-----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, LpGWnPeia26pHGbdGqiu6u1P7PtFGpdVJ97CkGIsOlE61w/fxzVW0+xWYvgnI2ZM ahiG5yP0cSHaIbCM1E6RXA== 0000926274-97-000026.txt : 19970401 0000926274-97-000026.hdr.sgml : 19970401 ACCESSION NUMBER: 0000926274-97-000026 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERCARGO CORP CENTRAL INDEX KEY: 0000815787 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 363414667 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16748 FILM NUMBER: 97571034 BUSINESS ADDRESS: STREET 1: 1450 EAST AMERICAN LN STREET 2: 20TH FLR CITY: SCHAUMBURG STATE: IL ZIP: 60173 BUSINESS PHONE: 7085172510 MAIL ADDRESS: STREET 1: 1450 EAST AMERICAN LANE 20TH FLOOR CITY: SCHAUMBURG STATE: IL ZIP: 60173 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 [No Fee Required] For the Fiscal Year Ended December 31, 1996 OR / / Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 [No Fee Required] Commission File Number 0-16748 ------------------------------ INTERCARGO CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-3414667 (State or other jurisdiction (I.R.S. employer of incorporation) identification no.) 1450 American Lane 20th Floor Schaumburg, Illinois 60173 (Address of principal executive office and zip code) Registrant's telephone number, including area code: 847-517-2990 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Title of Class ----------------------------- Common Stock, $1.00 Par Value Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- 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 the definitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Aggregate Market Value of Voting Stock held by nonaffiliates as of March 20, 1997: $50,177,462 Number of Shares of Common Stock outstanding as of March 20, 1997: 7,659,981 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Annual Report for 1996 (incorporated by reference under Part II). Portions of the Registrant's definitive Proxy Statement for the 1997 Annual Meeting of Stockholders (incorporated by reference under Part III). ================================================================================ PART I Item 1. Business. The Company, through Intercargo Insurance Company ("IIC"), its U.S. insurance company subsidiary, and Intercargo Insurance Company H.K. Limited, a subsidiary of IIC, is engaged in the business of underwriting specialized insurance coverages for international trade. This includes U.S. Customs bonds, marine cargo insurance, professional liability insurance and property and casualty insurance. U.S. Customs bonds guarantee payment of duties on imported goods and marine cargo insurance protects shippers from loss or damage to goods in transit. IIC's professional liability and property and casualty insurance is marketed to customs brokers, freight forwarders, and other service firms engaged in the international movement of cargo. Additionally, IIC markets contract surety through independent agents. In the United States, IIC's products are distributed primarily through a wholly-owned subsidiary, International Advisory Services, Inc. ("IAS") and its insurance agency subsidiaries under the trade name, Trade Insurance Services, Inc. IIC opened a branch office in London in April, 1994. This office underwrites marine insurance through independent insurance brokers. In October, 1995, the Company acquired Eastern Insurance Limited, a Hong Kong licensed insurer and renamed the company Intercargo Insurance Company H.K. Limited, and commenced operations in May, 1996. The Hong Kong subsidiary underwrites marine cargo and professional liability insurance through Trade Insurance Services and independent brokers. In December, 1995 the Company participated in an initial public offering by the Company's Canadian subsidiary, Kingsway Financial Services, Inc. ("Kingsway") and as a result of this and the underwriters' overallotment exercised in January 1996, the Company's ownership interest in Kingsway was reduced from 100% to 47%. In October, 1996 Kingsway completed a secondary public offering in which the Company also participated. As a result of this, the ownership interest was further reduced to 31.5%. Kingsway underwrites commercial nonstandard automobile insurance as its primary line. It also provides property and casualty coverage in niche markets and specialized insurance coverages for international trade. The Company no longer considers Kingsway to be a subsidiary. Unless the context otherwise requires, the term the "Company" shall mean Intercargo Corporation and/or its subsidiaries. U.S. CUSTOMS BONDS U.S. Customs bonds guarantee that the importer will pay all attendant duties and taxes at the time of entry of merchandise, pay any supplemental duties assessed and observe the laws governing imports. U.S. Customs bonds are a form of security required by the U.S. Customs Service ("Customs") from virtually all importers of merchandise into the United States. U.S. Customs bonds facilitate the flow of goods by permitting importers to take possession of such goods prior to final determination of Customs duties and of related regulatory issues. U.S. Customs bonds are of two types, either continuous or single transaction. The required bond amounts are set by Customs directives. Continuous bond amounts are set on an annual basis at 10% of the duties, taxes and fees paid by the importer to Customs in the previous calendar year. Single transaction bond amounts are determined based on specific transactions or entries to be secured. Most often, single transaction bonds are set at an amount equal to the entered value plus estimated duties, taxes and fees. The average duty payment required on an import shipment, which is payable by the importer within ten business days of entry, is approximately 4% to 5% of the value of the shipment. However, if Customs disagrees with the importer's classification or valuation of the shipment, the importer will be required to pay additional duty. Customs also is authorized to assess fines and damages against importers which fail to comply with certain import laws and regulations. These laws and regulations include import quota restrictions, labeling laws, Food and Drug Administration regulations and the regulations of other government agencies. Although the importer remains liable for these adjustments, fines and damages, Customs makes demand for payment upon the insurance company that issued the bond in the event of a default by the importer. The Company carefully evaluates the information available from its database and operating experience in establishing its underwriting parameters. All U.S. Customs bond risks must meet these parameters or be specifically approved by designated underwriters. This evaluation is based on a number of factors including the size of the U.S. Customs bond, the financial strength of the importer, the type of transaction, the type of commodity, the commodity's country of origin and the importer's loss history. The Company has developed a database which integrates information received from production sources with detailed information received from Customs on a weekly basis. The Company uses this database extensively as it provides enhanced capabilities for underwriting control and claims handling. The Company also enhances its underwriting selectivity by declining business written through subproducers which have historically failed to file complete documentation with Customs in a timely manner and through its understanding of the laws and regulations which affect imported cargo. MARINE CARGO INSURANCE A marine cargo policy issued by the Company insures the shipper or consignee against physical loss or damage to cargo while in transit. The Company's marine cargo policies provide coverage for general commercial and industrial goods of all types, but exclude among other things, oil shipments and bulk commodities (such as grain shipments). A small portion of the Company's marine business also consists of overland carrier and warehouseman's cargo liability insurance. Marine risks are underwritten based on a number of factors, including type of commodity to be insured (susceptibility to theft and damage), adequacy of packaging, country of origin and destination, extent and type of coverage required, method of transportation and shipping practices and loss experience of the shipper and consignee. The Company issues marine cargo policies primarily for shipments from the U.S. to foreign ports, from foreign ports to the U.S. and, to a limited extent, from one foreign port to another. The Company, however, endeavors to avoid coverage for troubled parts of the world. Marine cargo policies are issued by the Company for an indefinite period of time. The policy insures individual shipments for amounts up to the policy limits at premium rates determined by the Company based upon the factors mentioned above. Premium written on individual shipments is considered to be earned when reported to the Company. PROFESSIONAL LIABILITY INSURANCE The Company provides professional liability coverage for customs brokers, freight forwarders and other service firms engaged in the international movement of cargo. Professional liability insurance policies protect insurers against certain claims arising from the unintentional errors or omissions of their operations that result in financial injury to their clients. These policies exclude coverage for punitive damages and are issued on a "claims made" basis, which means that claims involving alleged negligent acts must be reported during the stated policy term. The Company's professional liability program has been endorsed by the National Customs Brokers and Forwarders Association of America since 1989. The Company introduced a modified version of its professional liability coverage in 1993. This coverage, referred to as international transit liability (ITL) insurance, includes marine legal liability insurance in addition to professional liability. IIC is the first U.S. based insurance company to offer this type of coverage. The program was developed to compete in new international markets. Unlike the traditional professional liability policy, this policy is issued on an "occurrence" basis which means the covered proximate cause of loss must occur during the policy period. 2 OTHER PROPERTY AND CASUALTY INSURANCE The Company markets commercial property and casualty products to customs brokers, freight forwarders and other service firms engaged in the international movement of cargo. The Company is authorized to write these coverages in 47 states. The product is designed to meet the specific requirements of the broker/forwarder industry. The Company's property and casualty and marine units offer a truckers program which includes property and casualty coverage, miscellaneous trucking bonds and cargo legal liability insurance. CONTRACT BONDS The Company sells bid, performance and payment bonds for construction and other types of contracts. The Company also underwrites license and permit bonds, miscellaneous financial guarantees, court bonds and specialty fidelity bonds. The Company has developed what it believes is an industry leading data processing system that enhances the quality of underwriting while reducing the costs and time of processing business. FOREIGN OPERATIONS See note 14 of Notes to Consolidated Financial Statements for information relating to revenues, operating income and identifiable assets related to the Company's operations in the United Kingdom and Hong Kong, which information is incorporated by reference from the Company's 1996 Annual Report to Stockholders. MARKETING AND DISTRIBUTION IAS has agency offices located in Atlanta, Boston, Charleston, Chicago, Hong Kong, Houston, Los Angeles, Miami, New York, San Francisco, Seattle and Toronto. Together with a network of subproducers, IAS acts as the principal insurance agency for approximately 82% of the Company's U.S. insurance product sales and for its marine cargo and professional liability insurance sold in Canada. IAS's agency offices operate under the trade name, Trade Insurance Services, Inc. In addition to IAS and its subproducers, the Company has appointed independent agents. IAS sells U.S. Customs bonds and marine cargo insurance primarily through customs brokers, freight forwarders and other service firms engaged in the international movement of cargo. These service firms act as subproducers for IAS and are compensated on insurance business placed through IAS. Customs brokers must be licensed by the U.S. Treasury Department to represent importers and arrange for clearance of cargo through Customs. Many customs brokers are also freight forwarders which arrange for the shipment of cargo both in the U.S. and abroad. IAS also generates sales through conventional insurance agencies and markets directly to large shippers of cargo. IAS sells the Company's professional liability and property and casualty insurance directly to customs brokers, freight forwarders, and other service firms engaged in the international movement of cargo. REINSURANCE The Company follows the industry practice of reinsuring a portion of its insured risks, paying to the reinsurer a portion of the premiums received on all policies. Insurance is ceded principally to reduce the net liability on individual risks and to protect against catastrophic losses. The Company endeavors to place reinsurance with reinsurance companies which have been approved by the U.S. Treasury (in the case of U.S. Customs bonds) and which have been rated A by A.M. Best Company. Excess of loss reinsurance on the Company's Customs bond business is provided through contracts with four reinsurance companies: Munich American Reinsurance Company ("Munich"), First Excess and Reinsurance Company, Employers Reinsurance Company ("Employers Re") and Transatlantic Reinsurance ("Transatlantic"). 3 Excess of loss reinsurance is a form of reinsurance which indemnifies the ceding insurer up to an agreed amount against all or a portion of the amount of loss in excess of a specified retention. The Company now retains risks up to $500,000 per bond or per principal. Under the contracts, the reinsurers automatically assume the risk of losses on the Company's bonds between $500,000 and $3,700,000 on any one principal. Bonds written for amounts greater than $3,700,000 must be submitted to the reinsurers for acceptance on a case-by-case basis and the Company may not fully reinsure all exposures above $3,700,000. Excess of loss reinsurance on the Company's marine cargo insurance is provided through a reinsurance treaty between the Company, Munich and Munich Reinsurance Company. Under the contracts, Munich and Munich Reinsurance Company automatically assume the risk of losses between $200,000 and $5,000,000 on any one occurrence. In addition, the Company has a facultative treaty with Lloyd's of London and several smaller participants which allows it to write policies in excess of $5,000,000 up to a limit of $20,000,000. The reinsurance on the Company's professional liability program is placed with Employers Re. The Company retains $100,000 of the first $200,000 of loss on any one policy or occurrence under a quota share arrangement. The reinsurer provides reinsurance of $800,000 in excess of this first $200,000 and also provides $2,000,000 additional capacity as needed. Reinsurance on the Company's other property and casualty insurance consists of quota share, excess of loss and surplus reinsurance. Surplus reinsurance indemnifies the Company by ceding a percentage of premiums and losses based upon total insured value. The Company's net retention is $100,000. Employers Re provides excess of loss coverage for the workers compensation, commercial automobile physical damage, and commercial general liability lines, and it provides surplus reinsurance for commercial property. Excess of loss coverage under truck liability and physical damage is provided by several reinsurers including Continental Casualty Company, Great Lakes American Re, Kemper Reinsurance Company, Security Insurance of Hartford, Trenwich America Reinsurance, USF Re, Gerling Global Reinsurance Corp. and Republic Western Insurance Company. USF Re also provides quota share coverage for truck liability. Quota share reinsurers for the commercial umbrella liability coverage include Security Insurance Company of Hartford, Kemper Reinsurance Company, Continental Casualty Company, Underwriters Reinsurance Company, and Sorema. The reinsurance program to cover contract and miscellaneous bonds includes a quota share treaty wherein the Company retains a 50% share of the first $250,000 in losses, while Kemper Reinsurance and Transatlantic Reinsurance provide the remainder. Losses in excess of $250,000 up to $4,000,000 are ceded to several reinsurers including Generali - U.S. Branch, Kemper Reinsurance, Republic Western Reinsurance, Security Insurance of Hartford and Transatlantic Reinsurance. The ceding of reinsurance does not discharge the original insurer from its primary liability to the policyholder. The ceding company is required to pay losses even if the reinsurer fails to meet its obligations under the reinsurance agreement. The Company also remains liable for losses which exceed the limits of coverage afforded by its reinsurance agreements. In addition to the per occurrence limits set forth above, the annual aggregate limit on the Company's Customs bond reinsurance contract is $6.4 million and the annual aggregate limits on the marine cargo reinsurance contract is $17.5 million. LOSSES AND LOSS RESERVES Claims on the Company's marine, professional liability, automobile, and contract bond lines are adjusted by Company personnel. Claims on property and casualty business are processed by a third party. Adjustment procedures include verification of the coverage, investigation of the loss, evaluation of the exposure and final settlement of the claim. The Company's general policy is to adjust and settle claims as quickly as possible. For marine cargo claims, salvage and subrogation are important factors in minimizing loss experience. Substantially all U.S. Customs bond losses are paid to Customs as the party indemnified by the bond. The Company receives periodic notices of importer defaults from Customs in the normal course of business. Because of the nature of the U.S. Customs bond business, the majority of claim notices received from Customs typically do not 4 result in actual claim payments by the Company because of payment by the principal, adequate defenses of the principal or the Company with respect to the claim or correction of a non-compliance situation. The two major types of bond claims received from Customs are assessment of additional duty and liquidated damages. The Company's claim adjustment procedures for additional duty assessments include identifying the bond related to the claim, obtaining supporting Customs' entry documentation, reviewing Customs' assessment of higher duty and contacting the importer of record in an attempt to secure payment. Claims for liquidated damages are more complex and require the implementation of several claim adjustment procedures. By working with the Customs broker that filed the import entry and produced the bond, the Company seeks to correct the non-compliance situation. If compliance is not achieved, the Company performs final adjustment procedures or makes payment. The principal remains liable for all claims paid by the Company. The Company's policy is to aggressively pursue the principal under rights of subrogation on any bond that results in a claim payment. In 1986, Customs began to automate its claims procedures, thus accelerating the reporting of claims. The Company has responded by enhancing its own automation of claims data. These enhancements, together with other improvements, have enabled the Company to achieve greater claims resolution through more timely pursuit of bond principals. Additionally, the Company has been preparing for a fully automated interface with Customs. In January 1993, Customs issued a Notice of Proposed Rulemaking Regarding the Automated Surety Interface ("ASI"). This notice provides the preliminary standards and procedures for ASI, allowing the Company to move forward towards more efficient underwriting and processing. On December 8, 1993 the Customs Modernization Act ("Mod Act") was enacted as Title VI of the North American Free Trade Agreement Implementation Act ("NAFTA"). The Mod Act contains several provisions which may affect sureties. These include changes in record keeping, interest, automation and liquidation procedures. These changes in total may affect the Company either positively or negatively depending on the final regulations and implementation. The Company maintains reserves for the payment of losses and loss adjustment expenses ("LAE") for all lines of business, on an undiscounted basis. The determination of reserves for losses and LAE is dependent on receipt of information regarding claims and the historical loss experience of the business. Generally, there is a lag between the time losses are incurred and the time they are reported to the Company. The liability for losses and LAE is an estimate of the ultimate unpaid net cost of all losses incurred through December 31 of each year. Since the provision is necessarily based on estimates, the ultimate liability may be more or less than such provision. These estimates include the anticipated recovery of salvage and subrogation based on historical patterns. Case reserves for individual claims are generally not established for the U.S. Customs bond business because of the historical problems of attempting to establish case reserves for small losses coupled with: (i) frequent errors in Customs claims, (ii) lack of or erroneous documentation furnished to the Company by Customs, and (iii) the experience of the Company that in excess of 90% of all claims initially reported by Customs are either canceled or settled by the principal. When there is sufficient evidence to document the validity of a claim, it is promptly paid by the Company. As a result, the Company estimates its ultimate losses on U.S. Customs bonds by projecting from its paid claim data. The combination of paid loss projections and the length of time to ultimate settlement adds a high degree of judgment to the reserving process. The reserves established for bond losses are regularly evaluated and adjusted when conditions in loss patterns indicate an adjustment is required. The reserves established for marine losses and professional liability losses are periodically evaluated against cases reported and adjustments to the reserves are recorded as deemed appropriate. Reserves for the Company's automobile and commercial and property and casualty lines are established on a case-by-case basis and include a provision for claims incurred but not yet reported (IBNR). The individual case reserves are reviewed periodically and adjusted as deemed necessary. The following table presents Company reserve balances for the periods indicated (net of ceded reinsurance): 5
YEAR ENDED DECEMBER 31, ----------------------- 1996 1995 1994 ----------------------------------- (DOLLARS IN THOUSANDS) Unpaid Losses and LAE at beginning of period, net of reinsurance recoverables of $3,138, $3,830, and $3,407 $33,155 35,006 26,289 Unpaid Losses and LAE of acquired entities at the beginning of the period -- 1,300 -- ------- ------- ------- Adjusted unpaid losses and LAE at the beginning of the period 33,155 36,306 26,289 ------- ------- ------- Provision for Losses and LAE for claims occurring during: U.S., U.K. and Hong Kong operations Current year 31,876 28,426 19,921 Prior years 431 2,090 1,808 Canadian operations Current year -- 17,216 9,541 Prior years -- 4,014 329 ------- ------- ------- Total 32,307 51,746 41,599 ------- ------- ------- Less Losses and LAE payments for claims occurring during: U.S., U.K. and Hong Kong operations Current year (10,798) (9,492) (7,349) Prior years (17,607) (12,049) (9,505) Canadian operations Current year -- (7,292) (11,289) Prior years -- (8,863) (4,739) ------- ------- ------- Total (28,405) (37,696) (32,882) Adjustment to deconsolidate Canadian operations -- (17,201) -- ------- ------- ------- Unpaid Losses and LAE at end of period, net of reinsurance recoverables of $9,980 $3,138 and $3,830 $37,057 33,155 35,006 ======= ======= =======
_______________ Any adjustments to reserves are reflected in operating results for the period in which they are made. 6 The following table presents development of total Company reserves and liability paid for the periods indicated.
Year Ended December 31, 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- (Dollars in thousands) Liability for unpaid losses and LAE $7,412 $9,414 $11,459 $12,584 $14,133 $25,867 $23,940 $26,289 $35,006 $33,155 $37,057 Cumulative amount of liability paid through: One Year Later 4,130 5,254 6,019 5,216 6,039 12,611 12,531 14,244 20,205 17,608 Two Years Later 7,307 8,803 8,826 8,748 10,893 18,471 17,711 22,819 25,890 Three Years Later 9,436 10,985 11,396 12,106 13,079 21,521 24,280 26,934 Four Years Later 11,203 12,963 14,375 13,525 13,782 28,746 25,908 Five Years Later 12,862 15,400 15,224 13,906 21,892 29,131 Six Years Later 14,805 16,108 15,488 14,179 22,223 Seven Years Later 15,106 16,318 15,766 14,432 Eight Years Later 15,181 16,517 15,830 Nine Years Later 15,134 16,478 Ten Years Later 15,018 Liability re-estimated as of: One Year Later 7,666 10,080 11,629 13,592 13,367 26,551 25,728 28,426 41,110 33,586 Two Years Later 9,379 11,356 14,011 13,301 16,666 25,974 24,667 29,851 41,491 Three Years Later 10,631 13,974 14,502 16,273 15,613 25,060 23,289 31,883 Four Years Later 12,986 15,301 17,499 15,351 14,966 24,192 24,208 Five Years Later 14,618 17,782 16,656 14,790 14,765 24,536 Six Years Later 16,502 17,051 16,038 14,209 15,225 Seven Years Later 15,717 16,736 15,774 14,613 Eight Years Later 15,413 16,565 16,010 Nine Years Later 15,158 16,713 Ten Years later 15,210 Cumulative deficiencies (Redundancies) $7,798 $7,299 $4,551 $2,029 $1,092 ($1,331) $268 $5,594 $6,485 $431 ====== ====== ====== ====== ====== ====== ==== ====== ====== ====
Generally accepted accounting principles (GAAP) require insurance liabilities on the balance sheet be reported without reduction for anticipated recoverables under reinsurance contracts. Statutory accounting practices continue to permit reporting on a net basis. The following table sets forth the reconciliation of GAAP reported reserves to reserves net of reinsurance as shown above.
December 31, 1996 1995 1994 ---------------------------- (dollars in thousands) Gross loss and loss adjustment expense reserves $47,037 $36,293 $38,836 Ceded to other insurance companies (1) 9,980 3,138 3,830 ------- ------- ------- Net liability as stated above $37,057 $33,155 $35,006 ======= ======= =======
____________________________ (1) Before reduction for funds held from reinsurers As indicated in the above tables, the Company has experienced adverse loss development for policy years other than 1991. Reserve deficiencies for 1991 and prior have developed primarily in the U.S. Customs bond line of business. Historical reserve deficiencies resulted from several causes, including modifications in the administrative procedures utilized by Customs in the claims assessment and collection area; the previously described computerization of the claims administration process by Customs; certain court decisions regarding claims administration procedures that were decided favorably to Customs and certain extraordinary losses experienced by the Company. The extraordinary losses were related to a discontinued line of bond business for 7 environmental and safety requirements for imported automobiles, a discontinued program for travel agents and a Customs determination on certain steel importations involving countervailing duty and anti-dumping issues. (In accordance with Customs procedures operative at the time, these risks were primarily secured by many single entry bonds.) The aggregate cumulative losses on these items is approximately $5,500,000, net of reinsurance ceded. The Customs regulations have been modified to restrict such aggregation of liability in the future. Moreover, the database now permits the Company to track and control such aggregations on a more timely basis. In 1993, reserve estimates for professional liability developed greater than originally estimated. The Company's experience with a certain segment of its insured population has been identified as the source of the adverse experience. Certain aspects of the Mod Act are expected to allow this group to be able to limit its exposure to loss in the future. Coupled with enhanced pricing and underwriting control, the Company believes these changes should result in improved loss experience in this area. As prior period reserve inadequacies became apparent, the Company took several actions to strengthen its reserve posture by increasing its premium rate, adjusting its current reserve practices and affecting lump sum increases to the reserves. During 1995, it became apparent that the estimated unpaid claims for liabilities established at December 31, 1994 on Kingsway's business lines would exceed initial expectations and loss reserves were increased accordingly by $4.0 million. In addition, the reserves reported to Kingsway by the Canadian Facility Association Risk Sharing Pool as at December 31, 1994 increased substantially during 1995. The Risk Sharing Pool was created by legislation in Ontario to ensure the availability of automobile insurance to every motorist in Ontario. Every insurer writing automobile insurance is required to share in these losses in proportion to their business in the Province. Also, during 1995, loss experience related to U.S. operations for 1994 and prior suggested reserve increases amounting to $5.2 million were required for the marine cargo, contract surety and other property and casualty lines. These increases were offset by savings of $3.1 million on 1994 and prior U.S. Customs bonds reserve estimates. During 1996 further adverse development for prior years emerged. Increases totaling $2.4 million were made in the contract surety, marine and professional liability product lines. These increases were partially offset by reductions totaling $814,000 to U.S. Customs bonds and other property and casualty reserve estimates. Claims experience tends to be dependent upon the frequency of claims versus the severity of individual claims. Severity exposures are the subject of certain excess of loss reinsurance treaties as described above. Until recent Customs' automation, obtaining reliable information on the frequency of claims was difficult and was further compounded by the historically long delays in Customs' claims assessment and processing. Currently, Customs forwards a computer tape of outstanding bills for additional duty and liquidated damages to the Company on a weekly basis. This data is input to the Company's computer and used to initiate claims handling procedures. The Company's bond and marine cargo losses are generally tied to the value of the goods as of the date of shipment and generally are not adversely affected by inflation; however, LAE is subject to the effects of inflation. LAE is composed primarily of hourly fee costs for attorneys, adjusters and survey firms. Such professional services typically are subject to rate increases at the discretion of the provider. While the Company makes every effort to control the rates and hours of service, it is imperative to retain qualified personnel familiar with the business of the Company and the insurance industry. 8 COMPETITION The insurance industry is highly competitive. The Company faces competition from bond underwriters, marine and non-marine insurers and numerous other insurance companies. These insurers vary in terms of size, quality, operating histories and financial, marketing and management resources. Many of these competitors are larger, have more agents and have substantially greater financial resources than the Company. The U.S. Customs bond business is highly specialized and requires significant technical knowledge in order to properly underwrite and respond to claims. Additionally, the automated processing systems which the U.S. Customs Service has installed for its own use necessitate that surety companies also be automated for claims. In addition to the ability to use the data tapes, and data base information, the time frames available for collection and payment have been shortened, requiring sureties to respond on a daily basis. There are over 300 companies in the United States Department of the Treasury's approved list of companies acceptable as sureties and reinsurers of federal bonds including U.S. Customs bonds. While there is no reliable data available from which to determine the amount or volume of U.S. Customs bonds written by these companies, the Company believes that it and one of its competitors, Washington International Insurance Company, are the dominant underwriters for U.S. Customs bonds. Many major insurance companies, agents and brokers compete for marine cargo insurance business. The Company believes that its ability to compete in this market is enhanced by its relationships with customs brokers and freight forwarders. The Company has few competitors in the U.S. for its professional liability product and believes that it has the largest professional liability program in the U.S. offering this type of coverage. In Canada, alternative coverages are marketed by competitors in conjunction with a broad form marine and liability policy. The Company developed a new form, the International Transit Liability Policy ("ITL"), to be more compatible to Canadian market expectations. The Company believes that its ability to provide prompt, efficient service to customs brokers and freight forwarders, as well as its expertise and understanding of the risks involved in those industries, provide a competitive advantage over other carriers in both its professional liability lines and its property and casualty lines. REGULATION U.S. Federal Regulation. U.S. Customs bonds are sold pursuant to federal regulations requiring virtually every importer of goods into the United States to post a bond. IIC currently maintains a Certificate of Authority as a surety company qualified to write U.S. Customs bonds pursuant to federal law and applicable regulations promulgated by the U.S. Department of Treasury (the "Treasury"). The Treasury determines the maximum amount of risk retention per bond for each qualified insurance company. IIC is qualified to write U.S. Customs bonds and retain an aggregate up to $2,664,000 of liability on any one bond. Although no specific statutory requirements exist, the Treasury generally recommends no greater than a three to one ratio of net premiums written to statutory surplus for sureties licensed to write U.S. Customs bonds. The Company continues to meet this guideline. Insurance companies issuing U.S. Customs bonds and customs brokers selling such bonds are extensively regulated by the Treasury, including an annual review of their financial statements. As a result of extensive federal regulation, the Company believes that under the McCarran Ferguson Act, its U.S. Customs bonds business is exempt from state regulation. No state has taken any action to require the Company's compliance with its licensure requirements with respect to its U.S. Customs bond business. State Regulation. The Company and its U.S. insurance subsidiary is subject to regulation under the various state insurance laws where the subsidiary is licensed, including each particular state's insurance holding company law ("Holding Company Law"). Such regulation is designed generally to protect policyholders rather 9 than investors and relates to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and examination of the affairs of insurance companies, which includes periodic financial and market conduct examinations by regulatory authorities; annual and other reports, prepared on a statutory accounting basis, required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. In general, the Company's insurance subsidiary must file rates for insurance directly underwritten with the insurance department of each state in which it operates. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by domiciled insurance companies in order to protect their solvency. Holding Company Laws impose standards on certain transactions between registered insurers and their affiliates, which include, among other things, that the terms of the transactions be fair and reasonable and that the books, accounts and records of each party be maintained so as to clearly and accurately disclose the precise nature and details of the transactions. Holding Company Laws also generally require that any person or entity desiring to acquire more than a specified percentage (commonly 10%) of the Company's outstanding voting securities is required first to obtain approval of the applicable state insurance regulators. The National Association of Insurance Commissioners (NAIC) facilitates the regulation of multi-state companies through uniform reporting requirements, standardized procedures for financial examinations, and uniform regulatory procedures embodied in model acts and regulations. Current developments address the reporting and regulation of the adequacy of capital and surplus. The NAIC has finalized its risk-based capital model act for property/casualty companies. At December 31, 1996, Intercargo Insurance Company's required risk-based capital was $5,619,398; reported capital and surplus was $30,697,154. INVESTMENT POLICY The Company's investment policy requires that invested assets be comprised of investment grade, fixed income securities of short to medium term. The Company does not invest in real estate or real estate securities, "high yield" bonds or derivatives. The Company's philosophy is to hold its investments to maturity when feasible, but will redeploy assets when market conditions dictate. Substantially all of the Company's investment portfolio is comprised of investment grade securities issued by the U.S. Treasury, various federal agencies, various state and local governments and major U.S. corporations. EMPLOYEES At December 31, 1996, the Company had 222 U.S. employees. Of these, 57 were managerial personnel and 165 were clerical employees. Except for 18 part-time employees, all such persons are employed on a full-time basis. The Company believes that it enjoys favorable relations with its employees. Item 2. Properties The Company occupies leased space in Schaumburg, Illinois where its principal executive offices are located. The Company shares its principal executive offices with IAS. IAS has eleven individual leases in locations where it maintains sales and service offices. IIC leases space in London where a branch office is maintained. Intercargo Insurance Company H.K. Ltd. leases office space in Hong Kong. Item 3. Litigation There are no pending material legal proceedings to which the Company or its subsidiaries is a party or of which any of the properties of the Company or its subsidiaries is subject, except for claims arising in the ordinary course of business. In the ordinary course of business, the Company is involved in certain litigation. In the opinion of management, the ultimate resolution of such litigation will not have a material effect on the financial condition of the Company. 10 Item 4. Submission of Matter to a Vote of Security Holders None. 11 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information regarding the Market for Registrant's Common Equity and Related Stockholder Matters is included in the Registrant's 1996 Annual Report to Stockholders under the heading "Management's Discussion and Analysis--Market Information," which is incorporated herein by reference. Item 6. Selected Financial Data The Selected Financial Data are contained in the Registrant's 1996 Annual Report to Stockholders under the heading "Selected Financial Data," which is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The Management's Discussion and Analysis of Financial Condition and Results of Operations are contained in the Registrant's 1996 Annual Report to Stockholders under the heading "Management's Discussion and Analysis," which is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The consolidated financial statements and related notes required in response to this item are contained in the Registrant's 1996 Annual Report to Stockholders, which financial statements and notes are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure On February 26, 1997, the Board of Directors of Intercargo Corporation (the "Company"), upon the advice of its Audit Committee, elected to not retain KPMG Peat Marwick LLP as its certifying accountant for fiscal year 1997. The decision to change accountants was based upon a cost analysis of services provided. There were no disagreements between management of the Company and the former accountants on any matters of accounting principles or practices, financial statement disclosures, or auditing scopes or procedures during the Company's two most recent fiscal years and any subsequent interim period through the date of dismissal. The accountant's reports on the financial statements of the Company in the 1995 and 1996 fiscal years were unqualified, not modified as to uncertainty, audit scope or accounting principles, and did not express any adverse opinion or disclaimer of opinion. In addition, on February 26, 1997, the Audit Committee recommended, and the Board of Directors approved, the appointment of Ernst & Young LLP as the Company's new independent accountants, effective for fiscal 1997, but subject to ratification of the appointment by the stockholders of the Company at the annual meeting of stockholders currently scheduled to be held on May 16, 1997. The selection of Ernst & Young LLP was through a request for proposal process with no consideration requested or made on the application of accounting principles, the type of audit opinion that might be rendered on the financial statements, or any other factor for reaching a decision as to accounting, auditing or financial reporting issues. PART III Item 10. Directors and Executive Officers of the Registrant For information regarding Directors and Executive Officers of the Registrant, reference is made to the Registrant's definitive proxy statement for its annual meeting of stockholders to be held on May 16, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, which is incorporated herein by reference. Item 11. Executive Compensation 12 For information regarding executive compensation, reference is made to the Registrant's definitive proxy statement for its annual meeting of stockholders to be held on May 16, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, which is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management For information regarding security ownership of certain beneficial owners and management, reference is made to the Registrant's definitive proxy statement for its annual meeting of stockholders to be held on May 16, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, which is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions For information regarding certain relationships and related transactions, reference is made to the Registrant's definitive proxy statement for its annual meeting of stockholders to be held on May 16, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996 which is incorporated herein by reference. 13 INTERCARGO 10-K --------------- PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) For information concerning the following consolidated financial statements of the Registrant, reference is made to the Registrant's 1996 Annual Report to Stockholders, which financial information is incorporated herein by reference. Consolidated Balance Sheets as of December 31, 1996 and 1995. Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994. Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994. Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994. Notes to Consolidated Financial Statements for each of the years in the three year period ended December 31, 1996. (a)(2) The following consolidated financial statement schedules of the Company listed below are contained in the index to Financial Statement Schedules on page FS-1 herein: Schedule I Summary of investments - other than investments in related parties Schedule II Condensed financial information of registrant Schedule IV Reinsurance Schedule VI Supplemental information concerning property/casualty operations (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1996 (c) Exhibits. See Exhibit Index immediately following financial statement schedules. (d) Financial statements, fifty percent or less owned persons The following consolidated financial statement of Kingsway Financial Services, Inc., of which the Registrant owns approximately 31.5%, are filed herewith. Independent Auditors Report. Consolidated Balance Sheets as of December 31, 1996 and 1995. Consolidated Statements of Operations and Retained Earnings for the years ended December 31, 1996 and 1995. Consolidated Statements of Changes in Financial Position for the years ended December 31, 1996 and 1995. Notes to Consolidated Financial Statements for the years ended December 31, 1996 and 1995. 14 INTERCARGO CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES Page Independent Auditors' Report FS-2 SCHEDULES Summary of Investments-Other than Investments in Related Parties (Schedule I) FS-3 Condensed Financial Information of Registrant (Schedule II) FS-4 Reinsurance (Schedule IV) FS-7 Supplemental Information Concerning Property/Casualty Insurance Operations (Schedule VI) FS-8 FS-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of Intercargo Corporation: Under date of February 21, 1997, we reported on the consolidated balance sheets of Intercargo Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, as contained in the 1996 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated supplementary financial statement schedules as listed in the accompanying index. These supplementary financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these supplementary financial statement schedules based on our audits. In our opinion, such supplementary financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Chicago, Illinois February 21, 1997 FS-2 SCHEDULE I INTERCARGO CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1996 (dollars in thousands)
Amount at Which Fair Shown in the Type of Investment Cost (1) Value Balance Sheets - ------------------ -------- ----- -------------- (Available for Sale) Fixed Maturities: U.S. Government and Agency obligations $20,870 20,397 20,397 State, municipal, and other tax advantaged securities 14,193 14,495 14,495 Corporate securities 15,128 14,936 14,936 Other fixed maturity investments 1,758 1,739 1,739 ------- ------ ------ Total fixed maturities 51,949 51,567 51,567 Equity securities 1,730 1,557 1,557 ------- ------ ------ Total investments $53,679 53,124 53,124 ======= ====== ======
______________ (1) Investments in fixed maturities are reflected at cost, adjusted for amortization of premium or accretion of discounts. See notes to consolidated financial statements. See accompanying report of independent auditors. FS-3 SCHEDULE II INTERCARGO CORPORATION CONDENSED BALANCE SHEETS (Registrant only) (dollars in thousands)
December 31, --------------------- 1996 1995 --------------------- ASSETS Investment in affiliates $ 13,519 11,898 Cash and cash equivalents 1,235 1,180 Equipment, at cost less accumulated depreciation 607 569 Investments in subsidiaries 33,198 29,476 Notes receivable Due from affiliates 8,260 8,260 Due from non-affiliates 108 209 Other assets 1,775 1,988 -------- ------ Total assets $ 58,702 53,580 ======== ====== LIABILITIES Accrued expenses and other liabilities $ 233 184 Federal income tax payable 722 40 Notes payable 9,735 9,735 -------- ------ Total liabilities 10,690 9,959 -------- ------ STOCKHOLDERS' EQUITY Common stock -- $1 par value; authorized 20,000,000 shares; issued and outstanding,7,659,981 shares in 1996 and 7,640,981 in 1995 7,660 7,641 Additional paid-in capital 24,180 24,104 Unrealized loss on foreign currency translation (978) (1,179) Net unrealized gain (loss) on available-for-sale securities (366) 567 Retained earnings 17,516 12,488 -------- ------ Total stockholders' equity 48,012 43,621 -------- ------ Total liabilities and stockholders' equity $ 58,702 53,580 ======== ======
See notes to consolidated financial statements. See accompanying report of independent auditors. FS-4 SCHEDULE II -- Continued INTERCARGO CORPORATION CONDENSED STATEMENTS OF INCOME (Registrant only) (in thousands)
December 31, -------------------------------------- 1996 1995 1994 -------------------------------------- Revenues Revenues from affiliates $ 12 17 70 Net investment and other income 3,151 1,261 665 ------- ----- ----- Total 3,163 1,278 735 ------- ----- ----- Expenses Interest expense 715 937 367 General and administrative expense 681 481 1,034 ------- ----- ----- Total 1,396 1,418 1,401 ------- ----- ----- Operating gain (loss) 1,767 (140) (666) Federal income tax benefit (expense) (601) 48 226 Equity in the operating earnings of subsidiaries, net of income taxes 5,238 2,231 5,421 ------- ----- ----- Net income $ 6,404 2,139 4,981 ======= ===== =====
See notes to consolidated financial statements. See accompanying report of independent auditors. FS-5 SCHEDULE II -- Continued INTERCARGO CORPORATION CONDENSED STATEMENTS OF CASH FLOW (Registrant only) (in thousands)
December 31, -------------------------------------- 1996 1995 1994 -------------------------------------- Cash flows from operating activities: Net income $ 6,404 2,139 4,981 Adjustments to reconcile net income to net cash provided from operating activities: Realized gains (2,394) (241) -- Equity in operating earnings of subsidiaries, net of income tax (5,238) (2,231) (5,421) Depreciation and amortization -- 2 219 Change in income tax accounts 682 (11) (173) (Increase) decrease in notes receivable Affiliates -- 1,850 (1,505) Non-affiliates 101 251 382 Increase (decrease) in accrued expenses and other liabilities 49 (62) 154 Other, net 197 (806) (1,356) ------- ------ ------ Net cash provided from (used in) operating activities (199) 891 (2,719) ------- ------ ------ Cash flows from investing activities: Long-term fixed maturities: Purchases -- -- -- Sales -- -- 796 Equity securities: Sales -- -- 347 Net (purchases) sales of short-term maturities -- -- 2,993 Dividends received from subsidiary -- 250 -- Contribution of capital to subsidiary (3,000) (5,000) (3,600) Sale of Kingsway common stock 4,573 4,107 -- (Purchase) Sale of equipment, net (38) 367 (458) ------- ------ ------ Net cash provided from (used in) investing activities 1,535 (276) 78 ------- ------ ------ Cash flows from (used in) financing activities: Proceeds from exercise of stock options 95 -- 50 Dividends paid to stockholders (1,376) (1,375) (1,375) Proceeds from loans -- 1,410 325 ------- ------ ------ Net cash provided from (used in) financing activities (1,281) 35 (1,000) ------- ------ ------ Net increase(decrease) in cash and cash equivalents 55 650 (3,641) Cash and cash equivalents: Beginning of the period 1,180 530 4,171 ------- ------ ------ End of the period $ 1,235 1,180 530 ======= ====== ======
See notes to consolidated financial statements. See accompanying report of independent auditors. FS-6 SCHEDULE IV INTERCARGO CORPORATION AND SUBSIDIARIES REINSURANCE (dollars in thousands)
Column A Column B Column C Column D Column E Column F - ------------------------------------------------------------------------------ Percentage Ceded to Assumed of amount Gross other from other Net assumed to amount companies companies amount net - ------------------------------------------------------------------------------ Property and liability premiums Year ended: December 31, 1996 $68,206 10,163 3,010 61,053 4.93% December 31, 1995 $98,460 13,594 1,288 86,154 1.49% December 31, 1994 $86,216 11,565 146 74,797 .20%
See accompanying report of independent auditors. FS-7 SCHEDULE VI INTERCARGO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL INFORMATION (dollars in thousands)
Column A Column B Column C Column D Column E Column F Column G Column H - -------------------------------------------------------------------------------------------------------------------------- Claims and Claim Reserves for Adjustment Expenses Deferred Unpaid Claims Discount, Incurred Related to Policy and Claim if any, Net (1) (2) Affiliation with Acquisition Adjustment Deducted in Unearned Earned Investment Current Prior Registrant Costs Expenses Column C Premiums Premiums Income Year Year - -------------------------------------------------------------------------------------------------------------------------- Consolidated property- casualty entities Year ended: December 31, 1996 $3,884 47,037 -- 17,617 61,053 6,364 31,877 431 December 31, 1995 4,898 36,293 -- 17,691 86,154 6,273 45,642 6,104 December 31, 1994 6,602 38,836 -- 31,586 74,797 4,378 39,462 2,137
Column A Column I Column J Column K - ---------------------------------------------------------- Amortization Paid Claims of Deferred and Claim Affiliation with Policy Acq. Adjustment Premiums Registrant Costs Expenses Written - ---------------------------------------------------------- Consolidated property- casualty entities Year ended: December 31, 1996 $17,410 28,406 58,453 December 31, 1995 22,829 37,696 90,804 December 31, 1994 18,511 32,882 80,737
See accompanying report of independent auditors. FS-8 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 31, 1997 INTERCARGO CORPORATION By: /s/ James R. Zuhlke ------------------------------ James R. Zuhlke, President and Chief Executive Officer FS-9 SIGNATURE DATE - --------------------------------------- -------------- /s/ James R. Zuhlke March 31, 1997 - --------------------------------------- James R. Zuhlke Chairman of the Board; President, Chief Executive Officer and a Director (Principal Executive Officer) /s/ Michael L. Sklar March 31, 1997 - --------------------------------------- Michael L. Sklar Director /s/ Arthur J. Fritz, Jr. March 31, 1997 - --------------------------------------- Arthur J. Fritz, Jr. Director /s/ Arthur L. Litman March 31, 1997 - --------------------------------------- Arthur L. Litman Director /s/ Kenneth A. Bodenstein March 31, 1997 - --------------------------------------- Kenneth A. Bodenstein Director /s/ Albert J. Gallegos March 31, 1997 - --------------------------------------- Albert J. Gallegos Director /s/ Robert B. Sanborn March 31, 1997 - --------------------------------------- Robert B. Sanborn Director /s/ Michael L. Rybak March 31, 1997 - --------------------------------------- Michael L. Rybak Chief Financial Officer, Vice President (Principal Financial and Accounting Officer) FS-10 EXHIBIT INDEX Description ----------- Exhibit Number - ------ 3.1 Certificate of Incorporation of the Company, including amendments thereto.(1) 3.2 Bylaws of the Company, including amendments thereto.(1) 4 Specimen Certificate of Common Stock.(2) 10.1 Form of Company's 1987 Non-Qualified and Incentive Stock Option Plan.(1) *10.2 Executive Incentive Compensation Plan.(3) 10.3 Secured Loan Agreement between the Company and LaSalle National Bank dated June 4, 1993(4). 10.4 First Amendment dated January 1, 1995, to Secured Loan Agreement between the Company and LaSalle National Bank dated June 4, 1993.(5) 10.5 Revolving Note dated June 4, 1993, executed by the Company in favor of LaSalle National Bank.(4) *10.6 Indemnification Agreements between the Company and the following directors: Kenneth A. Bodenstein, Arthur L. Litman, Arthur J. Fritz, Jr., Albert J. Gallegos and James R. Zuhlke.(3) *10.7 Supplemental Life Insurance Policy for James R. Zuhlke.(3) *10.8 Employment Agreement dated August 25, 1993, between the Company and Robert S. Kielbas. (4) *10.9 Employment Agreement dated August 12, 1996 between the Company and Michael L. Rybak. (filed herewith) *10.10 Supplemental Life Insurance Policy for Robert S. Kielbas.(5) *10.11 Indemnification Agreement dated February 18, 1994 between the Company and Robert B. Sanborn.(5) *10.12 Indemnification Agreement dated August 12, 1996 between the Company and Michael L. Rybak. (filed herewith) 10.13 Second Amendment dated June 4, 1995, to Secured Loan Agreement between the Company and LaSalle National Bank dated June 4, 1993. (filed herewith) 10.14 Third Amendment dated March 31, 1996, to Secured loan Agreement between the Company and LaSalle National Bank dated June 4, 1993. (filed herewith) 11 Statement regarding Computation of Per Share Earnings. (filed herewith) 12 Statement regarding Computation of Ratios. (filed herewith) 13 Portions 1996 Annual Report to Stockholders incorporated by reference. (filed herewith) 21 Subsidiaries of the Company. (filed herewith) 23 Consent of Independent Auditors. (filed herewith) 27 Financial Data Schedule. (filed herewith) 28 Information from reports furnished to State Insurance regulatory authorities (filed separately in paper format). The Company's Canadian subsidiaries are not required to file Schedules O and P with the Ontario Insurance Commissioner. Accordingly, no such schedules have been filed herewith. ___________________ (1) Filed with the Company's Registration Statement on Form S-18, Registration No. 33-21270C and incorporated herein by reference. (2) Filed with Amendment No. 1 to the Company's Registration Statement on Form S-18, Registration No. 33-21270C and incorporated herein by reference. (3) Filed with the Company's Registration Statement on Form S-2, Registration No. 33-45658 and incorporated herein by reference. (4) Filed with the Company's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. (5) Filed with the Company's Form 10-K for the year ended December 31, 1994, and incorporated herein by reference. * Management contract or compensatory plan required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K. FS-11 KINGSWAY FINANCIAL SERVICES INC. AUDITORS' REPORT To the Shareholders of Kingsway Financial Services Inc. We have audited the consolidated balance sheets of Kingsway Financial Services Inc. as at December 31, 1996 and December 31, 1995 and the consolidated statements of operations and retained earnings and changes in financial position for the years then ended. 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 an audit to obtain reasonable assurance 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. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 1996 and December 31, 1995 and the results of its operations and the changes in its financial position for the years then ended in accordance with generally accepted accounting principles. KPMG Chartered Accountants Toronto, Canada February 19, 1997 FS-12 KINGSWAY FINANCIAL SERVICES INC. APPOINTED ACTUARY'S REPORT To the Shareholders of Kingsway Financial Services Inc. I have valued the policy liabilities in Kingsway Financial Services Inc.'s consolidated balance sheets as at December 31, 1996 and December 31, 1995 and the changes in policy liabilities reflected in its statements of operations for each of the years then ended in accordance with accepted actuarial practice. In my opinion, the valuations are appropriate and the consolidated financial statements fairly present their results. Claudette Cantin, F.C.A.S., F.C.I.A. Tillinghast - Towers Perrin February 19, 1997 FS-13 CONSOLIDATED BALANCE SHEETS
As at December 31 (In thousands of dollars) 1996 1995 ---- ---- ASSETS Cash $ 4,165 $ 1,363 Investments (note 3) 152,189 59,924 Accrued investment income 1,473 583 Financed premiums receivable 30,182 12,914 Accounts receivable 12,580 5,587 Due from reinsurers (notes 6 and 9) 27,154 6,967 Deferred policy acquisition costs 13,060 5,210 Deferred income taxes 1,668 691 Capital assets (note 4) 5,662 2,173 Goodwill 140 189 ----------------------- $ 248,233 $ 95,601 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accounts payable and accrued liabilities $ 4,096 $ 1,350 Income taxes payable 1,779 55 Unearned premiums (note 6) 64,064 27,463 Unpaid claims (notes 6 and 9) 90,656 29,486 Deferred service charges 1,004 570 ----------------------- 161,599 58,924 Shareholders' equity: Share capital (note 5) 59,037 21,889 Share warrant (note I 1) 1,647 - Retained earnings (note 10) 25,950 14,788 ----------------------- 86,634 36,677 ----------------------- $ 248,233 $ 95,601
See accompanying notes to consolidated financial statements. F-14 CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
Years ended December 31 ($ in thousands, except per share amounts) 1996 1995 - ------------------------------------------------------------------------ Gross premiums written $ 140,610 $ 60,049 ---------------------- Net premiums written $ 134,121 $ 50,440 ---------------------- Revenue: Net premiums earned (note 6) $ 107,679 $ 46,063 Investment income 9,181 3,615 Premium finance income 1,868 1,298 ---------------------- 118,728 50,976 Expenses: Claims incurred (notes 6 and 9) 69,889 30,638 Commissions and premium taxes (note 6) 21,523 7,882 General and administrative expenses 11,560 5,983 ---------------------- 102,972 44,503 Income before income taxes 15,756 6,473 Income taxes (note 8): Current 5,095 3,034 Deferred (501) (328) ---------------------- 4,594 2,706 Net income 11,162 3,767 Retained earnings, beginning of year 14,788 11,021 Retained earnings, end, of year $ 25,950 $ 14,788 ---------------------- Earnings per share (note 5): Basic $ 1.04 $ 0.61 Fully diluted $ 1.00 $ 0.61 - ------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. F-15 CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
Years ended December 31 ($ in thousands) 1996 1995 - -------------------------------------------------------------------------------- Cash provided by (used in): Operating activities: Net income $ 11,162 $ 3,767 Items not involving cash: Amortization 465 244 Deferred income taxes (977) (328) Gain on sale of capital assets (162) - Net realized gain on sale of investments (2,616) (255) Amortization of bond premiums and discounts (1,029) (2,190) ---------------------- 6,843 1,238 Change in non-cash balances: Accrued investment income (419) 72 Accounts receivable 6,346 120 Financed premiums receivable (17,268) (1,703) Deferred policy acquisition costs (4,500) (1,125) Due to brokers - (187) Income taxes payable 1,725 (91) Accounts payable and accrued liabilities 1,560 697 Due from reinsurers 6,633 (1,089) Unearned premiums 18,857 5,024 Unpaid claims 24,882 8,100 Deferred service charges 433 (67) ---------------------- 45,092 10,989 Financing activities: Issuance of share capital, net 37,148 16,253 Share warrant (note 11) 1,647 - Note payable to Intercargo - (2,500) Decrease in bank demand loan (1,480) - ---------------------- 37,315 13,753 Investing activities: Purchase of investments (241,406) (144,061) Proceeds from sale of investments 169,675 117,924 Purchase of subsidiary (note I 1) (4,343) - Additions to capital assets (4,366) (809) Proceeds on sale of capital assets 835 - ---------------------- (79,605) (26,946) Increase (decrease) in cash during the year 2,802 (2,204) Cash, beginning of year 1,363 3,567 ---------------------- Cash, end of year $ 4,165 $ 1,363
See accompanying notes to consolidated financial statements FS-16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All tabular figures are in $ thousands unless indicated other. Kingsway Financial Services Inc. (the "Company") was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. On November 10, 1995, the Company filed articles of amendment deleting its "private company" share restrictions. On December 18, 1995, the Company completed an Initial Public Offering and its shares were listed on The Toronto Stock Exchange. Prior to the Company issuing shares to the public, it was a wholly owned subsidiary of Intercargo Corporation ("Intercargo"), a company listed on Nasdaq in the United States. Intercargo owned approximately 3 1 % and 50% of the Company's shares at December 31, 1996 and 1995 respectively. 1. SIGNIFICANT ACCOUNTING POLICIES These consolidated financial statements are prepared in accordance with accounting principles generally accepted in Canada and include the accounts of the Company and its wholly owned subsidiaries, Kingsway General Insurance Company ("Kingsway General") and York Fire & Casualty Insurance Company ("York"). The Company through its subsidiaries writes all classes of insurance, other than life. Kingsway General is licensed in all provinces and territories in Canada, and York is licensed in Ontario only. (a) INVESTMENTS: Fixed term investments are carried at amortized cost. Investments in common or preferred shares are carried at cost. Gains and losses on disposal of investments are determined and recorded as at the settlement date, and are calculated on the basis of average cost. (b) CAPITAL ASSETS: Capital assets are carried at cost less accumulated amortization. Amortization is provided on a declining balance basis at the following annual rates: Asset - --------------------------------------- Buildings 5% Computers and office equipment 30% Automobiles 30% Furniture 20% - --------------------------------------- FS-17 (c) GOODWILL: Goodwill arising on the purchase of the subsidiary company is recorded at cost less accumulated amortization. Goodwill is amortized on a straight-fine basis over ten years. (d) DEFERRED POLICY ACQUISITION COSTS: Deferred policy acquisition costs represent certain costs such as commissions and premium taxes related to the acquisition of new and renewal premiums written during the period and are expensed as the related premiums are recorded as income. The method followed in determining the deferred policy acquisition costs limits the deferral to its realizable value by giving consideration to losses and expenses expected to be incurred as premiums are earned. (e) PREMIUM REVENUE AND UNEARNED PREMIUMS: The Company earns premium revenue evenly over the period covered by each individual insurance contract. Unearned premiums represent the portion of premiums written related to the unexpired portion of the policy at the year end. The reinsurer's share of unearned premiums is recognized as amounts recoverable using principles consistent with the Company's method for determining the unearned premium liability. (f) UNPAID CLAIMS: The provision for unpaid claims includes adjustment expenses and represents an estimate for the full amount of all expected costs, including investigation, and the projected final settlements of claims incurred on or before the balance sheet date. The provision does not take into consideration the time value of money or make an explicit provision for adverse deviation except for statutory automobile accident benefits claims which are discounted in accordance with accepted actuarial practice as permitted by the Superintendent of Insurance (Ontario). Expected reinsurance recoveries on unpaid claims are recognized as amounts recoverable at the same time using principles consistent with the Company's method for establishing the related liability. These estimates of future loss activity are necessarily subject to uncertainty and are selected from a wide range of possible outcomes. All provisions are periodically reviewed and evaluated in the light of emerging claim experience and changing circumstances. The resulting changes in estimates of the ultimate liability are recorded as incurred claims in the accounting period in which they are determined. (g) REINSURANCE: Net premiums earned and claims incurred a-re recorded net of amounts ceded to, and recoverable from, reinsurers. Estimates of amounts recoverable from reinsurers on unpaid claims are recorded separately from estimated amounts payable to policyholders. Unearned premiums and deferred policy acquisition costs are also reported before reduction for business ceded to reinsurers and the reinsurer's portion is classified with amounts due from reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the policy liabilities associated with the reinsured policy. FS-18 (h) INCOME TAXES: Income taxes are accounted for using the deferral method of tax allocation. Under this method, a provision for deferred income taxes arises as a result of timing differences between income reported for financial statement purposes and that reported for income tax purposes. The major differences relate to unpaid claims and adjustment expenses, unearned premiums, investments in shares and amortization of capital assets. The deferred income taxes balance is not adjusted to reflect changes in income tax rates. 2. ROLE OF THE ACTUARY AND EXTERNAL AUDITOR ROLE OF THE ACTUARY The actuary is appointed by the board of directors of the Company. With respect to the preparation of the audited financial statements, the actuary is required to carry out a valuation of the policy liabilities and to report thereon to the Company's shareholders. The valuation is carried out in accordance with accepted actuarial practice and regulatory requirements. The scope of the valuation encompasses the policy liabilities as well as any other matter specified in any direction that may be made by the Superintendent of Insurance (Ontario). The policy liabilities consist of a provision for unpaid claims and adjustment expenses on the expired portion of policies and of future obligations on the unexpired portion of policies. In performing the valuation of these policy liabilities, which are by their very nature inherently variable, assumptions are made as to future loss ratios, trends, reinsurance recoveries, external claims expenses and other contingencies, taking into consideration the circumstances of the Company and the nature of the insurance policies. The valuation is based on projections of future development relating to claims and claims adjustment expenses. It is certain that actual claims and claims adjustment expenses will not develop exactly as projected and may, in fact, vary significantly from the projections. Further, the projections make no provision for new classes of claims or claims categories not sufficiently recognized in the claims database. The actuary relies on data and related information prepared by the Company and makes use of the work of the auditor with respect to the actuary's responsibility for the data as set forth by the standards of the Canadian Institute of Actuaries. The actuary's report outlines the scope of her valuation and opinion. ROLE OF THE AUDITOR The external auditors have been appointed by the shareholders, pursuant to the Insurance Act, Ontario. Their responsibility is to conduct an independent and objective audit of the consolidated financial statements in accordance with generally accepted auditing standards and to report thereon to the shareholders. In carrying out their audit, the auditors make use of the work of the actuary and her report on the policy liabilities of the Company. The auditors' report outlines the scope of their audit and their opinion. 3. INVESTMENTS The principal amounts, carrying amounts and fair values of investments are summarized below: FS-19
December 31, 1996 Principal Carrying Fair Term to maturity amount amount value - --------------------------------------------------------------------------- BONDS AND DEBENTURES GOVERNMENT OF CANADA: Due in one year or less $ 19,240 $ 19,220 $ 19,389 After one through five years 27,515 27,378 28,246 After five years 6,827 6,519 7,061 CANADIAN MUNICIPAL AND PUBLIC AUTHORITIES: After one through five years 100 104 104 CANADIAN CORPORATE: Due in one year or less 5,629 5,643 5,647 After one through five years 6,661 7,088 7,227 After five years 6,177 6,248 6,428 OTHER INVESTMENTS DUE IN ONE YEAR OR LESS: Bankers' acceptances 500 492 495 Treasury bills 57,100 56,858 56,928 - --------------------------------------------------------------------------- Sub-total 129,749 129,550 131,525 Preferred shares 13,767 14,378 Common shares 8,872 9,571 - --------------------------------------------------------------------------- $152,189 $155,474 - ---------------------------------------------------------------------------
FS-20
December 31, 1996 Principal Carrying Fair Term to maturity amount amount value - --------------------------------------------------------------------------- BONDS AND DEBENTURES Government of Canada: Due in one year or less $ 6,209 $ 6,034 $ 6,069 After one through five years 5,158 5,228 5,262 After five years 11,560 13,053 13,428 Canadian municipal and public authorities: Due in one year or less 441 445 445 After one through five years 1,000 932 942 Canadian corporate: Due in one year or less 1,000 992 1,015 After one through five years 1,300 1,292 1,328 Other investments due in one year or less: Guaranteed Investment Certificates 540 540 543 Bankers' acceptances 27,503 27,419 27,355 - --------------------------------------------------------------------------- Sub-total 54,711 55,935 56,387 Preferred shares 1,839 1,852 Common shares 2,150 2,199 - --------------------------------------------------------------------------- $ 59,924 $ 60,438 - ---------------------------------------------------------------------------
The principal amounts and carrying amounts are known by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. Fair values are considered to approximate quoted market values based on the latest bid prices. All of the Company's fixed term investments have fixed interest rates. As the fair value and carrying amounts are not materially different, the effective rates of interest are not materially different from the coupon rates. The coupon rates for the Company's fixed term investments range from 3.5% to 10.9% at December 31, 1996 and from 4.8% to 14.0% at December 31, 1995. The Company limits its investment concentration in any one investee or related group of investees to less than 5% of the Company's investments. FS-21 4. CAPITAL ASSETS
December 31, 1996 Accumulated Net book Cost amortization value - -------------------------------------------------------------------- Land $ 1,142 $ - $ 1,142 Buildings 3,605 262 3,343 Computers and office equipment 962 388 574 Automobiles 367 124 243 Furniture 592 272 320 - -------------------------------------------------------------------- $ 6,668 $ 1,046 $ 5,622 - --------------------------------------------------------------------
December 31, 1995 Accumulated Net book Cost amortization value - -------------------------------------------------------------------- Land $ 413 $ - $ 413 Buildings 1,409 160 1,249 Computers and office equipment 525 247 278 Automobiles 272 145 127 Furniture 194 88 106 - -------------------------------------------------------------------- $ 2,813 $ 640 $ 2,173 - --------------------------------------------------------------------
5. SHARE CAPITAL Share capital consists of the following after giving retroactive effect to the subdivisions of the Company's shares as noted below:
December 31, 1996 1995 - ------------------------------------------------------------- Authorized: Unlimited number of common shares Issued: 13,271,866 (1995-9,633,000) common shares $ 59,037 $ 21,889 - -------------------------------------------------------------
(a) On November 10,.1995, the Company filed articles of amendment deleting its "private company" share restrictions, subdividing the Company's the Company's outstanding common shares on a 3-for-1 basis, and on October 10, 1996 the shareholders approved a resolution to subdivide the company's common stock on a 2-for-1 basis. The number of shares outstanding and earnings per share amounts reflect these subdivisions on a retroactive basis. FS-22 (b) On December 6, 1995, 33,000 common shares were issued to certain employees of the Company for nominal consideration. (c) Pursuant to an underwriting agreement dated December 8, 1995, the Company sold 3,600,000 common shares for gross proceeds of $18,000,000. Underwriters' fees and expenses of the issue amounting to $1,747,000 have been deducted from the Company's share capital. (d) On January 15, 1996, pursuant to the underwriting agreement, the underwriters exercised their over-allotment option to acquire an additional 360,000 common shares from the Company for gross proceeds of $1,800,000. Underwriters' fees and expenses of the issue amounting to $112,000 have been deducted from the Company's share capital. (e) On February 29, 1996 pursuant to the agreement to purchase York, as described in note 11, the Company issued 128,200 common shares for consideration of $641,000. (f) Pursuant to an underwriting agreement dated October 8, 1996, the Company sold 3,150,000 common shares at $11.75 per share for gross proceeds of $37,013,000. The Company's share of underwriters' fees and expenses of the issue amounting to $2,194,000 was deducted from share capital. (g) The Company has established a stock option incentive plan for directors, officers and key employees of the Company. The maximum number of common shares that may be issued under the plan is 600,000 common shares. The maximum number of common shares available for issuance to any one person under the stock option plan is 5% of the common shares outstanding at the time of the grant. The exercise price is based on the market value of the shares at the time the option is granted. At December 31, 1996 and December 31, 1995 options to purchase 258,334 and 129,000 common shares respectively, were outstanding. The exercise price of the options ranges from $5 to $8 per share and the options expire in the period from December 5, 2000 to July 18, 2001. During 1996, options to acquire 666 shares were exercised at $5 per share. (h) The weighted average number of shares outstanding for 1996 and 1995 were 10,724,000 and 6,130,480, respectively. On a fully diluted basis, the weighted average number of shares outstanding for 1996 and 1995 were 11,200,200 and 6,130,480, respectively. The number of shares outstanding and earnings per share amounts have been retroactively restated to reflect the sub-divisions described in paragraph (a) above. FS-23 6. UNDERWRITING POLICY AND REINSURANCE CEDED In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophe or other events that cause unfavorable under-writing results by reinsuring certain levels of risk, in various areas of exposure, with other insurers. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvency. The amounts due from reinsurers substantially relate to a single reinsurers The Company follows the policy of underwriting and reinsuring contracts of insurance, which limits the net exposure of the Company to a maximum amount on any one loss of $200,000 in the years ended December 31, 1996 and 1995, in the event of a property or liability claim. In addition, the Company has obtained catastrophe reinsurance which provides coverage in the event of a series of claims arising out of a single occurrence to a maximum of 95% of $4,000,000 (U.S. dollars). The amounts deducted from net earned premiums, claims incurred and commissions and premium taxes for the years December 31, 1996 and 1995 were as follows:
1996 1995 - ----------------------------------------------------- Net earned premiums $ 11,894 $ 8,961 Claims incurred 12,829 3,596 Commissions and premium taxes 1,319 3,010 - -----------------------------------------------------
7. RELATED PARTY TRANSACTIONS In the normal course of business, the Company enters into reinsurance transactions with Intercargo which were as follows:
December 31, 1996 1995 - ----------------------------------------------------- Premiums ceded $ 2,193 $ 1,747 Claims incurred 1,623 823 Commission and premium taxes 613 524 - -----------------------------------------------------
The note payable to Intercargo was repaid on December 15, 1995. Interest paid during the year ended December 31, 1995 was $227,000. FS-24 8. INCOME TAXES The Company's provision for income taxes, compared to combined federal and provincial statutory rates, is summarized as follows:
1996 1995 - ---------------------------------------------------------------- Income before taxation $ 15,756 $ 6,473 - ---------------------------------------------------------------- Statutory tax rate 44.5% 44.5% - ---------------------------------------------------------------- Provision based on statutory rate 7,011 2,880 - ---------------------------------------------------------------- Non-taxable investment income (248) (40) Utilization of prior year tax losses (1,796) - Other (373) (134) - ---------------------------------------------------------------- $ 4,594 $ 2,706 - ----------------------------------------------------------------
At December 31, 1996, the deferred tax effect of unclaimed tax reserves of a subsidiary company amounting to approximately $10,000,000 (1995 - $Nil) have not been recognized in these financial statements. These deductions are available to reduce the amount of income taxes payable by the subsidiary in the future. 9. UNPAID CLAIMS (a) Nature of unpaid claims and adjustment expenses: The establishment of the provision for unpaid claims and adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company's experience with similar cases and historical trends involving claim payment patterns, loss payments, pending levels of unpaid claims, product mix or concentration, claims severity and claim frequency patterns. Other factors include the continually evolving and changing regulatory and legal environment, actuarial studies, professional experience and expertise of the Company's claim departments' personnel and independent adjusters retained to handle individual claims, the quality of the data used for projection purposes, existing claims management practices including claims handling and settlement practices, the effect of inflationary trends on future claims settlement costs, court decisions, economic conditions and public attitudes. In addition, time can be a critical part of the provision determination, since the longer the span between the incidence of a loss and the payment or settlement of the claims, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims such as property claims, tend to be more reasonably predictable than long-tailed claims, such as general liability and automobile accident benefit claims. FS-25 Consequently, the process of establishing the provision for unpaid claims relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the estimated provisions necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made. (b) Provision for unpaid claims and adjustment expenses: The provision for unpaid claims and adjustment expenses does not take into account the time value of money or make explicit provision for adverse deviation except for accident benefit claims under automobile insurance policies. The provision for unpaid claims recorded in the Company's balance sheet approximates the undiscounted amount of those liabilities. The Company has a concentration of business in automobile and property insurance in the provinces of Ontario and Alberta. For the year ended December 31, 1996 and the year ended December 31, 1995, automobile premiums represented approximately 68% and 63% respectively, and property premiums 23% and 28% respectively, of gross premiums written. Of gross premiums written in 1996, Ontario accounted for 69% (1995 - 60%) and Alberta 17% (1995 - 23%). The Company's appointed actuary completes an annual evaluation of the adequacy of policy liabilities at the end of each financial year. This evaluation includes a re-estimation of the liability for unpaid claims relating to each preceding financial year compared to the liability that was originally established. The results of this comparison and the changes in the provision for unpaid claims for the years ended December 31, 1996 and 1995 were as follows:
December 31 1996 1995 - -------------------------------------------------------------------- Unpaid claims - Beginning of year - net $ 24,322 $ 16,988 Deficiency in estimated unpaid claims, for claims occurring in prior years 3,383 5,789 Net unpaid claims of York at acquisition 18,889 - Provision for claims occurring in the current year 66,506 24,848 Claims paid during the year (47,958) (23,303) - -------------------------------------------------------------------- Unpaid Claims - End of year - net 65,142 24,322 Reinsurers' share of unpaid claims 25,514 5,164 - -------------------------------------------------------------------- Provision for unpaid claims - end of year $ 90,656 $ 29,486 - --------------------------------------------------------------------
FS-26 The deficiencies in 1995 and 1996 relating to prior year claims result from unfavorable trends in severity (average cost per claim) on automobile claims. This is largely due to higher than anticipated losses and medical cost inflation for personal automobile injury under Bill 164 bodily injury claims and accident benefits in Ontario for accident years 1993 and 1994 and increases in the Company's share of unpaid claims reported by the insurance industry's risk sharing pools. The Company believes that its overall practices have been consistently applied over many years, and that its provisions for unpaid claims have resulted in reasonable approximations of the ultimate costs of claims incurred. (c) The fair value of unpaid claims and adjustment expenses, gross and recoverable from reinsurers, has been omitted because it is not practicable to determine fair value with sufficient reliability. 10. STATUTORY REQUIREMENTS INSURANCE SUBSIDIARIES The regulations of the Ontario Ministry of Financial Institutions require that the insurance subsidiaries of the Company appropriate part of their retained earnings for assets that are non-admitted for regulatory purposes. The amounts appropriated amounted to $3,110,000 and $1,466,000 at December 31, 1996 and 1995, respectively. The regulations also govern the payments of dividends from insurance subsidiaries to the Company. 11. ACQUISITION OF YORK On January 17, 1996, the Company entered into an agreement to purchase all of the issued shares of York from Highbourne Capital Corporation, now named A & E Capital Funding Inc. ("A & E"). The transaction closed on February 29, 1996. The transaction has been accounted for by the purchase method with the results of operations included in these financial statements from the date of acquisition. Details of the acquisition are as follows: FS-27 Net assets acquired at assigned values at date of acquisition:
- ---------------------------------------------------------- ASSETS: Investments $17,051 Premiums receivable 8,875 Due from reinsurers 30,413 Accounts receivable 5,047 Other assets 4,225 - ---------------------------------------------------------- 65,611 LIABILITIES: Unpaid claims 35,423 Unearned premiums 17,743 Bank overdraft 1,480 Other liabilities 4,889 - ---------------------------------------------------------- 59,535 - ---------------------------------------------------------- $ 6,076 CONSIDERATION GIVEN: Cash $ 1,500 Issuance of common shares 641 Share warrant 3,935 - ---------------------------------------------------------- $ 6,076 - ----------------------------------------------------------
The purchase price, which is expected to be approximately $ 3,788,000, is based on the adjusted Regulatory Capital of York as at December 31, 1995. The policy liabilities (unpaid claims, unearned premiums, deferred acquisition costs and premium deficiencies) at December 31, 1995 are regularly re-evaluated based on the changes in amounts of claims paid and estimated liabilities to be paid. For the period from the date of acquisition of York to December 31, 1996 the re-evaluation of the policy liabilities resulted in a decrease in the estimated purchase price of $2,288,000 to $3,788,000. Accordingly the value ascribed to the liability under the share warrant has been reduced to $1,647,000. Under the purchase agreement the final re-evaluation will be made as of December 31, 1997. At closing, the Company paid $1,500,000, and issued 128,200 common shares valued at $5 per share (after giving effect to the 2-for-1 share subdivision described in note 5(a) for an aggregate value equal to one-third of the purchase price. A & E also received a warrant which entitles it to receive as of February 28, 1997, (and for 30 days thereafter), 164,700 common shares valued at $5 per share having an aggregate value equal to $823,500 being one-half of the difference between the adjusted purchase price (evaluated as at December 31, 1996) and the amounts paid at closing. FS-28 The warrant further allows A & E to receive as of February 28, 1998, and for 30 days thereafter, that number of common shares valued at $ 5 per share equal to the remaining balance of the adjusted purchase price evaluated as at December 31, 1997. The maximum number of common shares which may be issued pursuant to the warrant is 900,000 shares. Should the balance due to A & E at February 28, 1998 exceed the value ascribed to the maximum number of shares which may be issued under the warrant, the balance will be paid to A & E in cash within 30 days of February 28, 1998, 12. COMMITMENTS AND CONTINGENT LIABILITIES On August 27, 1996, the Company entered into a $25 million operating credit facility with a Canadian bank. Upon draw down of this facility, the Company has an option to borrow at a floating rate equivalent to the bank's prime rate, or for a fixed term at a fixed rate of a banker's acceptance plus I%. The facility is unsecured. At December 31, 1996 there were no amounts outstanding under this facility. In connection with its operations, the Company and its subsidiaries are, from time to time, named as defendants in actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the outcome of the various proceedings at this time, such actions have generally been resolved with minimal damages or expense in excess of amounts provided and the Company does not believe that it will incur any significant additional loss or expense in connection with such actions. 13. FAIR VALUE DISCLOSURE The fair value of financial assets and liabilities, other than investments (note 3) and unpaid claims (note 9) approximate their carrying amounts. 14. FINANCIAL STATEMENT PRESENTATION These financial statements have been reclassified to reflect the retroactive application of new disclosure and presentation standards relating to financial instruments and measurement uncertainty. As a result, the amounts shown in the balance sheets relating to unpaid claims are shown on a gross basis with the net amount due from reinsurers shown as an asset. The amounts relating to unearned premiums and deferred policy acquisition costs have also been reclassified and are shown on a gross basis with the reinsurer's portion included with the net amount due from reinsurers on the balance sheets. FS-29 EX-10.9 2 EXHIBIT 10.9 EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT is made and entered into as of the 12th day August, 1996, by and between INTERCARGO CORPORATION, a Delaware corporation ("Intercargo"), and MICHAEL L. RYBAK, an individual residing in the State of Illinois ("Employee"). Other capitalized terms shall have the respective meanings set forth in Section 15 and elsewhere herein. WITNESSETH ---------- WHEREAS, Intercargo wishes to employ Employee under the terms and conditions as set forth herein; and WHEREAS, the Employee is willing to accept such employment on the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, it is hereby agreed as follows: 1. Employment. Intercargo hereby employs the Employee, and the Employee hereby accepts employment with Intercargo, on the terms and conditions set forth in this Agreement. 2. Employment Period. The term of Employee's employment shall be for a one year period and shall commence as of August 12, 1996 and shall continue on a month to month basis thereafter, unless this Agreement is terminated pursuant to Section 14 hereof. 3. Duties. Employee shall serve as the Chief Financial Officer of Intercargo and will, under the direction of Intercargo's Board of Directors and President, faithfully and to the best of his ability perform the duties of a Chief Financial Officer as assigned and revised by Intercargo's Board of Directors and President from time to time. The Employee agrees to devote his entire working time, energy and skills to such employment during the Employment Period, and shall not render any services of a business, commercial or professional nature to any person or organization other than Intercargo or be engaged in any other business activity, without the prior written consent of Intercargo's Board of Directors and/or the President. All duties to be rendered hereunder shall be performed at such place or places as the President and/or Board of Directors of Intercargo shall in good faith require. The Employee represents and warrants that he is not a party to or bound by any agreement or contract or subject to any restrictions, particularly, but without limitation, in connection with any previous employment, which prevents the Employee from entering into and performing his obligations under this Agreement. 4. Compensation. During the Employment Period, the Employee shall be compensated for his services as follows: 1 (a) Base Salary. The Employee shall receive an annual base salary for the calendar year 1996 in the amount of One Hundred Twenty Thousand and 00/100 Dollars ($120,000.00), payable in accordance with Intercargo's payroll schedule for all employees. If the Employment Period is extended as provided for in Section 2, this base salary will be increased, on a pro rata basis, beginning monthly at the beginning of each month commencing as of August 12, 1996. (b) Employee Benefits. The Employee shall be entitled to participate in all employee benefit plans maintained by the Company, including but not limited to, group hospitalization, medical and disability plans, if applicable. 5. Employee Expenses. During the Employment Period, and following the submission by Employee of the documentation necessary for deduction by Intercargo on its Federal and State income tax returns of reasonable or necessary expenditures incurred in the performance of Employee's duties hereunder and the prior approval of such expenses by the President, Employee shall be entitled to be reimbursed for such reasonable and necessary expenses, including, but not limited to, expenses for entertainment, travel, meals, hotel accommodations, professional seminars, and related use of the telephone. 6. Vacation. During the Employment Period, Employee shall be entitled to vacations with pay in accordance with Intercargo's regular vacation policies in effect from time to time. 7. No Competing Business. Employee hereby agrees that during the Employment Period and for a period of two (2) years following termination of the Employment Period, regardless of whether this Agreement is terminated for Cause, or as a result of the natural termination of the Employment Period, except as permitted by Section 10 of this Agreement, the Employee will not directly or indirectly own, manage, operate, control, invest or acquire an interest in, or otherwise engage or participate in (whether as a proprietor, partner, stockholder, director, officer, employee, joint venture, investor, sales representative or other participant in) any Competitive Business in Intercargo's Market, without regard to (a) whether the Competitive Business has its office or other business facilities within Intercargo's Market, (b) whether any of the activities of the Employee referred to above itself occurs or is performed within Intercargo's Market or (c) whether the Employee resides, or reports to an office, within Intercargo's Market. 2 8. No Interference with the Business. (a) Business Relationships. Employee hereby agrees that during the Employment Period, and for a period of two (2) years following the expiration of the Employment Period, except as permitted by Section 10 of this Agreement, Employee will not directly or indirectly solicit, induce or influence any sales representative, supplier, lender, lessor or any other person which has a business relationship with Intercargo, or which had on the date of this Agreement a business relationship with Intercargo, to discontinue, reduce the extent of, discourage the development of or otherwise harm such relationship with Intercargo. (b) Customers. Employee hereby agrees that during the Employment Period and during the remaining term as extended pursuant to any extension options of Intercargo of any contracts between Intercargo and any customers of Intercargo, to the extent such contracts extend beyond the Employment Period, that Employee will not directly or indirectly attempt to induce any such customers to terminate such contracts or otherwise divert from Intercargo any trade or business being conducted by such customers with Intercargo pursuant to such contracts; and, during the Employment Period and for two (2) years following the expiration thereof, Employee will not directly or indirectly solicit from, or otherwise agree to provide any services to any customer to which Intercargo has provided any services during the two years next preceding the termination of the Employment Period, or any party whose identity or potential as a customer was confidential or learned by the Employee during the Employment Period. (c) Employees. Employee hereby agrees that during the Employment Period and for a period of two (2) years following the expiration of the Employment Period, except as permitted by Section 10 of this Agreement, Employee will not (i) directly or indirectly recruit, solicit or otherwise induce or influence any employee or sales agent of Intercargo to discontinue such sales, employment or agency relationship with Intercargo, or (ii) employ, seek to employ or cause any Competitive Business to employ or seek to employ as a sales representative or employee for any Competitive Business in Intercargo's Market, any person who is then (or was at any time within six months prior to the date the Employee or the Competitive Business employs or seeks to employ such person) employed by Intercargo. 9. No Disclosure of Confidential Information. The Employee hereby agrees that he will not knowingly, directly or indirectly, disclose to anyone, or use or otherwise exploit for the Employee's own benefit or for the benefit of anyone other than Intercargo, any Confidential Information, except as permitted by Section 10 of this Agreement. 10. Permitted Activities. The restrictions set forth in Sections 7, 8 and 9 of this Agreement shall not apply to Permitted Activities or to actions taken by the Employee during the time the Employee may be employed by Intercargo to the extent, but only to the extent, that such actions are (i) necessary in connection with such employment, and (ii) expressly approved in writing by the Board of Directors. 11. Inventions and Other Intellectual Property. Employee hereby agrees that any design, invention or copyright materials made or created in the course of his employment shall be the property of Intercargo. Employee further agrees that at Intercargo's request and expense, he will execute any deeds or documents necessary to transfer any such design, invention, copyright or trademark materials to Intercargo and to cooperate with Intercargo or its nominee in perfecting Intercargo's title (or the title of Intercargo's nominee) in such materials. During the Employment Period, Employee shall keep Intercargo informed of the development of all 3 designs, inventions or copyright materials made, conceived or reduced to practice by Employee, in whole or in part, alone or with others, which either result from any work Employee may do for, or at the request of Intercargo, or are related to Intercargo's present or contemplated activities, investigations, or obligations. 12. Reduction of Restrictions by Court Action. If the length of time, type of activity, geographic area or other restrictions set forth in the restrictions of Sections 7, 8 or 9 are deemed unreasonable in any court proceeding, the parties hereto agree that the court may reduce such restrictions to ones it deems reasonable to protect the substantial investment of Intercargo in its business and the goodwill attached thereto. 13. Remedies. Employee understands that Intercargo will not have an adequate remedy at law for the material breach or threatened breach by Employee of any one or more of the covenants set forth in this Agreement and agrees that in the event of any such material breach or threatened breach, Intercargo may, in addition to the other remedies which may be available to it: (a) declare forfeited any monies otherwise payable to the Employee as of the date of such breach under the terms of Section 4 of this Agreement, and otherwise cease all payments and obligations under this Agreement; and/or (b) file a suit in equity to enjoin Employee from the breach or threatened breach of such covenants. 14. Termination. The Employment Period shall terminate upon the first to occur of: (a) the Employee's death, (b) the Disability of Employee, (c) the termination of the Agreement by the President of Intercargo for Cause, (d) after the first anniversary hereof upon 30 days notice. Termination of the Employment shall not relieve the Employee of his obligations under Sections 7, 8 and 9 hereof, notwithstanding that Employee's compensation and this Agreement shall otherwise terminate. In the event of the termination of Employee's employment with the Employer for the reasons outlined in Sections (a), (b) (c) or (d), the Employee shall receive from the Employer all accrued but unpaid compensation due under Section 4 herein. 15. Definitions. As used in this Agreement, terms defined in the preamble and recitals of this Agreement shall have the meanings set forth therein and the following terms shall have the meanings set forth below: "Board of Directors" shall mean the Board of Directors of Intercargo. "Cause" shall include, without limitation, (i) the inability of the Employee to perform his duties due to a legal impediment such as, without limitation, the entry against the Employee of an injunction, restraining order or other type of judicial judgment, decree or order which would prevent or hinder the Employee from performing his duties; (ii) a breach of any of the restrictions 4 or covenants set forth in Sections 7, 8, 9, 11 and 12 hereof; (iii) the failure to follow Intercargo's reasonable instructions with respect to the performance of the Employee's duties; (iv) failure to comply with the normal and customary methods of operation for Intercargo as reasonably determined by the President of Intercargo, (v) excessive absenteeism, flagrant neglect of work, serious misconduct, conviction of a felony, fraud, disclosure of any proprietary information of Intercargo without the consent of Intercargo, or aiding a competitor of Intercargo to the detriment of Intercargo. "Competitive Business" shall mean any person or entity engaged in a business similar to Intercargo's Line of Business. "Confidential Information" shall mean trade secrets, customer and supplier lists, marketing arrangements, business plans, projections, financial information, training manuals, pricing manuals, product and service development plans, market strategies, internal performance statistics and other competitively sensitive information belonging to and concerning Intercargo and which is material to Intercargo and not generally known by or available to the public, whether or not in written or tangible form, as the same may exist at any time during the Employment Period or during prior periods in which Employee was employed by Intercargo. "Control" shall mean, with respect to any person, the power to direct the management and policies of such person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise. "Disability" shall mean any illness, disability or incapacity of such a character as to render Employee unable to perform his duties hereunder (which determination shall be made by the Board of Directors) for a total period of ninety (90) days, whether or not such days are consecutive, during any consecutive twelve (12) month period. "Employment Period" shall mean that period of time set forth in Section 2 of this Agreement. "Intercargo's Line of Business" shall mean and include any products or services manufactured, developed or distributed at any time during the Employment Period by Intercargo. For purposes of this Agreement, such business shall be deemed to be conducted with any person, institution, association or entity to which sales or negotiations therefor (whether or not sales resulted) have been made, products delivered or services performed, or to or from which advertising, solicitation or other communications have been directed or received during the previous three years. "Intercargo's Market" shall mean those states or countries in which Intercargo is doing business at any time during the Employment Period. "Permitted Activities" shall mean (i) owning not more than 5% of the outstanding shares of any one or more publicly-held Competitive Business which has shares listed for trading on a securities exchange registered with the Securities and Exchange Commission or through the automated quotation system of a registered securities association, (ii) owning capital stock of Intercargo, and (iii) serving as an officer, director or employee of Intercargo. 5 16. Notices. All notices, demands or other communications required or provided hereunder shall be in writing and shall be deemed to have been given and received when delivered in person or transmitted by facsimile transmission (telecopy), cable, or telex to the respective parties, or seven (7) days after dispatch by registered or certified mail, postage prepaid, addressed to the parties at the addresses set forth below or at such other addresses as such parties may designate by notice to the other parties: If to Intercargo: Intercargo Corporation Attn: James R. Zuhlke 1450 East American Lane 20th Floor Schaumburg, IL 60173 with a copy to: Michael Sklar Rudnick & Wolfe 203 North LaSalle Street Suite 1800 Chicago, IL 60601-1293 If to Employee: Michael Rybak c/o Intercargo Corporation 1450 East American Lane 20th Floor Schaumburg, IL 60173 17. Assignment. Neither party to this Agreement may assign or delegate any of its rights or obligations hereunder without first obtaining the written consent of the other party. However, this Agreement shall be binding upon and inure to the benefit of any successor of Intercargo and any such successor shall be deemed substituted for Intercargo under the terms of this Agreement. As used in this Agreement, the term "successor" shall include any person, persons, firm, partnership, corporation, or company which at any time, whether by merger, purchase, or otherwise, acquires all or substantially all of the assets or business of Intercargo and assumes Intercargo's obligations hereunder. 18. Amendment and Modification. No amendment or modification of the terms of this Agreement shall be binding upon either party unless reduced to writing and signed by Employee and a duly appointed officer of Intercargo. 19. Governing Law. The provisions of this Agreement shall be construed in accordance with the internal laws and not the choice of laws provisions of the State of Illinois. 20. Counterparts. This Agreement may be executed in two or more counterparts, any one of which shall be deemed the original without reference to the others. 21. Severability. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions and portions of this Agreement shall be unaffected thereby and shall remain in full force and effect to the fullest extent permitted by law. 6 22. Waiver. The failure of either party to insist, in any one or more instances, upon performance of the terms or conditions of this Agreement shall not be construed as a waiver or relinquishment of any right granted hereunder or of the future performance of any such term, covenant or condition. 23. Headings. Headings of the paragraphs in this Agreement are for reference purposes only and shall not be deemed to have any substantive effect. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement as of the day and year first above written. ____________________________ Michael L. Rybak INTERCARGO CORPORATION By:__________________________ Its:__________________________ 7 RIDER TO EMPLOYEMENT AGREEMENT ------------------------------ THIS RIDER is made this 12th day of August, 1996 by and between Intercargo Corporation ("Employer") and Michael L. Rybak ("Employee"). RECITALS A. The Employer and Employee entered into an employment agreement dated August 12, 1996 relative to the Employee's employment at Intercargo Corporation. a) B. The Employer and Employee wish to amend the terms of the Employment Agreement pursuant to the terms of this Rider as follows: 1. It is agreed that Michael Rybak shall start with three weeks vacation and enter the vacation entitlement schedule as if he were a five year employee. All other terms of the Employment Agreement shall remain the same. Where the terms of this Rider conflict with the terms of the Employment Agreement, this Rider shall govern. ____________________________ Michael L. Rybak INTERCARGO CORPORATION By:__________________________ Its:__________________________ 8 EX-10.12 3 EXHIBIT 10.12 INDEMNIFICATION AGREEMENT This Agreement is made this 12th day of August, 1996, by and between Intercargo Corporation, a Delaware corporation and its subsidiaries (the "Company") and Michael Rybak, ("Officer"). WITNESSETH: WHEREAS, the Company has been advised that there can be no assurance that directors' and officers' liability insurance will continue to be available to the Company and Officer, and believes that it is possible that the cost of such insurance, if obtainable, may not be acceptable to the Company; and WHEREAS, Officer is unwilling to serve, or continue to serve, the Company as an Officer without assurances that adequate liability insurance, indemnification or a combination thereof is, and will continue to be, provided; and WHEREAS, the Company, in order to induce Officer to continue to serve the Company, has agreed to provide Officer with the benefits contemplated by this Agreement; and WHEREAS, as a result of the provision of such benefits, Officer has agreed to serve or to continue to serve as an Officer of the Company. NOW, THEREFORE, in consideration of the promises, conditions, representations and warranties set forth herein, including the Officer's continued service to the Company, the Company and Officer hereby agree as follows: 1. Definitions. The following terms, as used herein, shall have the following respective meanings: "Covered Amount" means losses and expenses which, in type or amount, are not insured under any directors' and officers' liability insurance maintained by the Company from time to time. 1 "Covered Act" means any breach of duty, neglect, error, misstatement, misleading statement, omission or other act done or wrongfully attempted by Officer or any of the foregoing alleged by any claimant or any claim against Officer solely by reason of him being an Officer of the Company. "Determination" means a determination, based on the facts known at the time, made by: i. A majority vote of a quorum of disinterested directors; or ii. Independent legal counsel in a written opinion prepared at the request of a majority of a quorum of disinterested directors; or iii. A majority of the disinterested stockholders of the Company; or iv. A final adjudication by a court of competent jurisdiction. "Determined" shall have a correlative meaning. "Excluded Claim" means any payment for Losses or Expenses in connection with any claim: i. Based upon or attributable to Officer gaining in fact any personal profit or advantage to which Officer is not entitled; or ii. For an accounting of profits in fact made from the purchase or sale by Officer of securities of the Company within the meaning of Section 16 of the Securities Exchange Act of 1934 as amended, or similar provisions of any state law; or iii. Resulting from Officer's knowingly fraudulent, dishonest or willful misconduct; or iv. The payment of which by the Company under this Agreement is not permitted by applicable law; or v. Which are not within the Covered Amount. "Expenses" means any reasonable expenses incurred by Officer as a result of a claim or claims made against him for Covered Acts including, without limitation, counsel fees and costs of investigative, judicial or administrative proceedings or appeals. "Loss" means any amount which Officer is legally obligated to pay as a result of a claim or claims made against him for Covered Acts including, without limitation, damages and judgments and sums paid in settlement of a claim or claims. 2. Indemnification. The Company shall indemnify Officer and hold him harmless from the Covered Amount of any and all Losses and Expenses subject, in each case, to the further provisions of this Agreement. 3. Excluded Coverage. a. The Company shall have no obligation to indemnify Officer for and hold him harmless from any Loss or Expense which has been Determined to constitute an Excluded Claim. b. The Company shall have no obligation to indemnify Officer and hold him harmless for any Loss or Expense to the extent that Officer is indemnified by the Company pursuant to the Company's bylaws or otherwise indemnified. 4. Indemnification Procedures. a. Promptly after receipt by Officer of notice of the commencement of or the threat of commencement of any action, suit or proceeding, Officer shall, if indemnification with respect thereto may be sought from the Company under this Agreement, notify the Company of the commencement thereof. 2 b. If, at the time of the receipt of such notice, the Company has directors' and officers' liability insurance in effect, the Company shall give prompt notice of the commencement of such action, suit or proceeding to the insurers in accordance with the procedures set forth in the respective policies in favor of Officer. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of Officer, all Losses and Expenses payable as a result of such action, suit or proceeding in accordance with the terms of such policies. c. To the extent the Company does not, at the time of the commencement of or the threat or commencement of such action, suit or proceeding, have applicable directors' and officers' liability insurance, or if a Determination is made that any Expenses arising out of such action, suit or proceeding will not be payable under the directors' and officers' liability insurance then in effect, the Company shall be obligated to pay the Expenses of any such action, suit or proceeding in advance of the final disposition thereof; and the Company, if appropriate, shall be entitled to assume the defense of such action, suit or proceeding with counsel satisfactory to Officer, upon the delivery to Officer of written notice of its election so to do. After delivery of such notice, the Company will not be liable to Officer under this Agreement for any legal or other Expenses subsequently insured by Officer in connection with such defense other than reasonable Expenses of investigation, provided that Officer shall have the right to employ its counsel in any such action, suit or proceeding, but the fees and expenses of such counsel incurred after delivery of notice from the Company of its assumption of such defense shall be at Officer's expense, provided further that if (i) the employment of counsel by Officer has been previously authorized by the Company, (ii) Officer shall have reasonably concluded that there may be a conflict of interest between the Company and Officer in the conduct of any such defense, or (iii) the Company shall not, in fact, have employed counsel to assume the defense of such action, the fees and expenses of counsel shall be at the expense of the Company. d. All payments on account of the Company's indemnification obligations under this Agreement shall be made within sixty (60) days of Officer's written request therefor unless a Determination is made that the claims giving rise to Officer's request are Excluded Claims or otherwise not payable under this Agreement, provided that all payments on account of the Company's obligations under Paragraph 4(c) of this Agreement prior to the final disposition of any action, suit or proceeding shall be made within twenty (20) days of Officer's written request therefor and such obligation shall not be subject to any such Determination but shall be subject to Paragraph 4(e) of this Agreement. e. Officer agrees that he will reimburse the Company for all Losses and Expenses paid by the Company in connection with any action, suit or proceeding against Officer in the event and only to the extent that a Determination shall have been made by a court in a final adjudication from which there is no further right of appeal that the Officer is not entitled to be indemnified by the Company for such Expenses because the claim is an Excluded Claim or because Officer is otherwise not entitled to payment under this Agreement. 5. Settlement. The Company shall have no obligation to indemnify Officer under this Agreement for any amounts paid in settlement of any action, suit or proceeding effected without the Company's prior written consent. The Company shall not settle any claim in any manner which would impose any obligation on Officer without Officer's written consent. Neither the Company nor Officer shall unreasonably withhold their consent to any proposed settlement. 6. Rights Not Exclusive. The rights provided hereunder shall not be deemed exclusive of any other rights to which the Officer may be entitled under any bylaw, agreement, vote of stockholders or of disinterested directors or otherwise, both as to action in his official capacity and as to action in any other capacity by holding such office, and shall continue after the Officer ceases to serve the Company as a Officer. 3 7. Enforcement. a. Officer's right to indemnification shall be enforceable by Officer notwithstanding any adverse Determination. In any such action, if a prior adverse Determination has been made, the burden of proving that indemnification is required under this Agreement shall be on Officer. The Company shall have the burden of proving that indemnification is not required under this Agreement if no prior adverse Determination shall have been made. b. In the event that any action is instituted by Officer under this Agreement, or to enforce or interpret any of the terms of this Agreement, Officer shall be entitled to be paid all court costs and expenses, including reasonable counsel fees, incurred by Officer with respect to such action, unless the court determines that each of the material assertions made by Officer as a basis for such action were not made in good faith or were frivolous. 8. Severability. In the event that any provision of this Agreement is determined by a court to require the Company to do or to fail to do any act which is in violation of applicable law, such provision shall be limited or modified in its application to the minimum extent necessary to avoid a violation of law, and, as so limited or modified, such provision and the balance of this Agreement shall be enforceable in accordance with their terms. 9. Choice of Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware. 10. Continuation of Indemnification. All agreements and obligations of the Company contained herein shall continue during the period that Officer is an Officer of the Company and shall continue thereafter so long as Officer shall be subject to any possible Loss or Expense by reason of the fact that Officer was an Officer of the Company. 11. Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Officer, who shall execute all documents and take all actions reasonably requested by the Company to implement such right of subrogation. 12. Successor and Assigns. This Agreement shall be (i) binding upon all successors and assigns of the Company (including any transferee of all or substantially all of its assets and any successor by merger or otherwise by operation of law), and (ii) shall be binding on and inure to the benefit of the heirs, personal representatives and estate of Officer. 4 13. Amendment. No amendment, modification, termination or cancellation of this Agreement shall be effective unless made in writing signed by each of the parties hereto. IN WITNESS WHEREOF, the Company and Officer have executed this Agreement as of the day and year first above written. INTERCARGO CORPORATION ___________________________________ James R. Zuhlke Chairman of the Board President and Chief Executive Officer ___________________________________ Michael Rybak Officer 5 EX-10.13 4 EXHIBIT 10.13 SECOND AMENDMENT TO SECURED LOAN AGREEMENT ------------------------------------------ This Second Amendment, dated as of June 4, 1995 (the "Second Amendment"), to that certain Secured Loan Agreement, dated as of June 4, 1993, between Intercargo Corporation, a Delaware Corporation, and LaSalle National Bank (hereinafter the "Original Agreement"), as amended pursuant to the First Amendment to the Original Agreement, dated January 1, 1995 (the "First Amendment") (together the Original Agreement, as amended by the First Amendment, shall be deemed the "Agreement"). W I T N E S S E T H: -------------------- WHEREAS, the Company and the Bank desire to amend certain provisions of the Agreement. NOW, THEREFORE, the Company and the Bank hereby agree as follows: 1. All capitalized terms used herein and not otherwise defined shall have the meanings given in the Agreement. 2. The definition of "Revolving Note Maturity Date" in Section 1.1 of the Agreement shall be amended by deleting the same and substituting therefor the following language: "Revolving Note Maturity Date" means the earlier to occur of (I) January 1, 1997, or (ii) the date on which the outstanding balance under the Revolving Loan (as may be amended from time to time) equals Ten Million Dollars ($10,000,000.00)." 3. Exhibit B to the Agreement, "Term Note", shall be amended by deleting the same and substituting therefor the Term Note attached hereto as Attachment 1. 4. Article VIII to the Agreement is hereby amended by the addition of the following Section 8.27: "Section 8.27 Sale of the Company's Securities. Not sell or otherwise transfer any shares of the Company's or any subsidiaries' capital stock or any options or warrants with respect thereto (collectively, "Sales"), except in accordance with the following: (i) proceeds of all Sales from and after the date hereof, by the Company or a subsidiary, as the case may be, in an aggregate amount less than or equal to Five Million dollars ($5,000,000.00) may be retained by the Company or such Subsidiary; (ii) fifty percent (50%) of the proceeds of all Sales from and after the date hereof, by the Company or a Subsidiary in an aggregate amount greater than Five Million Dollars ($5,000,000.00) and less than or equal to Fifteen Million dollars ($15,000,000.00) shall be immediately transferred to Bank as an optional prepayment of Loans pursuant to Section 5.1 of the Agreement; and (iii) proceeds of all Sales from and after the date hereof, by the Company or a Subsidiary in excess of 1 Fifteen Million Dollars ($15,000,000.00) may be retained by the Company or such Subsidiary." 5. In consideration of the Bank entering into this Second Amendment, upon the execution hereof, the Company shall pay the Bank an amount equal to Twenty-Three Thousand four Hundred Sixty-Two and no/100ths Dollars ($23,462.00). 6. The Company represents and warrants to the Bank that the execution and delivery of this Second Amendment and the consummation of the transactions contemplated hereby do not constitute a breach of, nor default under, any document, instrument or agreement to which the Company is a party and that no Event of Default exists as of the date hereof. 7. Except as amended by this Second Amendment, all of the terms, covenants and conditions of the Agreement are ratified, approved and confirmed and shall remain in full force and effect. The Agreement, together with this Second Amendment, shall constitute the Agreement between the Company and the Bank. IN WITNESS WHEREOF, this Second Amendment has been duly executed as of the day and year specified at the beginning hereof. INTERCARGO CORPORATION, a Delaware Corporation By: /s/ Lawrence P. Goecking ----------------------------- Its: Treasurer ----------------------------- LASALLE NATIONAL BANK By: ----------------------------- Its: ----------------------------- 2 EX-10.14 5 EXHIBIT 10.14 THIRD AMENDMENT TO SECURED LOAN AGREEMENT ----------------------------------------- This Third Amendment, dated as of March 31, 1996 (the "Third Amendment") to that certain Secured Loan Agreement, dated as of June 4, 1993, between Intercargo Corporation, a Delaware corporation, and LaSalle National Bank (hereinafter the "Original Agreement"), as amended pursuant to the First Amendment to the Original Agreement, dated January 1, 1995 (the "First Amendment"), the Second Amendment to the Original Agreement, dated as of June 4, 1995 (the "Second Amendment") (together, the Original Agreement, as amended by the First Amendment and the Second Amendment, shall be deemed the "Agreement"). W I T N E S S E T H: - - - - - - - - - - WHEREAS, the Company and the Bank desire to amend certain provisions of the Agreement. NOW, THEREFORE, the Company and the Bank hereby agree as follows: 1. All capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Agreement. 2. Section 1.1 of the Agreement is hereby amended by adding therefor the following definitions: ""Amended and Restated Revolving Note" shall mean that certain $15,000,000 Amended and Restated Revolving Note of the Company of even date herewith. All references in the Agreement to the Revolving Note shall mean the Amended and Restated Revolving Note. "Applicable Margin" means the rate specified below, subject to quarterly adjustments: When Following Status Exists Applicable Margin for any Determination Date for LIBOR Portion is: Level I Status 1.75% Level II Status 1.90% Notwithstanding the foregoing, if the Consolidated Net Income of the Company and its Subsidiaries for the 1996 fiscal year equals or exceeds that set forth in the Company's 1996 Fiscal Year budget (a copy of which is attached hereto as Annex 1) and the Company is otherwise in compliance with its covenants and other obligations in the Agreement, the "Applicable Margin" for all applicable periods thereafter (commencing on the next applicable Determination Date, estimated at April 30, 1997) shall mean the rate specified below, subject to quarterly adjustments: 1 When Following Status Exists Applicable Margin for any Determination Date for LIBOR Portion is: Level I Status 1.5% Level II Status 1.65% "Determination Date" means the date on or before the date that is thirty (30) Business Days after the date on which the Company is obligated to deliver a Compliance Certificate to the Bank pursuant to Section 8.1 hereof. "Interest Period" shall mean, with regard to any LIBOR Loan, successive one, two, three or six months periods as selected from time to time by the Company by notice given to the Bank not less than three Business Days prior to the first day of each respective Interest Period; provided, however, that: (i) each such Interest Period occurring after the initial Interest Period shall commence on the day on which the next preceding Interest Period expires, (ii) whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day, provided, however, that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, then the last day of such Interest Period shall occur on the immediately preceding Business Day; and (iii) the final Interest Period shall be such that its expiration occurs on or before the Revolving Note Maturity Date. "Level I Status" means for any Determination Date, that as of the close of the accounting period with reference to which such Determination Date was set, that both (i) the ratio determined pursuant to Section 8.21(e) hereof equals or exceeds 3.00:1.00; and (ii) the ratio determined pursuant to Section 8.21(b) hereof is less than or equal to 0.25:1.00. "Level II Status" means for any Determination Date, that as of the close of the accounting period with reference to which such Determination Date was set, that either (i) the ratio determined pursuant to Section 8.21(e) hereof is less than 3.00:1.00; or (ii) the ratio determined pursuant to Section 8.21(b) hereof is greater than 0.25:1.00. "LIBOR" shall mean a rate of interest equal to the per annum rate of interest at which U.S. dollar deposits in an amount comparable to the amount of the relevant LIBOR Loan and for a period equal to the relevant Interest Period are offered generally to the Bank (rounded upward if necessary, to the nearest 1/16 of 1.00%) in the London Interbank Eurodollar market at 11:00 a.m. (London time) two Business Days prior to the commencement of each Interest Period, or as LIBOR is otherwise determined by the Bank in its sole and absolute discretion, such rate to remain fixed for such Interest Period. The Bank's determination of LIBOR as provided above shall be conclusive, absent manifest error. "LIBOR Loan" or "LIBOR Loans" shall mean that portion, and collectively those portions, of the aggregate outstanding principal balance of the Revolving Loans that will bear interest at LIBOR plus the Applicable Margin, per annum, of which at any time and from time to time, the Company may identify no more than five (5) separate Revolving Loans which will bear interest based on LIBOR, of which any particular LIBOR 2 Loan must be in an amount equal to $1,000,000.00 or a higher amount in $100,000.00 increments. "Reference Rate Loan" or "Reference Rate Loans" shall mean that portion, and collectively, those portions of the aggregate outstanding principal balance of the Revolving Loans that will bear interest at the Reference Rate, of which any particular Reference Rate Loan must be in an amount equal to $10,000.00 or a higher integral multiple of $5,000.00. "Regulatory Change" shall mean the introduction of, or any change in any applicable law, treaty, rule, regulation or guideline or in the interpretation or administration thereof by any governmental authority or any central bank or other fiscal, monetary or other authority having jurisdiction over the Bank of its lending office." 3. The definition of "Tangible Net Worth" in Section 1.1 of the Agreement shall be amended by deleting same and substituting therefore the following language: ""Tangible Net Worth" means at any time the Company's, and its Subsidiaries', consolidated net worth determined in accordance with GAAP after excluding therefrom (i) Foreign Currency Adjustments; and (ii) the aggregate amount of any intangible assets of the Company and its Subsidiaries, including without limitation, covenants not to compete, prepayments (but expressly without excluding from such consolidated net worth prepaid reinsurance premiums), deferred changes, goodwill, franchises, licenses, patents, trademarks, trade names, copyrights, service marks and brand names." 4. The Agreement is hereby amended by deleting the following definitions: "Term Loan," "Term Loan Commitment" and "Term Note" from Section 1.1 thereof and by deleting reference to such terms throughout the Agreement. 5. The definition of "Revolving Note Maturity Date" in Section 1.1 of the Agreement shall be amended by deleting the same and substituting therefor the following language: ""Revolving Note Maturity Date" means December 1, 2001." 6. The Agreement is amended by deleting the definition of "Business Day" from Section 1.1 thereof and substituting the following: "Business Day" shall mean (i) for all purposes other than as covered by clause (ii) hereof, any day, other than a Saturday, Sunday, a day that is a legal holiday under the laws of the State of Illinois or any other day on which banking institutions located in Chicago, Illinois are authorized or required by law or other governmental action to close; and (ii) with respect to determinations in connection with, and payments of principal and interest in LIBOR Loans, any day which is a Business Day described in clause (i) and which is also a day for trading by and between banks in U.S. dollar deposits in the London Interbank Eurodollar Market." 7. The Agreement is hereby amended by deleting Section 2.1 and adding the following in its place and stead: "Bank's Revolving Loan Commitment". On the terms and subject to the conditions set forth in this Agreement, the Bank agrees to make revolving loans (such loans herein, collectively, called "Revolving Loans" and, individually, called a "Revolving Loan") to the Company from time to time before the "Revolving Note Maturity Date," in such aggregate amounts as the Company may, from time to time, request but not exceeding the amounts and with respect to the time period set forth below (and subject to reduction pursuant to the remaining provisions of this Agreement): 3 Aggregate Amount of Revolving Loans On or Before --------------- ------------ $15,000,000.00 12/31/96 $13,750,000.00 01/01/97 $12,500,000.00 07/01/97 $11,250,000.00 01/01/98 $10,000,000.00 07/01/98 $ 8,750,000.00 01/01/99 $ 7,500,000.00 07/01/99 $ 6,250,000.00 01/01/00 $ 5,000,000.00 07/01/00 $ 3,750,000.00 01/01/01 $ 2,500,000.00 07/01/01 $ -0- Revolving Note Maturity Date On the terms and subject to the conditions set forth in this Agreement, the Company shall have the right to repay and reborrow any of the Revolving Loans. The Bank's commitment to make Revolving Loans is herein called the "Revolving Credit Commitment." 8. Sections 2.2 and 3.2 of the Agreement are hereby deleted. 9. Section 2.3 of the Agreement is hereby amended by deleting the initial two sentences of said Section and by the addition of the following at the beginning of such Section: "Each Revolving Loan may be advanced either as a Reference Rate Loan or a LIBOR Loan, provided, however, that at any time and from time to time, the Company may identify no more than five (5) Revolving Loans which may be LIBOR Loans. A request for a Reference Rate Loan must be (i) received by no Later than 11:00 a.m. Chicago, Illinois time, on the day it is to be funded, and (ii) in an amount equal to $10,000.00 or a higher integral multiple of $5,000.00. A request for a LIBOR Loan must be (i) received by no later than 11:00 a.m. Chicago, Illinois time, three days before the day it is to be funded, and (ii) in an amount equal to $1,000,000.00 or a higher amount in $100,000.00 increments. If for any reason the Company shall fail to select timely an Interest Period for an existing LIBOR Loan, then such LIBOR Loan shall be immediately converted to a Reference Rate Loan on the last Business Day of the then existing Interest Period, all without demand, presentment, protest or notice of any kind, all of which are hereby waived by the Company. The proceeds of each Reference Rate Loan or LIBOR Loan shall be made available at the office of the Bank by credit to the account of the Company or by other means requested by the Company and acceptable to the Bank. The Bank is authorized to rely on the telephonic, telecopy or telegraphic loan requests which the Bank believes in its good faith judgment to emanate from a properly authorized representative of the Company, whether or not that is in the fact the case. The Company does hereby irrevocably confirm, ratify and approve all such advances by the Bank and does hereby indemnify the Bank against losses and expenses (including court costs, attorneys' and paralegals' fees) and shall hold the Bank harmless with respect thereto." 4 10. The Agreement is hereby amended by the addition of the following Section 2.4 - 2.6: "2.4 Eurodollar Advances and Conversions. Provided no Event of Default has occurred and is continuing, Company shall have the option, subject to the other provisions of this Agreement, to (i) request that any Revolving Loan or any portion of a Revolving Loan hereunder be a LIBOR Loan by giving telephonic notice to Bank at least three (3) Business Days prior to the day any LIBOR Loan is to be made hereunder specifying the applicable Interest Period; provided that Company gives Bank written confirmation by facsimile of its telephone notice prior to the day any LIBOR Loan is to be made hereunder, and (ii) convert on any Business Day, all or any portion of the outstanding principal amount of any Revolving Loan or portion thereof from one type of interest rate Revolving Loan to another type of interest rate Revolving Loan by giving at least three (3) Business Days prior telephonic notice to Bank thereof; provided that Company gives Bank written confirmation of its telephonic notice by facsimile prior to the day any such conversion is made herunder. Notwithstanding the foregoing, no LIBOR Loan may be converted into a Reference Rate Loan pursuant to this Section 2.4 except effective on the last day of the Interest Period applicable thereto. 2.5 LIBOR Unavailability. If the Bank determines in good faith (which determination shall be conclusive, absent manifest error) prior to the commencement of any Interest Period that (i) U.S. dollar deposits of sufficient amount and maturity for funding any LIBOR Loan are not available to the Bank in the London Interbank Eurodollar market in the ordinary course of business, or (ii) by reason of circumstances affecting the London Interbank Eurodollar market, adequate and fair means do not exist for ascertaining the rate of interest to be applicable to the relevant LIBOR Loan, the Bank shall promptly notify the Company thereof and, so long as the foregoing conditions continue, Revolving Loans may not be advanced as a LIBOR Loan thereafter. In addition, at the Company's option, each existing LIBOR Loan shall be immediately (i) converted to a Reference Rate Loan on the last Business Day of the then existing Interest Period, or (ii) due and payable on the last Business Day of the then existing Interest Period, without further demand, presentment, protest or notice of any kind, all of which are hereby waived by the Company. 2.6 Regulatory Change. In addition, if, after the date hereof, a Regulatory Change shall, in the reasonable determination of the Bank, make it unlawful for the Bank to make or maintain the LIBOR Loans, then the Bank shall promptly notify the Company, and Revolving Loans may not be advanced as a LIBOR Loan thereafter. In addition, at the Company's option, each existing LIBOR Loan shall be immediately (i) converted to a Reference Rate Loan on the last Business Day of the then existing Interest Period or on such earlier date as required by law, or (ii) due and payable on the last Business Day of the then existing Interest Period or on such earlier date as required by law, all without further demand, presentment, protest or notice of any kind, all of which are hereby waived by the Company. Further, the Company shall pay to the Bank, on demand, such additional amounts as the Bank shall, from time to time, determine are sufficient to compensate and indemnify the Bank for such increased cost or reduced amount." 11. Sections 4.1 and 4.2 of the Agreement are hereby deleted and the following shall be inserted in its place and stead: "4.1 Interest Rates on Loan. The Company hereby promises to pay interest on the unpaid 5 principal amount of the Revolving Loan for the period commencing on the date of the Revolving Loan until the Revolving Loan is paid in full at a rate per annum equal to the Reference Rate from time to time in effect, plus (a) in the case of the Reference Rate Loans, at the Reference Rate, and (b) in the case of the LIBOR Loans, at LIBOR plus the Applicable Margin, provided, however, that in the event that any principal of the Revolving Loan is not paid when due (whether by acceleration or otherwise) or upon the occurrence of an Event of Default, the unpaid principal amount of the Revolving Loan shall bear interest after the due date of such principal until such principal is paid at a rate per annum equal to the Reference Rate (whether or not such Revolving Loan is a Reference Rate Loan or a LIBOR Loan), plus two and one-half percent (2½%). 4.2 Interest Payment Dates. Accrued interest on Reference Rate Loans shall be payable in arrears, monthly on the first Business Day of each month and through maturity. Accrued and unpaid interest on the unpaid principal balance of the LIBOR Loans shall be payable on the last Business Day of each Interest Period, commencing on the first such date to occur after the date hereof, on the date of any principal repayment of a LIBOR Loan and on the Revolving Note Maturity Date. After maturity (whether by acceleration or otherwise) accrued and unpaid interest on the Reference Rate Loans and the LIBOR Loans shall be payable on demand." 12. Article V of the Agreement is hereby amended by adding therefor the following Section 5.2, Mandatory Prepayments: "Section 5.2 Mandatory Prepayments. (a) The Company covenants and agrees that if at any time the sum of the then unpaid Revolving Loans shall exceed the Revolving Credit commitment as then determined and computed, or if any other mandatory prepayment event shall occur, the Company shall immediately pay over to the Bank, without demand or notice, the amount of such excess as a mandatory prepayment of such obligations under the Revolving Loan." (b) The principal balance of the LIBOR Loans may not be prepaid in whole or in part at any time. If, for any reason, a LIBOR Loan is paid prior to the last Business Day of any Interest Period, the Company agrees to indemnify the Bank against any loss (including any loss on redeployment of the funds repaid), cost or expense incurred by the Bank as a result of such prepayment. (c) In addition, if the Company chooses not to convert any LIBOR Loan to a Reference Rate Loan as provided in Sections 2.4 and 2.5, then such LIBOR Loan shall be immediately due and payable on the last Business Day of the then existing Interest Period or on such earlier date as required by law, all without further demand, presentment, protest or notice of any kind, all of which are hereby waived by the Company. (d) All outstanding Revolving Loans shall be immediately due and payable on the Revolving Note Maturity Date. 13. Article VIII to the Agreement is hereby amended by the deletion of Section 8.27 and the insertion of the following Section 8.27 in its place and stead: "Section 8.27 Sale of the Company's Securities. Not sell or otherwise transfer any shares of the Company's or any Subsidiaries' or any of Kingsway General Issuance Company's 6 ("Kingsway") capital stock or any options or warrants with respect thereto (collectively, "Sales"), except in accordance with the following: (i) proceeds of all Sales from and after the date hereof, by the Company, a Subsidiary or of Kingsway, as the case may be, in an aggregate amount less than or equal to Five Million Dollars ($5,000,000.00) may be retained by the Company or such Subsidiary; (ii) fifty percent (50%) of the proceeds of all Sales from and after the date hereof, by the Company, a Subsidiary or of Kingsway in an aggregate amount greater than Five Million Dollars ($5,000,000.00) and less than or equal to Twenty Million Dollars ($20,000,000.00) shall be immediately transferred to Bank as a mandatory prepayment of Revolving Loans pursuant to Section 5.2 of the Agreement; (iii) proceeds of all Sales from and after the date hereof, by the Company, a Subsidiary or of Kingsway in excess of Twenty Million Dollars ($20,000,000.00) may be retained by the Company or such Subsidiary; and (iv) The Revolving Credit Commitment shall be reduced by the amount of any payment required to be made to Bank as a mandatory prepayment pursuant to the terms of this Section 8.27 (the "Sale Prepayment"). (I) In the event the Sale Prepayment equals or exceeds $2,500,000, (A) the Revolving Credit Commitment then in effect (set forth in Section 2.1 hereof) shall be reduced by the amount of Sale Prepayment, provided, however, that the Revolving Credit Commitment (as reduced) shall remain in effect and shall not be reduced at the next two scheduled reductions (as set forth in Section 2.1 hereof) to the Revolving Credit Commitment, and (B) thereafter, on the date of each scheduled reduction therefrom, the Revolving Credit Commitment shall be reduced by an additional One Million Two Hundred Fifty Thousand and no/100ths Dollars ($1,250,000.00) until the Revolving Credit Commitment shall be reduced to $0. (II) In the event the Sale Prepayment equals or exceeds $1,250,000 but is less than $2,500,000, (A) the Revolving Credit Commitment then in effect shall be reduced by the amount of the Sale Prepayment, provided, however, that the Revolving Credit Commitment (as reduced) shall remain in effect and shall not be reduced at the next scheduled reduction to the Revolving Credit Commitment, and (B) on the next scheduled date for a reduction in the Revolving Credit Commitment, the Revolving Credit Commitment shall be reduced by the difference between the amount of the Sale Prepayment and $1,250,000, and (C) thereafter, on the date of each scheduled reduction therefrom, the Revolving Credit Commitment shall be reduced by an additional $1,250,000 until the Revolving Credit Commitment shall be reduced to zero, whereupon the Revolving Loans shall be due and payable in full. (III) In the event the Sale Prepayment is less than $1,250,000 (A) the Revolving Credit Commitment then in effect shall be reduced by the amount of the Sale Prepayment, (B) on the next scheduled date for a reduction in the Revolving Credit Commitment, the Revolving Credit Commitment shall be reduced by the difference between the 7 amount of the Sale Prepayment and $1,250,000, and (C) thereafter, on the date of each scheduled reduction therefrom, the Revolving Credit Commitment shall be reduced by an additional $1,250,000 until the Revolving Credit Commitment shall be reduced to zero whereupon the Revolving Loans shall be due and payable in full. (v) As an example of the provisions of this Section 8.27, if Sales occur on June 1, 1996 in the amount of Fifteen Million and no/100ths Dollars ($15,000,000.00), the following would occur: (A) The Company would retain $10,000,000.00 (representing $5,000,000.00 plus 50% of the excess between $5,000,000.00 and $20,000,000.00); (B) $5,000,000.00 (representing 50% of the excess between $5,000,000.00 and $20,000,000.00) would be immediately transferred to the Bank as a mandatory prepayment; and (C) the Revolving Credit Commitment set forth in Section 2.1 would be adjusted as follows: Aggregate Amount of Revolving Loans On or Before --------------- ------------ $10,000,000.00 01/01/97 $10,000,000.00 07/01/97 $ 8,750,000.00 01/01/98 $ 7,500,000.00 07/01/98 $ 6,250,000.00 01/01/99 $ 5,000,000.00 07/01/99 $ 3,750,000.00 01/01/00 $ 2,500,000.00 07/01/00 $ 1,250,000.00 01/01/01 $ 0.00 07/01/01" 14. The Agreement is hereby amended by deleting Section 8.21(a) and adding the following in its respective place and stead: "(a) Not permit or suffer the sum of (i) the consolidated statutory surplus as required to be shown on the Statutory Financial Statements of Intercargo Insurance Company, plus (ii) the fair market value of any of those U.S. Treasury Bills, Permitted Commercial Paper or certificates of deposit issued by the Bank, if any, as are hereafter pledged to the Bank by the Company as additional Collateral and maintained thereafter on deposit with the Bank, to fall below Eighteen Million Dollars ($18,000,000.00) (the "Section 8.21(a) Target") at December 31, 1995 or during the twelve (12) months period thereafter. The Section 8.21(a) Target shall increase by One Million Dollars ($1,000,000.00) at each fiscal year end commencing December 31, 1996 and thereafter, provided, however, that any such increase to the Section 8.21(a) Target shall be postponed if, prior to such fiscal year end, Intercargo Insurance Company shall make a 8 dividend payment to the Company in the amount of One Million Dollars ($1,000,000.00) and Company shall then pay such amount to Bank as a mandatory prepayment pursuant to Section 5.2 hereof. 15. The Agreement is hereby amended by deleting the second and third sentence of Section 8.21(d). Section 8.21(d) shall now read as follows: "8.21(d) Not permit or suffer the combined net written premium of Intercargo Insurance Company for any four (4) consecutive calendar quarterly periods to exceed 2.5 times the combined statutory surplus of Intercargo Insurance Company as required to be shown on its Statutory Financial Statements." 16. Section 8.21(e) of the Agreement is hereby amended by deleting same and substituting therefore the following language: "8.21(e) Not permit or suffer for any four (4) consecutive calendar quarter periods, the ratio of (x) the sum of (A) with regard to Subsidiaries which are regulated by state or province insurance commissions, the maximum dividend or distribution which said Subsidiaries may legally make to the Company during the applicable fiscal period pursuant to the applicable rules, regulations, procedures and laws of all such applicable insurance commissions of any state or province plus (B) if such Subsidiary is not regulated by such state or province insurance commissions ("Non-Insurance Subsidiaries"), the Net Income of Non-Insurance Subsidiaries after eliminating intercompany items and adding back interest, depreciation and amortization expense plus (C) the "value of Kingsway capital stock" (as herein defined) held by the Company as of the end of such fiscal period, to (y) the sum of the Company's interest and required principal payments under the Loans (including but not limited to any required prepayments or other obligations of Company hereunder) or pursuant to any other Indebtedness of the Company, to be at any time less than 1.25:1. For purposes hereof, the "value of Kingsway capital stock" shall be the closing price for Kingsway shares on the Canadian exchange on which Kingsway shares are traded and listed." 17. The Agreement is hereby amended by deleting Section 8.21(f). 18. Exhibit B to the Agreement, "Term Loan", is hereby deleted in its entirety. 19. In consideration of the Bank entering into this Third Amendment, upon the execution hereof, the Company shall pay the Bank an amount equal to Twenty-Five Thousand Dollars ($25,000.00). 20. Except as amended by this Third Amendment, all of the terms, covenants and conditions of the Agreement are ratified, approved and confirmed and shall remain in full force and effect. The Agreement, together with this Third Amendment, shall constitute the Agreement between the Company and the Bank. 21. Company and Bank further acknowledge and agree that the Amended and Restated Revolving Note evidences a rollover of indebtedness heretofore outstanding and that Bank has not and does not, by accepting the amendments thereto or otherwise, release any Collateral or security interest or other encumbrance on the assets and property which Bank now holds. 9 22. Upon demand by Bank therefor, the Company shall reimburse Bank for all costs, fees and expenses incurred by Bank or for which Bank becomes obligated, in connection with the negotiation, preparation and conclusion of this Third Amendment, including without limitation, reasonable attorneys' fees, costs and expenses, search fees, title insurance policy fees, costs and expenses, filing and recording fees and all taxes payable in connection with this Third Amendment. 23. Company hereby acknowledges, agrees and affirms that it possesses no claims, defenses, offsets, recoupment or counterclaims of any kind or nature against or with respect to the enforcement of the Agreement, the Amended and Restated Note and any amendments thereto (collectively, the "Claims"), nor does the Company now have knowledge of any facts that would or might give rise to any Claims. If facts now exist which would or could give rise to any Claim against or with respect to the enforcement of the Agreement, the Revolving Note, as amended by the amendments thereto, the Company hereby unconditionally, irrevocably and unequivocally waives and fully releases any and all such Claims as of such Claims were the subject of a lawsuit, adjudicated to final judgment from which no appeal would be taken and therein dismissed with prejudice. 24. All of the provisions of the Agreement, including without limitation, the right to declare principal and accrued interest due for any cause specified in the Agreement, shall remain in full force and effect except as herein expressly modified and they are hereby reaffirmed, ratified and confirmed in their entirety and incorporated by reference as if fully set forth herein. The Agreement and all rights and powers created thereby and thereunder are in all respects ratified and confirmed. From and after the date hereof, the Agreement shall be deemed to be amended and modified as herein provided, but, except as so amended and modified, the Agreement shall continue in full force and effect and the Agreement, the First Amendment, the Second Amendment and this Amendment shall be read, taken and construed as one and the same instrument. 25. THIS AMENDMENT HAS BEEN DELIVERED FOR ACCEPTANCE BY BANK IN CHICAGO, ILLINOIS AND SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO THE CONFLICTS OF LAW PROVISIONS) OF THE STATE OF ILLINOIS. COMPANY HEREBY (i) IRREVOCABLY SUBMITS, TO THE EXTENT PERMITTED BY APPLICABLE LAW, TO THE JURISDICTION OF ANY STATE OR FEDERAL COURT LOCATED IN CHICAGO, ILLINOIS, OVER ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY MATTER ARISING FROM OR RELATED TO THIS AMENDMENT; (ii) IRREVOCABLY WAIVES, TO THE FULLEST EXTENT COMPANY MAY EFFECTIVELY DO SO, THE DEFENSE OF AN INCONVENIENT FORUM TO THE MAINTENANCE OF ANY SUCH ACTION OR PROCEEDING IN ANY SUCH COURT; (iii) AGREES THAT, TO THE EXTENT PERMITTED BY APPLICABLE LAW, A FINAL JUDGMENT IN ANY SUCH ACTION OR PROCEEDING IN ANY SUCH COURT SHALL BE CONCLUSIVE AND MAY BE ENFORCED IN ANY OTHER JURISDICTIONS BY SUIT ON THE JUDGMENT OR IN ANY OTHER MANNER PROVIDED BY LAW; AND (iv) TO THE EXTENT PERMITTED BY APPLICABLE LAW, AGREES NOT TO INSTITUTE ANY LEGAL ACTION OR PROCEEDING AGAINST BANK OR ANY OF BANK'S DIRECTORS, OFFICERS, EMPLOYEES, AGENTS OR PROPERTY, CONCERNING ANY MATTER ARISING OUT OF OR RELATING TO THIS AMENDMENT IN ANY COURT OTHER THAN ANY STATE OR FEDERAL COURT LOCATED IN COOK COUNTY, ILLINOIS. NOTHING IN THIS SECTION SHALL AFFECT OR IMPAIR BANK'S RIGHT TO SERVE LEGAL PROCESS IN ANY MANNER PERMITTED BY 10 LAW OR BANK'S RIGHT TO BRING ANY ACTION OR PROCEEDING AGAINST THE COMPANY OR COMPANY'S PROPERTY IN THE COURTS OF ANY OTHER JURISDICTION. TO THE EXTENT PERMITTED BY LAW, THE COMPANY AND BANK EACH HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES THE RIGHT TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS AMENDMENT OR ANY COURSE OF CONDUCT, COURSE OF DEALINGS, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF EITHER PARTY IN CONNECTION HEREWITH. THE COMPANY HEREBY EXPRESSLY ACKNOWLEDGES THAT THIS WAIVER IS A MATERIAL INDUCEMENT FOR BANK TO MAKE THE LOANS. 26. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. To induce Bank to enter into this Third Amendment, the Company hereby represents and warrants to Bank that: (a) the execution and delivery of this Amendment, and the performance by the Company of its obligations under this Agreement and the Amended and Restated Revolving Note are within the Company's corporate powers, have been duly authorized by all necessary corporate action, have received all necessary governmental approval (if any shall be required) and do not and will not contravene or conflict with any provisions of law or the Articles of Incorporation or corporate By-Laws or the Company or of any agreement binding upon the Company; (b) this Amendment, the Amended and Restated Revolving Note, and each other instrument executed by the Company concurrently herewith is the legal, valid and binding obligation of the Company enforceable against the Company in accordance with their terms, except as enforcement thereof may be subject to the effect of applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, and to the general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at laws); (c) all of the representations and warranties of the Company made in the Agreement are true and correct as of the date hereof, except where such representation or warranty specifically relates to an earlier date; and (d) no Event of Default or Unmatured Event of Default under the Agreement exists. 27. Concurrently herewith (and as a condition to this Amendment becoming effective), the Company shall execute and deliver or cause to be executed and delivered the Amended and Restated Revolving Note, in form and substance satisfactory to Bank and its counsel. 28. The Company hereby represents that it has been represented by competent counsel of its choice in the negotiation and execution of this Third Amendment; that it has read and fully understood the terms hereof and intends to be bound hereby. This Third Amendment has been thoroughly reviewed by counsel for the Company and in the event of an ambiguity or conflict in the terms hereof, there shall be no presumption against Bank as the drafter hereof. 29. The parties agree that the effective date of this Third Amendment shall be March 31, 1996. 11 IN WITNESS WHEREOF, this Third Amendment has been duly executed as of the day and year specified at the beginning hereof. INTERCARGO CORPORATION, a Delaware corporation By: ____________________________ Its: _________________________ LASALLE NATIONAL BANK By: ____________________________ Its:__________________________ 12 EX-11 6 EXHIBIT 11 Intercargo Corporation and Subsidiaries Computation of Net Income Per Common Share
1996 1995 1994 -------------------------------------- Primary earnings per common share: Average common shares outstanding 7,645,578 7,640,981 7,639,646 Shares assumed to be repurchased under the treasury stock method at average market prices of $10.321, $9.302 and $13.043, respectively (1) 11,011 22,656 22,096 -------------------------------------- Total 7,656,589 7,667,637 7,661,742 -------------------------------------- Net income $6,404,000 2,139,000 4,981,000 -------------------------------------- Per common share amount $ 0.84 0.28 0.65 ====================================== Fully diluted earnings per common share: Average common shares outstanding 7,645,578 7,640,981 7,639,646 Shares assumed to be repurchased under the treasury stock method at the average market prices of $10.321, $9.302, and $13.043, respectively (1) 11,011 26,656 22,096 -------------------------------------- Total 7,656,589 7,667,637 7,661,742 -------------------------------------- Net income $6,404,000 2,139,000 4,981,000 -------------------------------------- Per common share amount $ 0.84 0.28 0.65 ======================================
(1) Earnings per share are computed based upon the weighted average number of common stock and common stock market equivalents outstanding during each year. EX-12 7 EXHIBIT 12 Intercargo Corporation and Subsidiaries Statement Regarding Computation of Ratios The Combined Ratio, as Computed on a GAAP basis, is the ratio of total underwriting expenses to insurance premium income. U.S. & U.K. OPERATIONS BONDS
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $22,030 $25,846 85.2 1995 20,631 24,700 83.5 1994 18,507 23,019 80.4 1993 21,015 19,739 106.5 1992 18,742 17,720 105.8
MARINE
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $27,050 $26,826 113.5 1995 25,942 20,808 124.7 1994 17,125 14,996 114.2 1993 10,430 12,154 85.8 1992 8,001 10,773 74.3
PROFESSIONAL LIABILITY
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ 4,000 $ 2,644 151.3 1995 4,920 3,069 160.3 1994 4,645 2,377 195.4 1993 2,945 1,681 175.2 1992 2,747 2,090 131.5
OTHER
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ 7,621 $ 5,631 135.3 1995 8,073 5,498 146.8 1994 3,573 3,362 106.3 1993 1,092 772 156.2 1992 927 566 165.2
1 TOTAL BONDS, MARINE, PROFESSIONAL LIABILITY AND OTHER
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $60,701 $60,947 105.2 1995 59,566 54,075 110.2 1994 43,850 43,754 100.2 1993 35,482 34,346 103.6 1992 30,417 31,149 97.7
CANADIAN OPERATIONS AUTO
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ -- $ -- -- 1995 22,289 24,046 92.7 1994 23,819 25,646 92.9 1993 7,850 8,863 88.6 1992 7,402 9,302 79.6
PROPERTY
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ -- $ -- -- 1995 8,333 7,647 109.0 1994 5,008 5,084 98.5 1993 2,508 2,059 121.8 1992 1,509 1,154 130.7
OTHER
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ -- $ -- -- 1995 284 386 73.6 1994 239 313 76.4 1993 220 225 97.8 1992 -- -- --
2 TOTAL AUTO, PROPERTY, AND OTHER
Year Total Insurance Combined Ended Underwriting Premium Ratio Dec. 31 Expenses Income % - -------------------------------------------------------------- 1996 $ -- $ -- -- 1995 30,906 32,079 96.3 1994 29,066 31,043 93.6 1993 10,578 11,147 94.9 1992 8,911 10,456 85.2
3 EX-13 8 EXHIBIT 13 KEY FINANCIAL INFORMATION
Years ended December 31, 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------ (in thousands) Revenues $ 68,241 94,186 80,885 50,712 46,376 - ------------------------------------------------------------------------------------------------------ Operating income $ 3,618 3,918 7,261 2,818 6,544 - ------------------------------------------------------------------------------------------------------ Net income $ 6,404 2,139 4,981 2,138 4,379 - ------------------------------------------------------------------------------------------------------ Total assets $ 133,710 116,166 128,423 114,841 87,753 - ------------------------------------------------------------------------------------------------------ Total stockholder's equity $ 48,012 43,621 39,921 38,527 29,619 - ------------------------------------------------------------------------------------------------------ (per share amounts) Net income from continuing operations $ 0.84 0.28 0.65 0.30 0.68 - ------------------------------------------------------------------------------------------------------ Dividends $ 0.18 0.18 0.18 0.17 0.08 - ------------------------------------------------------------------------------------------------------ Combined ratio (1) 104.6% 103.6% 97.5% 101.5% 94.5% - ------------------------------------------------------------------------------------------------------
(1) Combined ratios have been computed, for all years, on a GAAP basis (see Management's Discussion and Analysis). 1 MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW The Company, through its subsidiaries, is engaged in the business of underwriting specialty insurance coverages for international trade. This includes U.S. customs bonds, marine cargo insurance, professional liability insurance, and property and casualty insurance. The Company has subsidiaries in Hong Kong and a branch office in the United Kingdom. Until December 18, 1995, the Company was the sole parent company of Kingsway Financial Services, Inc. ("Kingsway"), an underwriter of automobile, and property and casualty insurance in Canada. On December 18, 1995 Kingsway sold 1.8 million shares of its common stock in an initial public offering. The Company participated in that transaction as a selling shareholder, reducing its equity interest in Kingsway from 100% to 50%. In January, 1996, as a result of the exercise of the underwriters' over allotment option, the Company's equity in Kingsway was reduced to 46.99%. In October, 1996, Kingsway conducted a secondary offering in which the Company participated. As a result of this, the Company's equity in Kingsway was further reduced to 31.5%. In accordance with generally accepted accounting principles, Kingsway's financial position is not consolidated with the Company's at December 31, 1995. For financial statement purposes the Company has consolidated its 100% equity in Kingsway's 1995 results of operations through December 18, 1995. Thereafter this investment has been accounted for by the equity method. The following chart compares certain 1996 information to information for 1995 and 1994 restated as if Kingsway had not been consolidated at any time during 1995 and 1994. Comparison of Selected Data (in thousands)
Proforma Proforma 1996 1995 1994 ------------------------------- Insurance premium income $61,053 $54,075 $43,754 Total revenues 68,241 58,594 47,507 Losses and loss adjustment expenses 32,307 30,517 21,729 Other underwriting expenses 14,138 10,993 9,102 Total expenses 64,623 59,199 44,583 Operating income 3,618 (605) 2,924 Equity in net income of investee 3,454 2,663 2,412 -------------------------------
Three significant factors in evaluating insurance company performance are earned premiums, loss ratios, and combined ratios. Earned premiums represent 2 the recognized revenue, calculated on a daily pro rata basis, of premiums paid to the Company. The loss ratio is a comparison of claims paid by the Company plus changes in the level of claim reserves as a percentage of earned premiums. The combined ratio is a comparison of claims costs plus other expenses as a percentage of premium earnings. FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's total revenue for the year ended December 31, 1996 decreased to $68.2 million, or 27.6%, from $94.2 million for the year ended December 31, 1995, which was an increase of 16.4% over the $80.9 million in 1994. Included in the 1995 amounts are revenues of $35.6 million attributable to Kingsway prior to its deconsolidation. Revenues in 1996 increased 16.5%, or $9.6 million after excluding the effects of Kingsway in 1995. In 1996, net premium written in U.S. operations increased 4.4% to $54.6 million from $52.3 million in 1995. The 1995 level of net written premium had increased 16.5% to $52.3 million from $44.9 million in 1994. Surety (U.S. Customs bonds and contract surety bonds) net premium written decreased 9.5% in 1996 to $23.2 million from $25.6 million in 1995. Gross premiums written for contract surety bonds were $1.5 million or 14.4% lower in 1996 than 1995. Market conditions for this product line were such that the Company did not consider the pricing adequate for the risk being undertaken and, therefore, the Company chose to curtail premium writings. Affecting the level of net written premium in the contract bond line in 1996 was an increase of 192% or $2.8 million in ceded premiums. This was a result of certain changes in reinsurance contracts implemented April 1, 1996, to reduce the volatility in this product line. Professional liability net premium written in 1996 declined 24.3% or $646 thousand to $2.0 million dollars after having increased 77.5% in 1995 as compared to 1994. The decrease in 1996 was attributable to an increase in premiums ceded in 1996 of $1.7 million. Approximately $1.4 million of this was due to retrospective reinsurance premiums applicable to the development of prior period coverages. Marine net premium written in 1996 increased 27.8% to $23.8 million, reflecting the seventh consecutive annual increase. In 1995 marine premium increased similarly, at a rate of 26.2% to $18.6 million. Other property and casualty net premium written increased 4.0% in 1996 to $5.6 million. In 1995 other property and casualty net premiums written had increased 25.3%. The decline in the rate of growth was due to the discontinuation of farm coverages and to more selective underwriting in a competitive pricing environment. Net written premium in the U.K. in 1996 increased 16.2% to $3.6 million as the Company continues to establish itself in the London market. The operation in Hong Kong, op ened in May 1996, contributed $211 thousand in net written premium. Earned premium on a consolidated basis for 1996 shows a decline of $25.1 million to $61.1 million from $86.2 million in 1995. The 1995 level was an increase of $11.4 million from the 1994 amount of $74.8 million. Included in 3 the 1995 earned premiums is $32.1 million attributable to Kingsway. Earned premium in 1996 increased 12.9% or $7.0 million after excluding the effects of Kingsway on 1995 earned premium. Surety earned premium increased $1.1 million, U.S. marine increased $5.3 million, other property and casualty increased $133 thousand, while professional liability decreased $425 thousand in 1996 (see "Results by Line"). Also in 1996, U.K. marine earned premium increased $700 thousand to $3.6 million from $2.9 million in 1995. Hong Kong operations contributed $106 thousand in net earned premium. In 1995, earned premium from U.S. and U.K. operations increased 23.6% to $54.1 million over 1994. Surety earned premium increased $1.7 million, marine increased $5.8 million, professional liability increased $700 thousand and other property and casualty increased $2.1 million in 1995 over 1994. Canadian earned premiums increased 3.3% in total to $32.1 million in 1995. In 1996, net investment income increased $91 thousand over 1995, or 1.5% to $6.4 million. The 1995 net investment income of $6.3 million includes $2.5 million related to Kingsway while it was still part of the consolidation. 1996 net investment income increased $2.6 million or 68% from the 1995 results after excluding the Kingsway net investment income from the 1995 amount. Included in the 1996 investment income is $2.4 million in gains from the sale of Kingsway stock. Investment income in 1995 includes $244 thousand in gains on the sale of Kingsway stock. The remainder of the increase in investment income in 1996 is attributable to an increase in the level of invested assets. Net investment income in 1995 had increased $1.9 million over 1994, or 43.3% to $6.3 million. Investment income excluding Kingsway and gains from the sale of Kingsway shares had increased 20.4% to $3.5 million in 1995, due primarily to an increase in investment balances. The company's investment policy requires that assets be comprised primarily of investment grade, fixed income securities of short to medium-term maturity. The length of maturity is intended to approximate the structure of the Company's liabilities. As a result of the Company's investment policy, which does not permit significant levels of equity securities but does include a significant level of securities with interest exempt from federal income tax, the Company's yield on its investment portfolio has tended to be lower than that of the insurance industry in general. It is the Company's general practice to hold its investments to maturity, but it will recognize its positions where market changes allow the redeployment of assets at no loss the Company. The Company's current position in Kingsway has a market value at December 31, 1996 of $50 million. The Company is reviewing the strategic alternatives relating to this investment. The Company does not invest in real estate, high yield securities or derivatives. In 1996, loss and loss adjustment expenses declined 37.6% to $32.3 million from $51.7 million in 1995. Included in the 1995 amount is $21.2 million attributable to Kingsway. 1996 loss and loss adjustment expenses increased 5.9% or $1.8 million after excluding the effects of Kingsway on 1995 loss and loss adjustment 4 expenses. Loss and loss adjustment expenses had increased 24.4% in 1995 from $41.6 million in 1994. The rate of increase for 1996 was less than the rate of increase in earned premiums, reflecting improved loss ratios in most product lines. Incurred losses on the marine product increased 11.5% to $16.5 million. The marine loss ratio declined in 1996 to 71.0% from 82.6% in 1995 as a result of improved claims frequency over the last eight months of the year and enhancements to administrative systems which have enabled the Company to better monitor individual accounts and take corrective actions more quickly. Surety loss and loss adjustment expenses in 1996 increased to $7.5 million from $5.6 million in 1995. Contract surety bond loss and loss adjustment expenses in 1996 decreased $279 thousand or 7.8%, but the loss ratio increased to 46.9% from 46.2% reflecting continued weakness in this product line. While the loss ratio for U.S. customs bonds deteriorated in 1996 to 22.1% from 12.0% in 1995, the ratio in 1994 was 23.2%. In 1996, loss and loss adjustment expenses for professional liability decreased 17.1% from 1995 as the loss ratio declined to 102.7% from 106.7%. In 1996, retrospective reinsurance premiums applicable to prior period coverages of $1.4 million were incurred. Excluding this would result in a loss ratio of 89.2% in 1996 for professional liability. The improvement in the loss ratio reflects system enhancements that have enabled improved analysis, leading to more appropriate pricing for covered risks under the professional liability program. In 1996, losses for the other property and casualty lines decreased 21.2% while the related loss ratio declined to 77.8% fr om 101.0%. As with other product lines, system enhancements have enabled better and more frequent detailed reviews of experience, leading to swifter action on adverse developments. Incurred losses for U.K. operations increased 38.5% to $1.8 million in 1996 from $1.3 million in 1995. This increase partially reflects the 24.7% increase in earned premium during 1996. The remainder of the increase can be attributed to the loss ratio increase in 1996 to 49.5% from 44.1% in 1995. In 1995, loss and loss adjustment expenses increased 24.4% to $51.7 million from $41.6 million in 1994. In 1995, loss and loss adjustment expenses related to U.S. operations increased 37.0% to $29.2 million from $21.3 million in 1994. Adverse development in loss and loss adjustment expense reserves for marine, other property and casualty, and contract surety bonds unfavorably affected 1995 calendar year loss ratios in these lines. Canadian incurred loss and loss adjustment expenses increased $1.3 million in 1995 or 6.8%. Adverse development relating to prior periods was the primary cause of this increase over the 1994 levels. Acquisition and other issue costs decreased 23.7% to $17.4 million in 1996 from $22.8 million in 1995. Included in the 1995 amount is $6.0 million attributable to Kingsway. Acquisition and other issue costs increased 3.2% or $544 thousand after excluding the effects of Kingsway on 1995 costs. This increase is due to increased premium volume. The magnitude of the increase was reduced 5 by the continuing change in the commission structure as product pricing moves to a net rate structure. U.S. policy acquisition costs in 1995 increased due to increased premium volume and to limitations on the ability to capitalize acquisition costs due to high loss ratios on certain lines. Canadian acquisition and other issue costs increased in 1995 consistent with the change in premium volume and mix. Other underwriting expenses decreased 3.9% in 1996 to $14.1 million from $14.7 million in 1995. Included in the 1995 amount is $3.7 million in other underwriting expenses attributable to Kingsway. Other underwriting expenses increased $3.1 million or 28.6% in 1996 after excluding the effects of Kingsway on the 1995 expenses. Agency operations expenses increased $1.0 million in 1996 primarily due to an increase in the allowance for doubtful accounts amounting to $527 thousand. U.S. insurance company operations for 1996 showed an increase in other underwriting expenses of $2.0 million, primarily due to higher levels of salary and other employee costs. These higher employee costs were related to the development of a customer service center and to the start-up of operations in Hong Kong. Hong Kong insurance operations, which began in 1996, had other underwriting expenses of $710 thousand. 1995 other underwriting expenses increased 14.9% to $14.7 million from $12.8 million in 1994. Excluding the effects of Kingsway, the 1995 increase was 20.8%. Combined ratios on a GAAP basis are presented here as the Company feels this provides a conservative and consistent representation of the operational performance as a whole. Canadian (i.e. Kingsway) operations are shown separately. A combined ratio of less than 100% generally indicates an underwriting profit. Many of the large property and casualty companies which sell standard commercial and personal lines of insurance have historically posted combined ratios well in excess of 100%. No assurance is made that loss and loss adjustment expense accruals upon which the Company's combined ratios are based may not prove to vary significantly from the ultimate results. 6 U.S. AND U.K. OPERATIONS (dollars in thousands)
Other Surety Marine Professional Liability Property &Casualty ------------------------------------------------------------------------------------------------------------ Year Premium Combined Premium Combined Premium Combined Premium Combined Earned Ratio (%) Earned Ratio (%) Earned Ratio (%) Earned Ratio (%) 1996 $25,846 85.2 $26,826 113.5 $2,644 151.3 $5,631 135.3 1995 24,700 83.5 20,808 124.7 3,069 160.3 5,498 146.8 1994 23,019 80.4 14,996 114.2 2,377 195.4 3,362 106.3 1993 19,739 106.5 12,154 85.8 1,681 175.2 772 156.2 1992 17,720 105.8 10,773 74.3 2,090 131.5 566 165.2
Year Total ---------------------- Premium Combined Earned Ratio (%) 1996 $60,947 105.2 1995 54,075 110.2 1994 43,754 100.2 1993 34,346 103.6 1992 31,149 97.7
CANADIAN OPERATIONS (dollars in thousands)
Other Auto Property Property & Casualty Total ------------------------------------------------------------------------------------------------------------------ Year Premium Combined Premium Combined Premium Combined Premium Combined Earned Ratio (%) Earned Ratio (%) Earned Ratio (%) Earned Ratio (%) 1996 --- --- --- --- --- --- --- --- 1995 $24,046 92.7 $7,647 109.0 $386 73.6 $32,079 96.3 1994 25,646 92.9 5,084 98.5 313 76.4 31,043 93.6 1993 8,863 88.6 2,059 121.8 225 97.8 11,147 94.9 1992 9,302 79.6 1,154 130.7 --- --- 10,456 85.2
7 RESULTS BY LINE Underwriting results for 1996 in the Company's surety business declined marginally, following a slight decline in 1995. The combined ratio in 1996 of 85.2% is up slightly from the 1995 ratio of 83.5%. The contract surety bond loss ratio increased to 46.9% in 1996 from 46.2% in 1995. These levels are up considerably from the 1994 loss ratio of 25.8%. Earned premiums for 1996 decreased 9.1% to $7.0 million from $7.7 million in 1995, which was an increase from $5.9 million in 1994. The Company is conducting a review of the strategic fit of contract bonds with the Company's other products, and the options that may be available to limit the Company's exposure to volatility. U.S. Customs bonds results deteriorated only slightly in 1996 despite an increase in the loss ratio to 22.1% from 12.0% in 1995. The 1995 results for U.S. Customs bonds improved over 1994 as a result of favorable loss developments. Earned premiums for Customs bonds increased 11.0% to $18.8 million in 1996 compared to $17.0 million in 1995. Marine earned premium in 1996 grew $6.0 million or 28.9%. Earned premium in 1995 grew $5.8 million. The 1996 and 1995 marine underwriting results were negatively affected by adverse developments on claims incurred prior to each of those years. However, the business has been improving, demonstrated by an improvement in the loss ratio in 1996 to 71.0% from 82.6% in 1995 and improvement in the combined ratio to 113.5% in 1996 from 124.7% in 1995. Also, claim frequency has been steadily improving since the second quarter of 1996. Improved administrative systems are now allowing the Company to better monitor results and to act more quickly on negative trends. 8 Other property and casualty lines show an increase in earned premium of 2.4% or $133,000 in 1996 while 1995 earned premium of $5.5 million was an increase of $2.1 million or 63.5% over 1994. The loss ratio for 1996 of 77.8% was an improvement over the 1995 ratio of 101.0%. This helped to reduce the combined ratio in 1996 to 136.2% from 146.8% in 1995. The professional liability program 1996 earned premium declined to $2.6 million from $3.1 million in 1995 due primarily to higher levels of reinsurance premium ceded. The 1995 year showed an increase of 29.1% from the 1994 earned premium of $2.4 million. The improvement in the 1996 loss ratio to 102.7% from 106.7% in 1995 and the improvement in the 1996 combined ratio to 152.1% from 160.3% in 1995 reflects rate actions taken by the Company as the result of improved analytical capabilities. 9 INFLATION AND OTHER FACTORS Periods of inflation have varying effects on the Company and other companies in the insurance industry. Because premium rates for the Company's U.S. Customs bond and marine cargo insurance products are usually tied to the value of cargo being imported or exported, an increase in price levels may result in revenue increases. In periods of inflation, the property and casualty industry generally experiences higher losses, loss adjustment expenses and operating costs. In contrast, the Company's U.S. Customs bond and marine cargo premiums and losses are tied to the value of goods as of the date of shipment and generally are not adversely affected by inflation. The value of the dollar relative to other world currencies also affects the Company's U.S. Customs bond and marine cargo business. When the dollar is strong relative to other world currencies, imports generally increase and U.S. Customs bond volume increases. When the dollar is weak relative to other world currencies, exports generally increase and marine cargo insurance volume increases. 10 U.S. AND CANADIAN FEDERAL INCOME TAXES The Company's effective tax rates for the years 1996, 1995 and 1994 were 18.4%, 47.7% and 31.4%, respectively. The effective tax rate differs from the U.S. federal corporate tax rate due to the Company's investments in tax exempt securities, changes in the valuation of deferred tax assets and, for the 1995 and 1994 years when Kingsway was a consolidated subsidiary, the Canadian tax rate differential (see accompanying Notes to Consolidated Financial Statements). LIQUIDITY AND CAPITAL RESOURCES The capacity of an insurance company to underwrite insurance is based upon maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. The Company has historically generated adequate capital resources to support its current operations. This position is further enhanced by its investment policy which emphasizes high quality, short to medium term investments. The primary sources of the Company's liquidity are funds generated from insurance premiums, investment income, and proceeds from investment maturities. The Company's position in Kingsway, with a market value at December 31, 1996 of appoximately $50 million, is also a potential source of liquidity. The principal application of such funds are payments of losses and loss adjustment expenses, investments, reinsurance, and operating expenses. Cash flow from operations amounted to $6.3 million in 1996 compared to $5.1 million in 1995 and $12.8 million in 1994. The increase in 1996 is commeasurate with the increase in premiums. Increased loss levels coupled with a leveling of premium growth account for the decline in 1995. Proceeds from the sale of Kingsway common stock amounting to $4.6 million in 1996 were used to increase the statutory capital and surplus of IIC and for general corporate purposes. In 1995 proceeds from the sale of Kingsway common stock amounting to $4.1 million were similarly used. The Company maintains a $15.0 million line of credit which has been used to facilitate the integration of IAS operations and other general purposes. As of December 31, 1996, the Company has utilized $9.7 million of this available line. In December 1994, borrowings totaling $4.3 million were made to increase the statutory capital and surplus of IIC and Kingsway. The Kingsway contribution made in the form of a note, was repaid in December 1995, with proceeds from the sale of Kingsway stock. The Company does not have any material commitments for capital expenditures. 11 DIVIDENDS The Company paid dividends of $0.18 per share, or $1.4 million in 1996 and 1995 and 1994. Any future dividends will depend upon the earnings and financial position of the Company's principal operating subsidiary, IIC, as well as legal and contractual restrictions. In addition, the insurance laws of Illinois, the domicile of IIC, require that dividends be paid only out of earned surplus, and are limited to the greater of 10% of statutory surplus or statutory net income, as defined. The Company's line of credit restricts dividend payments to 25% of consolidated net income of the Company for the four quarters prior to payment. MARKET INFORMATION The Company's common stock, par value $1.00, is traded on the Nasdaq National Market under the symbol ICAR. The table shown on the left contains the range of high and low closing sale prices of the common stock of the Company as reported by Nasdaq for each calendar quarter for the last two fiscal years. HOLDERS The number of holders of record of Company common stock on March 14, 1997, was approximately 121. Certain information made available to the Company from Automatic Data Processing (ADP) and other broker dealers holding securities in street name indicates there are approximately 2,100 beneficial owners of the Company's common stock. Quarter High Low - ------- ---- --- 4th 1996 9.13 7.75 3rd 1996 9.25 8.25 2nd 1996 9.75 8.38 1st 1996 11.50 7.50 4th 1995 14.75 8.25 3rd 1995 14.75 11.00 2nd 1995 11.75 9.00 1st 1995 9.75 8.00 12 THE BOARD OF DIRECTORS AND STOCKHOLDERS OF INTERCARGO CORPORATION: We have audited the consolidated balance sheets of Intercargo Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Intercargo Corporation and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Chicago, Illinois February 21, 1997 13 CONSOLIDATED BALANCE SHEETS At December 31, 1996 1995 ------------------ (in thousands) ASSETS Investments Fixed maturities available-for-sale, at fair value $ 51,567 44,769 Equity securities, at fair value 1,557 3,474 Investee at cost plus cumulative undistributed earnings (fair value: $50,327 in 1996 and $17,590 in 1995) 13,519 11,898 --------------------- Total investments 66,643 60,141 Cash and cash equivalents 18,492 16,478 Premiums receivable 16,231 14,920 Accrued investment income 833 804 Deferred policy acquisition costs 3,884 4,898 Reinsurance recoverable on loss and loss expenses: Paid claims 96 1,192 Unpaid claims 9,980 2,964 Prepaid reinsurance premiums 4,549 2,089 Notes receivable 672 349 Income tax recoverable - 1,092 Deferred income tax 2,375 822 Equipment, at cost less accumulated depreciation 2,276 1,738 Goodwill 2,091 2,468 Other assets 5,588 6,211 --------------------- Total assets $133,710 116,166 ===================== LIABILITIES Losses and loss adjustment expenses $ 47,037 36,293 Unearned premiums 17,617 17,691 Funds held by Company 491 748 Supplemental duty deposits 2,358 2,669 Accrued expenses and other liabilities 8,460 5,409 Notes payable 9,735 9,735 --------------------- Total liabilities 85,698 72,545 --------------------- Commitments and contingencies STOCKHOLDERS' EQUITY Common stock--$1 par value; authorized 20,000,000 shares; issued and outstanding, 7,659,981 shares in 1996 and 7,640,981 in 1995 7,660 7,641 Additional paid-in capital 24,180 24,104 Net unrealized loss on foreign currency translation (978) (1,179) Net unrealized gain (loss) on available-for-sale securities (366) 567 Retained earnings 17,516 12,488 --------------------- Total stockholders' equity 48,012 43,621 --------------------- Total liabilities and stockholders' equity $133,710 116,166 =====================
See accompanying Notes to Consolidated Financial Statements. 14 CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, 1996 1995 1994 --------------------------- (in thousands, except per share data) REVENUES Insurance premium income $61,053 86,154 74,797 Net investment income 6,364 6,273 4,378 Commission income 686 531 433 Other income 138 1,228 1,277 ------------------------------ Total 68,241 94,186 80,885 ------------------------------ LOSSES AND EXPENSES Losses and loss adjustment expenses 32,307 51,746 41,599 Policy acquisition and other issue costs 17,410 22,829 18,511 Other underwriting expenses 14,138 14,706 12,801 Interest expense 768 987 512 Litigation settlement expense - - 201 ------------------------------ Total 64,623 90,268 73,624 ------------------------------ Operating income 3,618 3,918 7,261 Income tax expense 668 1,868 2,280 ------------------------------ Net income before equity in net income of investee 2,950 2,050 - Equity in net income of investee 3,454 89 - ------------------------------ NET INCOME $6,404 2,139 4,981 ============================== Average number of shares of common stock and equivalents outstanding 7,657 7,668 7,662 NET INCOME PER SHARE $ 0.84 0.28 0.65 ==============================
See accompanying Notes to Consolidated Financial Statements. 15 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Net Unrealized Net Gain (Loss) Unrealized Additional on Foreign Gain Stock- Number Common Paid-in Currency (Loss) on Retained holders' of Shares Stock Capital Translation Securities Earnings Equity -------------------------------------------------------------------------------------- (in thousands) Balance at December 31, 1993 7,631 $7,631 24,064 (1,375) 89 8,118 38,527 Cumulative effect of the implementation of SFAS No. 115 1,166 1,166 Net income 4,981 4,981 Change in foreign currency translation (627) (627) Change in unrealized gain (loss) on available-for-sale securities (2,801) (2,801) Dividends paid to stockholders ($0.18 per share) (1,375) (1,375) Employee stock options exercised 10 10 40 50 - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1994 7,641 7,641 24,104 (2,002) (1,546) 11,724 39,921 Net income 2,139 2,139 Change in foreign currency translation 823 823 Change in unrealized gain (loss) on available-for-sale securities 2,113 2,113 Dividends paid to stockholders ($0.18 per share) (1,375) (1,375) - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1995 7,641 7,641 24,104 (1,179) 567 12,488 43,621 Net income 6,404 6,404 Change in foreign currency translation 201 201 Change in unrealized gain (loss) on available-for-sale securities (933) (933) Dividends paid to stockholders ($0.18 per share) (1,376) (1,376) Employee stock options exercised 19 19 76 95 - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 7,660 $7,660 24,180 (978) (366) 17,516 48,012 ==========================================================================================================================
See accompanying Notes to Consolidated Financial Statements. 16 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 1996 1995 1994 ------------------------------- (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,404 2,139 4,981 Adjustments to reconcile net income to net cash provided from operating activities: Realized gains (2,379) (415) (43) Depreciation and amortization 1,546 702 680 Amortization of premiums (discounts) on investments 102 52 (422) Undistributed earnings of affiliate (3,454) (2,662) - Increase in premiums receivable (1,311) (5,417) (4,598) Decrease (increase) in deferred policy acquisition costs 1,014 (420) (1,387) Increase in reinsurance balances (8,380) (1,406) (1,868) Decrease (increase) in notes receivable (323) 2,297 433 Change in income tax accounts 20 (1,453) 948 Increase in other assets (56) (1,171) (924) Increase in liability for losses and loss adjustment expenses 10,744 9,571 9,140 Increase (decrease) in unearned premiums (74) 1,831 5,116 Increase (decrease) in funds held (257) 480 300 Decrease in supplemental duty deposits (311) (478) (938) Increase in accounts payable and accrued expenses 3,051 850 1,482 Other, net (16) 626 (82) ---------------------------------- Net cash provided from operating activities 6,320 5,126 12,818 ---------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Fixed maturities available-for-sale: Purchases (27,314) (21,957) (20,102) Sales 13,332 8,080 5,005 Maturities and calls 5,370 4,563 5,715 Equity securities: Purchases (502) - (1,472) Sales 2,140 4,191 2,743 Calls 185 - 187 Net sales (purchases) of short-term investments 510 (260) 4,721 Purchase of subsidiary - (1,499) - Subsidiary cash at purchase date - 170 - Sale of Kingsway common stock 4,573 4,107 - Decrease in cash due to deconsolidation of Kingsway - (3,964) - Purchase of property and equipment, net (1,319) (814) (1,191) ---------------------------------- Net cash used in investing activities (3,025) (7,383) (4,394) ---------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payment of) notes payable - 1,099 (2,312) Proceeds from the exercise of stock options 95 - 50 Dividends paid to stockholders (1,376) (1,375) (1,375) ---------------------------------- Net cash used in financing activities (1,281) (276) (3,637) ---------------------------------- Net increase (decrease) in cash and cash equivalents 2,014 (2,533) 4,787 Cash and cash equivalents: Beginning of the period 16,478 19,011 14,224 ---------------------------------- End of the period $18,492 16,478 19,011 ==================================
See accompanying Notes to Consolidated Financial Statements. 17 Notes to Consolidated Financial Statements (1) ORGANIZATION Intercargo Corporation is an insurance holding company incorporated in the State of Delaware whose wholly owned subsidiaries at December 31, 1996, consist of Intercargo Insurance Company (IIC), International Advisory Services, Inc. (IAS), Intercargo International Limited (IIL), and TRM Insurance Services, Inc. (TRM). IIL's name was changed from Interocean Company, Ltd. in 1995. IIC is a property and casualty insurer based in the United States, which primarily writes U.S. Customs bonds, marine cargo, professional liability and other property and casualty insurance. IIC conducts business in the United Kingdom through a branch office operation. Its products are sold to importers and exporters through customs brokers, freight forwarders, and other service firms engaged in the international and domestic movement of cargo. In October, 1995, IIC purchased the stock of Eastern Insurance Company (H.K.), a Hong Kong licensed insurance company for $1.5 million. The company was renamed Intercargo Insurance Company H.K. Limited (IIC - H.K.). The acquisition is accounted for by the purchase method, and accordingly, the operations of IIC - H.K. are included in the Company's financial statements from the date of acquisition. In connection with the acquisition, the Company has recorded an intangible asset of $2.7 million related to IIC - H.K.'s license to operate as an insurance company in Hong Kong. IIC owned 100% of Oceanic Insurance and Surety Company (Oceanic). In December 1995, the Illinois Department of Insurance approved a plan of merger which merged all of Oceanic's assets and liabilities into IIC. On December 18, 1995, Kingsway Financial Services (Kingsway), a then wholly owned subsidiary of the Company, sold 1.8 million shares of its common stock in a public offering. The Company sold 600 thousand of its 3.0 million Kingsway shares in that transaction thereby reducing its equity interest in Kingsway to 50% at December 31, 1995. The Company's consolidated results of operations for 1995 include 100% of Kingsway's results of operations through December 18, 1995. The Company's financial position reflects the remaining 50% interest in Kingsway on the equity method of accounting at December 31, 1995. On January 15, 1996, the Company sold 60 thousand additional shares of Kingsway stock as part of the over allotment option from the initial public offering. This reduced the Company's ownership percentage to approximately 47%. On October 18, 1996, the Company participated in a secondary offering of Kingsway stock by selling 250 thousand shares, which along with the new shares issued by Kingsway, reduced its equity interest in Kingsway to approximately 31%. The Company's financial position reflects the remaining 31% interest in Kingsway on the equity method of accounting at December 31, 1996. 18 The Company primarily operates in the business of underwriting property and casualty insurance. Business placed by the insurance agency subsidiaries with insurance companies unrelated to the Company is not significant, and therefore, the Company believes property and casualty insurance is its only reportable business segment. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Investment Valuations Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held-to-maturity, trading, or available-for-sale. Held-to-Maturity Securities: Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at amortized cost. Except for declines that are other than temporary, changes in the fair value are not reflected in the financial statements. The Company holds no debt securities in this category. 19 Trading Securities: Debt and equity securities purchased for short-term resale are classified as trading securities. Unrealized gains and losses are included in earnings. The Company holds no debt or equity securities in this category. Available-for-Sale Securities: All other debt and equity securities not included in the above categories are classified as available-for-sale and reported at fair value. Unrealized gains and losses are excluded from earnings and reported in a separate component of stockholders' equity net of deferred income taxes. All of the Company's equity securities and debt securities are classified as available-for-sale. Prior to the adoption of SFAS No. 115, the Company classified all of its debt securities as held-to-maturity which were carried at amortized cost. Investments in equity securities were carried at fair value with unrealized appreciation or depreciation included in stockholders' equity. In conjunction with the adoption of SFAS No. 115, all of the Company's debt securities were deemed as available-for-sale. Unrealized holding gains on adoption amounted to $1.2 million, net of tax. The adoption of SFAS No. 115 had no effect on net income as the amount was credited directly to stockholders' equity. Gains and losses on sales of investments are computed on the specific identification method and are reflected in net income. Fair values are based upon quoted market prices or values obtained from independent pricing sources. (c) Investment in Investee The Company does not recognize into income its equity share of changes in an investee's reported net assets resulting from an investee's issuance of stock. Unconsolidated investees between 20% and 50% owned are accounted for under the equity method of accounting. (d) Cash and Cash Equivalents Cash includes $170 thousand on deposit with Hong Kong regulatory authorities at December 31, 1995. Cash equivalents consist of investments with an original or remaining maturity of three months or less at purchase. (e) Premium Trust Funds Premiums collected from insureds but not yet remitted to insurance carriers are restricted as to use by laws in certain states in which IAS operates. The amount of cash and cash equivalents so restricted was $4.6 million at December 31, 1996. (f) Premiums Receivable Current accounts receivable are stated net of allowances for uncollectible accounts of approximately $1.1 million and $605 thousand at December 31, 1996 and 1995, respectively. 20 (g) Policy Acquisition Costs Policy acquisition costs are costs such as commissions and certain other underwriting and agency expenses which vary with and are directly related to the production of business. Such costs are deferred to the extent recoverable from future earned premiums and are amortized ratably over the terms of the related policies. Costs deferred and amortized over the past three years are summarized as follows (in thousands):
Year ended December 31, 1996 1995 1994 -------------------------- Deferred policy acquisition costs, beginning of period $ 4,898 6,602 5,215 Deferred: Direct commissions 11,136 17,766 15,636 Premium taxes 1,026 2,536 2,234 Other direct underwriting expenses 6,479 6,740 4,894 Ceding commissions (2,245) (3,201) (2,866) ------------------------------ Net deferred 16,396 23,841 19,898 Amortized (17,410) (22,829) (18,511) Adjustment due to deconsolidation of Kingsway - (2,716) - ------------------------------ Deferred policy acquisition costs, end of period $ 3,884 4,898 6,602 ==============================
(h) Federal Income Tax Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period in which the change is enacted. (i) Goodwill and Other Intangible Assets Goodwill is the excess of the fair value of consideration paid for companies acquired over the fair value of the related net assets acquired. Goodwill is amortized using the straight-line method over periods not exceeding 20 years. Intangible assets relate to the acquisition of licenses, customer lists, non-compete agreements, and employment agreements and are amortized using the straight-line method over periods not exceeding 20 years. (j) Liability for Losses and Loss Adjustment Expenses The liability for losses and loss adjustment expenses represents estimates of the ultimate unpaid cost of all claims incurred, including claims incurred but not yet 21 reported. These estimates are based upon historical experience of the business written by the Company and other direct writers reinsured by the Company, adjusted for current trends. Management believes that the provision for losses and loss adjustment expenses is adequate to cover the ultimate liability; however, such estimates may be more or less than the amount ultimately paid when the claims are settled. Reinsurance recoverables on unpaid losses and ceded unearned premiums are reported as assets instead of netting these against related reserves (see note 4). (k) Premium Recognition Insurance premiums are recognized as revenue ratably over the terms of the policies. Unearned premiums are computed on the daily pro rata basis. 22 (l) Foreign Exchange Assets and liabilities relating to foreign operations are translated to U.S. dollars using current exchange rates. Revenues and expenses are translated to U.S. dollars using the average exchange rate as determined on a yearly basis. Translation adjustments for financial reporting in U.S. dollars are reflected as a separate component of stockholders' equity. (m) Commission Income The Company recognizes commission income when the premiums are billed to the customer, or the effective date of the policy, whichever is later. (n) Stock-Based Compensation The Company applies the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB No. 25) and related Interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized as the exercise prices of the options and stock appreciation rights equaled the market prices at the grant dates. The effect of recording compensation cost for the Company's stock-based compensation plans based on SFAS No. 123's fair value method results in net income and earnings per share that are not materially different from amounts reported. The Company does not expect its net income and earnings per share to be materially different under SFAS No. 123 than under APB No. 25 in future periods. (o) Earnings Per Share Earnings per share are computed based upon the weighted average number of shares of common stock and common stock equivalents (to the extent dilutive) outstanding each year. Common stock equivalents consist of shares issuable under the Company's stock option plan. (p) Reclassifications Certain reclassifications have been made to the prior years' financial statements to conform with the current presentation. 23 (3) INVESTMENTS Amortized cost, unrealized gains and losses, and estimated fair value of investments as of December 31, 1996 and 1995, are summarized as follows (in thousands):
December 31, 1996 ------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------ (Available-for-Sale) Fixed maturities: U.S. Government and Agency obligations $20,870 49 (522) 20,397 State, municipal, and other tax advantaged securities 14,193 325 (23) 14,495 Corporate securities 15,128 23 (215) 14,936 Other fixed maturity investments 1,758 1 (20) 1,739 --------------------------------------------- Total fixed maturities 51,949 398 (780) 51,567 Equity securities 1,730 3 (176) 1,557 --------------------------------------------- Total $53,679 401 (956) 53,124 =============================================
December 31, 1995 ------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------ (Available-for-Sale) Fixed maturities: U.S. Government and Agency obligations $13,670 111 (42) 13,739 State, municipal, and other tax advantaged securities 19,776 689 (20) 20,445 Corporate securities 9,545 275 (8) 9,812 Other fixed maturity investments 774 - (1) 773 --------------------------------------------- Total fixed maturities 43,765 1,075 (71) 44,769 Equity securities 3,618 11 (155) 3,474 --------------------------------------------- Total $47,383 1,086 (226) 48,243 =============================================
24 Amortized cost and estimated fair value for fixed maturities held as of December 31, 1996, summarized by maturity, are as follows (in thousands):
Estimated Amortized Fair Cost Value ----------------------- Due in one year or less $ 1,075 1,079 Due after one year through five years 12,529 12,655 Due after five years through ten years 30,164 29,648 Due after ten years 8,181 8,185 ------- ------ $51,949 51,567 ======= ======
Excluding sales of Kingsway shares, gross gains realized on the sale of investments were $238 thousand, $390 thousand, and $187 thousand in 1996, 1995, and 1994 respectively. Gross losses from the sale of investments were $171 thousand, $28 thousand, and $144 thousand in 1996, 1995, and 1994 respectively. Investment securities carried at $ 9.5 million and $9.6 million at December 31, 1996 and 1995, respectively, were on deposit or pledged to governmental authorities as required by law. The sources of net investment income are as follows (in thousands):
Year ended December 31, 1996 1995 1994 ------------------------ Income from fixed maturities in excess of one year $3,183 3,064 2,699 Income from short-term investments and cash equivalents 844 2,421 828 Income from other sources - 74 379 Income from equity issues 104 641 699 Gain on sale of Kingsway common stock 2,394 244 - Investment expenses (161) (171) (227) -------------------------- Net investment income $6,364 6,273 4,378 ==========================
At December 31, 1996, the net unrealized loss on available-for-sale securities was net of a deferred tax benefit of $189 thousand. At December 31, 1995, the net unrealized gain on available-for-sale securities was net of a deferred tax liability totaling $292 thousand. (4) REINSURANCE In the normal course of business, the Company assumes and cedes reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of contingent liability. The majority of the Company's ceded reinsurance is placed with a limited number of reinsurers; however, the Company evaluates the financial condition of 25 its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses from insolvencies. A contingent liability exists to the extent that the Company's reinsurers are unable to meet their contractual obligations. Management makes provision for uncollectible reinsurance when warranted and is of the opinion that no additional liability will accrue to the Company with respect to this contingency. 26 The effects of reinsurance on premiums written, premiums earned, and loss and loss adjustment expenses incurred for the three years ended December 31, 1996, 1995, and 1994, are as follows (in thousands):
Direct Ceded Assumed Net ------------------------------------------------------ Year ended December 31, 1996 - ---------------------------- Premiums written $ 67,933 12,514 3,034 58,453 Premiums earned $ 68,206 10,163 3,010 61,053 Loss and loss adjustment expenses incurred $ 45,500 14,910 1,717 32,307 Year ended December 31, 1995 - ---------------------------- Premiums written $103,396 14,001 1,409 90,804 Premiums earned $ 98,460 13,594 1,288 86,154 Loss and loss adjustment expenses incurred $ 58,431 7,208 523 51,746 Year ended December 31, 1994 - ---------------------------- Premiums written $ 92,047 11,561 251 80,737 Premiums earned $ 86,216 11,565 146 74,797 Loss and loss adjustment expenses incurred $ 49,140 7,540 (1) 41,599
5) FEDERAL INCOME TAX The components of income tax expense are as follows (in thousands):
Year ended December 31, 1996 1995 1994 ---------------------------------- Current $1,740 2,308 2,639 Deferred (1,072) (440) (359) ------------------------------------- $ 668 1,868 2,280 ===================================== Tax (benefit) on unrealized gain (loss) on investments $ (189) 292 (800) =====================================
The tax effects of temporary differences that give rise to significant portions of the Company's net deferred tax asset at December 31, 1996 and 1995, were (in thousands):
December 31, 1996 1995 ----------------- Deferred tax assets: Loss reserves $1,453 1,257 Unearned premium reserves 881 1,061 Future benefit of net operating losses 1,476 1,476 Unrealized investment loss 189 - Other 503 550 Less: valuation allowance (738) (1,476) ----------------- Deferred tax assets 3,764 2,868 ----------------- Deferred tax liabilities: Deferred policy acquisition costs (1,255) (1,617) Unrealized investment gain - (292) Depreciation (128) (128) Other (6) (9) ----------------- Deferred tax liabilities (1,389) (2,046) ----------------- Net deferred tax asset $2,375 822 =================
27 The valuation allowances of approximately $738 thousand and $1.5 million at December 31, 1996 and 1995, respectively, pertain solely to net operating losses (NOL) of IAS. These NOLs are considered to have arisen in separate return limitation years (SRLY) and under Federal tax law can only be utilized against future taxable income generated by IAS. Valuation allowances have been established to reduce the deferred tax asset related to the pre-acquisition NOLs of IAS to the amount that, based upon available evidence, is, in management's judgment, more likely than not to be realized. The NOL carryforwards at December 31, 1996, begin expiring in 2002. Income taxes paid (net of taxes recovered) were ($108) thousand, $3.2 million, and $1.6 million in 1996, 1995, and 1994, respectively. The actual Federal income tax expense for 1996, 1995, and 1994 differed from the "expected" tax expense for those years as described below (in thousands). "Expected" tax expense is computed by applying the U.S. Federal corporate tax rate of 34% to operating income.
Year ended December 31, 1996 1995 1994 ---------------------------- Computed expected tax $1,230 1,332 2,469 Foreign tax rate differential 131 475 451 Tax exempt interest and dividend received deduction (323) (487) (577) Realization of pre-merger operating loss benefit - - (212) Foreign source income 207 106 (98) Deferred tax valuation allowance (738) 357 (491) Other 161 85 738 ---------------------------- $ 668 1,868 2,280 ============================
The Company and its U.S. subsidiaries file a consolidated tax return. Federal income tax expenses are calculated on an entity basis and are allocated accordingly. Foreign income not expected to be taxed in the United States has arisen because Kingsway is not subject to U.S. income taxes. For 1995 and 1994, pre-tax income includes $4.5 million and $4.3 million, respectively, attributable to Kingsway. Included in 1995 and 1994 income tax expense is $1.9 million related to such income. Kingsway's income has been subject to Canadian federal and provincial income taxes at the cumulative corporate rate of 44.5% in 1995, and 44.3% in 1994. Temporary differences relating to Kingsway arising from tax law for Canadian insurance companies are similar to those of the U.S. subsidiaries. (6) RELATED PARTY TRANSACTIONS Certain of the Company's reinsurers are affiliated insurance companies. The 28 Company ceded to these affiliates premiums written of $649 thousand, $524 thousand, and $381 thousand in 1996, 1995, and 1994 respectively. Current and former employees of the Company are indebted to the Company for loans 29 outstanding. At December 31, 1996 and 1995, employee indebtedness amounted to $72 thousand and $140 thousand, respectively. The loans receivable are current as to principal and interest at December 31, 1996. (7) LITIGATION In July 1993, the Company settled a lawsuit in which the Company and its Chairman of the Board, James R. Zuhlke, were named defendants. The suit sought to recover damages for the return of insurance premiums purportedly written by G. Nicholas Brueggen on behalf of Binford Insurance Company. The lawsuit, which sought damages up to $3 million, was settled by the payment of $875 thousand in full satisfaction of all claims. Other costs related to the matter amounted to $439 thousand. In July, 1994, the Company obtained a judgment of $1.4 million against Mr. Brueggen and an associate which is not reflected in the financial statements. During 1994, the Company settled litigation in the amount of $201 thousand for which there is no continuing liability. There are no other significant pending legal proceedings to which the Company or its subsidiaries is a party or of which any of the properties of the Company or its subsidiaries is subject, except for claims arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such litigation will not have a material effect on the financial condition of the Company. (8) RECONCILIATIONS TO STATUTORY ACCOUNTING The Company's insurance subsidiaries are required to file statutory financial statements with insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from financial statements prepared on the basis of generally accepted accounting principles. Reconciliations of combined net income and statutory capital and surplus as determined using statutory accounting principles to the amounts included in the accompanying financial statements are as follows (in thousands):
Year ended December 31, 1996 1995 1994 --------------------------- Statutory net income of insurance subsidiaries $2,645 2,634 2,510 Increases (decreases): Net income (loss) from non-insurance operations 3,323 (564) 822 Deferred policy acquisition costs (U.S. operations) (1,034) 420 1,590 Deferred income taxes 1,072 440 177 Provision for uncollectible balances 139 (705) - Consolidating eliminations and other adjustments, net 259 (86) (118) --------------------------- Consolidated net income as reported herein $6,404 2,139 4,981 ===========================
30
Year ended December 31, 1996 1995 ----------------------- Statutory capital and surplus of insurance subsidiaries $30,697 26,639 Increases (decreases): Non-insurance net assets (liabilities) 6,955 7,859 Non-admitted assets and other statutory adjustments, net 3,738 2,146 Deferred policy acquisition costs (U.S. operations) 3,864 4,898 Costs in excess of net assets of purchased businesses 2,091 2,468 Deferred income taxes 2,375 822 Unrealized loss on foreign currency translation (978) (1,179) Adjustment to GAAP fair values (281) 681 Consolidating eliminations and other adjustments (449) (713) ----------------------- Stockholders' equity as reported herein $48,012 43,621 =======================
The statutory surplus and capital of the Company's U.S. insurance subsidiary is sufficient to satisfy current regulatory requirements. Dividend payments to the Company from its insurance subsidiary are restricted by insurance laws as to the amount that may be paid without prior approval of insurance regulatory authorities. Under the insurance regulations of Illinois, IIC's state of domicile, ordinary dividends are limited to the greater of 10% of statutory surplus or statutory net income, as defined, for the prior twelve month period. The estimated dividend distribution which can be made to the Company by its subsidiary in 1997 based on these regulatory guidelines is approximately $3.1 million. The Company's U.S. insurance subsidiary, IIC, is required to file annual statements with insurance regulatory authorities which are prepared on an accounting basis prescribed or permitted by such authorities. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. That project will likely change the definition of what comprises prescribed versus permitted statutory accounting practices, and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory 31 financial statements. IIC does not currently use permitted statutory accounting practices which could have a significant impact on its statutory financial statements. 32 (9) UNAUDITED INTERIM FINANCIAL INFORMATION (in thousands, except per share data),
Three months ended March 31 June 30 Sept 30 Dec 31 ----------------------------------------- 1996 Revenues $15,903 17,896 14,334 20,108 ---------------------------------------- Net income from operations $564 646 (138) 1,878 Net income from investee 552 1,108 809 985 ---------------------------------------- Net income 1,116 1,754 671 2,863 ======================================== Net income per share $0.15 0.23 0.09 0.37 ======================================== 1995 Revenues $23,166 24,126 23,103 23,791 ---------------------------------------- Net income from operations $2,075 2,075 1,628 (3,728) Net income from investee - - - 89 ---------------------------------------- Net income $2,075 2,075 1,628 (3,639) ======================================== Net income per share $0.27 0.27 0.21 (0.47) ========================================
During the fourth quarter of 1996, the Company realized an after tax gain of $1.6 million from the sale of a portion of its investment in Kingsway. Also during the fourth quarter of 1996, the Company increased its surety reserves $570 thousand on a pre-tax basis for prior period development. During the fourth quarter of 1995, the Company, on a pre-tax basis, increased its provision for loss and loss adjustment expenses by approximately $4.0 million, wrote-off approximately $600 thousand of deferred acquisition costs deemed unrecoverable related to its professional liability business, and recorded $400 thousand in charges for contingently non-recoverable reinsurance on programs terminated in 1993. (10) STOCK OPTIONS AND STOCK APPRECIATION RIGHTS On July 28, 1987, the Company's stockholders approved the Company's 1987 Non-Qualified and Incentive Stock Option Plan (Option Plan). A total of 600 thousand shares of common stock were authorized for issuance under the Option Plan upon exercise of incentive stock options and non-qualified stock options. On November 13, 1989, options were granted which were exercisable at $5.00 per share, totaling 54 thousand shares. During 1991, an additional 44 thousand options were granted with an exercise price of $14.50 per share. On November 12, 1992, an additional 33 thousand options were granted at $14.00 per share as the exercise price. During 1993, options granted at $5.00 per share were exercised, resulting in the issuance of 5 thousand new shares. On May 19, 1994, an additional 4 thousand options were granted at $10.25 per share as the exercise price. On November 10, 1994, 29 thousand options were granted at $8.00 per share as the exercise price. During 1994, options granted at $5.00 per share were exercised, resulting in the issuance of 10 thousand new shares. On August 22, 1995, 6,000 options were granted at an exercise price of $11.75. On November 10, 1995, 36,000 options were granted at an exercise 33 price of $13.25. No options were exercised in 1995. On August 7, 1996, 6,000 options were granted at an exercise price of $8.33. During 1996, options granted at $5.00 per share were exercised, resulting in the issuance of 19 thousand new shares. There are vested and non-vested options outstanding to purchase 163 thousand shares of stock at prices ranging from $5.00 to $14.50 at December 31, 1996. The Company also has 30 thousand stock appreciation rights outstanding at December 31, 1996 with exercise prices ranging from $8.25 to $9.25 per share. (11) COMMITMENTS The Company has obligations under long-term operating leases for its office premises in the United States, Hong Kong, and the United Kingdom. The future minimum lease payments are as follows (in thousands): 1997 $1,221 1998 1,067 1999 1,011 2000 934 2001 866 2002 and thereafter 101 ------ $5,200 ====== 34 Included in other underwriting expenses is rental expense of $1.5 million, $1.3 million, and $1.1 million for 1996, 1995, and 1994, respectively. The Company has indemnification agreements with each of the Company's directors whereby the Company has agreed to indemnify each director from certain losses and expenses. Certain amounts are excluded from the Company's indemnification obligation, including any illegal payments or fraudulent, dishonest, or willful misconduct. In addition, the directors have agreed to reimburse the Company for all losses and expenses paid by the Company in connection with any action, suit, or proceeding in which a court in a final adjudication decides that the director is not entitled to indemnification. (12) CAPITALIZATION In March 1993, the Company obtained a $10.0 million revolving bank line of credit. In March 1996, this revolving line was increased to $15.0 million. At December 31, 1996 and 1995, the outstanding balance on the line of credit amounted to approximately $9.7 million. The aggregate amount of the commitment is reduced as set forth below: Aggregate Amount of Loan Commitment On or Before ------------------ ------------ $15,000,000 12/31/1996 $13,750,000 01/01/1997 $12,500,000 07/01/1997 $11,250,000 01/01/1998 $10,000,000 07/01/1998 $ 8,750,000 01/01/1999 $ 7,500,000 07/01/1999 $ 6,250,000 01/01/2000 $ 5,000,000 07/01/2000 $ 3,750,000 01/01/2001 $ 2,500,000 07/01/2001 $ 0 12/01/2001 Interest on the revolving loans is adjustable to either the bank prime rate or LIBOR plus 1.65% at the option of the Company at each interest period. Debt service on the revolving line of credit is limited to interest only payable monthly. The proceeds from the line of credit borrowings were used to cure deficiencies in IAS's premium trust fund accounts and to increase the capital and surplus of the Company's insurance subsidiaries. The line of credit and the term loan are collateralized by the Company's stock of IIC and Kingsway. Under the terms of the loan agreement, the Company must maintain tangible net worth, as defined (based on generally accepted accounting principles), of at least 35 $29.5 million at December 31, 1996 (increasing $2.5 million per year, thereafter), maintain statutory net worth of IIC at certain levels, and limit dividends to 25% of consolidated net income for the prior four quarters. The Company paid interest expense of $768 thousand, $987 thousand, and $512 thousand in 1996, 1995, and 1994, respectively. 36 (13) SUPPLEMENTAL DUTY DEPOSITS Supplemental duty deposits are security deposits held by IAS until the insured bond principal (Depositor) has settled duty charges imposed by U.S. Customs. Under the terms of the agreement with the Depositor, the Depositor is not entitled to a refund of its deposit until it has provided competent written legal evidence that the conditions of each and every bond connected with the deposit have been fully satisfied. IAS considers its liability to the Depositor to have expired after seven years if the Depositor has not met the conditions necessary to receive a refund under the terms of the deposit agreement. The expiration of the liability for these deposits was $33 thousand, $31 thousand, and $119 thousand in 1996, 1995, and 1994, respectively, and is reflected in the accompanying consolidated statements of income. (14) FOREIGN OPERATIONS Revenues, operating income, and identifiable assets included in the accompanying consolidated financial statements related to foreign operations as of and for the years ended December 31, 1996, 1995, and 1994, were as follows:
December 31, 1996 1995 1994 ------------------------- (dollars in millions) Revenues $4.0 35.9 32.6 Operating income $0.4 4.6 3.9 Identifiable assets $8.3 3.4 42.9
(15) LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES Loss and loss adjustment expense reserves are based on long-range projections which are subject to uncertainty. Uncertainty regarding reserves of a given accident year is gradually reduced as new information emerges each succeeding year, allowing more reliable reevaluations of such reserves. While management believes that reserves as of December 31, 1996, are adequate, uncertainties in the reserving process could cause such reserves to develop favorably or unfavorably as new or additional information emerges. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Movements in reserves which are small relative to the amount of such reserves could significantly impact future reported earnings of the Company. 37 Activity related to unpaid loss and loss adjustment expenses (LAE) follows (in thousands):
Year Ended December 31, 1996 1995 1994 ------------------------------- Unpaid Losses and LAE at the beginning of the period, net of reinsurance recoverables of $3,138, $3,830, and $3,407 $33,155 35,006 26,289 Unpaid Losses and LAE of acquired entities at the beginning of the period - 1,300 - ---------------------------------- Adjusted unpaid losses and LAE at the beginning of the period 33,155 36,306 26,289 ---------------------------------- Provision for Losses and LAE for claims occurring during: Current year 31,876 45,642 39,462 Prior years 431 6,104 2,137 ---------------------------------- Total 32,307 51,746 41,599 ---------------------------------- Less Losses and LAE payments for claims occurring during: Current year (10,798) (17,491) (18,638) Prior years (17,607) (20,205) (14,244) ---------------------------------- Total (28,405) (37,696) (32,882) ---------------------------------- Adjustment due to deconsolidation of Kingsway - (17,201) - ---------------------------------- Unpaid Losses and LAE at the end of period, net of reinsurance recoverables of $9,980, $3,138, and $3,830 $37,057 33,155 35,006 ==================================
During 1995, it became apparent that the estimated unpaid claims for liabilities established at December 31, 1994 on Kingsway's business lines would exceed initial expectations and loss reserves were increased accordingly by $4.0 million. Also, during 1995, loss experience related to U.S. operations for 1994 and prior years suggested reserve increases amounting to $5.2 million were required for the marine cargo, contract surety and other property and casualty lines. These increases were offset by savings of $3.1 million on 1994 and prior U.S. customs bonds reserve estimates. During 1995, it became apparent that the estimated upaid claims for liabilities established at December 31, 1994 on Kingsway's business lines would exceed initial expectations and loss revenues were increased accordingly by $4.0 million. Also, during 1995, loss experience related to U.S. operations for 1994 and prior years suggested reserve increases amounting to $5.2 million were required for the marine cargo, contract surety and other property and casualty lines. These increases were offset by savings of $3.1 million on 1994 and prior U.S. customs bonds reserve estimates. (16) EMPLOYEE BENEFIT PLAN The Company sponsors a defined contribution plan covering substantially all employees. The plan provides for Company contributions at the discretion of the board of directors. For 1996, 1995 and 1994, the Company contributed $0.50 for each $1.00 contributed by the participants up to 5% of employee compensation. The Company's cost of this plan was $116 thousand, $94 thousand, and $88 thousand in 1996, 1995 and 1994, respectively. (17) FINANCIAL INSTRUMENTS In the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The fair value estimates of financial instruments presented below are not necessarily indicative of the amounts the Company might pay or receive in actual market transactions. Potential taxes and 38 other transaction costs have not been considered in estimating fair value. As a number of the Company's significant assets and liabilities are not considered financial instruments, the disclosures that follow do not reflect the fair value of the Company as a whole. The estimated fair values of the Company's financial instruments at December 31, 1996 are as follows (in thousands):
Carrying Fair Value Value ----------------------- Assets: Fixed maturities $51,567 51,567 Equity securities 1,557 1,557 Investment in investee 13,519 50,327 Cash and cash equivalents 18,492 18,492 Premiums receivable 16,231 16,231 Reinsurance recoverable on paid claims 96 96 Notes receivable 672 672 Liabilities: Funds held by Company 491 491 Supplemental duty deposits 2,358 2,358 Notes payable 9,735 9,735
The estimated fair values of the Company's financial instruments at December 31, 1995 are as follows (in thousands):
Carrying Fair Value Value ----------------------- Assets: Fixed maturities $44,769 44,769 Equity securities 3,474 3,474 Investment in investee 11,898 17,590 Cash and cash equivalents 16,478 16,478 Premiums receivable 14,920 14,920 Reinsurance recoverable on paid claims 1,192 1,192 Notes receivable 349 349 Income tax recoverable 1,092 1,092 Liabilities: Funds held by Company 748 748 Supplemental duty deposits 2,669 2,669 Notes payable 9,735 9,735
Fixed maturities, equity securities, and the investment in investee are valued at quoted market prices, where available, or from independent pricing sources. Cash and cash equivalents, premiums receivable, reinsurance recoverable on paid claims, funds held, and supplemental duty deposits are valued at their carrying value due to their short-term nature. The carrying value of notes receivable and notes payable approximates fair value as the notes bear floating rates of interest. (18) FOREIGN CURRENCY TRANSLATION 39 The net assets of the Company's foreign operations are translated into U.S. dollars using exchange rates in effect at each year end. An analysis of this account for the respective years ended December 31 follows (amounts in thousands):
Year Ended December 31, 1996 1995 1994 -------------------------------- Beginning amount of cumulative translation adjustments $(1,179) (2,002) (1,375) Included in Kingsway's basis at sale 189 319 - Aggregate adjustment for the period resulting from translation adjustments 12 504 (627) -------------------------------- Net aggregate translation included in equity 201 823 (627) -------------------------------- Ending amount of cumulative translation adjustments $ (978) (1,179) (2,002) -------------------------------- Canadian foreign exchange rate at end of year 0.72970 0.73290 0.71290 British foreign exchange rate at end of year 1.71250 1.55300 1.56500 Hong Kong foreign exchange rate at end of year 0.12930 0.12930 0.12925
(19) INVESTMENT IN KINGSWAY Kingsway is a property and casualty insurance holding company based in Canada which primarily writes and assumes commercial and other automobile insurance considered to be non-standard, and other specialty insurance for commercial properties through its 100% owned subsidiaries, Kingsway General Insurance Company and York Fire & Casualty Insurance Company. Included in the Company's consolidated retained earnings is undistributed net income from Kingsway of approximately $9.3 million and $7.6 million at December 31, 1996 and December 31, 1995 respectively. The following presents summary financial data for Kingsway as of December 31, 1996 and 1995, and for each of the years in the three-year period ended December 31, 1996 (in thousands).
December 31, 1996 1995 ------------------- Assets: Investments $111,052 43,918 Other assets 70,084 20,434 ------------------- Total assets $181,136 64,352 =================== Liabilities: Unpaid claims $ 66,152 17,826 Unearned premiums 46,747 17,531 Other liabilities 5,020 2,115 ------------------- Total liabilities $117,919 37,472 Shareholders' equity 63,217 26,880 ------------------- Total liabilities and shareholders' equity $181,136 64,352 ===================
40
Year Ended December 31, 1996 1995 1994 -------------------------- Revenues: Net premiums earned $78,972 33,617 31,043 Other revenues 8,103 3,585 2,441 ----------------------------- Total revenues 87,075 37,202 33,484 ----------------------------- Expenses: Claims incurred 51,257 22,360 19,870 Other expenses 24,263 10,118 9,276 ----------------------------- Total expenses 75,520 32,478 29,146 ----------------------------- Income before income taxes 11,555 4,724 4,338 Income taxes 3,369 1,975 1,926 ----------------------------- Net income $ 8,186 2,749 2,412 =============================
41 EX-21 9 EXHIBIT 21 SUBSIDIARIES OF THE COMPANY STATE OR JURISDICTION SUBSIDIARY OF INCORPORATION - ---------- ---------------- Intercargo Insurance Company Illinois Intercargo Insurance Company H.K. Limited Hong Kong Intercargo International Limited British Virgin Islands International Advisory Services, Inc. (1) Illinois TRM Insurance Services, Inc. Illinois (1) International Advisory Services has nine subsidiaries all known as Trade Insurance Services, Inc. and operating as insurance agencies. These are located in various states as well as one location each in Canada and Hong Kong. EX-23 10 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders of Intercargo Corporation: We consent to incorporation by reference in registration statement No. 333-11867 on Form S-8 of Intercargo Corporation of our report dated February 21, 1997, relating to the consolidated balance sheets of Intercargo Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996, and all related schedules, which report appears in the December 31, 1996 annual report on Form 10-K of Intercargo Corporation. KPMG Peat Marwick LLP Chicago, Illinois March 31, 1997 EX-27 11
7 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 51,567 51,567 51,567 1,557 0 0 66,643 18,492 10,076 3,884 133,710 47,037 17,617 0 0 9,735 0 0 7,660 40,352 133,710 61,053 3,903 2,461 824 32,307 17,410 14,906 3,618 668 2,950 0 0 0 6,404 0.84 0.84 33,155 31,876 431 10,798 17,607 37,057 431
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