, by any distribution and/or recharacterization of Excess Contributions pursuant to Section 11.5(a) for the Plan Year beginning with or within the taxable year of the Participant. (h) At Normal Retirement Date, or such other date when the Participant shall be entitled to receive benefits, the fair market value of the Participant's Elective Account shall be used w provide benefits to the Participant or his Beneficiary. (i) Employer Elective Contributions made pursuant to this Section may be segregated into a separate account for each Participant in a federally insured savings account, certificate of deposit in a bank or savings and loan association, money market certificate, or other short-term debt security acceptable to the Trustee until such time as the allocations pursuant to Section 11.3 have been made. (j) The Employer and the Administrator shall adopt a procedure necessary to implement the salary reduction elections provided for herein. 11.3 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS (a) The Administrator shall establish and maintain an account in the name of each Participant to which the Administrator shall credit as of each Anniversary Date, or other valuation date, all amounts allocated to each such Participant as set forth herein. (b) The Employer shall provide the Administrator with all information required by the Administrator to make a proper allocation of the Employer's contributions for each Plan Year. Within a reasonable period of time after the date of receipt by the Administrator of such information, the Administrator shall allocate such contribution as follows: (1) With respect to the Employer's Elective Contribution made pursuant to Section 11.1(a), to each Participant's Elective Account in an amount equal to each such Participant's Deferred Compensation for the year. 69 77 (2) With respect tO the Employer's Matching Contribution made pursuant to Section 11.1(b), to each Participant's Account, or Participant's Elective Account as selected in E3 of the Adoption Agreement, in accordance with Section 11.1(b). Except, however, a Participant who is not credited with a Year of Service during any Plan Year shall or shall not share in the Employer's Matching Contribution for that year as provided in E3 of the Adoption Agreement. However, for Plan Years beginning after 1989, if this is a standardized Plan, a Participant shall share in the Employer's Matching Contribution regardless of Hours of Service. (3) With respect to the Employer's Non-Elective Contribution made pursuant to Section 11.1(c), to each Participant's Account in accordance with the provisions of Sections 4.3(b)(2) or 4.3(b)(3), whichever is applicable, 4.3(k) and 4.3(l). (4) With respect to the Employer's Qualified Non-Elective Contribution made pursuant to Section 11.1(d), to each Participant's Qualified Non-Elective Contribution Account in the same proportion that each such Participant's Compensation for the year bears to the total Compensation of all Participants for such year. However, for any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, a Participant who is not credited with a Year of Service during any Plan Year shall not share in the Employer's Qualified Non-Elective Contribution for that year, unless required pursuant to Section 4.3(h). In addition, the provisions of Sections 4.3(k) and 4.3(l) shall apply with respect to the allocation of the Employer's Qualified Non-Elective contribution. (c) Notwithstanding anything in the Plan to the contrary, for Plan Years beginning after December 31, 1988, in determining whether a Non-Key Employee has received the required minimum allocation pursuant to Section 4.3(f) such Non-Key Employee's Deferred Compensation and matching contributions used to satisfy the "Actual Deferral Percentage" test pursuant to Section 11.4(a) or the "Actual Contribution Percentage" test of Section 11.6(a) shall not be taken into account. (d) Notwithstanding anything herein to the contrary, participants who terminated employment during the Plan Year shall share in the salary reduction contributions made by the Employer for the year of termination without regard to the Hours of Service credited. (e) Notwithstanding anything herein to the contrary (other than Sections 11.3(d) and 11.3(g)), any Participant who terminated employment during the Plan Year for reasons other than death, Total and Permanent Disability, or retirement shall or shall not share in the allocations of the Employer's Matching Contribution made pursuant to Section 11.1(b), the Employer's Non-Elective Contributions made pursuant to Section 11.1(c), the Employer's Qualified Non-Elective Contribution made pursuant to Section 11.1(d), and Forfeitures as provided in the Adoption Agreement. Notwithstanding the foregoing, for Plan Years beginning after 1989, if this is a standardized Plan, any such terminated Participant shall share in such allocations provided the terminated Participant completed more than 500 Hours of Service. (f) Notwithstanding anything herein to the contrary, Participants terminating for reasons of death, Total and Permanent Disability, or retirement shall share in the allocation of the Employer's Matching Contribution made pursuant to Section 11.1(b), the Employer's Non-Elective Contributions made pursuant to Section 11.1(c), the Employer's Qualified Non-Elective Contribution made pursuant to Section 11.1(d), and Forfeitures as provided in this Section regardless of whether they completed a Year of Service during the Plan Year. 70 78 (g) Notwithstanding any election in the Adoption Agreement to the contrary, if this is a non-standardized Plan that would otherwise fail to meet the requirements of Code Sections 401(a)(26),410(b)(1), or 410(b)(2)(A)(i) and the Regulations thereunder because Employer matching Contributions made pursuant to Section 11.1(b), Employer Non-Elective Contributions made pursuant to Section 11.1(c) or Employer Qualified Non-Elective Contributions made pursuant to Section 11.1 (d) have not been allocated to a sufficient number or percentage of Participants for a Plan Year, then the following rules shall apply: (1) The group of Participants eligible to share in the respective contributions for the Plan Year shall be expanded to include the minimum number of Participants who would not otherwise be eligible as are necessary to satisfy the applicable test specified above. The specific participants who shall become eligible under the terms of this paragraph shall be those who are actively employed on the last day of the Plan Year and, when compared to similarly situated Participants, have completed the greatest number of Hours of Service in the Plan Year. (2) If after application of paragraph (1) above, the applicable test is still not satisfied, then the group of Participants eligible to share for the Plan Year shall be further expanded to include the minimum number of Participants who are not actively employed on the last day of the Plan Year as are necessary to satisfy the applicable test. The specific Participants who shall become eligible to share shall be those Participants, when compared to similarly situated Participants, who have completed the greatest number of Hours of Service in the Plan Year before terminating employment. 11.4 ACTUAL DEFERRAL PERCENTAGE TESTS (a) Maximum Annual Allocation: For each Plan Year beginning after December 31, 1986, the annual allocation derived from Employer Elective Contributions and Qualified Non-Elective Contributions to a Participant's Elective Account and Qualified Non-Elective Account shall satisfy one of the following tests: (1) The "Actual Deferral Percentage" for the Highly Compensated Participant group shall not be more than the "Actual Deferral Percentage" of the Non-Highly Compensated Participant group multiplied by 1.25, or (2) The excess of the "Actual Deferral Percentage" for the Highly Compensated Participant group over the "Actual Deferral Percentage" for the Non-Highly Compensated Participant group shall not be more than two percentage points. Additionally, the "Actual Deferral Percentage" for the Highly Compensated Participant group shall not exceed the "Actual Deferral Percentage" for the Non-Highly Compensated Participant group multiplied by 2. The provisions of Code Section 401(k)(3) and Regulation 1.401(k)-1(b) are incorporated herein by reference. However, for Plan Years beginning after December 31, 1988, to prevent the multiple use of the alternative method described in (2) above and Code Section 401(m)(9)(A), any Highly Compensated Participant eligible to make elective deferrals pursuant to Section 11.2 and to make Employee contributions or to receive matching contributions under this Plan or under any other plan maintained by the Employer or an Affiliated Employer shall have his actual contribution ratio reduced pursuant to Regulation 1.401(m)-2, the provisions of which are incorporated herein by reference. 71 79 (b) For the purposes of this Section "Actual Deferral Percentage" means, with respect to the Highly Compensated Participant group and Non-Highly Compensated Participant group for a Plan Year, the average of the ratios, calculated separately for each Participant in such group, of the amount of Employer Elective Contributions and Qualified Non-Elective Contributions allocated to each Participant's Elective Account and Qualified Non-Elective Account for such Plan Year, to such Participant's "414(s) Compensation" for such Plan Year. The actual deferral ratio for each Participant and the "Actual Deferral Percentage" for each group, for Plan Years beginning after December 31, 1988, shall be calculated to the nearest one-hundredth of one percent of the Participant's "414(s) Compensation." Employer Elective Contributions allocated to each Non-Highly Compensated Participant's Elective Account shall be reduced by Excess Deferred Compensation to the extent such excess amounts are made under this Plan or any other plan maintained by the Employer. (c) For the purpose of determining the actual deferral ratio of a Highly Compensated Participant who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Participant is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, the following shall apply: (1) The combined actual deferral ratio for the family group (which shall be treated as one Highly Compensated Participant) shall be the greater of: (i) the ratio determined by aggregating Employer Elective Contributions and "414(s) Compensation" of all eligible Family Members who are Highly Compensated Participants without regard to family aggregation; and (ii) the ratio determined by aggregating Employer Elective Contributions and "414(s) Compensation" of all eligible Family Members (including Highly Compensated Participants). However, in applying the $200,000 limit to "414(s) Compensation" for Plan Years beginning after December 31, 1988, Family Members shall include only the affected Employee's spouse and any lineal descendants who have not attained age 19 before the close of the Plan Year. (2) The Employer Elective Contributions and "414(s) Compensation" of all Family Members shall be disregarded for purposes of determining the "Actual Deferral Percentage" of the Non-Highly Compensated Participant group except to the extent taken into account in paragraph (1) above. (3) If a Participant is required to be aggregated as a member of more than one family group in a plan, all Participants who are members of those family groups that include the Participant are aggregated as one family group in accordance with paragraphs (1) and (2) above. (d) For the purposes of this Section and Code Sections 401(a)(4), 410(b) and 401(k), if two or more plans which include cash or deferred arrangement are considered one plan for the purposes of Code Section 401(a)(4) or 410(b) (other than Code Section 401(b)(2)(A)(ii) as in effect for Plan Years beginning after December 31, 1988), the cash or deferred arrangements included in such plans shall be treated as one arrangement. In addition, two or more cash or deferred arrangements may be considered as a single arrangement for purposes of determining whether or not such arrangements satisfy Code Sections 401(a)(4), 410(b) and 401(k). In such a case, the cash or deferred arrangements included in such plans and the plans including such arrangements shall be treated as one arrangement and as one plan for purposes of this Section and Code Sections 401(a)(4), 410(b) and 401(k). For plan years beginning after December 31, 1989, plans may be aggregated under this paragraph (e) only if they have the same plan year. Notwithstanding the above, for Plan Years beginning after December 31, 1988, an employee stock ownership plan described in Code Section 4975(e)(7) may not be combined with this 72 80 Plan for purposes of determining whether the employee stock ownership plan or this Plan satisfies this Section and Code Sections 401(a)(4), 410(b) and 401(k). (e) For the purposes of this Section, if a Highly Compensated Participant is a Participant under two (2) or more cash or deferred arrangements (other than a cash or deferred arrangement which is part of an employee stock ownership plan as defined in Code Section 4975(e)(7) for Plan Years beginning after December 31, 1988) of the Employer or an Affiliated Employer, all such cash or deferred arrangements shall be treated as one cash or deferred arrangement for the purpose of determining the actual deferral ratio with respect to such Highly Compensated Participant. However, for Plan Years beginning after December 31, 1988, if the cash or deferred arrangements have different Plan Years, this paragraph shall be applied by treating all cash or deferred arrangements ending with or within the same calendar year as a single arrangement. 11.5 ADJUSTMENT TO ACTUAL DEFERRAL PERCENTAGE TESTS In the event that the initial allocations of the Employer's Elective Contributions and Qualified Non-Elective Contributions do not satisfy one of the tests set forth in Section 11.4, for Plan Years beginning after December 31, 1986, the Administrator shall adjust Excess Contributions pursuant to the options set forth below: (a) On or before the fifteenth day of the third month following the end of each Plan Year, the Highly Compensated Participant having the highest actual deferral ratio shall have his portion of Excess Contributions distributed to him and/or at his election recharacterized as a voluntary Employee contribution pursuant to Section 4.7 until one of the tests set forth in Section 11.4 is satisfied, or until his actual deferral ratio equals the actual deferral ratio of the Highly Compensated Participant having the second highest actual deferral ratio. This process shall continue until one of the tests set forth in Section 11.4 is satisfied. For each Highly Compensated Participant, the amount of Excess Contributions is equal to the Elective Contributions and Qualified Non-Elective Contributions made on behalf of such Highly Compensated Participant (determined prior to the application of this paragraph) minus the amount determined by multiplying the Highly Compensated Participant's actual deferral ratio (determined after application of this paragraph) by his "414(s) Compensation." However, in determining the amount of Excess Contributions to be distributed and/or recharacterized with respect to an affected Highly Compensated Participant as determined herein, such amount shall be reduced by any Excess Deferred Compensation previously distributed to such affected Highly Compensated Participant for his taxable year ending with or within such Plan Year. Any distribution and/or recharacterization of Excess Contributions shall be made in accordance with the following: (1) With respect to the distribution of Excess Contributions pursuant to (a) above, such distribution: (i) may be postponed but not later than the close of the Plan Year following the Plan Year to which they are allocable; (ii) shall be made first from unmatched Deferred Compensation and, thereafter, simultaneously from Deferred Compensation which is matched and matching contributions which relate to such Deferred Compensation. However, any such matching contributions which are not Vested shall be forfeited in lieu of being distributed; (iii) shall be made from Qualified Non-Elective Contributions only to the extent that Excess Contributions exceed the balance in the Participant's Elective Account attributable to Deferred Compensation and Employer matching contributions. 73 81 (iv) shall be adjusted for Income; and (v) shall be designated by the Employer as a distribution of Excess Contributions (and Income). (2) With respect to the recharacterization of Excess Contributions pursuant to (a) above, such recharacterized amounts: (i) shall be deemed to have occurred on the date on which the last of those Highly Compensated Participants with Excess Contributions to be recharacterized is notified of the recharacterization and the tax consequences of such recharacterization; (ii)for Plan Years ending on or before August 8, 1988, may be postponed but not later than October 24, 1988; (iii) shall not exceed the amount of Deferred Compensation on behalf of any Highly Compensated Participant for any Plan Year; (iv)shall be treated as voluntary Employee contributions for purposes of Code Section 401(a)(4) and Regulation 1.401(k)-1(b). However, for purposes of Sections 2.2 and 4.3(f), recharacterized Excess Contributions continue to be treated as Employer contributions that are Deferred Compensation. For Plan Years beginning after December 31, 1988, Excess Contributions recharacterized as voluntary Employee contributions shall continue to be nonforfeitable and subject to the same distribution rules provided for in Section 11.2(c); (v) which relate to Plan Years ending on or before October 24, 1988, may be treated as either Employer contributions or voluntary Employee contributions and therefore shall not be subject to the restrictions of Section 11.2(c); (vi)are not permitted if the amount recharacterized plus voluntary Employee contributions actually made by such Highly Compensated Participant, exceed the maximum amount of voluntary Employee contributions (determined prior to application of Section 11.6) that such Highly Compensated Participant is permitted to make under the Plan in the absence of recharacterization; (vii) shall be adjusted for Income. (3) Any distribution and/or recharacterization of less than the entire amount of Excess Contributions shall be treated as a pro rata distribution and/or recharacterization of Excess Contributions and Income. (4) The determination and correction of Excess Contributions of a Highly Compensated Participant whose actual deferral ratio is determined under the family aggregation rules shall be accomplished as follows: (i) If the actual deferral ratio for the Highly Compensated Participant is determined in accordance with Section 11.4(c)(1)(ii), then the actual deferral ratio shall be reduced as required herein and the Excess Contributions for the family unit shall be allocated among the Family Members in proportion to the Elective Contributions of each Family Member that were combined to determine the group actual deferral ratio. 74 82 (ii)If the actual deferral ratio for the Highly Compensated Participant is determined under Section 11.4(c)(1)(i), then the actual deferral ratio shall first be reduced as required herein, but not below the actual deferral ratio of the group of Family Members who are not Highly Compensated Participants without regard to family aggregation. The Excess Contributions resulting from this initial reduction shall be allocated (in proportion to Elective Contributions) among the Highly Compensated Participants whose Elective Contributions were combined to determine the actual deferral ratio. If further reduction is still required, then Excess Contributions resulting from this further reduction shall be determined by taking into account the contributions of all Family Members and shall be allocated among them in proportion to their respective Elective Contributions. (b) Within twelve (12) months after the end of the Plan Year, the Employer shall make a special Qualified Non-Elective Contribution on behalf of Non-Highly Compensated Participants in an amount sufficient to satisfy one of the tests set forth in Section 11.4(a). Such contribution shall be allocated to the Participant's Qualified Non-Elective Account of each Non-Highly Compensated Participant in the same proportion that each Non-Highly Compensated Participant's Compensation for the year bears to the total Compensation of all Non-Highly Compensated Participants. (c) For purposes of this Section, "Income" means the income or loss allocable to Excess Contributions which shall equal the sum of the allocable gain or loss for the Plan Year and the allocable gain or loss for the period between the end of the Plan Year and the date of distribution ("gap period"). The income or loss allocable to Excess Contributions for the Plan Year and the "gap period" is calculated separately and is determined by multiplying the income or loss for the Plan Year or the "gap period" by a fraction. The numerator of the fraction is the Excess Contributions for the Plan Year. The denominator of the fraction is the total of the Participant's Elective Account attributable to Elective Contributions and the Participant's Qualified Non-Elective Account as of the end of the Plan Year or the "gap period," reduced by the gain allocable to such total amount for the Plan Year or the "gap period" and increased by the loss allocable to such total amount for the Plan Year or the "gap period." In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable Income for the "gap period." Under such "safe harbor method," allocable Income for the "gap period" shall be deemed to equal ten percent (10%) of the Income allocable to Excess Contributions for the Plan Year of the Participant multiplied by the number of calendar months in the "gap period." For purposes of determining the number of calendar months in the "gap period," a distribution occurring on or before the fifteenth day of the month shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. Notwithstanding the above, for Plan Years which began in 1987, Income during the "gap period" shall not be taken into account. Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any Income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with. Section 43(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. (d) Any amounts not distributed or recharacterized within 2 1/2 months after the end of the Plan Year shall be subject to the 10% Employer excise tax imposed by Code Section 4979. 75 83 11.6 ACTUAL CONTRIBUTION PERCENTAGE TESTS (a) The "Actual Contribution Percentage," for Plan Years beginning after the later of the Effective Date of this Plan or December 31, 1986, for the Highly Compensated Participant group shall not exceed the greater of: (1) 125 percent of such percentage for the Non-Highly Compensated Participant group; or (2) the lesser of 200 percent of such percentage for the Non-Highly Compensated Participant group, or such percentage for the Non-Highly Compensated Participant group plus 2 percentage points. However, for Plan Years beginning after December 31, 1988, to prevent the multiple use of the alternative method described in this paragraph and Code Section 401(m)(9)(A), any Highly Compensated Participant eligible to make elective deferrals pursuant to Section 11.2 or any other cash or deferred arrangement maintained by the Employer or an Affiliated Employer and to make Employee contributions or to receive matching contributions under any plan maintained by the Employer or an Affiliated Employer shall have his actual contribution ratio reduced pursuant to Regulation 1.401(m)-2. The provisions of Code Section 401 (m) and Regulations 1.401(m)-1(b) and 1.401(m)-2 are incorporated herein by reference. (b) For the purposes of this Section and Section 11.7, "Actual Contribution Percentage" for a Plan Year means, with respect to the Highly Compensated Participant group and Non-Highly Compensated Participant group, the average of the ratios (calculated separately for each Participant in each group) of- (1) the sum of Employer matching contributions made pursuant to Section 11.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 11.4), voluntary Employee contributions made pursuant to Section 4.7 and Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 on behalf of each such Participant for such Plan Year; to (2) the Participant's "414(s) Compensation" for such Plan Year. (c) For purposes of determining the "Actual Contribution Percentage" and the amount of Excess Aggregate Contributions pursuant to Section 11.7(d), only Employer matching contributions (excluding matching contributions forfeited or distributed pursuant to Section 11.2(f), 11.5(a), or 11.7(a)) contributed to the Plan prior to the end of the succeeding Plan Year shall be considered. In addition, the Administrator may elect to take into account, with respect to Employees eligible to have Employer matching contributions made pursuant to Section 11.1(b) or voluntary Employee contributions made pursuant to Section 4.7 allocated to their accounts, elective deferrals (as defined in Regulation 1.402(g)-1(b)) and qualified non-elective contributions (as defined in Code Section 401(m)(4)(C)) contributed to any plan maintained by the Employer. Such elective deferrals and qualified non-elective contributions shall be treated as Employer matching contributions subject to Regulation 1.401(m)-1(b)(2) which is incorporated herein by reference. However, for Plan Years beginning after December 31, 1988, the Plan Year must be the same as the plan year of the plan to which the elective deferrals and the qualified non-elective contributions are made. (d) For the purpose of determining the actual contribution ratio of a Highly Compensated Employee who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Employee is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, the following shall apply: 76 84 (1) The combined actual contribution ratio for the family group (which shall be treated as one Highly Compensated Participant) shall be the greater of: (i) the ratio determined by aggregating Employer matching contributions made pursuant to Section 11.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 11.4), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and "414(s) Compensation" of all eligible Family Members who are Highly Compensated Participants without regard to family aggregation; and (ii) the ratio determined by aggregating Employer matching contributions made pursuant to Section 11.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 11.4), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and "414(s) Compensation" of all eligible Family Members (including Highly Compensated Participants). However, in applying the $200,000 limit to "414(s) Compensation" for Plan Years beginning after December 31, 1988, Family Members shall include only the affected Employee's spouse and any lineal descendants who have not attained age 19 before the close of the Plan Year. (2) The Employer matching contributions made pursuant to Section 11.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 11.4), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and "414(s) Compensation" of all Family Members shall be disregarded for purposes of determining the "Actual Contribution Percentage" of the Non-Highly Compensated Participant group except to the extent taken into account in paragraph (1) above. (3) If a Participant is required to be aggregated as a member of more than one family group in a plan, all Participants who are members of those family groups that include the Participant are aggregated as one family group in accordance with paragraphs (1) and (2) above. (e) For purposes of this Section and Code Sections 40 1 (a)(4), 410(b) and 401(m), i f two or more plans of the Employer to which matching contributions, Employee contributions, or both, are made are treated as one plan for purposes of Code Sections 401(a)(4) or 410(b) (other than the average benefits test under Code Section 410(b)(2)(A)(ii) as in effect for Plan Years beginning after December 31, 1988), such plans shall be treated as one plan. In addition, two or more plans of the Employer to which matching contributions, Employee contributions, or both, are made may be considered as a single plan for purposes of determining whether or not such plans satisfy Code Sections 401(a)(4), 410(b) and 401(m). In such a case, the aggregated plans must satisfy this Section and Code Sections 401(a)(4), 410(b) and 401(m) as though such aggregated plans were a single plan. For plan years beginning after December 31, 1989, plans may be aggregated under this paragraph only if they have the same plan year. Notwithstanding the above, for Plan Years beginning after December 31, 1988, an employee stock ownership plan described in Code Section 4975(c)(7) may not be aggregated with this Plan for purposes of' determining whether the employee stock ownership plan or this Plan satisfies this Section and Code Sections 401(a)(4), 410(b) and 401(m). (f) If a Highly Compensated Participant is a Participant under two or more plans (other than an employee stock ownership plan as defined in Code Section 4975(c)(7) for Plan Years beginning after December 31, 1988) which are maintained by the Employer or an Affiliated Employer to which matching contributions, Employee contributions, or both, are made, all such contributions on behalf of such Highly Compensated Participant shall be aggregated for purposes of determining such Highly Compensated Participant's actual contribution ratio. However, for Plan Years beginning after 77 85 December 31, 1988, if the plans have different plan years, this paragraph shall be applied by treating all plans ending with or within the same calendar year as a single plan. (g) For purposes of Section 11.6(a) and 11.7, a Highly Compensated Participant and a Non-Highly Compensated Participant shall include any Employee eligible to have matching contributions made pursuant to Section 11.1(b) (whether or not a deferred election was made or suspended pursuant to Section 11.2(e)) allocated to his account for the Plan Year or to make salary deferrals pursuant to Section 11.2 (if the Employer uses salary deferrals to satisfy the provisions of this Section) or voluntary Employee contributions pursuant to Section 4.7 (whether or not voluntary Employee contributions are made) allocated to his account for the Plan Year. (h) For purposes of this Section, "Matching Contribution" shall mean an Employer contribution made to the Plan, or to a contract described in Code Section 403(b), on behalf of a Participant on account of an Employee contribution made by such Participant, or on account of a participant's deferred compensation, under a plan maintained by the Employer. 11.7 ADJUSTMENT TO ACTUAL CONTRIBUTION PERCENTAGE TESTS (a) In the event that for Plan Years beginning after December 31, 1986, the "Actual Contribution Percentage" for the Highly Compensated Participant group exceeds the "Actual Contribution Percentage" for the Non-Highly Compensated Participant group pursuant to Section 11.6(a), the Administrator (on or before the fifteenth day of the third month following the end of the Plan Year, but in no event later than the close of the following Plan Year) shall direct the Trustee to distribute to the Highly Compensated Participant having the highest actual contribution ratio, his portion of Excess Aggregate Contributions (and Income allocable to such contributions) or, if forfeitable, forfeit such non-Vested Excess Aggregate Contributions attributable to Employer matching contributions (and Income allocable to such Forfeitures) until either one of the tests set forth in Section 11.6(a) is satisfied, or until his actual contribution ratio equals the actual contribution ratio of the Highly Compensated Participant having the second highest actual contribution ratio. This process shall continue until one of the tests set forth in Section 11.6(a) is satisfied. The distribution and/or Forfeiture of Excess Aggregate Contributions shall be made in the following order: (1) Employer matching contributions distributed and/or forfeited pursuant to Section 11.5(a)(1); (2) Voluntary Employee contributions including Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5(a)(2); (3) Remaining Employer matching contributions. (b) Any distribution or Forfeiture of less than the entire amount of Excess Aggregate Contributions (and Income) shall be treated as a pro rata distribution of Excess Aggregate Contributions and Income. Distribution of Excess Aggregate Contributions shall be designated by the Employer as a distribution of Excess Aggregate Contributions (and Income). Forfeitures of Excess Aggregate Contributions shall be treated in accordance with Section 4.3. However, no such Forfeiture may be allocated to a Highly Compensated Participant whose contributions are reduced pursuant to this Section. (c) Excess Aggregate Contributions attributable to amounts other than voluntary Employee contributions, including forfeited matching contributions, shall be treated as Employer contributions for purposes of Code Sections 404 and 415 even if distributed from the Plan. 78 86 (d) For the purposes of this Section and Section 11.6, "Excess Aggregate Contributions" means, with respect to any Plan Year, the excess of. (1) the aggregate amount of Employer matching contributions made pursuant to Section 11.1(b) (to the extent such contributions are taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 11.6(c) actually made on behalf of the Highly Compensated Participant group for such Plan Year, over (2) the maximum amount of such contributions permitted under the limitations of Section 11.6(a). (e) For each Highly Compensated Participant, the amount of Excess Aggregate Contributions is equal to the total Employer matching contributions made pursuant to Section 11.6 (b) (to the extent taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section I 1.6(c) on behalf of the Highly Compensated Participant (determined prior to the application of this paragraph) minus the amount determined by multiplying the Highly Compensated Participant's actual contribution ratio (determined after application of this paragraph) by his "414(s) Compensation." The actual contribution ratio must be rounded to the nearest one-hundredth of one percent for Plan Years beginning after December 31, 1988. In no case shall the amount of Excess Aggregate Contribution with respect to any Highly Compensated Participant exceed the amount of Employer matching contributions made pursuant to Section 11.1(b) (to the extent taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 11.6(c) on behalf of such Highly Compensated Participant for such Plan Year. (f) The determination of the amount of Excess Aggregate Contributions with respect to any Plan Year shall be made after first determining the Excess Contributions, if any, to be treated as voluntary Employee contributions due to recharacterization for the plan year of any other qualified cash or deferred arrangement (as defined in Code Section 401(k)) maintained by the Employer that ends with or within the Plan Year or which are treated as voluntary Employee contributions due to recharacterization pursuant to Section 11.5. (g) The determination and correction of Excess Aggregate Contributions of a Highly Compensated Participant whose actual contribution ratio is determined under the family aggregation rules shall be accomplished as follows: (1) If the actual contribution ratio for the Highly Compensated Participant is determined in accordance with Section 11.6(d)(1), then the actual contribution ratio shall be reduced and the Excess Aggregate Contributions for the family unit shall be allocated among the Family Members in proportion to the sum of Employer matching contributions made pursuant to Section 11.1(b) (to the extent taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 11.6(c) of each Family Member that were combined to determine the group actual contribution ratio. 79 87 (2) If the actual contribution ratio for the Highly Compensated Participant is determined under Section 11.6(d)(2), then the actual contribution ratio shall first be reduced, as required herein, but not below the actual contribution ratio of the group of Family Members who are not Highly Compensated Participants without regard to family aggregation. The Excess Aggregate Contributions resulting from this initial reduction shall be allocated among the Highly Compensated Participants whose Employer matching contributions made pursuant to Section IL I (b) (to the extent taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 11.6(c) were combined to determine the actual contribution ratio. If further reduction is still required, then Excess Aggregate Contributions resulting from this further reduction shall be determined by taking into account the contributions of all Family Members and shall be allocated among them in proportion to their respective Employer matching contributions made pursuant to Section 11.1(b) (to the extent taken into account pursuant to Section 11.6(a)), voluntary Employee contributions made pursuant to Section 4.7, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 11.5 and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 11.6(c). (h) Notwithstanding the above, within twelve (12) months after the end of the Plan Year, the Employer may make a special Qualified Non-Elective Contribution on behalf of Non-Highly Compensated Participants in an amount sufficient to satisfy one of the tests set forth in Section 11.6. Such contribution shall be allocated to the Participant's Qualified Non-Elective Account of each Non-Highly Compensated Participant in the same proportion that each Non-Highly Compensated Participant's Compensation for the year bears to the total Compensation of all Non-Highly Compensated Participants. A separate accounting shall be maintained for the purpose of excluding such contributions from the "Actual Deferral Percentage" tests pursuant to Section 11.4. (i) For purposes of this Section, "Income" means the income or loss allocable to Excess Aggregate Contributions which shall equal the sum of the allocable gain or loss for the Plan Year and the allocable gain or loss for the period between the end of the Plan Year and the date of distribution ("gap period"). The income or loss allocable to Excess Aggregate Contributions for the Plan Year and the "gap period" is calculated separately and is determined by multiplying the income or loss for the Plan Year or the "gap period" by a fraction. The numerator of the fraction is the Excess Aggregate Contributions for the Plan Year. The denominator of the fraction is the total Participant's Account and Voluntary Contribution Account attributable to Employer matching contributions subject to Section 11.6, voluntary Employee contributions made pursuant to Section 4.7, and any Qualified Non-Elective Contributions and elective deferrals taken into account pursuant to Section 11.6(c) as of the end of the Plan Year or the "gap period," reduced by the gain allocable to such total amount for the Plan Year or the "gap period" and increased by the loss allocable to such total amount for the Plan Year or the "gap period." In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable Income for the "gap period." Under such "safe harbor method," allocable Income for the "gap period" shall be deemed to equal ten percent (10%) of the Income allocable To Excess Aggregate Contributions for the Plan Year of the Participant multiplied by the number of calendar months in the "gap period." For purposes of determining the number of calendar months in the "gap period," a distribution occurring on or before the fifteenth day of the month shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. 80 88 The Income allocable to Excess Aggregate Contributions resulting from recharacterization of Elective Contributions shall be determined and distributed as if such recharacterized Elective Contributions had been distributed as Excess Contributions. Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any Income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 4.3(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. Notwithstanding the above, for Plan Years which began in 1987, Income during the "gap period" shall not be taken into account. Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any Income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 43(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. 11.8 ADVANCE DISTRIBUTION FOR HARDSHIP (a) The Administrator, at the election of the Participant, shall direct the Trustee to distribute to any Participant in any one Plan Year up to the lesser of (1) 100% of his accounts as specified in the Adoption Agreement valued as of the last Anniversary Date or other valuation date or (2) the amount necessary to satisfy the immediate and heavy financial need of the Participant. Any distribution made pursuant to this Section shall be deemed to be made as of the first day of the Plan Year or, if later, the valuation date immediately preceding the date of distribution, and the account from which the distribution is made shall be reduced accordingly. Withdrawal under this Section shall be authorized only if the distribution is on account of one of the following or any other items permitted by the Internal Revenue Service: (1) Medical expenses described in Code Section 213(d) incurred by the Participant, his spouse, or any of his dependents (as defined in code Section 152) or expenses necessary for these persons to obtain medical care; (2) The purchase (excluding mortgage payments) of a principal residence for the Participant; (3) Payment of tuition and related educational fees for the next 12 months of post-secondary education for the Participant, his spouse, children, or dependents; or (4) The need to prevent the eviction of the Participant from his principal residence or foreclosure on the mortgage of the Participant's principal residence. (b) No such distribution shall be made from the Participant's Account until such Account has become fully Vested. (c) No distribution shall be made pursuant to this Section unless the Administrator, based upon the Participant's representation and such other facts as are known to the Administrator, determines that all of the following conditions are satisfied: 81 89 (1) The distribution is not in excess of the amount of the immediate and heavy financial need of the Participant (including any amounts necessary to pay any federal, state, or local taxes or penalties reasonably anticipated to result from the distribution); (2) The Participant has obtained all distributions, other than hardship distributions, and all nontaxable loans currently available under all plans maintained by the Employer; (3) The Plan, and all other plans maintained by the Employer, provide that the Participant's elective deferrals and voluntary Employee contributions will be suspended for at least twelve (12) months after receipt of the hardship distribution; and (4) The Plan, and all other plans maintained by the Employer, provide that the Participant may not make elective deferrals for the Participant's taxable year immediately following the taxable year of the hardship distribution in excess of the applicable limit under Code Section 402(g) for such next taxable year less the amount of such Participant's elective deferrals for the taxable year of the hardship distribution. (d) Notwithstanding the above, distributions from the Participant's Elective Account and Qualified Non-Elective Account pursuant to this Section shall be limited solely to the Participant's Deferred Compensation and any income attributable thereto credited to the Participant's Elective Account as of December 31, 1988. (e) Any distribution made pursuant to this Section shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. 82 90 VALUSELECT(R) TRUST AGREEMENT This Trust Agreement ("Trust Agreement" or "Agreement") entered into this 31st day of December, 1997, between National Insurance Group , (the "Company") a corporation organized under the laws of the State of California, and FRANKLIN TEMPLETON TRUST COMPANY, a trust company chartered under California law (the "Trustee"). PURPOSE The Company has adopted a plan called National Insurance Group 401(k) Plan (the "Plan") for the exclusive purpose of providing benefits to certain of its employees and their beneficiaries and defraying reasonable expenses of administering the Plan. The Plan provides that, from time to time, cash and other acceptable property may be paid to the Trustee by the Company to be held and administered as a trust (the "Trust Fund" or "Trust") for the uses and purposes of the Plan. The Company intends that the Plan shall qualify under section 401 of the Internal Revenue Code of 1986, as amended (the "Code"), and that the Trust shall constitute a part of the Plan, as a tax-exempt entity within the meaning of Code section 501(a). Subject to specific conditions set forth in this Agreement, the Trustee agrees that it will hold in Trust and invest cash and other acceptable property received pursuant to this Agreement and received as contributions from the Company or transfers from another plan qualified under section 401(a) of the Code upon the terms and conditions stated below. ARTICLE I. TRUST FUND. 1.1 The Company's President, Secretary or other duly authorized official shall certify in writing to the Trustee the names and specimen signatures of all those persons who are authorized to act as or on behalf of the Plan's named fiduciary, which term shall include the administrator of the Plan, another trustee or other person who under the Plan's provisions is authorized to make administrative decisions for the Plan, Plan participants and beneficiaries, including an appointed investment manager (collectively referred to as the "Administrator"), and these names and specimen signatures shall be updated as necessary by the President, Secretary or other duly authorized official. 1.2 All contributions or transfers shall be received by the Trustee in cash or other property acceptable to the Plan and acceptable to the Trustee and under the Plan's investment guidelines ("Investment Guidelines"), which are incorporated herein and made part of the Agreement as amended from time to time, provided that the contributions or transfers are not impermissible investments under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). The Trust Fund shall consist of the contributions and transfers received by the Trustee, together with the income and earnings from them and any increments to them. The Trustee shall manage and administer the Trust Fund without distinction between principal and income and without liability for the payment of interest thereon. The Trustee shall have no duty or authority to (i) compute any amount required to be transferred or paid to the Trust Fund by the Company, (ii) collect any contributions or transfers to the Trust Fund, or (iii) determine whether any contribution or transfer complies with the terms of the Plan. If the Company creates or maintains one or more employee benefit plans qualified under Code section 401(a) in addition to the Plan, the Company may request the Trustee to hold the assets of the additional plan or plans in a separate trust fund. The Administrator shall keep separate records or enter into an agreement with the Trustee or another party to keep separate records for each such plan and trust fund. The Company or Administrator as the case may be shall not permit or cause the assets of one plan and trust fund to be used to pay benefits or the administrative expenses of any other plan and trust fund. 1.3 The Trustee shall accept a contribution of cash or other acceptable property that has been distributed to a participant (or an eligible employee who is about to become a participant) from another employee Franklin Templeton ValuSelect(R) All Rights Reserved Page 1 91 benefit plan qualified under Code section 401(a), or from an individual retirement account or annuity described in Code section 408, at the direction of the Administrator. The Administrator shall be solely responsible for determining that such assets represent an eligible rollover contribution within the meaning of Code sections 402(c) or 408(d)(3). The Trustee shall accept a transfer of cash or other acceptable property on behalf of a participant (or an employee who is about to become a participant) directly from the trustee of an employee benefit plan qualified under Code section 401(a) at the direction of the Administrator. ARTICLE II. INVESTMENTS AND DISTRIBUTIONS. 2.1 (a) Except as provided below, the Administrator shall have all power over and responsibility for the management, disposition, and investment of the Trust assets, and the Trustee shall comply with proper written directions of the Administrator concerning those assets. The Administrator shall not issue directions in violation of the terms of the Plan and Trust or prohibited by the fiduciary responsibility rules of ERISA. The Trustee shall have no duty or responsibility to review, initiate action, or make recommendations regarding Trust assets and shall retain assets until directed in writing by the Administrator to dispose of them. The Administrator may delegate to any other person or persons any of the Administrator's rights, powers or responsibilities with respect to the operation and administration of the Trust Fund. Any such delegation shall be made in writing and certified to the Trustee. (b) If permissible under the Plan, each participant and/or beneficiary may have investment power over the account maintained for him or her and may direct the investment and reinvestment of assets of his or her account among the options authorized by the Plan and Administrator. Such direction shall be furnished to the Trustee, in writing, through an automatic voice system, or other similar direction, under procedures agreed to by the Trustee and the Administrator. The Trustee shall not be liable for any loss which results from such participant's or beneficiary's exercise of control. The Administrator shall maintain records or enter into an agreement with another party to keep separate accounts showing the interest of each participant and/or beneficiary in the Trust Fund. The Trustee shall have no duty or responsibility to review or make recommendations regarding investments made at the direction of the Administrator or a participant/beneficiary, and the Trustee shall be required to act only upon receipt of directions. A participant or beneficiary shall not have authority to direct the investment of assets in his or her account in "collectibles" within the meaning of Code section 408(m)(2). (c) The Company or Administrator as the case may be may appoint an investment manager or managers within the meaning of section 3(38) of ERISA to direct, control or manage the investment of all or a portion of the Trust assets, as provided in sections 3(38) and 403(a)(2) of ERISA. The Company or Administrator shall notify the Trustee in writing of (i) the appointment of each investment manager and (ii) the assets over which each manager shall exercise control. The Company or Administrator shall also cause the investment manager to acknowledge to the Trustee in writing that the investment manager is a fiduciary with respect to the Plan. If the foregoing conditions are met, the investment manager shall have the power to manage, acquire, or dispose of any Trust assets so identified as under such manager's control, and the Trustee shall not be liable for acts or omissions of the investment manager or be under an obligation to invest or otherwise manage any asset of the Trust that is subject to the management of such investment manager. The Trustee shall act only upon receipt of proper written directions from a duly appointed investment manager, and shall have no responsibility or authority to review or question instructions from any such investment manager. (d) If the Plan authorizes loans to Plan participants, the duties of the Trustee and Administrator may be covered by a separate agreement to be incorporated as part of this Agreement. 2.2 (a) Subject to the investment being acceptable to the Trustee and the Investment Guidelines of the Plan and subject to the provisions of Section 2.1 above, the person with investment responsibility ("Authorized Person") may cause the Trust Fund to be invested and reinvested in every kind of investment including, without limitation, publicly traded equity and debt interests of all kinds issued by domestic or foreign governments, business organizations, limited partnerships, investment companies and trusts or other entities, Franklin Templeton ValuSelect(R) All Rights Reserved Page 2 92 convertible securities of all kinds, interest-bearing deposits in any depository institution, domestic or foreign, (including the Trustee or any affiliate of the Trustee), money market securities of all kinds, collective investments as described in subsection (b) below, and insurance contracts as described in subsection (c) below. Notwithstanding anything in the Trust Agreement to the contrary, the Trustee may hold uninvested and without liability for interest such part of the Trust Fund as may be reasonably necessary for the orderly administration of the Trust Fund. (b) Subject to the following provisions, all or a portion of the assets of the Trust Fund may be invested and reinvested in any collective investment fund (referred to as a "pooled fund") maintained by the Trustee or by any other entity authorized to maintain such a fund in which the Plan and this Trust Fund is eligible to participate. Notwithstanding any other provision of this Agreement, to the extent Trust Fund assets are invested in any such pooled fund, the terms of the pooled fund's governing instrument shall govern the operation of the pooled fund and the investment responsibilities and powers of the entity responsible for management of the pooled fund (referred to as "fund manager"), and, to the extent required by law, the terms of such governing instrument shall be incorporated into the Trust Agreement. The value of any interest in a pooled fund held by the Trust Fund shall be the fair market value of the interest as determined by the fund manager in accordance with the pooled fund's governing instrument. For purposes of valuation of the Trust Fund assets, the Trustee shall be entitled to rely conclusively on the value reported by the fund manager. (c) At the direction of the Authorized Person, the Trustee may purchase shares of registered or unregistered investment companies (or other investment vehicles), which may include such companies advised by the Trustee or any affiliated entity ("Franklin Templeton Funds"). (d) Subject to being acceptable to the Trustee, the Trust Fund may be invested in a pooled investment vehicle funded by contracts issued by an insurance company qualified to do business under a state's law (within the meaning of ERISA section 3(10)) including, without limitation, group annuity and guaranteed investment contracts. Any such contract may provide for the allocation of amounts received by the insurance company to its general account, one or more of its separate accounts (including pooled separate accounts), or both. To the extent Trust Fund assets are allocated to a separate account of an insurance company, the Administrator shall appoint the insurance company as an investment manager as provided above. Notwithstanding any other provision of the Trust Agreement, the terms of the contract(s) governing the separate accounts(s) in which the Trust Fund is invested shall govern the investment responsibilities and powers of the insurance company and, to the extent required by law, the terms of such contract(s) shall be incorporated into the Trust Agreement. (e) To the extent permitted by the Plan and acceptable to the Trustee, the Authorized Person may direct the Trustee to apply for and purchase life insurance or annuity contracts (referred to as "contracts") from an insurance company, subject to the following provisions: (i) The Authorized Person shall be responsible for ensuring that the purchases conform with the requirements of the Plan and any rules and policies established by the Administrator regarding the form, value, optional settlement methods and other provisions of the contracts. The Trustee shall not be responsible for the validity or proper execution of any contract delivered to it or for any act of any person which renders the contract void or voidable. The Trustee shall not be responsible if the contract held in the Trust Fund fails to meet the requirements of the Plan, and the Trustee shall have no duty to inform participants of the terms and conditions of any such contract. (ii) The Administrator shall instruct the insurance company to notify the Administrator of all premiums becoming due under the contracts. The Administrator shall deliver all premium notices to the Trustee, together with a direction to the Trustee to pay the premiums out of the Trust Fund. The Trustee shall have no responsibility for paying the premium unless sufficient assets of the Trust Fund are available for that purpose. (iii) The Administrator shall cause the Trustee to be designated as the sole owner of any such contract, with sole power to exercise all rights, privileges, options and other incidents of ownership at the Administrator's direction. The Administrator from time to time shall direct the Trustee regarding the designation of Franklin Templeton ValuSelect(R) All Rights Reserved Page 3 93 a beneficiary of the death benefit payable under any such contract in accordance with the applicable provisions of the Plan. (f) To the extent permitted by the Plan and ERISA, and to the extent acceptable to the Trustee, and subject to the applicable federal and state securities laws, the Authorized Person may direct the Trustee to invest in qualifying employer securities within the meaning of ERISA section 407(d)(5) ("Employer Securities"). The Company or Administrator as the case may be shall have full responsibility for determining that any such investment and the voting rights attributable to such investment comply with applicable law. Notwithstanding any other provision of the Plan or this Trust Agreement, the Company or Administrator shall have the responsibility for voting any shares or directing that such shares shall be sold, exchanged or otherwise disposed of except to the extent that such duties are made the responsibility of another person or persons under the terms of the Plan or other governing document, and such person performs according to such terms. The Trustee shall have no duty or responsibility for voting any such shares or directing that such shares be sold, exchanged or otherwise disposed of except upon the express written instructions of the Company or Administrator. 2.3 In its administration of the Trust Fund, the Trustee shall have and exercise whatever powers are necessary to discharge its obligations and exercise its rights under the Trust Agreement. Subject to the direction of the Administrator, participants or beneficiaries, or an investment manager as provided in Section 2.1, the Trustee shall have full power and authority with respect to property held in the Trust Fund to do all such acts, take all proceedings, and exercise all such rights and privileges, whether specifically referred to or not in this document, as could be done, taken, or exercised by the absolute owner, including, without limitation, the following: (a) To collect income generated by the Trust Fund investments and proceeds realized on the sale or disposition of assets and to hold the same pending reinvestment or distribution in accordance with this Agreement; (b) To register Trust Fund property in the Trustee's own name, in the name of a nominee or in bearer form, provided the Trustee's records and accounts show that such property is an asset of the Trust Fund; (c) To appoint sub-custodians to hold title to, or other indicia of ownership of, property of the Trust Fund in those jurisdictions, domestic or foreign, in which the Trustee is not authorized to do business and to define the scope of the responsibilities of each such ancillary or subordinate custodian, or to deposit such securities with a domestic or foreign securities depository or bank regulated by a government agency or regulatory authority in the domestic or foreign jurisdiction, and to permit the securities so deposited to be held in the nominee name of the depository or bank, provided that the Trustee's records and accounts show that such securities belong to the Trust Fund; (d) To hold securities issued by a foreign government or business entity at a foreign office of the Trustee or any of its affiliates, or to deposit such securities with a foreign securities depository or bank regulated by a government agency or regulatory authority in the foreign jurisdiction, and to permit the securities so deposited to be held in the nominee name of the depository or bank, provided that the Trustee's records and accounts show that such securities belong to the Trust Fund; (e) To retain the property in the Trust; (f) To sell Trust assets, at either public or private sale, at such time or times and on such terms and conditions as it may deem appropriate; (g) To consent to or participate in any plan for the reorganization, consolidation, or merger of any business unit, any security of which is held in the Trust Fund, to pay calls and assessments imposed upon the owners of such securities as condition of their participating therein, and to consent to any contact, lease, mortgage, purchase or sale of property, by or between such business unit and any other party; Franklin Templeton ValuSelect(R) All Rights Reserved Page 4 94 (h) To exercise or dispose of any right it may have as the holder of any security, to convert the same into another security, to acquire any additional security or securities, to make any payments, to exchange any security, or to do any other act with reference thereto; (i) To renew or extend the time of payment of any obligation due or becoming due; (j) To grant options to purchase property held in the Trust; (k) To compromise, arbitrate, or otherwise adjust or settle claims in favor of or against the Trust and to deliver or accept consideration in either total or partial satisfaction of any indebtedness or other obligation, and to continue to hold property so received for the period of time that the Trustee deems appropriate; (l) To exchange any property for other property upon such terms and conditions as the Trustee may deem proper, and to give or receive money to effect equality in price; (m) To foreclose any obligation by judicial proceeding or otherwise; (n) To sue or defend in connection with any and all securities or property at any time received or held in the Trust Fund; (o) To borrow money from any person other than a party in interest of the Plan with or without giving security; (p) To deposit any security with any protective or reorganization committee, and to delegate to that committee such power and authority as the Trustee may deem proper; (q) To deliver to the Company or Administrator as the case may be, or the person or persons identified by the Company or Administrator, proxies and powers of attorney and related informational material, for any shares or other property held in the Trust. The Company or Administrator shall have responsibility for voting such shares, by proxy or in person, except to the extent such responsibility is delegated to another person, under the terms of the Plan or to any investment manager under an agreement between the named fiduciary of the Plan and an investment manager, in which case such persons shall have such responsibility. The Trustee may use agents to effect such delivery to the Company or Administrator or the person or persons identified by the Administrator. In no event shall the Trustee be responsible for the voting of shares of securities held in the Trust or for ascertaining or monitoring whether, or how, proxies are voted or whether the proper number of proxies is received; (r) To appoint agents as necessary or desirable, including legal counsel who may be counsel for the company; (s) To hold that portion of the Trust Fund as the Trustee may deem necessary for ordinary administration and for the disbursement of funds in cash, without liability for interest, by depositing the same in any bank (including deposits which bear a reasonable rate of interest in a bank or similar financial institution supervised by the United States or a State, even where a bank or financial institution is the Trustee, or otherwise is a fiduciary of the Plan, including Franklin Templeton Trust Company), subject to the rules and regulations governing such deposits, and without regard to the amount of any such deposit; (t) To retain group or individual insurance contracts of all kinds authorized under the Plan; (u) If directed by the Administrator, participant, or investment manager, to acquire and hold limited partnership interests or interests in other specialized investment vehicles, provided that such Authorized Person signs any agreement or other necessary documents requested by the Trustee prior to entering into the transaction; (v) To lend securities from the Trust on a secured basis in accordance with a separate written agreement between the Administrator and the Trustee; and Franklin Templeton ValuSelect(R) All Rights Reserved Page 5 95 (w) To pay out of the Trust Fund, in accordance with the provisions of Article V, any expense incurred by the Trustee in administering the Trust (including attorneys' fees, appraisal fees and other service provider fees and compensation and its own fees and compensation hereunder. 2.4 The Trustee is authorized to contract or make other arrangements with affiliates of the Trustee (the "Franklin Templeton Affiliates") or their successors and assigns and any other organizations affiliated with the Trustee or related entities, for the provision of necessary, non-discretionary services to the Trust or Plan, except where such arrangements are prohibited by law or regulation. 2.5 The Trustee is authorized to disclose such information as is necessary to the operation and administration of the Trust to Franklin Templeton Affiliates, and to such other persons or organizations that the Trustee determines have a legitimate business purpose for obtaining such information. 2.6 Uninvested cash of the Trust may be invested in one or more of the Franklin Templeton Funds which is a money market fund designated by the Authorized Person for that purpose, unless the Authorized Person specifically instructs the use of another fund or account, except to the extent prohibited by law or regulation. 2.7 The Administrator shall have responsibility for establishing and carrying out funding policy and method, as specified in section 402(b)(1) of ERISA, consistent with the objectives of the Plan and requirements of ERISA, taking into consideration the Plan's short-term financial needs. As a non-discretionary trustee, the Trustee shall not be responsible for proper diversification of the assets of the Trust Fund. The Administrator or any person to whom such responsibility has been properly delegated under the requirements of ERISA, shall be responsible for the funding policy, for diversification of assets held in trust for the Plan, and for compliance of the Trust Fund with statutory limitations on the amount of investment in securities or other property of the Company or its affiliates. 2.8 No assets of the Trust Fund shall be invested in the securities of the Company or its affiliates unless the Administrator determines that the securities are exempt from registration under the federal Securities Act of 1933, as amended, and are exempt from registration or qualification under the applicable state law, and of any other applicable blue sky law, or in the alternative, that the securities have been so registered and/or qualified. The Administrator shall also specify what restrictive legend on transfer, if any, is required to be set forth on the certificates for the securities and the procedure to be followed by the Trustee to effectuate a resale of such securities. The Administrator shall not direct the investment in "employer securities" within the meaning of section 407 of ERISA if such investment would be prohibited by ERISA. The Administrator shall only direct the investment of Trust Funds into securities of the Company or an affiliate (i) if those securities are traded on an exchange permitting a readily ascertainable fair market value or (ii) if the Administrator shall have obtained a current valuation by a qualified independent appraiser. 2.9 At the written direction of the Administrator, the Trustee shall make distributions or transfers from the Trust. The Trustee shall be responsible for reporting withdrawals to the Internal Revenue Service (IRS) in accordance with IRS rules and regulations. The Trustee is authorized, to the extent required under applicable law, to withhold from distributions to any payee an amount that the Trustee determines is necessary to cover federal taxes, and the Trustee is required to withhold such amounts if so directed by the Administrator. The Trustee shall have no liability for making any distribution or transfer pursuant to the direction of the Administrator (including amounts withheld pursuant to the previous sentence) and shall be under no duty to make inquiry whether any distribution or transfer directed by the Administrator is made pursuant to the provisions of the Plan. The Administrator shall furnish to the Trustee all information necessary to carry out such withholding, or, if such information is not provided to the Trustee, the Administrator shall hold the Trustee harmless from and indemnify it for any liability and related expenses that arise in connection with improper withholding. 2.10 The Trustee shall not be liable for the proper application of any part of the Plan or Trust if distributions or transfers are made in accordance with the written directions of the Administrator, including any distribution made pursuant to a domestic relations order which the Administrator has determined to be qualified within the meaning of section 414(p) of the Code, nor shall the Trustee be responsible for the adequacy of the Trust Fund to discharge any and all payments and liabilities under the Plan. Franklin Templeton ValuSelect(R) All Rights Reserved Page 6 96 2.11 All persons dealing with the Trustee (other than the Company or Administrator) are released from inquiring into the decisions or authority of the Trustee and from seeing to the proper application of any monies paid or securities or other property delivered to the Trustee. 2.12 The Trustee shall bear no liability for acting upon any instruction or document reasonably believed by it to be genuine and to be presented or signed by a party duly authorized to do so, and the Trustee shall be under no duty to make any investigation or inquiry about the correctness of such instruction or document. 2.13 The Trustee may consult with legal counsel of its choice, including counsel for the Company, upon any question or matter arising hereunder, and the opinion of such counsel when relied upon by the Trustee shall be evidence the Trustee was acting in good faith. 2.14 Absent a separate agreement to the contrary, the Trustee under this Agreement shall have no duties or responsibilities for Plan assets not held in the Trust by the Trustee. ARTICLE III. SETTLEMENT OF ACCOUNTS. 3.1 The Trustee shall maintain, or cause to be maintained, accurate records and detailed accounts of all investments, receipts, disbursements, and other transactions related to the Trust on an overall Plan basis, and those records shall be available at all reasonable times to the Administrator, the Company, or their authorized representatives. 3.2 The Trustee, at the direction of the Administrator, shall submit or cause to be submitted to the Administrator such valuations, reports or other information regarding aggregate Plan assets invested with the Trustee, as the Administrator may reasonably require. In any case, the Trust Fund shall be valued by the Trustee at least annually, at the fair market value as of the last day of each Plan Year. The fair market value of assets in the Trust shall be determined by the Trustee based upon such sources of information as it may deem reliable, including, but not limited to, information reported in: (a) newspapers of general circulation, (b) standard financial periodicals or publications, (c) statistical and valuation services, (d) the records of securities exchanges or brokerage firms deemed by the Trustee to be reliable, (e) records of mutual fund transfer agents, or (f) any combination thereof. In the absence of negligence, fraud or bad faith, the valuation of the Trust by the Trustee shall be conclusive. The Trustee may take whatever reasonable action, including consultation with the Administrator, the employment of attorneys, independent appraisers or other professionals, the reasonable expense of which shall be an expense of the Trust, and the Trustee shall not incur any liability for an inaccurate valuation based in good faith upon such information. 3.3 Notwithstanding any other provision of this Article 3, if the Trustee shall determine that the Trust Fund consists in whole or in part of property not traded freely on a recognized market, or that information necessary to ascertain the fair market value is not readily available, the Trustee may request instructions from the Administrator on the value of such property for all purposes under the Plan and this Trust Agreement, and the Administrator shall comply with that request. The Trustee shall be entitled to rely upon the value placed upon such property by the Administrator. At the Trustee's option, it may request that the Administrator hire an independent appraiser that meets the requirements of Code section 401(a)(28)(c) to value the property. Alternatively, if the Trustee chooses, or if the Administrator shall fail or refuse to instruct the Trustee on the value of such property within a reasonable time after receipt of the Trustee's request, the Trustee at its sole discretion may engage an independent appraiser to determine the fair market value of such property. Franklin Templeton ValuSelect(R) All Rights Reserved Page 7 97 3.4 Within sixty days following the last day of each Plan Year (or following the close of any period as may be agreed upon by the Trustee and Administrator), the Trustee shall file with the Administrator a written account setting forth a description of Trust Fund transactions during such period, and listing the assets held by the Trust Fund at the end of such period, together with the then fair market value thereof. The Administrator may approve the accounting by written approval delivered to the Trustee. Failure by the Administrator to approve or disapprove an accounting within sixty days after receipt of such accounting shall be deemed an approval of it. 3.5 The Trustee shall act as custodian for Trust Fund assets and may perform any act, keep any records, or make any computations which are required of it by the Company or Administrator as the case may be under this Trust Agreement or under the Plan. The Trustee may also employ agents to act for it as Custodian for Trust Fund assets. Such employment shall not be deemed to be contrary to or inconsistent with the provisions of this Trust Agreement. ARTICLE IV. INDEMNIFICATION. 4.1 Neither the Trust nor any fiduciary hereunder shall have any liability for a breach of fiduciary or other responsibility of another party providing services to this Plan unless it (1) participates knowingly in such breach, (2) knowingly undertakes to conceal such breach, (3) has actual knowledge of such breach and fails to take reasonable action to remedy said breach, (4) through negligence in performing its specific responsibility, it has enabled such other party to commit a breach of the latter's responsibilities, or (5) such other circumstances exist as may give rise to co-fiduciary liability under section 405 of ERISA. 4.2 The Trustee shall have no duty or responsibility to inquire into the acts or omissions of any former trustee, if any, to the Trust, or of any other fiduciary of the Trust, prior to receipt of the assets of the Trust. 4.3 All releases and indemnities provided herein shall survive termination of this Agreement. The Company hereby indemnifies the Trustee against, and agrees to hold the Trustee harmless from, all liabilities and claims (including reasonable attorney's fees and expenses in defending against such liabilities and claims) against the Trustee that arise in connection with (i) any reasonable, good faith act taken in accordance with written directions (or reasonable, good faith failure to act, in the absence of any required direction) from the Company, Administrator, any investment manager properly appointed, or any other person designated to act on their behalf, (ii) the Trustee's reasonable, good faith execution of its duties under this Trust Agreement, or (iii) any acts or omissions by any former Trustee or former fiduciary of the Trust, or by any other party which formerly provided services to the Trust, except that the Company shall not indemnify the Trustee in the event of the Trustee's own misconduct or negligence. The Trustee shall be entitled to collect on the Company's indemnity under this Section only from the Company and shall not be entitled to payment directly or indirectly from Trust Fund assets. ARTICLE V. TAXES, EXPENSES AND COMPENSATION OF TRUSTEE. 5.1 The Trustee shall notify the Company or Administrator as the case the may be of any tax levied upon or assessed against the Trust Fund of which the Trustee has knowledge. Moreover, the Company or Administrator may direct the Trustee to charge the taxes against the assets of the Trust Fund. If the Trustee receives no instructions from the Administrator, the Trustee may pay the tax from the Trust Fund. If the Plan Administrator wishes to contest the tax assessment, it shall give appropriate written instructions to the Trustee. The Trustee shall not be required to bring any legal actions or proceedings to contest the validity of any tax assessments unless the Trustee has been indemnified to its satisfaction against loss or expense related to such actions or proceedings, including reasonable attorney's fees. 5.2 The Company shall quarterly pay the Trustee its expenses in administering the Trust Fund (including attorneys' fees, appraisal fees and other service-provider fees and compensation for services rendered pursuant to this Agreement) and reasonable compensation for its services as Trustee at a rate set forth in the Fee Schedule, which may be amended from time to time. The Trustee reserves the right to alter this rate of compensation at any time by providing the company with notice of such change at least sixty days prior to its effective date. Reasonable compensation shall include compensation for any extraordinary services or computations required, such as determination of the value of assets when current market values are not published, and the Franklin Templeton ValuSelect(R) All Rights Reserved Page 8 98 covering of overdrafts. The fees and reasonable compensation herein discussed may be withdrawn from the Trust Fund, if any such amount remains unpaid by the Company thirty days after mailing of the written billing by the Trustee. Moreover the Company may direct the Trustee to charge the fees and expenses herein described against the assets of the Trust Fund. ARTICLE VI. RESIGNATION OR REMOVAL OF TRUSTEE. 6.1 The Trustee may resign as Trustee or may be removed by the Company. This resignation or removal may be accomplished at any time upon the giving of sixty-days' written notice to the Trustee or Company, as applicable (or less notice if the other party agrees to waive notice). Upon resignation or removal, the Company shall appoint a successor trustee. Such successor trustee shall thereupon succeed to all of the powers and duties of the predecessor trustee. Should no successor trustee named by the Company accept such appointment within thirty days after delivery of notice of resignation or removal, the Trustee may, at the expense of the Trust (to the extent such expense is reasonable), apply to a court of competent jurisdiction for the appointment of a successor trustee. In the alternative, or upon the failure of the Company to timely appoint a successor trustee, the individual members of the board of directors of the Company shall become successor trustee until another successor trustee has accepted its appointment. 6.2 Within sixty days following the transfer of the property in the Trust to the successor trustee, the resigning or removed Trustee shall render to the Company an account in the form and manner prescribed for the annual account by Section 3 hereof. Unless the Company files with the resigning or removed Trustee written objections within sixty days after such account has been mailed or otherwise delivered, the account shall be deemed to have been approved. ARTICLE VII. DURATION, AMENDMENT AND TERMINATION OF TRUST. 7.1 It is the intention of the Company that this Trust and the Plan of which it is a part shall be permanently administered for the benefit of the Plan's participants and their beneficiaries, and for the purpose of defraying reasonable expenses of administering the Plan. This Trust is, accordingly, irrevocable except to the extent described in Section 9.7; however, if changing conditions require, this Trust may be terminated at any time by the Company, and upon such termination, the Trust Fund shall be distributed by the Trustee as and when directed by the Administrator in accordance with the provisions of Section 2.9 and the Plan document. From the date of termination of the Plan and until the final distribution of the Trust assets, the Trustee shall continue to have all the powers provided under this Agreement that are necessary or desirable for the orderly liquidation and distribution of the Trust Fund. In no instance upon any termination, or discontinuance, and subsequent distribution shall the Trust Fund or any part or it be used for, or diverted to, purposes other than providing benefits to participating employees and their beneficiaries, and defraying the administrative expenses of the Plan until all Plan liabilities have been satisfied, except in the instance of the failure of the Trust initially to qualify for tax-exempt status as set forth in Section 9.7. 7.2 This Trust Agreement, other than Section 7.1 may be amended at any time by written agreement of the Company and the Trustee, provided that such amendment shall not operate to: (a) cause the Trust or any part thereof to revert to the Company or to be used for or diverted to purposes other than the exclusive benefit of participants and their beneficiaries, except to the extent permitted by law and the Plan; or (b) reduce the then accrued benefits or the amounts then held for the benefit of any participant or beneficiary in the Plan. 7.3 The Trustee may condition the transfer or distribution of any assets of the Trust Fund upon termination of the Trust on receipt of a favorable determination letter from the Internal Revenue Service confirming that the termination of the Plan does not adversely affect the tax-exempt status of the Trust Fund. Alternatively, the Trustee, in its sole discretion, may accept the indemnification of the Company and Administrator against any liability arising from such transfer or distribution that is directed by the Company or Administrator or may require Franklin Templeton ValuSelect(R) All Rights Reserved Page 9 99 the Company and Administrator to post a bond sufficient to protect the Trustee against such liability until such time as a favorable determination letter is received. ARTICLE VIII. APPROVAL OF USE OF FUNDS FOR PLAN. The Company acknowledges that it is independent of and unrelated to the Trustee, and that it has not received, directly or indirectly, any compensation or other consideration for its own personal account from any party dealing with the Plan in connection with this transaction. The Company understands that by investing Plan assets in the [Franklin Templeton Funds (the "Funds")], affiliates of the Trustee may receive fees for investment advisory, transfer agency and other services provided to the Funds. The Company further acknowledges receipt of a prospectus and, if applicable, a collective investment disclosure statement for each of the Funds available as an investment under the Plan, and a full and detailed written disclosure of the investment advisory and other fees charged to or by the Plan and the Funds, including the nature and extent of any differential between the rates of such fees. The Company hereby approves investing Plan assets in the Funds, and approves the fee arrangements that such Funds may charge against the Plan assets. The Company understands that shares of the Funds and units of the collective investment fund are not deposits or obligations of, or guaranteed or endorsed by, any bank, that such shares or units are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency, and that investing in shares or units of the Funds involve investment risks including the possible loss of principal. ARTICLE IX. MISCELLANEOUS. 9.1 The Trust will be administered according to the laws of the United States and the State of California, and its validity, construction, and all rights hereunder shall be governed by the laws of the State of California to the extent that the latter are not preempted by the laws of the United States. 9.2 If any provisions of this Trust Agreement are invalid or unenforceable, the remaining provisions thereof shall continue to be fully effective. 9.3 The headings in this instrument have been inserted for convenience of reference only, and are to be ignored in any construction of the provisions thereof. 9.4 Except pursuant to a "qualified domestic relations order" as defined at section 206(d)(3)(B)(i) of ERISA, no person entitled to any benefit under this Trust Agreement shall have any right to assign, transfer, hypothecate, encumber, commute or anticipate his interest in any benefits under this Trust, except pursuant to the loan provisions of the Plan, and such benefit shall not in any way be subject to any legal process or levy of execution upon, or attachment or garnishment proceedings against the same for the payment of any claim against such period. 9.5 This Trust Agreement is effective as of the date executed by the Company and the Trustee. 9.6 This Trust Agreement and the Plan are both part of and constitute a single, integrated employee benefit plan and trust and shall be construed together. If there is a conflict between the provisions of the Plan and this Trust Agreement, the provisions of this Trust Agreement (to the extent that such provisions comply with applicable law) shall control with respect to all rights, duties, responsibilities, obligations, powers and authorities of the Trustee, and the Trustee shall have no duty to inquire into, nor shall it have any obligation or liability with respect to, the provisions of the Plan. 9.7 It is intended that this Trust shall be tax exempt under section 501(a) of the Code and that the Plan referred to herein shall qualify under section 401(a) of the Code. However, notwithstanding any other provisions of the Trust, if the Internal Revenue Service is requested to issue to the Company a favorable written determination or ruling with respect to the initial qualification of the Plan and exemption of the Trust from tax and such request is denied, the Trustee shall, after receiving a written direction from the Administrator, pay to each participant that portion of the Trust Fund applicable to said participant's voluntary contributions, if any, and provided the Plan so Franklin Templeton ValuSelect(R) All Rights Reserved Page 10 100 states, pay to the Company any part of the Trust Fund attributable to Company contributions then remaining in the Trustee's possession. As a condition to such repayment, the Company must execute, acknowledge, and deliver to the Trustee its written undertaking, in form satisfactory to the Trustee, to indemnify, defend, and hold the Trustee harmless from all claims, demands, or liabilities arising in connection with such repayment, and provided, further, that such repayment will occur within one year after the date the request for qualifications is denied. 9.8 The duties and responsibilities of the Trustee shall be solely those set forth in this document. The Trustee shall not be a named fiduciary under the Plan and shall not have the authority to interpret the Plan. 9.9 To the extent permitted by statutory or administrative exemption, the Trustee may engage in actions that otherwise would violate section 406 of ERISA. 9.10 Each party providing services to the Plan shall be solely responsible for its own acts or omissions under the Plan or the Trust. The parties specifically intend that no party shall be liable for any breach of responsibility of another party. 9.11 The Trustee is authorized to tape record conversations between the Trustee and persons acting on behalf of the Plan, including but not limited to the Company, the Administrator, or the Plan participants. 101 EXECUTION OF TRUST AGREEMENT IN WITNESS WHEREOF, National Insurance Group and Franklin Templeton Trust Company have caused this Trust Agreement to be executed by its officer(s) duly authorized, as of the 31st day of December, 1997. FRANKLIN TEMPLETON TRUST COMPANY, TRUSTEE /s/ JOHN G. HITCHCOCK - ----------------------------------------- John G. Hitchcock President National Insurance Group /s/ ROBERT P BARBAROWICZ - ----------------------------------------- Signature ROBERT P. BARBAROWICZ, - ----------------------------------------- Title Executive Vice President & General Counsel 102 ADOPTION AGREEMENT FOR FRANKLIN TEMPLETON VALUSELECT STANDARDIZED 401(K) PROFIT SHARING PLAN AND TRUST (WITH PAIRING PROVISIONS) The undersigned Employer adopts the Franklin Templeton ValuSelect Standardized 401(k) Profit Sharing Plan and Trust for those Employees who shall qualify as Participants hereunder, to be known as the A1 National Insurance Group 401(k) Plan - -------------------------------------------------------------------------------- (Enter Plan Name) It shall be effective as of the date specified below. The Employer hereby selects the following Plan specifications: CAUTION: The failure to properly fill out this Adoption Agreement may result in disqualification of the Plan. EMPLOYER INFORMATION B1 Name of Employer National Insurance Group B1 Address 395 Oyster Point Boulevard, Suite 500 South San Francisco, CA 94080 City State Zip Telephone 415-246-3318 B1 Employer Identification Number 94-3031790 B1 Date Business Commenced November 7, 1986 B1 TYPE OF ENTITY a. ( ) S Corporation b. ( ) Professional Service Corporation c. (X) Corporation d. ( ) Sole Proprietorship e. ( ) Partnership f. ( ) Other___________________________ AND, is the Employer a member of... g. a controlled group? (X) Yes ( ) No h. an affiliated service group? ( ) Yes (X) No 103 B1 NAME(S) OF TRUSTEE(S) a. Franklin Templeton Trust Company b.____________________________________________________________________ c.____________________________________________________________________ d.____________________________________________________________________ e.____________________________________________________________________ AND, a separate Trust agreement d. (X) shall be used with this Plan. e. ( ) shall not be used with this Plan. NOTE: If d is selected, an executed copy of the Trust agreement between the Trustee named in item B6a and the Employer must be attached to the Plan. The Plan and Trust agreement will be read and construed together. The responsibilities, rights and powers of the Trustee are limited as specified in the Trust agreement. All additional responsibilities, duties, rights and powers of the Trustee in the Plan are to be allocated between the Record Keeper and the Administrator as they shall agree in writing, or to the Administrator if no Record Keeper has been appointed. B1 TRUSTEES' ADDRESS a. ( ) Use Employer Address b. (X) 1800 Gateway Drive Street San Mateo, California 94404-9963 City State Zip B1 LOCATION OF EMPLOYER'S PRINCIPAL OFFICE: a. (X) State b. ( ) Commonwealth of c. California and this Plan and Trust shall be governed under the same. B1 EMPLOYER FISCAL YEAR means the 12 consecutive month period: Commencing on a. January 1st (e.g., January 1st) and month day ending on b. December 31st. month day 2 104 PLAN INFORMATION C1 EFFECTIVE DATE This Adoption Agreement of the Franklin Templeton ValuSelect Standardized 401(k) Profit Sharing Plan and Trust shall: a. ( ) establish a new Plan and Trust effective as of___ (hereinafter called the "Effective Date"). b. (X) constitute an amendment and restatement in its entirety of a previously established qualified Plan and Trust of the Employer which was effective July 1, 1996 (hereinafter called the "Effective Date"). Except as specifically provided in the Plan, the effective date of this amendment and restatement is October 1, 1997 (For TRA '86 amendments, enter the first day of the first Plan Year beginning in 1989). C1 PLAN YEAR means the 12 consecutive month period: Commencing on a. January 1st (e.g., January 1st) and ending on b. December 31st. IS THERE A SHORT PLAN YEAR? c. (X) No d. ( ) Yes, beginning___________________ and ending_______________________. C1 ANNIVERSARY DATE of Plan (Annual Valuation Date) a. December 31st month day C1 PLAN NUMBER assigned by the Employer (select one) a. (X) 001 b. ( ) 002 c. ( ) 003 d. ( ) Other_________________ 3 105 C1 NAME OF PLAN ADMINISTRATOR (Document provides for the Employer to appoint an Administrator. If none is named, the Employer will become the Administrator.) a. (X) Employer (Use Employer Address) b. ( ) Name __________________________________________ Address ( ) Use Employer Address __________________________________________ Address ___________________________________________ __________________, ____________ ________ City State Zip Telephone __________________________________________ Administrator's I.D. Number__________________________ C1 PLAN'S AGENT FOR SERVICE OF LEGAL PROCESS a. (X) Employer (Use Employer Address) b. ( ) Name ___________________________________________ Address ___________________________________________ ___________________________________________ 4 106 ELIGIBILITY, VESTING AND RETIREMENT AGE D1 ELIGIBLE EMPLOYEES (Plan Section 1.15) shall mean all Employees who have satisfied the eligibility requirements except those checked below: a. (X) N/A. No exclusions. b. ( ) Employees whose employment is governed by a collective bargaining agreement between the Employer and "employee representatives" under which retirement benefits were the subject of good faith bargaining. For this purpose, the term "employee representatives" does not include any organization more than half of whose members are employees who are owners, officers, or executives of the Employer. c. ( ) Employees who are nonresident aliens who received no earned income (within the meaning of Code Section 911(d)(2)) from the Employer which constitutes income from sources within the United States (within the meaning of Code Section 861(a)(3)). NOTE: For purposes of this section, the term Employee shall include all Employees of this Employer, any Affiliated Employer, and any leased employees deemed to be Employees under Code Section 414(n) or 414(o). D1 HOURS OF SERVICE (Plan Section 1.31) will be determined on the basis of the method selected below. Only one method may be selected. The method selected will be applied to all Employees covered under the Plan. a. (X) On the basis of actual hours for which an Employee is paid or entitled to payment. b. ( ) On the basis of days worked. An Employee will be credited with ten (10) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the day. c. ( ) On the basis of weeks worked. An Employee will be credited forty-five (45) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the week. d. ( ) On the basis of semi-monthly payroll periods. An Employee will be credited with ninety-five (95) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the semi-monthly payroll period. e. ( ) On the basis of months worked. An Employee will be credited with one hundred ninety (190) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the month. 5 107 D1 CONDITIONS OF ELIGIBILITY (Plan Section 3.1) (Check either a OR b and c, and if applicable, d) Any Eligible Employee will be eligible to participate in the Plan if such Eligible Employee has satisfied the service and age requirements, if any, specified below: a. ( ) NO AGE OR SERVICE REQUIRED. b. (X)SERVICE REQUIREMENT. (may not exceed 1 year) 1. ( ) None 2. ( ) 1/2 Year of Service 3. ( ) 1 Year of Service 4. (X) Other 3 consecutive months NOTE: If the Year(s) of Service selected is or includes a fractional year, an Employee will not be required to complete any specified number of Hours of Service to receive credit for such fractional year. If expressed in Months of Service, an Employee will not be required to complete any specified number of Hours of Service in a particular month. c. (X)AGE REQUIREMENT (may not exceed 21) 1. ( ) N/A - No Age Requirement. 2. ( ) 20 1/2 3. (X) 21 4. ( ) Other d. ( ) FOR NEW PLANS ONLY - Regardless of any of the above age or service requirements, any Eligible Employee who was employed on the Effective Date of the Plan shall be eligible to participate hereunder and shall enter the Plan as of such date. D1 EFFECTIVE DATE OF PARTICIPATION (Plan Section 3.2) An Eligible Employee shall become a Participant as of: a. ( ) the first day of the Plan Year in which he met the requirements. b. ( ) the first day of the Plan Year in which he met the requirements, if he met the requirements in the first 6 months of the Plan Year, or as of the first day of the next succeeding Plan Year if he met the requirements in the last 6 months of the Plan Year. c. ( ) the earlier of the first day of the seventh month or the first day of the Plan Year coinciding with or next following the date on which he met the requirements. d. ( ) the first day of the Plan Year next following the date on which he met the requirements. (Eligibility must be 1/2 Year of Service or less and age 20 1/2 or less.) e. ( ) the first day of the month coinciding with or next following the date on which he met the requirements. f. (X) Other: January 1, April 1, July 1, and October 1, provided that an Employee who has satisfied the maximum age and service requirements that are permissible in Section D3 above and who is otherwise entitled to participate, shall commence participation no later than the earlier of (a) 6 months after such requirements are satisfied, or (b) the first day of the first Plan Year after such requirements are satisfied, unless the Employee separates from service before such participation date. 6 108 D1 VESTING OF PARTICIPANT'S INTEREST (Plan Section 6.4(b)) The vesting schedule, based on number of Years of Service, shall be as follows: a. ( ) 100% upon entering Plan. (Required if eligibility requirement is greater than one (1) Year of Service.) b. ( ) 0-2 years 0% c. ( ) 0-4 years 0% 3 years 100% 5 years 100% d. ( ) 0-1 year 0% e. ( ) 1 year 25% 2 years 20% 2 years 50% 3 years 40% 3 years 75% 4 years 60% 4 years 100% 5 years 80% 6 years 100% f. ( ) 1 year 20% g. ( ) 0-2 years 0% 2 years 40% 3 years 20% 3 years 60% 4 years 40% 4 years 80% 5 years 60% 5 years 100% 6 years 80% 7 years 100%
h. (X)Other - Must be at least as liberal as either c or g above.
Years of Service Percentage Less than 4 0% 4 or more 100%
7 109 D1 FOR AMENDED PLANS (Plan Section 6.4(f)) If the vesting schedule has been amended to a less favorable schedule, enter the pre-amended schedule below: a. (X) Vesting schedule has not been amended or amended schedule is more favorable in all years. b. ( ) Years of Service Percentage D1 TOP HEAVY VESTING (Plan Section 6.4(c)) If this Plan becomes a Top Heavy Plan, the following vesting schedule, based on number of Years of Service, for such Plan Year and each succeeding Plan Year, whether or not the Plan is a Top Heavy Plan, shall apply and shall be treated as a Plan amendment pursuant to this Plan. Once effective, this schedule shall also apply to any contributions made prior to the effective date of Code Section 416 and/or before the Plan became a Top Heavy Plan. a. ( ) N/A (D5a, b, d, e or f was selected) b. ( ) 0-1 year 0% c. (X) 0-2 years 0% 2 years 20% 3 years 100% 3 years 40% 4 years 60% 5 years 80% 6 years 100%
NOTE: This section does not apply to the Account balances of any Participant who does not have an Hour of Service after the Plan has initially become top heavy. Such Participant's Account balance attributable to Employer contributions and Forfeitures will be determined without regard to this section. 8 110 D1 VESTING (Plan Section 6.4(h)) In determining Years of Service for vesting purposes, Years of Service attributable to the following shall be EXCLUDED: a. ( ) Service prior to the Effective Date of the Plan or a predecessor plan. b. (X) N/A. c. ( ) Service prior to the time an Employee attained age 18. d. (X) N/A. D1 PLAN SHALL RECOGNIZE SERVICE WITH PREDECESSOR EMPLOYER a. ( ) No. b. (X) Yes: Years of Service with American Realty Tax Services, Inc. and American Realty Tax Services of New York, Inc. shall be recognized for the purpose of this Plan. NOTE: If the predecessor Employer maintained this qualified Plan, then Years of Service with such predecessor Employer shall be recognized pursuant to Section 1.74, and b. must be marked. D1 NORMAL RETIREMENT AGE ("NRA") (Plan Section 1.42) means: a. (X) the date a Participant attains his 65th birthday. (not to exceed 65th) b. ( ) the later of the date a Participant attains his __ birthday (not to exceed 65th) or the c.___ (not to exceed 5th) anniversary of the first day of the Plan Year in which participation in the Plan commenced. D1 NORMAL RETIREMENT DATE (Plan Section 1.43) shall commence: a. ( ) as of the Participant's "NRA." OR (must select b. or c. AND 1. or 2.) b. (X) as of the first day of the month... c. ( ) as of the Anniversary Date... 1. (X) coinciding with or next following the Participant's "NRA." 2. ( ) nearest the Participant's "NRA." D1 EARLY RETIREMENT DATE (Plan Section 1.12) means the: a. (X) No Early Retirement provision provided. b. ( ) date on which a Participant... c. ( ) first day of the month coinciding with or next following the date on which a Participant... d. ( ) Anniversary Date coinciding with or next following the date on which a Participant... AND, if b, c or d was selected... 1. ( ) attains his___birthday and has 2. ( ) completed at least___Years of Service. 9 111 CONTRIBUTIONS, ALLOCATIONS AND DISTRIBUTIONS E1 a. COMPENSATION (Plan Section 1.9) with respect to any Participant means: 1. (X) Wages, tips and other Compensation on Form W-2. 2. ( ) Section 3401(a) wages (wages for withholding purposes). 3. ( ) 415 safe-harbor compensation. AND COMPENSATION 1. ( ) shall 2. (X) shall not exclude (even if includible in gross income) reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits. b. COMPENSATION shall be 1. (X) actually paid (must be selected if Plan is integrated) 2. ( ) accrued c. FOR PURPOSES OF THIS SECTION E1, Compensation shall be based on: 1. (X) the Plan Year. 2. ( ) the Fiscal Year coinciding with or ending within the Plan Year. 3. ( ) the Calendar Year coinciding with or ending within the Plan Year. NOTE: The Limitation Year shall be the same as the year on which Compensation is based. d. HOWEVER, for an Employee's first year of participation, Compensation shall be recognized as of: 1. ( ) the first day of the Plan Year. 2. (X) the date the Participant entered the Plan. e. IN ADDITION, COMPENSATION and "414(s) Compensation" 1. (X) shall 2. ( ) shall not include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). E1 SALARY REDUCTION ARRANGEMENT - ELECTIVE CONTRIBUTION (Plan Section 11.2) Each Employee may elect to have his Compensation reduced by: a. ( )___% b. ( ) up to___% c. (X)from 1% % to 15% % d. ( ) up to the maximum percentage allowable not to exceed the limits of Code Sections 401(k), 404 and 415. AND... e. (X)A Participant may elect to commence salary reductions as of January 1, April 1, July 1, and October 1 (ENTER AT LEAST ONE DATE OR PERIOD). A Participant may modify 10 112 the amount of salary reductions as of the first day of any month (ENTER AT LEAST ONE DATE OR PERIOD). AND... Shall cash bonuses paid within 2 1/2 months after the end of the Plan Year be subject to the salary reduction election? f. ( ) Yes g. (X) No 11 113 E1 FORMULA FOR DETERMINING EMPLOYER'S MATCHING CONTRIBUTION (Plan Section 11.1(b)) a. ( ) N/A. There shall be no matching contributions. b. ( ) The Employer shall make matching contributions equal to___% (e.g. 50%) of the Participant's salary reductions. c. (X) The Employer may make matching contributions equal to a discretionary percentage, to be determined by the Employer, of the Participant's salary reductions. d. ( ) The Employer shall make matching contributions equal to the sum of___% of the portion of the Participant's salary reduction which does not exceed___% of the Participant's Compensation plus % of the portion of the Participant's salary reduction which exceeds ___% of the Participant's Compensation, but does not exceed___% of the Participant's Compensation. e. ( ) The Employer shall make matching contributions equal to the percentage determined under the following schedule:
Participant's Total Matching Percentage Years of Service --------- ---------- --------- ---------- --------- ----------
FOR PLANS WITH MATCHING CONTRIBUTIONS f. (X) Matching contributions g. ( ) shall h. (X) shall not be used in satisfying the deferral percentage tests. (If used, full vesting and restrictions on withdrawals will apply and the match will be deemed to be an Elective Contribution). i. ( ) For Plan Years beginning prior to 1990, a Year of Service ( ) shall j. ( ) shall not be required in order to share in the matching contributions. For Plan Years beginning after 1989, a Year of Service shall not be required in order to share in the matching contributions. k. ( ) In determining matching contributions, only salary reductions up to___ % of a Participant's Compensation will be matched. l. (X) N/A m. ( ) The matching contribution made on behalf of a Participant for any Plan Year shall not exceed $___. n. (X) N/A o. (X) Matching contributions shall be made on behalf of 1. (X) all Participants. 2. ( ) only Non-Highly Compensated Employees. p. (X) Notwithstanding anything in the Plan to the contrary, all matching contributions which relate to distributions of Excess Deferred Compensation, Excess Contributions, and Excess Aggregate Contributions shall be Forfeited. (Select this option only if it is applicable.) 12 114 E1 WILL A DISCRETIONARY EMPLOYER CONTRIBUTION BE PROVIDED (OTHER THAN A DISCRETIONARY MATCHING OR QUALIFIED NON-ELECTIVE CONTRIBUTION) (Plan Section 11.1(c))? a. (X) No. b. ( ) Yes, the Employer may make a discretionary contribution out of its current or accumulated Net Profit. c. ( ) Yes, the Employer may make a discretionary contribution which is not limited to its current or accumulated Net Profit. IF YES (b. or c. is selected above), the Employer's discretionary contribution shall be allocated as follows: d. ( ) FOR A NON-INTEGRATED PLAN The Employer discretionary contribution for the Plan Year shall be allocated in the same ratio as each Participant's Compensation bears to the total of such Compensation of all Participants. e. ( ) FOR AN INTEGRATED PLAN The Employer discretionary contribution for the Plan Year shall be allocated in accordance with Plan Section 4.3(b)(2) based on a Participant's Compensation in excess of: f. ( ) The Taxable Wage Base. g. ( ) The greater of $10,000 or 20% of the Taxable Wage Base. h. ( ) ___% of the Taxable Wage Base. (See Note below) i. ( ) $___. (see Note below) NOTE: The integration percentage of 5.7% shall be reduced to: 1. 4.3% if h. or i. above is more than 20% and less than or equal to 80% of the Taxable Wage Base. 2. 5.4% if h. or i. above is less than 100% and more than 80% of the Taxable Wage Base. 13 115 E1 QUALIFIED NON-ELECTIVE CONTRIBUTIONS (Plan Section 11.1(d)) a (X) N/A. There shall be no Qualified Non-Elective Contributions except as provided in Section 11.5(b) and 11.7(h). b. ( ) The Employer shall make a Qualified Non-Elective Contribution equal to___% of the total Compensation of all Participants eligible to share in the allocations. c. ( ) The Employer may make a Qualified Non-Elective Contribution in an amount to be determined by the Employer. E1 FORFEITURES (Plan Section 4.3(e)) a. Forfeitures of contributions other than matching contributions shall be... 1. ( ) added to the Employer's contribution under the Plan. 2. ( ) allocated to all Participants eligible to share in the allocations in the same proportion that each Participant's Compensation for the year bears to the Compensation of all Participants for such year. b. Forfeitures of matching contributions shall be... 1. ( ) N/A. No matching contributions or match is fully vested. 2. (X) used to reduce the Employer's matching contribution. 3. ( ) allocated to all Participants eligible to share in the allocations in proportion to each such Participant's Compensation for the year. 4. ( ) allocated to all Non-Highly Compensated Employee's eligible to share in the allocations in proportion to each such Participant's Compensation for the year. 14 116 E1 ALLOCATIONS TO TERMINATED PARTICIPANTS (Plan Section 4.3(k)) Any Participant who terminated employment during the Plan Year for reasons other than death, Total and Permanent Disability or retirement: a. With respect to the allocation of Employer Non-Elective Contributions (other than matching), Qualified Non-Elective Contributions, and Forfeitures for Plan Years beginning prior to 1990: 1. (X) N/A 2. ( ) shall share in such allocations provided such Participant completed a Year of Service. 3. ( ) shall not share in such allocations regardless of Hours of Service. NOTE: The Plan provides that for Plan Years beginning after 1989, a terminated Participant shall share in such allocations provided such Participant completed more than 500 Hours of Service. b. With respect to the allocation of Employer Matching Contributions, a Participant: 1. For Plan Years beginning after 1989, i. ( ) N/A, Plan does not provide for matching contributions. ii. (X) shall share in the allocations, regardless of Hours of Service. iii. ( ) shall share in the allocations provided such Participant completed more than 500 Hours of Service. 2. For Plan Years beginning before 1990, i. (X) N/A, new Plan, or same as Plan Years beginning after 1989. ii. ( ) shall share in the allocations, regardless of Hours of Service. iii. ( ) shall share in the allocations provided such Participant completed a Year of Service. E1 ALLOCATIONS OF EARNINGS (Plan Section 4.3(c)) Allocations of earnings with respect to amounts contributed to the Plan after the previous Anniversary Date or other valuation date shall be determined... a. ( ) by using a weighted average. b. ( ) by treating one-half of all such contributions as being a part of the Participant's nonsegregated account balance as of the previous Anniversary Date or valuation date. c. (X) by using the method specified in Section 4.3(c). d. ( ) other___ 15 117 E1 LIMITATIONS ON ALLOCATIONS (Plan Section 4.4) a. If any Participant is or was covered under another qualified defined contribution plan maintained by the Employer, other than a Master or Prototype Plan, or if the Employer maintains a welfare benefit fund, as defined in Code Section 419(e), or an individual medical account, as defined in Code Section 415(l)(2), under which amounts are treated as Annual Additions with respect to any Participant in this Plan: 1. (X) N/A. 2. ( ) The provisions of Section 4.4(b) of the Plan will apply as if the other plan were a Master or Prototype Plan. 3. ( ) Provide the method under which the Plans will limit total Annual Additions to the Maximum Permissible Amount, and will properly reduce any Excess Amounts, in a manner that precludes Employer discretion. NOTE: If a.3 above is selected, an Employer may not rely on the opinion letter issued by the Internal Revenue Service that this Plan is qualified under Code Section 401. b. If any Participant is or ever has been a Participant in a defined benefit plan maintained by the Employer: 1. (X) N/A. 2. ( ) In any Limitation Year, the Annual Additions credited to the Participant under this Plan may not cause the sum of the Defined Benefit Plan Fraction and the Defined Contribution Fraction to exceed 1.0. If the Employer's contribution that would otherwise be made on the Participant's behalf during the limitation year would cause the 1.0 limitation to be exceeded, the rate of contribution under this Plan will be reduced so that the sum of the fractions equals 1.0. If the 1.0 limitation is exceeded because of an Excess Amount, such Excess Amount will be reduced in accordance with Section 4.4(a)(4) of the Plan. 3. ( ) Provide the method under which the Plans involved will satisfy the 1.0 limitation in a manner that precludes Employer discretion. 16 118 E1 DISTRIBUTIONS UPON DEATH (Plan Section 6.6(h)) Distributions upon the death of a Participant prior to receiving any benefits shall... a. (X) be made pursuant to the election of the Participant or beneficiary. b. ( ) begin within 1 year of death for a designated beneficiary and be payable over the life (or over a period not exceeding the life expectancy) of such beneficiary, except that if the beneficiary is the Participant's spouse, begin within the time the Participant would have attained age 70 1/2. c. ( ) be made within 5 years of death for all beneficiaries. d. ( ) other E1 LIFE EXPECTANCIES (Plan Section 6.5(f)) for minimum distributions required pursuant to Code Section 401(a)(9) shall... a. (X) be recalculated at the Participant's election. b. ( ) be recalculated. c. ( ) not be recalculated. E1 CONDITIONS FOR DISTRIBUTIONS UPON TERMINATION Distributions upon termination of employment pursuant to Section 6.4(a) of the Plan shall not be made unless the following conditions have been satisfied: a. (X) N/A. Immediate distributions may be made at Participant's election. b. ( ) The Participant has incurred___ 1-Year Break(s) in Service. c. ( ) The Participant has reached his or her Early or Normal Retirement Age. d. ( ) Distributions may be made at the Participant's election on or after the Anniversary Date following termination of employment. e. ( ) Other E1 FORM OF DISTRIBUTIONS (Plan Sections 6.5 and 6.6) Distributions under the Plan may be made... a. 1. ( ) in lump sums. 2. ( ) in lump sums or installments. Please see addendum for E13a b. AND, pursuant to Plan Section 6.13, 1. (X) no annuities are allowed (avoids Joint and Survivor rules). 2. ( ) annuities are allowed (Plan Section 6.13 shall not apply). NOTE: b.1. above may not be elected if this is an amendment to a plan which permitted annuities as a form of distribution or if this Plan has accepted a plan to plan transfer of assets from a plan which permitted annuities as a form of distribution. c. AND may be made in... 1. (X) cash only (except for insurance or annuity contracts). 2. ( ) cash or property. 17 119 TOP HEAVY REQUIREMENTS F1 TOP HEAVY DUPLICATIONS (Plan Section 4.3(i)): When a Non-Key Employee is a Participant in this Plan and a Defined Benefit Plan maintained by the Employer, indicate which method shall be utilized to avoid duplication of top heavy minimum benefits. a. (X) The Employer does not maintain a Defined Benefit Plan. b. ( ) A minimum, non-integrated contribution of 5% of each Non-Key Employee's total Compensation shall be provided in this Plan, as specified in Section 4.3(i). (The Defined Benefit and Defined Contribution Fractions will be computed using 100% if this choice is selected.) c. ( ) A minimum, non-integrated contribution of 7 1/2% of each Non-Key Employee's total Compensation shall be provided in this Plan, as specified in Section 4.3(i). (If this choice is selected, the Defined Benefit and Defined Contribution Fractions will be computed using 125% for all Plan Years in which the Plan is Top Heavy, but not Super Top Heavy.) d. ( ) Specify the method under which the Plans will provide top heavy minimum benefits for Non-Key Employees that will preclude Employer discretion and avoid inadvertent omissions, including any adjustments required under Code Section 415(e). 18 120 F1 PRESENT VALUE OF ACCRUED BENEFIT (Plan Section 2.2) for Top Heavy purposes where the Employer maintains a Defined Benefit Plan in addition to this Plan, shall be based on... a. (X) N/A. The Employer does not maintain a defined benefit plan. b. ( ) Interest Rate:___ Mortality Table:___ F1 TOP HEAVY DUPLICATIONS: Employer maintaining two (2) or more Defined Contribution Plans (other than paired plans). a. (X) N/A. b. ( ) A minimum, non-integrated contribution of 3% of each Non-Key Employee's total Compensation shall be provided in the Money Purchase Plan (or other plan subject to Code Section 412), where the Employer maintains two (2) or more non-paired Defined Contribution Plans. c. ( ) Specify the method under which the Plans will provide top heavy minimum benefits for Non-Key Employees that will preclude Employer discretion and avoid inadvertent omissions, including any adjustments required under Code Section 415(e). F1 IS THIS A PAIRED PLAN? a. ( ) Yes. Name the Plan(s) with which this is paired. ___________________________________________________________________ b. (X) No or N/A. 19 121 MISCELLANEOUS G1 LOANS TO PARTICIPANTS (Plan Section 7.4) a. (X) Yes, loans may be made up to $50,000 or 1/2 Vested interest. b. ( ) No, loans may not be made. If YES, (check all that apply)... c. (X) loans shall be treated as a Directed Investment. d. ( ) loans shall only be made for hardship or financial necessity. e. (X) the minimum loan shall be $1,000. NOTE: Department of Labor Regulations require the adoption of a SEPARATE written loan program setting forth the requirements outlined in Plan Section 7.4. G1 DIRECTED INVESTMENT ACCOUNTS (Plan Section 4.8) are permitted for the interest in any one or more accounts. a. (X) Yes, regardless of the Participant's Vested interest in the Plan. b. ( ) Yes, but only with respect to the Participant's Vested interest in the Plan. c. ( ) Yes, but only with respect to those accounts which are 100% Vested. d. ( ) No directed investments are permitted. G1 TRANSFERS FROM QUALIFIED PLANS (Plan Section 4.6) a. (X) Yes, transfers from qualified plans (and rollovers) will be allowed. b. ( ) No, transfers from qualified plans (and rollovers) will not be allowed. AND, transfers shall be permitted... c. (X) from any Employee, even if not a Participant. d. ( ) from Participants only. 20 122 G1 EMPLOYEES' VOLUNTARY CONTRIBUTIONS (Plan Section 4.7) a. ( ) Yes, Voluntary Contributions are allowed subject to the limits of Section 4.10. b. (X) No, Voluntary Contributions will not be allowed. NOTE: TRA '86 subjects voluntary contributions to strict discrimination rules. G1 HARDSHIP DISTRIBUTIONS (Plan Sections 6.11 and 11.8) a. (X) Yes, from any accounts which are 100% Vested. b. ( ) Yes, from Participant's Elective Account only. c. ( ) Yes, but limited to the Participant's Account only. d. ( ) No. NOTE: Distributions from a Participant's Elective Account are limited to the portion of such account attributable to such Participant's Deferred Compensation and earnings attributable thereto up to December 31, 1988. Also hardship distributions are not permitted from a Participant's Qualified Non-Elective Account. G1 PRE-RETIREMENT DISTRIBUTION (Plan Section 6.10) a. (X) If a Participant has reached the age of 59 1/2, distributions may be made, at the Participant's election, from any accounts which are 100% Vested without requiring the Participant to terminate employment. b. ( ) No pre-retirement distribution may be made. NOTE: Distributions from a Participant's Elective Account and Qualified Non-Elective Account are not permitted prior to age 59 1/2. 21 123 An Employer who has ever maintained or who later adopts any plan in addition to this Plan (including a welfare benefit fund, as defined in Code Section 419(e), which provides post-retirement medical benefits allocated to separate accounts for Key Employees, as defined in Code Section 419A(d)(3) or an individual medical account, as defined in Code Section 415(l)(2)) (other than paired plan #01-002, #01-004) may not rely on the opinion letter issued by the National Office of the Internal Revenue Service as evidence that this Plan is qualified under Code Section 401. If the Employer who adopts or maintains multiple plans wishes to obtain reliance that the Employer's plan(s) are qualified, application for a determination letter should be made to the appropriate key district director of Internal Revenue. This Adoption Agreement may be used only in conjunction with basic Plan document #01. This Adoption Agreement and the basic Plan document shall together be known as Franklin Templeton ValuSelect Standardized 401(k) Profit Sharing Plan and Trust #01-006. The adoption of this Plan, its qualification by the IRS, and the related tax consequences are the responsibility of the Employer and its independent tax and legal advisors. Franklin Templeton ValuSelect will notify the Employer of any amendments made to the Plan or of the discontinuance or abandonment of the Plan provided this Plan has been acknowledged by Franklin Templeton ValuSelect or its authorized representative. Furthermore, in order to be eligible to receive such notification, we agree to notify Franklin Templeton ValuSelect of any change in address. 22 124 IN WITNESS WHEREOF, the Employer and Trustee hereby cause this Plan to be executed on December 31, 1997. Furthermore, this Plan may not be used unless acknowledged by Franklin Templeton ValuSelect or its authorized representative. EMPLOYER: National Insurance Group By: /s/ ROBERT P. BARBAROWICZ ----------------------------------------- Executive Vice President (X) The signature of the Trustee appears on Separate Trust Agreement attached to the Plan pursuant to B6 of the Adoption Agreement. PARTICIPATING EMPLOYER: Great Pacific Insurance Company Fastrac Systems Incorporated By: /s/ ROBERT P. BARBAROWICZ By: /s/ ROBERT P. BARBAROWICZ ---------------------------------- -------------------------------- Pinnacle Data Corporation Fastrac Systems Incorporated Insurance Agent & Broker By: /s/ ROBERT P. BARBAROWICZ By: /s/ ROBERT P. BARBAROWICZ ---------------------------------- -------------------------------- Pinnacle Real Estate Tax Services, Inc. Pinnacle Real Estate Tax Services of New York, Inc. By: /s/ ROBERT P. BARBAROWICZ By: /s/ ROBERT P. BARBAROWICZ ---------------------------------- -------------------------------- This Plan may not be used, and shall not be deemed to be a Prototype Plan, unless an authorized representative of Franklin Templeton ValuSelect has acknowledged the use of the Plan. Such acknowledgment is for administerial purposes only. It acknowledges that the Employer is using the Plan but does not represent that this Plan, including the choices selected on the Adoption Agreement, has been reviewed by a representative of the sponsor or constitutes a qualified retirement plan. Franklin Templeton ValuSelect By: /s/ CHARLES DORR ---------------------------------- With regard to any questions regarding the provisions of the Plan, adoption of the Plan, or the effect of an opinion letter from the IRS, call or write (this information must be completed by the sponsor of this Plan or its designated representative): Name Laura D. Higbie, Vice President Human Resources --------------------------------------------------------------------------- Address 395 Oyster Point Boulevard, Suite 500 ------------------------------------------------------------------------- South San Francisco, Ca 94080 ------------------------------------------------------------------------- Telephone (650) 246-3318 ----------------------------------------------------------------------- 23 EX-11.1 7 COMPUTATION OF WEIGHTED AVERAGE SHARES OUTSTANDING 1 EXHIBIT 11.1 NATIONAL INSURANCE GROUP AND SUBSIDIARIES COMPUTATION OF WEIGHTED AVERAGE SHARES OUTSTANDING AND EARNINGS PER SHARE FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 BASIC EPS UNDER SFAS NO. 128
1995 1996 1997 ----------- ----------- ----------- Weighted average common shares ....................... 4,679,201 4,109,655 3,946,257 Net income (loss) (in thousands) ..................... $ (4,864) $ 1,274 $ 3,266 Per share results: Net income (loss) ....................... $ (1.04) $ 0.31 $ 0.83
DILUTED EPS UNDER SFAS NO. 128
1995 1996 1997 ----------- ----------- ----------- Weighted average common shares ....................... 4,679,201 4,109,655 3,946,257 Common shares issuable under outstanding stock options -- 31,705 181,125 ----------- ----------- ----------- Total ................................... 4,679,201 4,141,360 4,127,382 =========== =========== =========== Net income (loss) (in thousands) ..................... $ (4,864) $ 1,274 $ 3,266 Per share results: Net income (loss) ....................... $ (1.04) $ 0.31 $ 0.79
Please refer to Note 11 of the Consolidated Financial Statements for a description of the method used to calculate earnings per share. EX-21.1 8 SUBSIDIARIES OF COMPANY 1 Exhibit 21.1 NATIONAL INSURANCE GROUP SUBSIDIARIES OF COMPANY
Name of Subsidiary State of Incorporation - ------------------ ---------------------- Fastrac Systems, Inc. California Great Pacific Insurance Company California New Arts Acquisition, Inc. Delaware Pinnacle Data Corporation California Pinnacle Management Solutions Insurance Services California Pinnacle Real Estate Tax Services, Inc. Delaware Pinnacle Real Estate Tax Services of New York, Inc. Delaware Pinnacle Tax Outsourcing Corporation California
EX-24.1 9 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, 1997 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 26, 1998 - ------------------------------- and Chief Executive Mark A. Speizer Officer and Director (Principal Executive Officer) /s/ Bruce A. Cole President and Director March 26, 1998 - ------------------------------- Bruce A. Cole /s/ Gregory S. Saunders Executive Vice President, March 26, 1998 - ------------------------------- Treasurer and Chief Gregory S. Saunders Financial Officer (Principal Financial and Accounting Officer) /s/ Bard E. Bunaes Director March 26, 1998 - ------------------------------- Bard E. Bunaes /s/ Saul B. Jodel Director March 26, 1998 - ------------------------------- Saul B. Jodel /s/ Lawrence M. Goodman Director March 26, 1998 - -------------------------------- Lawrence M. Goodman
1 EX-27.1 10 FINANCIAL DATA SCHEDULE
7 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 15,359 0 0 4,200 0 0 26,623 3,339 0 2,704 66,742 3,232 6,217 0 0 9,601 0 0 18,610 9,170 66,742 19,037 1,839 0 32,201 6,482 8,643 33,249 4,702 1,436 3,266 0 0 0 3,266 0.83 0.79 2,198 6,364 119 3,292 2,157 3,232 119
EX-27.2 11 RESTATED FINANCIAL DATA SCHEDULE FOR 9/30/97
7 0000815555 NATIONAL INSURANCE GROUP 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 13,995 0 0 2,856 0 0 27,705 4,888 0 2,690 68,045 2,803 6,244 0 0 9,768 0 0 18,256 8,862 68,045 13,364 1,280 0 22,091 4,491 6,127 22,242 3,875 1,358 2,517 0 0 0 2,517 0.64 0.62 2,198 4,260 232 1,999 1,888 2,803 232 For Purposes of This Exhibit, Primary means Basic.
EX-27.3 12 RESTATED FINANCIAL DATA SCHEDULE FOR 6/30/97
7 0000815555 NATIONAL INSURANCE GROUP 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 13,972 0 0 2,159 0 0 25,165 4,955 0 2,492 47,976 2,446 5,819 0 0 833 0 0 17,693 8,339 47,976 8,648 899 0 13,961 2,886 3,983 14,124 2,515 875 1,640 0 0 0 1,640 0.42 0.41 2,199 2,741 145 1,080 1,559 2,446 145 For purposes of this Exhibit, Primary means Basic.
EX-27.4 13 RESTATED FINANCIAL DATA SCHEDULE FOR 3/31/97
7 0000815555 NATIONAL INSURANCE GROUP 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 14,842 0 0 2,196 0 0 31,501 3,255 0 2,403 49,045 2,450 5,223 0 0 1,083 0 0 17,592 11,763 49,045 4,177 454 0 6,283 1,213 1,784 6,738 1,179 377 802 0 0 0 802 0.21 0.20 2,198 1,248 (34) 179 783 2,450 (34) For purposes of this Exhibit, Primary means Basic.
EX-27.5 14 RESTATED FINANCIAL DATA SCHEDULE FOR 12/31/96
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 0.31 0.31 3,055 3,970 32 2,318 2,541 2,198 32 For purposes of this Exhibit, Primary means Basic.
EX-27.6 15 RESTATED FINANCIAL DATA SCHEDULE FOR 9/30/96
7 0000815555 NATIONAL INSURANCE GROUP 1,000 9-MOS DEC-31-1996 JAN-01-1996 SEP-30-1996 14,594 0 0 2,211 36 0 31,575 914 11 2,080 48,088 2,800 4,523 0 0 2,000 0 0 18,287 9,798 48,088 9,888 1,490 0 19,292 3,647 4,781 21,987 255 93 162 0 0 0 162 0.04 0.04 3,055 3,659 (12) 1,740 2,161 2,801 (12) For purposes of this Exhibit, Primary means Basic.
EX-27.7 16 RESTATED FINANCIAL DATA SCHEDULE FOR 6/30/96
7 0000815555 NATIONAL INSURANCE GROUP 1,000 6-MOS DEC-31-1996 JAN-01-1996 JUN-30-1996 15,843 0 0 2,190 36 0 35,987 509 11 2,239 51,814 3,104 4,867 0 0 0 0 0 23,259 9,046 51,814 6,841 1,002 0 12,712 2,672 3,278 15,722 (1,116) (408) (708) 0 0 0 (708) (0.15) (0.15) 3,055 2,240 432 682 1,941 3,104 432 For purposes of this Exhibit, Primary means Basic.
EX-27.8 17 RESTATED FINANCIAL DATA SCHEDULE FOR 3/31/96
7 0000815555 NATIONAL INSURANCE GROUP 1,000 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 16,545 0 0 2,225 36 0 34,983 827 11 2,156 50,104 2,968 4,687 0 0 0 0 0 23,071 9,927 50,104 3,786 512 0 6,125 1,107 1,921 7,161 234 85 149 0 0 0 149 0.03 0.03 3,055 1,390 (283) 191 1,003 2,968 (283) For purposes of this Exhibit, Primary means Basic.
EX-27.9 18 RESTATED FINANCIAL DATA SCHEDULE FOR 12/31/95
7 0000815555 NATIONAL INSURANCE GROUP 1,000 12-MOS DEC-31-1995 JAN-01-1995 DEC-31-1995 15,444 0 0 2,271 36 0 37,202 133 11 2,624 52,096 3,055 5,703 0 0 0 0 0 23,071 9,810 52,096 17,020 2,042 0 16,881 6,044 9,597 24,762 (7,423) (2,559) (1,119) 0 (6,304) 0 (4,864) (1.04) (1.04) 3,360 6,378 (334) 4,329 2,020 3,055 (334) For purposes of this Exhibit, Primary means Basic.
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