-----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, D1k9ZlJQx+jWUSSGBIWU2hI4JmWX1CXXM2gKIIt5vrHGUXUsDBk4jcvyGThePWG8 hONPh+Ml+0V2b6KOXJWOnQ== 0001005477-99-001564.txt : 19990402 0001005477-99-001564.hdr.sgml : 19990402 ACCESSION NUMBER: 0001005477-99-001564 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENHANCE FINANCIAL SERVICES GROUP INC CENTRAL INDEX KEY: 0000881889 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE CARRIERS, NEC [6399] IRS NUMBER: 133333448 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-10967 FILM NUMBER: 99582303 BUSINESS ADDRESS: STREET 1: 335 MADISON AVE CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 2129833100 MAIL ADDRESS: STREET 1: 335 MADISON AVENUE STREET 2: 25TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10017 10-K405 1 FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended Commission file December 31, 1998 number 1-10967 ENHANCE FINANCIAL SERVICES GROUP INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) New York 13-3333448 - -------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 335 Madison Avenue, New York, NY 10017 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 212-983-3100 Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.10 par value New York Stock Exchange, Inc. - ---------------------------- ------------------------------------------- (Title of Class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None ---------------- (Title of class) 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 definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| The approximate aggregate market value of voting stock held by non-affiliates of the registrant as of the close of trading on March 26, 1999 was $783,431,009. The number of shares of Common Stock outstanding as of that date was 37,933,836. For purposes of this calculation, shares of Common Stock held by directors, executive officers and shareholders whose ownership exceeds ten percent of the Common Stock outstanding on that date were excluded. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant. PART I Item 1. Business. GENERAL Enhance Financial Services Group Inc. ("Enhance Financial," and together with its consolidated subsidiaries, the "Company") is a holding company engaged, through its subsidiaries, principally in the reinsurance of financial guaranties of municipal and asset-backed debt obligations issued by monoline financial guaranty insurers. The Company is also engaged in other insurance, reinsurance and asset-based businesses that utilize the Company's expertise in performing sophisticated analysis of complex, credit-based risks. The Company's businesses are divided into two operating segments: insurance businesses and asset-based businesses. The Company's business strategy is to maintain its financial guaranty business, both primary and reinsurance, and its commitment to intensive and prudent credit underwriting and conservative investment policies; to utilize its expertise in underwriting credit risks to expand and develop its other insurance businesses; and to continue to pursue its asset-based businesses and diversification efforts utilizing its credit analysis skills in areas that the Company believes have strong profit and growth potential relative to risk. The Company expects that a significant portion of its growth will come from asset-based businesses and non-financial guaranty businesses. As part of its diversification and expansion efforts, the Company expects to further develop its strategic relationships with Mortgage Guaranty Insurance Corporation ("MGIC"), a leading U.S. provider of private mortgage insurance coverage, and Swiss Reinsurance Company ("Swiss Re"), both initiated in 1996. Reinsurance of financial guaranties issued by monoline financial guaranty insurers represented 61.8% of the Company's gross premiums written for the year ended December 31, 1998. During the year ended December 31, 1998, the Company received 24.7% of the total reinsurance premiums ceded by all monoline financial guaranty insurers. The Company's other insurance businesses include the issuance of direct financial guaranties of smaller debt obligations, trade credit reinsurance and excess-SIPC/excess-ICS and similar types of bonds. These other insurance businesses represent 38.2% of the Company's gross premiums written for the year ended December 31, 1998. The Company is also engaged in various asset-based businesses, including the origination, purchase, servicing and/or securitization of special assets, including state lottery awards, structured settlements, viatical settlements, sub-performing/non-performing and seller-financed residential mortgages and delinquent unsecured consumer assets. The Company is continuing to expand these asset-based businesses and is diversifying its products and services into other areas that the Company believes have strong growth potential and in which the Company's strengths in credit analysis and securitization can provide a competitive advantage. Enhance Financial has since its inception conducted substantially its entire insurance business through its wholly-owned indirect financial guaranty insurance subsidiaries, Enhance Reinsurance Company ("Enhance Re") and Asset Guaranty Insurance Company ("Asset Guaranty"; together, the "Insurance Subsidiaries"). Enhance Re has been rated by Standard & Poor's Corporation ("Standard & Poor's"), Moody's Investors Service, Inc. ("Moody's") and Duff & Phelps Credit Rating Company ("Duff & Phelps"), each of which have assigned it triple-A claims-paying ability ratings, their highest respective ratings. Asset Guaranty has been rated by Duff & Phelps and Standard & Poor's, which have assigned it triple-A and double-A claims-paying ability ratings, respectively. On March 29, 1999, Moody's advised the Company that it had placed on review for possible downgrade both the Aaa insurance financial strength rating of Enhance Re and the Aa3 senior long-term debt rating of Enhance Financial. Moody's explained that this action with respect to Enhance Re's rating was based on the possible increased risk and strain to Enhance Re resulting from the Company's diversification and on the increasing competition in the reinsurance industry. Moody's explained this action with respect to Enhance Financial's debt rating was based on the Company's diversification into what Moody's described as higher-return non-insurance businesses with risk characteristics that are distinct from the Company's traditional financial guaranty activities. See "Description of Business -- Rating Agencies" in this section. FINANCIAL GUARANTY INSURANCE INDUSTRY OVERVIEW General Financial guaranty insurance provides an unconditional and irrevocable guaranty to the holder of a debt obligation of full and timely payment of principal and interest. In the event of a default under the obligation, the insurer has recourse against the issuer and/or any related collateral (which is a more common component in the case of insured asset-backed obligations or other non-municipal debt) for amounts paid under the terms of the policy. Payments under the insurance policy may not be accelerated by the holder of the debt obligation. Absent payment in full at the option of the insurer, in the event of a default under an insured obligation, the holder continues to receive payments of principal and interest on schedule, as if no default had occurred. Each subsequent purchaser of the obligation generally receives the benefit of such guaranty. The issuer of the obligation pays the premium for financial guaranty insurance either in full at the inception of the policy or, less commonly, in installments on an annual basis. Premium rates are typically calculated as a percentage of either the principal amount of the debt or total exposure (principal and interest). Rate setting reflects such factors as the credit strength of the issuer, type of issue, sources of income, collateral pledged, restrictive covenants, maturity and competition from other insurers. Premiums are generally non-refundable and are earned over the life of the insured obligation. This long and relatively predictable earnings pattern is characteristic of the financial guaranty insurance industry and provides a relatively stable source of future revenues and claims-paying ability to financial guaranty insurers and reinsurers. There are currently four major monoline primary U.S. financial insurers: MBIA Insurance Corporation ("MBIA"), AMBAC Assurance Corporation ("AMBAC"), Financial Guaranty Insurance Company ("FGIC") and Financial Security Assurance Inc. ("FSA"). Two previous primary U.S. financial insurers, Capital Market Assurance Corporation ("CapMAC") and Construction Loan Insurance Corporation ("Connie Lee"), were acquired by MBIA in February 1998 and by AMBAC in December 1997, respectively. Financial Guaranty Market The primary financial guaranty insurance market consists of two main sectors: municipal bond insurance and insurance on asset-backed debt. Municipal Bond Market. Municipal bond insurance provides credit enhancement of bonds, notes and other evidences of indebtedness issued by states and their political subdivisions (for example, counties, cities, or towns), utility districts, public universities and hospitals, public housing and transportation authorities, and other public and quasi-public entities. Municipal bonds are supported by the issuer's taxing power in the case of general obligation or special tax-supported bonds, or by its ability to impose and collect fees and charges for public services or specific projects in the case of most revenue bonds. Insurance provided to the municipal bond market has been and continues to be the major source of revenue for the financial guaranty insurance industry. 2 The following table sets forth certain information regarding new-issue long term (over one year) municipal bonds and new-issue insured long term municipal bonds, in each case issued during the years indicated:
New Insured Volume New New as Percent of Year Total Volume (1) Insured Volume (1) New Total Volume - ---- ---------------- ------------------ ---------------- (Dollars in billions) 1994 $165.0 $ 61.5 37.3% 1995 160.0 68.5 42.8 1996 185.0 85.7 46.3 1997 220.7 107.5 48.7 1998 286.0 145.3 50.8
- ----------------------- (1) Based upon estimated data provided by The Bond Buyer, February 9, 1999. The overall increase in the volume of municipal bond issuance in 1998 resulted from an increase in refunding issues, which represented 28.5% of total issuance compared to 27.3% in 1997, as well as a higher amount of bonds issued for new money purposes, which increased to $161.7 billion in 1998 from $138.6 billion in 1997. Asset-Backed Debt Market. Asset-backed transactions or securitizations constitute a form of structured financing which are distinguished from unsecured debt issues by being secured by a specific pool of assets held by the issuing entity, rather than relying on the general unsecured creditworthiness of the issuer of the obligation. While most asset-backed debt obligations represent interests in pools of assets, such as residential and commercial mortgages and credit card and auto loan receivables, monoline financial guarantors have also insured asset-backed debt obligations secured by one or a few assets, such as utility mortgage bonds and multi-family housing bonds. While the asset-backed securities market has grown significantly in recent years, consensus estimates are lacking as to the insured volume. Reinsurance Reinsurance is the commitment by one insurance company, the "reinsurer," to reimburse another insurance company, the "ceding company," for a specified portion of the insurance risks underwritten by the ceding company. Because the insured party contracts for coverage solely with the ceding company, the failure of the reinsurer to perform does not relieve the ceding company of its obligation to the insured party under the terms of the insurance contract. While reinsurance provides various benefits to the ceding company, perhaps most importantly it enables a primary insurer to write greater single risks and greater aggregate risks without contravening the capital requirements of applicable state insurance laws and rating agency guidelines. State insurance regulators allow primary insurers to reduce the liabilities appearing on their balance sheets to the extent of reinsurance coverage obtained from licensed reinsurers or from unlicensed reinsurers meeting certain solvency and other financial criteria. Similarly, the rating agencies permit such a reduction for reinsurance in an amount that depends on the claims-paying ability rating of the reinsurer. See "Insurance Regulatory Matters" and "Description of Business -- Rating Agencies" in this section. 3 The principal forms of reinsurance are treaty and facultative. Under a treaty arrangement the ceding company is obligated to cede, and the reinsurer is correspondingly obligated to assume, a specified portion of a specified type of risk or risks insured by the ceding company during the term of the treaty (although the reinsurance risk thereafter extends for the life of the respective underlying obligations). Under a facultative agreement, the ceding company from time to time during the term of the agreement offers a portion of specific risks to the reinsurer, usually in connection with particular debt obligations. A facultative arrangement further differs from a treaty arrangement in that under a facultative arrangement the reinsurer oftentimes performs its own underwriting credit analysis to determine whether to accept a particular risk, while in a treaty arrangement the reinsurer generally relies on the ceding company's credit analysis. Both treaty and facultative agreements are typically entered into for an indefinite term, subject to a right of termination under certain circumstances. Treaty and facultative reinsurance are typically written on either a proportional or non-proportional basis. Proportional relationships are those in which the ceding company and the reinsurer share the premiums, as well as the losses and expenses, of a single risk or group of risks in an agreed percentage. In addition, the reinsurer generally pays the ceding company a ceding commission, which is typically related to the ceding company's cost of obtaining the business being reinsured. Non-proportional reinsurance relationships are typically on an excess-of-loss basis. An excess-of-loss relationship provides coverage to a ceding company up to a specified dollar limit for losses, if any, incurred by the ceding company in excess of a specified threshold amount. Reinsurers may also, in turn, purchase reinsurance under retrocessional agreements to cover all or a portion of their own exposure for reasons similar to those that cause primary insurers to purchase reinsurance. See "Description of Business - Reinsurance Ceded" in this item. DESCRIPTION OF BUSINESS Insurance Businesses Reinsurance of Monoline Financial Guaranty Insurers The Company's principal business is the reinsurance of financial guaranty insurance written by the U.S. monoline financial guaranty insurers. The Company provides reinsurance on a treaty and/or a facultative basis for such companies. See "Sources of Premiums" in this item. As of December 31, 1998, 39.6% of the Company's insurance in force attributable to the monoline financial guaranty insurers represented business underwritten on a treaty basis, with the balance being facultative. The reinsurance written by the Company is subject to a detailed underwriting review. Most of the Company's reinsurance activity is written on a proportional reinsurance basis. The Company believes that the reinsurance of municipal bond guaranties, which the Company expects will grow in response to the anticipated long-term growth in the municipal bond market, provides a relatively stable source of premium income for the Company. In addition, premiums received are credited as deferred premium revenue and are earned as the related risks amortize, thereby providing a relatively stable, predictable source of earned premiums. Premiums Ceded by Individual Primary Insurers. The following table sets forth certain information regarding written premiums ceded to the Company by the monoline financial guaranty insurers in 1998, 1997 and 1996: 4
Year Ended December 31, ------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Gross Gross Gross Premiums Percent of Premiums Percent of Premiums Percent of Primary Insurer Ceded Total Ceded Total Ceded Total - --------------- ----- ----- ----- ----- ----- ----- (Dollar amounts in millions) MBIA (1) $24.8 30.8% $26.6 45.2% $23.9 42.0% FSA 24.3 30.1 17.3 29.4 14.0 24.6 AMBAC (2) 24.2 30.0 10.1 17.2 11.7 20.6 FGIC 7.0 8.7 4.8 8.2 7.3 12.8 Other - Foreign 0.3 0.4 -- -- -- -- ----- ----- ----- ----- ----- ----- Total $80.6 100.0% $58.8 100.0% $56.9 100.0% ===== ===== ===== ===== ===== =====
(1) Includes $5.9 million (or 7.3% of total), $8.0 million (or 13.6% of total) and $6.2 million (or 10.9% of total) of gross premiums ceded for 1998, 1997 and 1996, respectively, by CapMAC, which was acquired by MBIA in February 1998. (2) Includes $0.3 million (or 0.5% of total) and $2.3 million (or 4.0% of total) of gross premiums ceded for 1997 and 1996, respectively, by Connie Lee, which was acquired by AMBAC in December 1997. Insurance Portfolio Data. The Company seeks to maintain a diversified insurance portfolio designed to spread its risk based on issuer, type of debt obligation insured and geographic concentration. The following table sets forth the distribution of the Company's reinsured monoline-guarantied obligations by bond type as of December 31, 1998.
As of December 31, 1998 ------------------------------------------ Type of Obligation Insurance in Force(1) Percent of Total - ------------------ --------------------- ---------------- (In billions) Municipal: General obligation/tax supported ............ $ 21.0 30.5% Water/sewer/electric/gas .................... 11.2 16.2 Airports/transportation ..................... 7.7 11.2 Health care ................................. 7.1 10.3 Housing revenue ............................. 1.5 2.2 Other (2) ................................... 5.1 7.4 ----- ----- Total municipal .......................... 53.6 77.8 ----- ----- Non-municipal Consumer obligations ........................ 7.0 10.2 Investor-owned utilities .................... 4.1 5.9 Commercial mortgage ......................... 0.2 0.3 Other (3) ................................... 4.0 5.8 ----- ----- Total non-municipal ...................... 15.3 22.2 ----- ----- Total .................................... $ 68.9 100.0% ===== =====
5 - ---------- (1) Represents the Company's proportionate share of the aggregate outstanding principal and interest payable on such insured obligations. (2) Represents other types of municipal obligations, none of which individually constitutes a material amount or percentage of the Company's insurance in force. (3) Includes $1.7 billion collateralized by corporate debt obligations. The balance represents other types of assets which collateralize obligations reinsured by the Company, none of which individually constitutes a material amount or percentage of the Company's insurance in force. The following table identifies by issuer the Company's ten largest single-risk insurance in force amounts outstanding as of December 31, 1998 and the credit rating assigned by Standard & Poor's as of that date (in the absence of financial guaranty insurance) to each such issuer:
Insurance in Force as of Credit Credit Rating Obligation Type December 31, 1998 - ------ ------------- --------------- ----------------- (In millions) New York City Municipal Water Finance Authority A- Water & Sewer $ 981.2 New York City, NY ........ BBB+ General Obligation 888.3 Port Authority of New York and New Jersey ......... AA Transportation 771.2 State of California ...... A+ General Obligation 740.9 Commerzbank - Citibank London ................. AAA Consumer Obligation 657.5 Commonwealth of Puerto Rico ............ A General Obligation 635.6 Dade County, Florida Water & Sewer System ......... A Water & Sewer 602.7 Houston, TX Combined Water & Sewer System ......... A Water & Sewer 591.2 San Francisco International Airport, CA ..................... A+ Airport 558.3 Commonwealth of Massachusetts .......... A+ General Obligation 540.5
The following table sets forth the distribution by state of the Company's insurance in force in connection with its reinsurance of monoline-guarantied obligations as of December 31, 1998:
As of December 31, 1998 ----------------------------------------- Jurisdiction Insurance in Force Percent of Portfolio - ------------ ------------------ -------------------- (In billions) California ............................ $8.2 11.9% New York .............................. 7.5 10.9 Florida ............................... 4.5 6.5 Texas ................................. 3.8 5.5 Pennsylvania .......................... 3.2 4.6 Illinois .............................. 2.8 4.1 New Jersey ............................ 2.7 3.9 Massachusetts ......................... 2.6 3.8
6 Puerto Rico ........................... 2.2 3.2 Ohio .................................. 1.5 2.2 Other (1) ............................. 29.9 43.4 ----- ----- Total $68.9 100.0% ===== =====
- --------------- (1) Includes $14.8 billion related to pooled or foreign credits for which specific allocation by state is not available. The balance represents all remaining states, the District of Columbia and several foreign countries, in which obligations insured and reinsured by the Company arise, none of which individually constitutes a material portion of the Company's insurance in force. Underwriting Staffing, Policies and Procedures. The Company believes that its underwriting discipline has been critical to its profitable growth. The Company has a structured underwriting process to determine the characteristics and creditworthiness of risks that it reinsures, which process supplements the underwriting procedures of the primary insurers. Rather than relying entirely upon the underwriting performed by the primary insurers, both the Company and the rating agencies conduct extensive reviews of the primary insurers. The Company conducts periodic detailed reviews of each monoline primary carrier with which it does treaty or facultative business. That review entails an examination of the primary insurer's operating, underwriting and surveillance procedures; personnel; organization and existing book of business, as well as the primary insurer's underwriting of a sample of business assumed under the treaty. Facultative transactions are reviewed individually under procedures adopted by the Company's credit committee. Any underwriting issues are discussed internally by the Company's credit committee and with the primary insurer's personnel. Moreover, the Company relies on ongoing oversight by its credit committee to avoid undue exposure concentration in any given type of obligation or geographic area. Moreover, the ceding insurer is typically required to retain at least 25% of the exposure on any single risk assumed. Limitations on the Company's single-risk exposure derive from state insurance regulation, rating agency guidelines and internally established criteria. The primary factor in determining single-risk capacity is the class or sector of business being underwritten. For municipal credits, the Company has self-imposed single-risk guidelines which range widely, depending upon the perceived risk of default of the municipal obligation reinsured. For asset-backed transactions, the Company's single-risk guidelines generally follow state insurance regulation limitations, as well as self-imposed single risk and cumulative servicer-related risk. On individual underwritings, the Company's credit committee may limit the allocation of capacity to an amount below that allowed by the single-risk guidelines noted above. The Company's surveillance procedures include reviews of those exposures assumed as a reinsurer as to which it may have concerns. The Company also maintains regular communication with the surveillance departments of the ceding primary insurers. 7 Other Insurance Businesses The Company services certain insurance specialty markets not served by the monoline financial guaranty industry. In certain of these new business areas, the Company operates as a primary insurer in areas or for transactions where the monoline financial guaranty primaries may decline to provide coverage; others involve the Company serving as a reinsurer for certain specialty primary insurers, in some of which the Company has significant equity interests or is otherwise a participant. In writing these other insurance lines of business, the Company utilizes its expertise in evaluating complex credit-based risks. These businesses represent 38.2% of the Company's gross premiums written for the year ended December 31, 1998, compared to 45.7% for the year ended December 31, 1997. The Company's business strategy is to expand and develop further these other insurance lines, which the Company believes have strong profit and growth potential and where the Company's expertise can be utilized. Premiums in respect of certain of the Company's other insurance businesses are earned over a significantly shorter period than those in respect of the Company's monoline reinsurance business. The Company's ability to realize consistent levels of earned premiums in these insurance businesses will therefore depend on its ability to write consistent levels of new insurance. The following tables set forth certain information concerning the Company's other insurance businesses as of December 31, 1998 and for the year then ended:
Insurance in Force(1) Category of Other Insurance Business As of December 31, 1998 - ------------------------------------ ----------------------- (In billions) Municipal bonds - direct ..................................... $5.7 Multi-family housing-backed financings ....................... 0.3 Other (2) .................................................... 0.8 ---- Total $6.8 ====
- ---------------------- (1) Does not include insurance in force pursuant to the excess-SIPC/excess-ICS program described below in this section. (2) Includes $0.2 billion of financial responsibility bonds in force, a line of business which the Company has decided to exit in 1999.
Year Ended December 31, 1998 --------------------------------- Net Premiums Category of Other Insurance Business Written Premiums Earned - ------------------------------------ ------- --------------- (In millions) Municipal bonds - direct ................... $17.6 $ 8.3 Trade credit reinsurance ................... 16.9 16.0 Other (1) .................................. 14.2 12.2 ----- ----- Total $48.7 $36.5 ===== =====
(1) Includes $1.8 million of Net Premiums Written and $2.5 million of Premiums Earned for financial responsibility bonds, a line of business which the Company has decided to exit in 1999. 8 Municipal bonds. The Company writes municipal bond insurance as a primary insurer in certain transactions where the financial guaranty monoline primary insurers generally elect not to participate. This writing is focused on various market sectors including tax-backed obligations, infrastructure revenue bonds, health-care bonds, higher education bonds and municipal lease obligations. Each such issue, after being insured, is reviewed by Standard & Poor's and Duff & Phelps, which determine the credit quality of the issue and report their findings to the Company. Trade Credit Reinsurance. Trade credit reinsurance protects sellers of goods under certain circumstances against non-payment of the receivables they hold from buyers of those goods. The Company covers receivables both where the buyer and seller are in the same country as well as cross-border receivables. Sometimes in the latter instance, the coverage extends to certain political risks (foreign currency controls, expropriation, etc.) which interfere with the payment from the buyer. The Company is a member-reinsurer, together with Great American Insurance Company, of the Foreign Credit Insurance Association ("FCIA"), which guaranties export financing for transactions between exporters and foreign purchasers. As of December 31, 1998, Enhance Financial owned an indirect 36.5% equity interest (representing 55% of the voting interest) in Exporters Insurance Company Ltd. ("Exporters"), an insurer of domestic and foreign trade receivables for multinational companies. The Company provides significant reinsurance capacity to this joint venture on a proportional quota-share basis. In addition, the Company participates in proportional and non-proportional reinsurance treaties with approximately 25 credit insurers, including many in Europe. The largest relationships in terms of premiums are with the FCIA (domiciled in the United States), the Euler Group (major subsidiaries domiciled in France, Belgium, the Netherlands, the United Kingdom and the United States) and Exporters (domiciled in Bermuda). In order to expand the trade credit reinsurance business, the Company is in the process of establishing a contact office in London, England to market and manage relationships with trade credit primary insurers. Upon receipt of appropriate authorizations in the United Kingdom, the London office will also underwrite trade credit insurance. Excess-SIPC/Excess-ICS. The Company writes surety bonds for the protection of customers of large securities brokers against the loss of securities, and in some cases, cash, in their brokerage accounts in the event of the broker's insolvency and liquidation. Bonds issued under this program typically provide coverage for loss per account in excess of the $500,000 in the case of loss covered by the U.S.-government-established Securities Investor Protection Corporation ("SIPC"), or 48,000 pounds sterling (approximately $78,000) in the case of loss covered by the U.K.-government-established Investors Compensation Scheme ("ICS"). The coverage is offered only to the members of the securities brokerage community that meet specific financial, legal and operating criteria established by the Company. Although the dollar value of customer account assets protected by the Company's excess-SIPC/excess-ICS policies totals in the billions, the Company's estimated exposure is considerably lower. Losses in a brokerage account occur only to the extent, if any, a covered broker-dealer becomes insolvent and securities are missing and the individual customer losses, which are prorated among all the customers of that broker-dealer, exceed the applicable deductible amount, 9 which ranges from $500,000 for losses covered by SIPC, or 48,000 pounds sterling for losses covered by ICS. As part of its underwriting process, the Company reviews the operations and exposure amounts of each broker-dealer applying for coverage and calculates a maximum loss based on the normal day-to-day operational exposures of that broker-dealer. Financial Responsibility Bonds. The Company owns substantially the entire interest in Van-American Insurance Company ("Van-Am"), which writes reclamation bonds for the coal mining industry, generally in strip mining ventures, and surety bonds covering the closure and post-closure obligations of landfill operators. Asset Guaranty reinsures the reclamation bonds for the coal mining industry issued by Van-Am on both a treaty and facultative basis and surety bonds for landfill operators issued by Van-Am on a facultative basis only. Due to intense pricing competition in Van-Am's core business and a poor strategic fit with the Company's other operations, the Company has decided to exit this line of business. The Company will either sell its interest in Van-Am or wind-down Van-Am's operations and place them into "run-off." The Company has engaged an investment bank to assist in completing the divestiture of Van-Am, which, if at all, is expected to occur in 1999. Underwriting Process and Surveillance. The underwriting criteria applied in evaluating a given issue for primary insurance coverage and the internal procedures (for example, credit committee review) for approval of the issue are substantially the same as for the underwriting of reinsurance. See "Reinsurance of Monoline Financial Guaranty Insurers -- Underwriting Staffing, Policies and Procedures" in this section. The entire underwriting responsibility rests with the Company as the primary insurer. As a result, the Company participates more actively in the structuring of the transaction than it does as a reinsurer. The Company conducts, in most cases annually, in-depth surveillance of issues insured as a primary insurer. Sources of Premiums The following table sets forth certain information regarding insurance business assumed and written by the Company: 10
Year Ended December 31, 1998 ---------------------------------------------------------------------------------- Premiums Gross Premiums Earned as Written as Percent of Gross Net Percent of Total Total Premium Earned Premiums Premiums Premiums Gross Premiums Premiums as Percent of Sources of Premiums Written Written Earned Written Earned Total Revenues - ------------------- ------- ------- ------ ------- ------ -------------- (Dollars in millions) Financial guaranty reinsurance: MBIA ........... $ 24.8 $ 24.6 $ 29.5 19.0% 28.8% 14.2% AMBAC .......... 24.2 24.4 10.1 18.6 9.9 4.9 FSA ............ 24.3 24.3 15.6 18.6 15.2 7.5 FGIC ........... 7.0 7.0 10.3 5.4 10.1 5.0 Other - Foreign 0.3 0.3 0.3 0.2 0.3 0.1 Other insurance(1) . 49.8 48.7 36.5 38.2 35.7 17.6 ------ ------ ------ ------ ------ ------ $130.4 $129.3 $102.3 100.0% 100.0% 49.3% ====== ====== ====== ====== ====== ======
- ---------- (1) Includes business written by the Company as a primary insurer. For the year ended December 31, 1998, no single primary insurer included in "Other insurance" provided greater than 2.2%, 2.2% and 2.8% of gross premiums written, net premiums written and premiums earned, respectively. The Company has maintained close and long-standing relationships with its monoline financial guaranty insurer clients, dating essentially from either the Company's or the given primary insurer's inception. In the Company's opinion, these relationships provide the Company with a comprehensive understanding of its clients' procedures and reinsurance requirements and allow the clients to utilize the Company's underwriting expertise effectively, thus improving the service they receive. The Company is a party to facultative agreements with all, and a party to treaty agreements with all except one of, the monoline financial guaranty primary insurers. The Company's facultative and treaty agreements usually are entered into for indefinite terms, subject to termination (i) upon written notice (ranging from 90 to 120 days) prior to the specified deadline for renewal or (ii) at the option of the primary insurer if the Company fails to maintain certain financial, regulatory and rating agency criteria which are equivalent to or more stringent than those the Company is otherwise required to maintain for its own compliance with the New York Insurance Law (the "Insurance Law") and to maintain a specified claims-paying ability rating for the particular Insurance Subsidiary. Upon termination under the conditions set forth in (ii) above, the Company may be required to return to the primary insurer all unearned premiums, less ceding commissions, attributable to reinsurance ceded pursuant to such agreements. Upon the occurrence of the conditions set forth in (ii) above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement. Of the Company's aggregate monoline reinsurance exposure of $68.9 billion as of December 31, 1998, $60.2 billion, or 87.4%, was derived through its treaty relationships with the primary insurers. 11 Reinsurance Ceded The Company is a party to certain facultative retrocession agreements, pursuant to which it cedes to certain retrocessionnaires a portion of its reinsurance exposure. Since it is required to pay its obligations in full to the primary insurer regardless of whether it is entitled to receive payments from its retrocessionnaire, the Company therefore believes that in most cases it is vital that retrocessions be made only to very creditworthy retrocessionnaires. The Company also cedes to reinsurers a portion of its direct insurance exposure, and the foregoing also describes in general the relationship between the Company and its reinsurers. The Company has historically retroceded relatively little of its financial guaranty reinsurance exposure for risk management reasons. In its specialty insurance businesses, the Company in recent years has increased the amount of direct exposure which it reinsures out, particularly that incurred in its excess-SIPC/excess-ICS program, principally in order to comply with applicable regulatory single-risk limitations. Most of the reinsurance capacity for its excess-SIPC/excess-ICS program is provided by certain of the primary financial guaranty insurers, for which the Company serves as reinsurer in their municipal bond and asset-backed transactions. In addition, the Company retrocedes a portion of its trade credit reinsurance business from FCIA to several international reinsurance companies. Enhance Re is party to an excess-of-loss reinsurance agreement with Hannover Ruckversicherungs AG ("Hannover Re") under which it will be entitled, subject to certain conditions, to draw from Hannover Re up to $25 million under certain circumstances. The agreement has a term of one year and is cancelable annually at the option of either party, except that the Company has the option to force a seven-year run-off period. Hannover Re is a German reinsurance company which has a claims-paying ability rating from Standard & Poor's of AA+. Gross written premiums of $1.1 million were ceded or retroceded by the Insurance Subsidiaries to unaffiliated companies in 1998, of which amount 78.0% was ceded or retroceded to insurance companies having AAA claims-paying ability ratings from Standard & Poor's. Loss Experience The Company establishes a provision for losses and related loss adjustment expenses ("LAE") when reported by primary insurers or when, in the Company's opinion, an insured risk is in default or a default is probable and the amount of the loss is reasonably estimable. Provisions for losses and LAE are established based on the estimated loss, including expenses associated with settlement of the loss, through the full term of the insured obligation. In the case of obligations with fixed periodic payments, the provision for losses and LAE represents the present value of the Company's ultimate expected losses, adjusted for estimated recoveries under salvage or subrogation rights. On any given municipal and asset-backed reinsurance transaction, the Company and its primary insurer clients underwrite with a zero-loss underwriting objective. For the trade credit reinsurance business, loss reserves are established based on historical loss development patterns experienced by the Company and by ceding companies in similar businesses. The estimate of reserves for losses and LAE, which includes a non-specific loss reserve, is periodically evaluated by the Company, and changes in estimate are reflected in income currently. As it anticipated, the Company has experienced relatively higher loss levels in certain of its other insurance businesses than it experienced in connection with its financial guaranty 12 reinsurance business. See "Other Insurance Businesses" in this section. The Company believes that the higher premiums it receives in these businesses adequately compensate it for the risks involved. At December 31, 1998, the Company had established $33.7 million in net reserves for losses and LAE (of which $16.4 comprised incurred but not reported and non-specific reserves). The following table sets forth certain information regarding the Company's loss experience for the years indicated:
Year Ended December 31, ------------------------------------------- 1998 1997 1996 ----- ----- ----- (In millions) Net reserve for losses and LAE beginning of year ........................... $31.0 $26.3 $29.0 Net provision for losses and LAE Occurring in current year ............... 6.0 6.0 6.1 Occurring in prior years ................ 4.3 3.7 3.1 ----- ----- ----- Total ............................... 10.3 9.7 9.2 ----- ----- ----- Net payments for losses and LAE Occurring in current year ................ 0.4 0.7 0.6 Occurring in prior years ................. 7.2 4.3 11.3 ----- ----- ----- Total .............................. 7.6 5.0 11.9 ----- ----- ----- Net reserve for losses and LAE at end of year $33.7 $31.0 $26.3 ===== ===== =====
In 1998, 1997 and 1996 the Company recorded losses of $6.5 million, $8.1 million and $7.3 million, respectively, in connection with its credit and surety businesses. The Company believes that the reserves for losses and LAE, including the case and non-specific reserves, are adequate to cover the ultimate net cost of claims. However, the reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not exceed such estimates. Asset-Based Businesses The Company is engaged in several additional lines of business that utilize its core skills in complex credit analysis and securitizations and, in certain cases, its strategic relationships. Enhance Financial's wholly-owned subsidiary, Singer Asset Finance Company, L.L.C. ("Singer"), conducting business from New York City and Boca Raton, Florida offices, purchases from individuals state lottery prizes, structured settlement payment rights and other long-term payment streams. Working with leading financial institutions, Singer securitizes lottery prizes and structured settlement payment streams, i.e., sells pools of such assets into the securities market. Singer markets its products targeted to individual consumers through a combination of direct marketing activities, a direct sales force and the use of commissioned brokers. In August 1998, the Company formed Enhance Consumer Services, LLC and subsidiary entities to conduct the viaticals business (the purchase of or the making of loans secured by life insurance policies from customers living with a terminal illness) and to utilize marketing and securitization techniques similar to those used by Singer for lottery prizes and structured settlement payment streams. Singer faces in all its business lines a variety of direct competitors, including specialized single-product providers and diversified multi-line entities. Some of these competitors have significantly greater financial resources than those available to the Company. 13 Enhance Financial and MGIC each own an approximate 48% interest in Credit-Based Asset Servicing and Securitization LLC ("C-BASS"), a New York City-based joint venture. C-BASS purchases, invests in and securitizes single-family residential sub-performing, non-performing and seller-financed mortgage loans and real estate and subordinated residential mortgage-backed securities. In addition, through a wholly-owned residential mortgage servicing subsidiary, C-BASS engages in loss mitigation, default collection, collection of insurance claims and guaranty collections under government-sponsored mortgage programs. C-BASS markets its products and services directly to financial institutions and institutional investors originating or purchasing residential mortgages and to entities issuing subordinated residential mortgage-backed securities. In addition, in connection with its seller-financed-mortgage business, C-BASS employs a direct sales force and direct mailings to sell or purchase its products. There are a significant number of direct competitors of C-BASS in its program to purchase, service and securitize residential mortgages and subordinated residential mortgage-backed securities. These competitors include major Wall Street investment firms and larger banking institutions, many of which have greater financial and other resources than C-BASS. There are a limited number of direct competitors of C-BASS in its seller-finance residential mortgages purchase and servicing programs. In December 1998, the Company and MGIC formed Sherman Financial Group LLC ("Sherman"), a New York City-based joint venture in which each owns a 45.5% interest and which will purchase, service and securitize delinquent consumer assets, including charged-off credit card receivables. To that end, Sherman acquired the assets of a leading provider of marketing analytics and diligence services to purchasers of unsecured delinquent consumer assets, and the Company acquired a leading servicer and collector of delinquent consumer assets, which it anticipates contributing to Sherman upon satisfaction of certain regulatory requirements. Enhance Financial and Swiss Re, respectively, own 25% equity interests in Seguradora Brasiliera de Fiancas ("SBF"), one of Brazil's largest surety companies. The remaining interest in SBF is held by Banco Pactual, S.A., one of Brazil's largest investment banks. The terms of the joint venture call for the expansion of SBF in the Latin American insurance and other credit-related markets and opportunities. In July 1998, the Company formed AGS Financial LLC ("AGS"), a New York City-based venture in which it holds an 80% interest focused on structured finance, asset servicing and specialized investment banking services in Latin American markets. The Company formed AGS to utilize resources made available to the Company through its interest in SBF. To date, AGS has been a major participant in the development of some of the most innovative origination and servicing capabilities critical to successful securitization programs in selected Latin American markets. Investments and Investment Policy The Company's investment portfolio, consisting of privately placed securities and municipal bonds, is managed with a view to maximizing after-tax performance. As of December 31, 1998, 58.2% of the portfolio is managed internally, while the remaining 41.8% is allocated to four external specialty managers. All investments are guided by the Company's general investment objectives and policies, including guidelines relating to average maturities and quality, which are periodically reviewed and revised as appropriate. The investment policies are 14 designed to achieve diversification of the portfolio and generally to preclude investments in obligations insured by the Company. Investments are almost entirely fixed income securities, with a mix of taxable and tax-exempt investments looking to maximize the net income of the Company. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company classifies all securities at the time of purchase as either "held to maturity" or "available for sale." Securities held to maturity are those securities which the Company intends and has the ability to hold until maturity and are carried at amortized cost. All other fixed maturity securities are classified as available for sale, are carried at fair value and may be sold in response to changes in interest rates, prepayment risk, payment of losses and other factors. Unrealized gains and losses, net of taxes, on the available-for-sale portfolio are charged or credited to accumulated other comprehensive income. The Company internally manages and controls invested assets representing approximately 58.2% of the carrying value of the investment portfolio at December 31, 1998. The Company intends to hold 20.8% (based on carrying value) of its invested assets to maturity, and, accordingly, in accordance with SFAS No. 115, they are accounted for on an amortized cost basis. The following tables set forth certain information concerning the types of investments and maturities composing the investment portfolio of the Company.
As of December 31, 1998 -------------------------------------------- Weighted Average Investment Category (1) Carrying Value (2) Yield (3) ----------------------- ------------------ --------- (Dollars in millions) Fixed Maturities, held to maturity Private placements ......................... $ 96.3 8.93% Municipal obligations - tax exempt ......... 93.3 7.53 Corporate securities ....................... 4.7 8.27 U.S. Government obligations ................ 2.5 6.95 ------ Total .................................... $196.8 8.23% ------
15
As of December 31, 1998 --------------------------------------------- Weighted Average Investment Category (1) Carrying Value (2) Yield (3) ----------------------- --------------------- --------- (Dollars in millions) Fixed maturities, available for sale Municipal obligations - tax exempt ..... $520.7 5.60% Mortgage-backed securities ............. 95.0 7.09 Corporate securities ................... 48.4 7.09 Foreign securities ..................... 26.7 5.81 U.S. Government obligations ............ 3.6 6.30 ------ Total ................................ $694.4 5.93% ------
Short-term investments (4) .............. 56.3 4.30 Common stocks ........................... 0.8 8.57 ------ Total Investments .................. $948.3 6.33% ======
- ------------- (1) Excludes investment in affiliates. See Note 5 of "Notes to Consolidated Financial Statements." (2) Investments in fixed maturities in the held-to-maturity portfolio are carried at amortized cost. Investments in fixed maturities in the available-for-sale portfolio are carried at market value. Short-term investments are carried at cost, which approximates their market values. Common stocks are carried at market value. Unrealized gains and losses on fixed maturities available for sale and common stocks are reflected in accumulated other comprehensive income net of tax. (3) Represents yield to maturity on fixed maturities and current yield on common stocks and certain short-term investments. All amounts are stated on a pre-tax basis. (4) Includes $5.5 million of cash and cash equivalents as of December 31, 1998. 16
Maturity of Fixed Maturities Carrying Value As of December 31, 1998 ---------------------------- -------------------------------------- (In millions) Held to Maturity (1) Due in one year or less .................................. $ 16.9 Due after one year through five years .................... 95.8 Due after five years through ten years ................... 51.8 Due after ten years ...................................... 32.3 ------ Total(2) ............................................. $196.8 ====== Available for Sale (3) Due in one year or less .................................. $ 2.6 Due after one year through five years .................... 33.5 Due after five years through ten years ................... 152.9 Due after ten years ...................................... 505.4 ------ Total(4) ............................................. $694.4 ======
- -------------- (1) The weighted average maturity of the held to maturity portfolio is estimated to be 4.4 years as of December 31, 1998. (2) Investments in fixed maturities in the held-to-maturity portfolio are carried at amortized cost. Total market value as of December 31, 1998 of fixed maturities, held to maturity, was $205.8 million. (3) The weighted average maturity of the available for sale portfolio as of December 31, 1998 is estimated to be 10.2 years. (4) Investments in fixed maturities in the available-for-sale portfolio are carried at market value. Total amortized cost of fixed maturities, available for sale, as of December 31, 1998 was $657.6 million. The Company has an investment policy of maintaining an investment portfolio having a weighted average credit rating of not lower than AA. The Company's adherence to these policies is reflected in the following table setting forth certain information concerning the rating of the Company's investments by Standard & Poor's. Percent of Investment Portfolio Rating As of December 31, 1998 - ------ ----------------------- AAA (1) ............................................. 49.3% AA .................................................. 31.5% A ................................................... 15.2% Other (2) ........................................... 4.0% - ---------- (1) Includes U.S. Treasury and agency obligations, which constituted 8.1% of the total portfolio as of December 31, 1998. 17 (2) Consists of common stock, unrated securities and securities rated less than A. Marketing Most of the Company's business derives from relationships it has established and maintains with primary insurance companies. These relationships provide business for the Company in the following major areas: (1) reinsurance for municipal bonds and asset-backed securities (in which area the Company currently has either treaty or facultative agreements with all the monoline primary companies); (2) trade credit reinsurance; and (3) reinsurance for affiliated-companies reinsurance (including Exporters and FCIA). The Company markets directly to the monoline insurers writing credit enhancement business and has direct relationships with their affiliated primary insurers. Specialist reinsurance intermediaries, most of which are located in London, usually present to the Company reinsurance opportunities in the credit insurance sector. These brokers work with the Company's marketing personnel in introducing the Company to the primary credit insurance markets and in structuring reinsurance to meet the needs of the primary insurers. Intermediaries are typically compensated by the reinsurer based on a percentage of premium assumed, which varies from agreement to agreement. The Company markets its excess-SIPC/excess-ICS polices through specialist intermediaries, primarily in New York and London. These brokers work with the Company's marketing personnel in introducing the Company to large securities brokers to meet the needs of such securities brokers. These brokers are typically compensated by the Company based on a percentage of premium collected, which varies from agreement to agreement. Competition Reinsurance of Monoline Financial Guaranties. The Company is subject to competition from three companies that specialize in financial guaranty reinsurance--Capital Reinsurance Company ("Capital Re"), Axa Reassurance Finance, S.A ("Axa") and RAM Reinsurance Co. Ltd ("Ram Re"), which the Company believes provide, together with the Company, most of the reinsurance capacity to the monoline financial guaranty primary insurers. In addition, several multiline insurers have recently increased their participation in financial guaranty reinsurance. Certain of these multiline insurers have formed strategic alliances with some of the U.S. primary financial guaranty insurers. The Company believes that it and Capital Re have the largest and roughly equivalent shares of financial guaranty premiums ceded by the monoline primary insurers inclusive of both treaty and facultative business. Competition in the financial guaranty reinsurance business is based upon many factors, including overall financial strength, pricing, service and evaluation by the rating agencies of claims-paying ability. The agencies allow credit to a ceding primary insurer's capital requirements and single-risk limits for reinsurance ceded in an amount which is a function of the claims-paying ability rating of the reinsurer. See "Rating Agencies" in this section. The Company believes that competition from multiline reinsurers and new monoline financial guaranty insurers will continue to be limited due to (a) the declining number of multiline insurers with the requisite financial strength and (b) the barriers to entry for new reinsurers posed by state insurance law and rating agency criteria governing minimum capitalization. 18 Financial guaranty insurance, including municipal bond insurance, also competes with other forms of credit enhancement, including letters of credit and guaranties provided primarily by foreign banks and other financial institutions, some of which are governmental entities or have been assigned the highest credit ratings awarded by one or more of the major rating agencies. However, these credit enhancements serve to provide primary insurers with increased insurance capacity only for rating agency purposes. They do not qualify as capital for state regulatory purposes, nor do they constitute credit against specific liabilities which would allow the primary insurer greater single-risk capacity. Other Insurance Businesses. The Company believes that there are a number of direct competitors of the Company in its other insurance businesses, some of which have greater financial and other resources than the Company. The Company has limited its activities in these market areas to those activities that are not served by the Company's financial guaranty monoline primary insurer clients. As a primary insurer, the Company writes insurance on those municipal bonds with respect to which such primary insurers have generally declined to participate because of the size or complexity of such bond issuances relative to the anticipated returns. The Company also serves as a reinsurer for certain specialty primary insurers which are not monoline financial guaranty insurers, in which the Company has significant equity interests or is otherwise a participant. Such reinsurance accounted for 5.3% of the Company's gross premiums written in 1998. These specialty primary insurers are themselves subject to competition from other primary insurers, many of which have greater financial and other resources. Rating Agencies The rating agencies allow credit to a ceding primary insurer's capital requirements and single-risk limits for reinsurance ceded in an amount depending on the claims-paying ability rating of the reinsurer. The rating criteria used by the rating agencies focus on the following factors: capital resources; financial strength; primarily in the case of a reinsurer whose common equity is not publicly traded, shareholder composition and commitment of the reinsurer's institutional stockholders; demonstrated management expertise in financial guaranty and traditional reinsurance; credit analysis; systems development; marketing; capital markets and investment operations, including the ability to raise additional capital; and a minimum policyholders' surplus comparable to primary company requirements, with initial capital sufficient to meet projected growth as well as access to such additional capital as may be necessary to continue to meet standards for capital adequacy. As part of their rating process, Standard & Poor's, Moody's and Duff & Phelps test the capital adequacy of the Insurance Subsidiaries by subjecting them to a "worst-case depression scenario." Expected losses over a depression period are established by applying capital charges to the existing and projected insurance portfolio. The claims-paying ability ratings assigned by the rating agencies to a reinsurance or insurance company are based upon factors relevant to policyholders and are not directed toward the protection of the reinsurer's or insurer's securityholders. Such a rating is neither a rating of securities nor a recommendation to buy, hold or sell any security. Claims-paying ability ratings assigned to the Insurance Subsidiaries should not be viewed as indicative of or relevant to any ratings which may be assigned to the Company's outstanding debt securities by any rating agency and should not be considered an evaluation of the likelihood of the timely payment of principal or interest under such securities. 19 On March 29, 1999, Moody's advised the Company that it had placed on review for possible downgrade both the Aaa insurance financial strength rating of Enhance Re and the Aa3 senior long-term debt rating of Enhance Financial. Moody's explained that this action with respect to Enhance Re's rating was based on the possible increased risk and strain to Enhance Re resulting from the Company's diversification and on the increasing competition in the reinsurance industry. Moody's explained that this action with respect to Enhance Financial's debt rating was based on the Company's diversification into what characteristics that are distinct from the Company's traditional financial guaranty activities. Management does not believe that a downgrade (should that be the result of the Moody's review) would have an adverse effect on Enhance Re's competitive position. This is because many of Enhance Re reinsurance competitors do not have financial strength ratings of Aaa from Moody's, and the Company's principal financial guaranty competitor has already been downgraded by Moody's. However, insofar as a downgrade could diminish the value Enhance Re provides to the primary insurers, they could seek an increase, which could be material, in the costs to Enhance Re associated with cessions under their treaties with Enhance Re. Should the Company fail to reach agreement with the primaries on the matter, some of them will be entitled to exercise their treaty right triggered by the downgrade to recapture business previously ceded to Enhance Re. While the Company believes that the recapture of business by the primaries would otherwise be inconsistent with their long-standing risk-management practices, such action, if it occurs and depending on its magnitude, could have a material adverse effect on the Company. A substantial portion of Asset Guaranty's written business is subject to similar provisions with respect to any downgrade of its Standard & Poor's or Duff & Phelps rating. The Company believes that the same consequences as set forth above would occur were Asset Guaranty to experience any such downgrade, which, in turn, could materially adversely affect the Company's ability to continue to engage in certain speciatly businesses, principally insurance of municipal bonds. See "Other Insurance Businesses" in this section. Data Processing The Company believes that its data processing systems are adequate to support its current needs and have the capacity to support a greater volume of reinsurance business. The Company completed a significant upgrade of its technology infrastructure in 1997, updating and modernizing its hardware, software and network. This modernization program provides a more reliable and resilient information technology environment. The Company has also improved the speed, security and quality of information available to the Company. The Company also has in progress, major application development programs that will provide operational support to many departments. One of the ultimate objectives of these development programs is to restructure, streamline and strengthen the Company's databases that support important reporting and decision support processes. See Item 7 "Management Discussion and Analysis of Financial Condition and Results of Operations Year 2000" for a description of the Company's systems preparedness for the Year 2000. Employees As of March 1, 1999, the Company (excluding Van-Am) had 260 employees. None of the employees are covered by collective bargaining agreements. The Company considers its employee relations to be good. INSURANCE REGULATORY MATTERS Financial Guaranty Insurance Regulations The Insurance Subsidiaries are domiciled and licensed in the State of New York as financial guaranty insurers under that portion of the Insurance Law constituting the financial guaranty insurance statute. They are also subject to the provisions of the Insurance Law and related rules and regulations governing property-casualty insurers to the extent such provisions are not inconsistent with the financial guaranty insurance statute. Both Insurance Subsidiaries are also licensed under the Insurance Law to write surety insurance, credit insurance and residual 20 value insurance, which are the only other types of insurance that a financial guaranty insurer licensed under the Insurance Law may be authorized to write. The Insurance Subsidiaries are required by New York and each other jurisdiction in which they are licensed to make various filings, including quarterly and annual financial statements prepared in accordance with statutory accounting practices, with those jurisdictions and with the National Association of Insurance Commissioners (the "NAIC"). The Insurance Law requires that each financial guaranty insurer and reinsurer maintain both a reserve for unearned premiums and for incurred losses (similar to the reserve described in "Description of Business -- Loss Experience" in this section) and a special, formulaically derived "contingency reserve" to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. As of December 31, 1998, the statutory contingency reserves of the Insurance Subsidiaries aggregated $207.9 million. Each calculated reserve may be drawn on with the approval of the New York Insurance Department (the "Department") under specified but limited circumstances. The Insurance Law establishes single-risk limits applicable to all obligations insured by a single entity and backed by a single revenue source and aggregate risk limits on the basis of aggregate net liability and policyholders' surplus requirements. The Insurance Law also regulates the types of securities in which the Insurance Subsidiaries may invest their minimum policyholders' surplus and imposes restrictions on the amount of dividends that the Insurance Subsidiaries may pay. See Item 5. "Market for Registrant's Common Equity and Related Stockholder Matters -- Dividend Policy." The Company believes that each of the Insurance Subsidiaries is in material compliance with all applicable laws and regulations of the State of New York and the laws and regulations of the other jurisdictions in which such Insurance Subsidiary is licensed pertaining to its business and operations. The Insurance Subsidiaries are also subject to the insurance laws in each jurisdiction in which they are licensed to transact insurance. Reinsurance activities are generally not directly regulated by state law, but are generally subject to limited indirect regulation in most states through the regulation of ceding primary insurers domiciled in those states. Insurance Holding Company Regulations Enhance Financial, as the parent, and the Insurance Subsidiaries, as controlled insurers, are subject to regulation under the insurance holding company laws of New York, which require the Insurance Subsidiaries to register with the Department and to file with it certain informational reports. State holding company laws also require prior notice or regulatory approval of direct or indirect changes in control of an insurer or its holding company and of certain material intercorporate transfers within the holding company structure. Upon obtaining control, the acquiror would become subject to various ongoing regulatory requirements in New York and certain other states. The Company believes that Enhance Financial and each of the Insurance Subsidiaries is 21 in material compliance with all applicable insurance holding company laws and regulations of the State of New York and the laws and regulations of the other jurisdictions in which such Insurance Subsidiary is licensed pertaining to its business and operations. Under the Insurance Law, any person holding or acquiring, directly or indirectly, 10% or more of the voting securities of an insurance company is presumed to be holding or acquiring "control" of such company and its subsidiaries, unless the Department determines upon application that such acquiror would not control such company. NAIC/IRIS Ratios The NAIC developed the Insurance Regulatory Information System primarily to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. The system identifies eleven industry ratios and specifies "usual values" for each ratio. Departure from these "usual values" on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer's business. The values of such ratios of the Insurance Subsidiaries all fell within these "usual values" except for three of such ratios for Enhance Re: the liabilities to liquid assets ratio fell outside the "usual value" as a result of an increase in the amount of funds held by or deposited with reinsured companies; the change in net writings ratio fell outside the "usual value" as a result of an increase in writing of municipal bond reinsurance by Enhance Re; and the investment yield ratio fell outside the "usual value" as a result of income on funds held or deposited with reinsurance companies. Accreditation The NAIC has instituted the Financial Regulatory Accreditation Standards Program ("FRASP") in response to federal initiatives to regulate the business of insurance. FRASP provides standards intended to establish effective state regulation of the financial condition of insurance companies. FRASP requires states to adopt certain laws and regulations, institute required regulatory practices and procedures, and have adequate personnel to enforce such items in order to become "accredited." In accordance with the NAIC's Model Law on Examinations, accredited states are not permitted to accept certain financial examination reports of insurers prepared solely by the insurance regulatory agency in states not accredited by January 1, 1994. Although the State of New York is not accredited, no states where the Insurance Subsidiaries are licensed have refused to accept the Department's Reports on Examination for the Insurance Subsidiaries. However, there can be no assurance that, should the Department remain unaccredited, other states that are accredited will continue to accept financial examination reports prepared solely by New York. The Company does not believe that the refusal by an accredited state to continue accepting financial examination reports prepared by New York, should that occur, will have a material adverse impact on the Company's insurance businesses. 22 Item 2. Properties. The Company, excluding Singer, occupies approximately 45,000 square feet of office space comprising its executive offices at 335 Madison Avenue, New York, New York pursuant to a sublease expiring April 2000. Singer occupies approximately 9,000 square feet of office space at the same address pursuant to a sublease expiring August 1999 and approximately 35,000 square feet of office space at 700 Banyan Trail Road, Boca Raton, Florida pursuant to a lease expiring August 2005. Item 3. Legal Proceedings. The Company is not a party, nor is any of its property subject, to any material legal proceedings. Item 4. Submission of Matters to a Vote of Securityholders. Not applicable. 23 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. SHARE INFORMATION The following table sets forth the high and low sales prices for the Common Stock for the calendar quarters indicated as reported in the New York Stock Exchange consolidated transaction system. Sales prices reflect a 2:1 split of Enhance Financial's stock effective June 1998. High Low ---- --- 1997 1st quarter .............................. $19-3/4 $17-1/8 2nd quarter .............................. 22-19/32 18-13/16 3rd quarter .............................. 28 22 4th quarter .............................. 31-1/16 24-9/16 1998 1st quarter .............................. $35 $26 2nd quarter .............................. 37-19/32 30-5/8 3rd quarter .............................. 37- 5/16 25 4th quarter .............................. 30-3/8 17-5/16 1999 1st quarter (through March 26) ........... $30-1/8 $20-11/16 As of March 26, 1999, there were 115 holders of record of the Common Stock. DIVIDEND POLICY Enhance Financial paid an aggregate dividend of $0.23 per share in 1998, and the board of directors, declared a dividend in the first quarter of 1999 of $0.06 per share. The amount of dividends payable in the future will be reviewed periodically by the board of directors in light of the Company's earnings, financial condition and capital requirements. The declaration and payment of dividends are subject to the discretion of the board of directors of Enhance Financial, and there is no requirement or assurance that dividends will be paid. Enhance Financial's ability to pay dividends as well as its operating, debt service and other expenses depends upon the ability of the Insurance Subsidiaries to pay dividends to Enhance Investment Corporation ("EIC"), a wholly-owned subsidiary of Enhance Financial and the sole shareholder of the Insurance Subsidiaries, and EIC's ability to pay dividends to Enhance Financial. Enhance Financial's ability to pay dividends is also subject to restrictions contained in an agreement relating to Enhance Financial's indebtedness. The Insurance Subsidiaries' ability to pay dividends to EIC is subject to restrictions contained in the Insurance Law. The Company expects that such restrictions will not affect the ability of such subsidiaries to declare and pay dividends to EIC in an amount sufficient to enable EIC to pay dividends to Enhance Financial to support the payment of dividends by Enhance Financial consistent with the practice adopted in recent years. Enhance 24 Financial is limited by the agreements relating to indebtedness in its ability to pay dividends under certain circumstances. As of December 31, 1998, up to $13.4 million was available for the payment of dividends to EIC by the Insurance Subsidiaries without the prior approval of the insurance regulatory authorities. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 8 of Notes to Consolidated Financial Statements. Item 6. Selected Historical Consolidated Financial Information. The following table presents selected historical consolidated financial information derived from the historical consolidated financial statements of the Company as of and for each of the years in the five-year period ended December 31, 1998. This information should be read in conjunction with the historical consolidated financial statements of the Company and the related notes thereto and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." All references to number of common shares and per-share information reflect the two-for-one stock split which was effective on June 26, 1998.
Year Ended December 31, ------------------------------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (Dollars in millions except per share amounts) Statement of Income Data: Gross premiums written .................. $ 130.4 $ 108.2 $ 98.6 $ 87.2 $ 85.1 Net premiums written ..... 129.3 100.5 95.7 83.0 80.7 Premiums earned .......... 102.3 85.4 77.4 63.0 61.8 Assignment sales ......... 45.4 29.2 -- -- -- Net realized gains (losses) on sale of investments ........... 2.4 0.7 4.0 3.5 (5.8) Net investment income (1) 53.4 50.6 47.5 44.2 38.2 Total revenues ........... 207.5 170.4 131.6 112.5 95.7 Income before income taxes .................... 112.8 94.0 76.4 63.8 32.7 Net income ............... 82.5 68.8 55.7 47.3 26.6 Basic earnings per share .................... 2.20 1.86 1.56 1.36 .75 Diluted earnings per share .................... 2.10 1.78 1.52 1.36 .75 Diluted operating earnings per share(2) .... 2.10 1.77 1.45 1.29 .85 Selected Financial Ratios(3) Loss ratio ............... 10.1% 11.4% 11.9% 15.1% 37.0% Insurance Expense ratio .................... 48.6% 50.3% 49.2% 50.9% 55.5% Combined ratio ........... 58.7% 61.7% 61.1% 66.0% 92.5%
Year Ended December 31, --------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (Dollars in millions except per share amounts) Balance Sheet Data: Investment portfolio(4) .... $ 948.3 $ 875.9 $ 797.1 $ 749.2 $ 639.9 Total assets ............... 1,336.4 1,147.5 983.4 886.0 749.4 Deferred premium revenue ... 308.2 281.3 266.2 248.1 227.9 Total liabilities .......... 673.8 566.1 495.1 462.0 389.1 Total shareholders' equity ..................... 662.6 581.4 488.3 423.9 360.3
25 Book value per share ...................... 17.50 15.55 13.52 12.30 10.23 Statutory Basis Reserves(5): Contingency reserves ....... $ 207.9 $ 171.7 $ 149.8 $ 120.8 $ 98.6 Policyholders' surplus ..... 324.2 324.2 312.0 294.5 287.6 ------- ------- ------- ------- ------- Qualified statutory capital .................... 532.1 495.9 461.8 415.3 386.2 Unearned premiums .......... 381.6 345.7 323.2 298.2 269.8 Losses and LAE reserves .... 30.8 22.5 17.7 22.0 19.5 ------- ------- ------- ------- ------- Total policyholders' reserves ................... $ 944.5 $ 864.1 $ 802.7 $ 735.5 $ 675.5 ======= ======= ======= ======= ======= Leverage ratio(6) .......... 142:1 130:1 122:1 128:1 124:1
(1) Excludes capital gains and losses. (2) The Company defines operating earnings as net income, less the effect of net realized capital gains and losses, foreign exchange gains and losses, and certain non-recurring items. Operating earnings is not a substitute for net income computed in accordance with GAAP, but is an important measure used by management, equity analysts and investors to measure the financial results of the Company. Diluted operating earnings per share is calculated by dividing operating earnings per share by the weighted average number of commons shares, outstanding for the period, reflecting the potential dilution that would occur if securities such as employee stock options were exercised. (3) The loss ratio is the quotient derived by dividing losses and LAE incurred by premiums earned. The expense ratio is the quotient derived by dividing underwriting and insurance related operating expenses by premiums earned. The combined ratio is the sum of the loss and expense ratios. Such ratios have been calculated using amounts determined in accordance with GAAP. (4) Excludes investments in affiliates. See Note 5 of Notes to Consolidated Financial Statements for information concerning Enhance Financial's investments in affiliates. (5) Represents the combined financial position of the Insurance Subsidiaries presented on a statutory basis. (6) Represents the quotient derived by dividing net insurance in force by qualified statutory capital. 26 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. General The Company divides its business operations into two reportable operating segments: insurance businesses and asset-based businesses. The insurance businesses, which are engaged through the Insurance Subsidiaries, include principally the reinsurance of financial guaranties of municipal and asset backed debt obligations issued by monoline financial guaranty insurers. In addition, the Company is engaged in other insurance, reinsurance and non-insurance businesses that utilize the Company's expertise in performing sophisticated analyses of complex, credit-based risks. The Company's other insurance businesses involve the issuance of direct financial guaranties of smaller municipal debt obligations, trade credit reinsurance, financial institutions, credit insurance and financial responsibility bonds. Some of these other insurance businesses are conducted by Van-American Insurance Company ("Van-Am"), a Kentucky domiciled insurer which writes reclamation bonds for the coal mining industry, and surety bonds covering the closure and post-closure obligations of landfill operators. The Company also provides surety and other credit-related insurance products through its 25% ownership of Seguradora Brasileirade Francas S.A. The Company operates its asset-based businesses primarily through its consolidated subsidiary, Singer Asset Finance Company, L.L.C. ("Singer") and a partially owned affiliate, Credit-Based Asset Servicing and Securitization L.L.C. ("C-BASS"). The Company's asset-based businesses include the origination, purchase, servicing and/or securitization of special assets, including lottery awards, structured settlement payments and sub-performing/non-performing and seller-financed residential mortgages, real estate and subordinated residential mortgage-backed securities. The Company's revenues consist primarily of (a) premiums earned on insurance and reinsurance contracts, (b) investment income and (c) the sale of securitized lottery prizes and structured settlement payment streams. Year Ended December 31, 1998 versus Year Ended December 31, 1997 Gross premiums written in 1998 increased 20.5% to $130.4 million from $108.2 million in 1997. Total premium writings in 1998 benefited from a 37.1% increase in monoline reinsurance. 27 Net premiums written increased 28.7% to $129.3 million in 1998 from $100.5 million in 1997, as a result of the increase in gross premiums and a decrease in ceded premiums written from $7.6 million in 1997 to $1.1 million in 1998. The following table shows net premiums written by line of business for the periods presented: Net Premiums Written (in millions) 1998 1997 - ---------------------------------- ---- ---- Municipal Reinsurance .................. $ 56.2 $ 34.3 Non-Municipal Reinsurance .............. 24.4 22.2 Other Insurance Lines .................. 48.7 44.0 ------ ------ $129.3 $100.5 ====== ====== The Company's other insurance lines include direct municipal bond insurance, credit reinsurance, surety, excess-SIPC/excess-ICS and other surety lines. Net premiums written from these businesses have grown from $18.3 million (21.1%) in 1993 to $48.7 million (37.7%) in 1998. The Company expects that these other insurance lines will continue to contribute a significant component of its premium revenues. In connection with certain of its other insurance lines, the Company underwrites with the anticipation of higher loss levels than those associated with its core municipal and non-municipal reinsurance business. The Company takes into account these higher loss levels in determining appropriate premium rates. Net premiums earned grew 19.6% to $102.3 million in 1998 from $85.5 million in 1997. This growth in premiums earned was in large part attributable to increased earnings from monoline reinsurance. The following table shows net premiums earned by line of business for the periods presented: Net Premiums Earned (in millions) 1998 1997 - -------------------------------------------- ------- ------- Municipal Reinsurance ...................... $ 42.0 $ 37.4 Non-Municipal Reinsurance .................. 23.8 12.6 Other Insurance Lines ...................... 36.5 35.5 ------- ------- $ 102.3 $ 85.5 ======= ======= 28 Monoline reinsurance earned premiums increased $16.1 million (32.3%) as a result of refunded earned premiums more than doubling from $8.6 million to $17.9 million as well as a $7.6 million (9.9%) growth in earned premiums before the effect of refundings. Refunding activities increased throughout the year due to a favorable interest rate environment. A refunding eliminates the Company's reinsurance exposure to the refunded obligation and, as a result, the Company recognizes in current earnings the remaining related deferred premium revenue. The growth in premiums earned also reflects the amortization of the deferred premium revenue balance, net of prepaid insurance premiums, which has grown to $308.2 million at year-end 1998 from $281.3 million at year-end 1997. Net investment income increased 5.5% to $53.4 million in 1998 from $50.6 million for 1997 reflecting the growth in invested assets in the period offset, in part, by a shift in the portfolio toward tax-exempt securities. After-tax investment income increased 7.6% in 1998 over 1997. The average yields on the Company's investment portfolio, after deducting associated costs, were 6.1% and 6.2% for the years ended December 31, 1998 and 1997, respectively. The average yields on the Company's investment portfolio on an after-tax basis, net of associated costs were 5.1% and 5.1% for the years ended December 31, 1998 and 1997, respectively. In addition, the Company realized $2.4 million and $0.7 million of net capital gains in 1998 and 1997, respectively. Net investment income is presented after deduction of both external investment management fees and internal costs associated with managing the investment portfolio. Assignment sales for 1998 and 1997 were $45.4 million and $29.2 million, respectively. This revenue results from Singer's operations being consolidated with the Company's, commencing March 21, 1997. 29 Incurred losses and loss adjustment expenses ("LAE") were $10.3 million in 1998 compared with $9.8 million in 1997. Of these amounts, $6.5 million and $8.1 million were incurred in connection with the Company's credit and surety businesses in 1998 and 1997, respectively. In addition, $10.6 million in municipal reinsurance losses were recorded, largely attributable to a $10 million case reserve established for anticipated losses related to reinsurance of Delaware Valley Obligated Group (DVOG) debt. The Company's non-specific reserve was reduced by $10 million accordingly. DVOG is an entity comprising five hospitals and a medical university in the Philadelphia area that is part of Allegheny Health, Education and Research foundation, based in Pittsburgh. The Company believes that the reserves for losses and LAE, including case and non-specific reserves, are adequate to cover the ultimate net cost of claims. However, the reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not exceed or be less than such estimates. The Company's insurance operating expense ratio for 1998 was 48.6% compared to 50.3% in 1997. Policy acquisition costs, which vary with and are directly related to the generation of new and renewal premiums, totaled $35.0 million and $30.0 million in 1998 and 1997, respectively, representing 34.2% and 35.1% of premiums earned in those respective periods. Other insurance operating expenses increased to $13.7 million in 1998 from $12.2 million in 1997. Non-insurance expenses increased from $25.1 million in 1997 to $39.9 million in 1998 reflecting the continued growth in its Singer operations as well the growth in expenses associated with the Company's diversification activities. The Company realized income of $14.1 million from its investments in affiliates in 1998 compared to $8.8 million in 1997 due to continued growth in the Company's asset-backed businesses. Interest expense of $8.5 million was incurred in 1998 compared to $7.3 million in 1997 reflecting an increase in the average borrowings outstanding under the Company's line of credit under a bank credit agreement (as amended, the "Credit Agreement") in 1998 compared to 1997. The Company's effective tax rate was 26.9% for 1998 compared to 26.8% in 1997. Net income for 1998 increased 19.8% to $82.5 million from $68.8 million in 1997. On a per share basis, basic earnings per share increased 18.3% to $2.20 in 1998 from $1.86 in 1997, while diluted earnings per share increased 18.0% to $2.10 in 1998 from $1.78 in 1997. Basic operating earnings per share increased 19.2% to $2.20 in 1998, while diluted operating earnings per share increased 18.6% to $2.10 in 1998. The Company defines operating earnings as net income, less the effect of net realized capital gains and losses, foreign exchange gains and losses, and certain non-recurring items. The weighted average shares outstanding for 1998 was 37.52 million compared to 37.07 million for 1997. The diluted weighted average shares outstanding for 1998 was 39.28 million compared to 38.63 million for 1997. All references to number of common shares and per-share information reflect the two-for-one stock split which was effective on June 26, 1998. 30 Year Ended December 31, 1997 versus Year Ended December 31, 1996 Gross premiums written in 1997 increased 9.7% to $108.2 million from $98.6 million in 1996. Total premium writings in 1997 benefited from a 25.2% increase in gross premiums derived from the Company's other insurance lines. Net premiums written increased 5.1% to $100.5 million in 1997 from $95.7 million in 1996, as a result of the increase in gross premiums partially offset by an increase in ceded premiums written from $2.9 million in 1996 to $7.6 million in 1997. The following table shows net premiums written by line of business for the periods presented: Net Premiums Written (in millions) 1997 1996 - ---------------------------------------------- ------- ------- Municipal Reinsurance ........................ $ 34.3 $ 41.2 Non-Municipal Reinsurance .................... 22.2 17.4 Other Insurance Lines ........................ 44.0 37.1 ------- ------- $ 100.5 $ 95.7 ======= ======= The Company's other insurance lines include direct municipal bond insurance, credit reinsurance, financial responsibility, excess-SIPC/excess-ICS and other surety lines. Net premiums written from these businesses have grown from $8.6 million (15.6%) in 1991 to $44.0 million (43.8%) in 1997. The Company expects that these other insurance lines will continue to contribute a significant component of its premium revenues. In connection with certain of its other insurance lines, the Company underwrites with the anticipation of higher loss levels than those associated with its core municipal and non-municipal reinsurance business. The Company takes into account these higher loss levels in determining appropriate premium rates. Net premiums earned grew 10.4% to $85.5 million in 1997 from $77.4 million in 1996. This growth in premiums earned was in large part attributable to increased earnings from the Company's other insurance lines as discussed in the preceding paragraph. The following table shows net premiums earned by line of business for the periods presented: Net Premiums Earned (in millions) 1997 1996 - -------------------------------------------- ------- ------- Municipal Reinsurance ...................... $ 37.4 $ 34.4 Non-Municipal Reinsurance .................. 12.6 13.0 Other Insurance Lines ...................... 35.5 30.0 ------- ------- $ 85.5 $ 77.4 ======= ======= Monoline reinsurance earned premiums increased 5.3% as a result of a $3.9 million (10.4%) growth in earned premiums before the effect of refundings. This growth was partially offset by a decrease in refunded earned premiums from $9.9 million in 1996 to $8.6 million in 1997. The growth in premiums earned also reflects the amortization of the deferred premium revenue balance, net of prepaid insurance premiums, which grew to $281.3 million at year-end 1997 from $266.2 million at year-end 1996. Net investment income increased 6.6% to $50.6 million in 1997 from $47.5 million for 1996 reflecting the growth in invested assets in the period offset, in part, by a shift in the portfolio towards tax-exempt securities. After-tax investment income increased 9.4% in 1997 over 1996. The average yields on the Company's investment portfolio, after deducting associated costs, were 6.2% and 6.4% for the years ended December 31, 1997 and 1996, respectively. The average yields on the Company's investment portfolio on an after-tax basis, net of associated 31 costs were 5.1% and 5.0% for the years ended December 31, 1997 and 1996, respectively. In addition, the Company realized $0.7 million and $4.0 million of net capital gains in 1997 and 1996, respectively. Net investment income is presented after deduction of both external investment management fees and internal costs associated with managing the investment portfolio. Assignment sales for 1997 were $29.2 million. This revenue results from Singer's operations being consolidated with the Company's, commencing March 21, 1997. Incurred losses and LAE were $9.8 million in 1997 compared with $9.2 million in 1996. Of these amounts, $8.1 million and $7.3 million were incurred in connection with the Company's credit and surety businesses in 1997 and 1996, respectively. The Company's insurance operating expense ratio for 1997 was 50.3% compared to 49.2% in 1996. Policy acquisition costs totaled $30.0 million and $26.7 million in 1997 and 1996, respectively, representing 35.1% and 34.5% of premiums earned in those respective periods. Other operating expenses increased to $12.2 million in 1997 from $10.5 million in 1996. Interest expense of $7.3 million was incurred in 1997 compared to $5.5 million in 1996 reflecting an increase in the average borrowings outstanding under the Company's line of credit under a bank credit agreement (as amended, the "Credit Agreement") in 1997 compared to 1996. The Company's effective tax rate was 26.8% for 1997 compared to 27.1% in 1996. The lower 1997 rate reflects the Company's strategy of migrating a greater proportion of its investment portfolio to tax-exempt securities in 1997 partially offset by an increase in income taxed at the statutory rate. Net income for 1997 increased 23.5% to $68.6 million from $55.7 million in 1996. On a per share basis, basic earnings per share increased 18.9% to $1.86 in 1997 from $1.56 in 1996, while diluted earnings per share increased 17.1% to $1.78 in 1997 from $1.52 in 1996. Basic operating earnings per share increased 24.2% to $1.85 in 1997, while diluted operating earnings per share increased 22.1% to $1.77 in 1997. The per-share increases were offset, in part, by the higher weighted average outstanding shares in 1997 following the issuance of 503,114 shares by Enhance Financial to acquire its partner's 50% interest in Singer and 299,496 shares in connection with the exercise of employee stock options, partially offset by the repurchase of 177,925 shares. The weighted average shares outstanding for 1997 was 37.07 million compared to 35.75 million for 1996. All references to number of common shares and per-share information reflect the two-for-one stock split which was effective on June 26, 1998. Liquidity and Capital Resources As a holding company, Enhance Financial finances the payment of its operating expenses, principal and interest on its debt obligations, dividends, if any, to its shareholders and the repurchase of its common stock primarily from dividends and other payments from the 32 Insurance Subsidiaries, manages cash flows associated with the Company's diversification activities and draws on its line of credit provided under the Credit Agreement. Payment of dividends to Enhance Financial by the Insurance Subsidiaries are subject to restrictions relating to statutory capital and surplus and net investment income. Enhance Re and Asset Guaranty declared and paid a total of $21.0 and $3.0 million, respectively, in dividends in 1998. As of December 31, 1998, under the Insurance Law, the Insurance Subsidiaries had an additional $13.4 million available for dividends to Enhance Financial compared with $14.4 million available as of December 31, 1997. Payments of dividends by Enhance Financial to its shareholders are further restricted by the terms of the Credit Agreement. At December 31, 1998, the maximum amount of quarterly dividends which may be paid by Enhance Financial to its shareholders in compliance with the terms of such agreement was $10.1 million. Enhance Financial paid dividends of $8.6 million to shareholders in 1998. As of December 31, 1998, the statutory policyholders' surplus of Enhance Re and Asset Guaranty were $225.7 million and $98.5 million, respectively, compared to the minimum $68.4 million required by each under the Insurance Law and compared to $228.3 million and $94.9 million at December 31, 1997. The Company maintains a credit facility providing for borrowings to be used for general corporate purposes. During the second quarter of 1998, the Company entered into a new unsecured credit agreement with four major commercial banks for up to $100 million of borrowings, an increase of $25 million over the previous agreement (which was terminated). The total outstanding under the Credit Agreement at year-end 1998 was $53.5 million. The Company believes that the operating liquidity needs of the Insurance Subsidiaries can be funded exclusively from their respective operating cash flows. The Company's cash flow from operations consists principally of insurance and reinsurance premiums collected, income earned on invested assets and sales of assignments, which in turn is applied to the payment of claims, operating expenses and income taxes. The Company's cash flow from operations was $95.7 million, $67.8 million and $42.2 million for the years 1998, 1997 and 1996, respectively. The Company paid a total of $7.6 million, $5.0 million and $11.9 million in claims in 1998, 1997 and 1996, respectively. Of the claim payments made in 1998, $7.2 million related to reserves established in prior years. Liquidity is also provided by the Company's sales of securities in its available-for-sale portfolio as well as payments of principal on investments upon maturity. In July 1996, the Company formed Credit-Based Asset Servicing and Securitization LLC ("C-BASS"), a joint venture in which Enhance Financial and MGIC each own 48% interests. The Company contributed $15.8 million in cash in 1996, $6.8 million in cash in 1997 and $32.9 million in cash (plus its 100% interest in LLSI) in 1998. In addition, in January 1998 the Company guarantied repayment of up to $25 million of the amount outstanding under a $50 million LIBOR-based unsecured revolving credit facility that C-BASS obtained from a major commercial bank. The full amount of $50 million was drawn down by C-BASS during the year. The outstanding principal under the facility currently is due not later than July 31, 1999. In 1995, Enhance Financial acquired a 50% joint venture interest in Singer. In 1997 Enhance Financial acquired the remaining 50% of Singer in a series of all-stock transactions. Enhance Financial issued 503,114 shares of its common stock in connection with the 1997 33 transactions. Enhance Financial makes available to Singer a $27 million LIBOR-based secured revolving credit facility and a LIBOR-based working capital credit line for its use in originating assets for securitization. At December 31, 1998, Singer had no outstanding liabilities under the combined credit facilities. In December 1996, the board of directors terminated the then existing stock repurchase program and authorized the repurchase of up to 1,500,000 shares of Enhance Financial's common stock from that date. In 1998, Enhance Financial purchased 666,394 shares of its common stock for an aggregate consideration of $17.8 million. Based on the historical cash flow of the Company, the Company's current financial results and the Company's expectation as to the level of the Company's net premiums written during 1999, the Company believes that cash flow provided by operating activities of the Insurance Subsidiaries during 1999 will provide sufficient liquidity for the operations of the Company, as well as funds to Enhance Financial so that Enhance Financial will be able to meet its debt service and other obligations. The ability of Enhance Financial to meet its debt service and other obligations after 1999 will depend upon the cash flow generated by its operating activities and the availability to Enhance Financial of sufficient amounts of funds from those operating activities in the form of dividends or other payments. The cash flow to Enhance Financial after 1999 may be influenced by a variety of factors, including market changes, insurance regulatory changes and changes in general economic conditions. Consequently, although Enhance Financial currently anticipates that it will be able to meet all debt service and other obligations over the long term, no assurance can be given that the available net cash provided by the Company's operating activities will provide sufficient liquidity for Enhance Financial to meet all its long-term liquidity needs. At December 31, 1998, 1997 and 1996, the carrying value of the Company's investment portfolio (total investments less investment in affiliates) was $948 million, $876 million and $797 million, respectively, on which was earned $53.4 million, $50.6 million and $47.5 million in those years, respectively, excluding $2.4 million, $.7 million and $4.0 million of net realized capital gains in those years, respectively. The increase in investments resulted principally from cash flows from operations generated during the period. As of December 31, 1998, the Company held approximately $50.8 million and $5.5 million in short-term investments and cash and cash equivalents, respectively, to meet liquidity needs. In 1998, the Company incurred annual debt service on its long- and short-term borrowings of $8.5 million and is anticipated to incur similar debt service expense in 1999. The Company has no other material commitments for capital or other expenditures during 1999 or thereafter. Year 2000 As the Year 2000 approaches, management is assessing the Company's potential exposure to the so called "millenium bug" and the effects the century date change may have on its electronic systems and those of its significant business partners. Since certain computer programs were written using two digits rather than four to define the applicable year, computing devices and 34 systems may recognize a date using the two digits "00" as 1900 rather than the year 2000. Those that do not recognize a date correctly could generate erroneous data and/or cause systems to fail. As part of its firm-wide Year 2000 Project, the Company has established a Year 2000 Task Force consisting of senior management of the Company, led by the Chief Information Officer and General Counsel of Enhance Financial. It has also retained an independent information technology consulting firm and outside legal counsel to provide assistance with Year 2000 compliance and has adequate staff to administer the Project. The progress of the Company's Year 2000 Project is being monitored by the Audit Committee of the board of directors. The Year 2000 Project covers both computer systems and infrastructure ("IT systems") as well as other systems and equipment which utilize embedded microchips ("non-IT systems"). It also considers the readiness of significant third parties on which the Company depends, such as clients, vendors and service providers. The Year 2000 Project has six phases: Project Development and Resource Mobilization, Assessment, Remediation, Testing, Contingency Planning and Implementation. The status of each phase is as follows. Project Development and Resource Mobilization is substantially complete. Assessment of internal IT systems and non-IT systems has proceeded through inventory and analysis of all systems deemed critical by management. Assessment of exposure to third party risks, by means of evaluation of questionnaires mailed to significant third parties is in progress. As part of its third-party due diligence, the Company is assessing the Year 2000 compliance of all major products and services purchased from vendors and service providers of IT and non-IT components and systems. Remediation and Testing of IT systems and non-IT systems are in progress and a separate IT test environment has been established for selected applications deemed critical by management. Contingency Planning, including disaster recovery planning is in progress and will continue throughout 1999. Implementation of contingency plans will be made as and when needed. Based on the assessment of its major IT systems and non-IT systems, the Company expects that all necessary remediation and testing will be completed to insure that it is substantially Year 2000 compliant in all material respects. Since 1997, Enhance has invested in a major initiative to replace and upgrade its technology. This ongoing project, addresses, among other matters, many of the Year 2000 issues of the Company's internal IT systems. The Company has expended approximately $2 million on this project, which, accordingly, includes a portion of the cost of Year 2000 compliance. Additional expenditures for Year 2000 compliance, which will be funded through operating cash flow, are expected to total approximately $1.5 million. These cost estimates are based upon currently available information and may change as the Year 2000 Project proceeds. However, the cost of Year 2000 compliance is not expected to affect materially the financial condition of the Company. The failure of IT systems and non-IT systems associated with cash management, servicing, communications and building facilities would in varying degrees have a material adverse effect on the Company. Such failures could disrupt the Company's ability to conduct normal business operations, including financial transactions such as payment of claims or debts, collecting or funding of receivables and selling of commercial paper. The consequences of such failures could include business interruption, lost revenue and illiquidity. The magnitude of the financial impact of such potential failures is not known at this time. The Year 2000 Project includes a provision for contingency planning for systems and facilities that will generally involve processing that does not rely upon computer systems and will utilize additional staff as 35 needed. The Company has communicated with third parties with which it has material dealings to determine the status of their Year 2000 readiness and it is in the process of assessing its exposure to potential third party Year 2000 failures. Management has determined that the following consequences to the Company could result from the failure of such third parties to successfully address their Year 2000 issues: Obligors of insured issues (see also next paragraph) - increased credit risk, claims, loss of premiums and renewals; Primaries and Reinsurers - increased credit risk, uncollected claims, premium loss, impaired liquidity; Counterparties and Issuers of Obligations - investment portfolio downgrade, loss of income and/or principal; Financial Institutions and Lenders - impaired liquidity, loss of income and/or principal; Vendors and Service Providers interrupted power, building access, telecommunications, flow of goods, security and professional and technical services. The insurance policies issued or reinsured by the insurers of the Company do not contain specific exclusions for Year 2000-related defaults. Generally, a default by an obligor insured or reinsured by the insurers would be covered in such case. Although the insurers would expect to eventually recover the amounts paid in claims for Year 2000-related defaults by obligors, the coincidence of several such unanticipated claims could result in short-term liquidity risk for the insurers. Failure of a trustee or paying agent for an obligor insured by the insurers to make payment on an obligation as a result of a Year 2000-related event (or otherwise) would generally not be covered by policies insured or reinsured and no such claims are expected. Nevertheless, the Company is investigating whether its insured obligors as well as their trustees, paying agents and other related parties will be Year 2000 compliant, and it will establish appropriate contingency plans based upon the results of this inquiry. In addition to other risks in connection with the Year 2000, general uncertainty among market participants could cause a decline in business activity and revenue in 1999 and 2000, as companies address their Year 2000 issues. The Company cannot predict the magnitude of this possible decline or the impact that it may have on its financial results for those years. However, the Company has undertaken a thorough review of third party risks inherent in Year 2000 issues, and it is working with the industry group allied with its core business to identify and address credit and other business issues related to Year 2000. The Company is also assessing potential effects of unexpected failures in local, national or international systems, including power, communication and transportation systems, on which the normal conduct of business depends, and it will establish contingency plans to deal with such failures, although there can be no assurance that such plans can be effective in such circumstances, especially in the case of widespread economic disruption. The Company believes that it will be substantially Year 2000 compliant on or before December 31, 1999. However, there can be no assurance, due to the uncertain nature of potential Year 2000 problems and the Company's lack of control over some of them, especially the readiness of third parties, that all Year 2000 issues will be foreseen and corrected in a timely fashion. While management does not believe that Year 2000 issues will have a material adverse effect on the Company, the failure of the efforts of the Company or its significant third parties to address material Year 2000 issues, could result in the disruption of the Company's normal business activities and have such a material adverse effect on the Company. 36 Item 7A. Quantitative and Qualitative Disclosures about Market Risk. Market Risk At year-end 1998, the Company's investment portfolio holdings are approximately 96% U.S. dollar-denominated fixed-income securities consisting of municipal bonds, mortgage and asset-backed securities, corporate bonds, and U.S. government bonds; the balance of the portfolio holdings are in non-U.S. dollar-denominated bonds in a variety of currencies. Although the Company has not invested more than 1% of its portfolio in bonds denominated in any one foreign currency, the Company uses currency forward contracts to manage its foreign exchange risk. The market values of the Company's reported financial instruments change as interest rates change. In general, rate decreases cause asset prices to rise, while rate increases cause asset prices to fall. Interest rate sensitivity can be modeled using the assets' effective duration and convexity to estimate price change for a given rate change. To model such changes, both spreads and yield curve slope are held constant while the portfolio is subjected to a hypothetical instantaneous rate change. Embedded optionality is considered, and municipal rates are assumed to change at a rate equal to the prevailing taxable/tax exempt ratio times the assumed taxable rate change. Based on market values and prevailing interest rates as of year-end 1998, a hypothetical instantaneous increase in rates of 100 basis points would produce an after-tax decrease in the Company's financial instruments' market value of approximately $33.5 million, or 3.5% of the Company's investment portfolio. Of this total, $28.4 million, or 3.8% of the portfolio, would be attributable to assets held as Available for Sale under SFAS 115; the balance, $5.1 million would be attributable to assets held as Hold to Maturity, which are carried at book value. Since the Company is able to hold its securities to maturity, it does not expect to suffer any material adverse effect to its results of operations under such a scenario. 37 Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES Page ---- Independent Auditors' Report 39 Consolidated Balance Sheets as of December 31, 1998 and 1997 40 Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996 41 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 42 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 43 Notes to Consolidated Financial Statements 44 All schedules not included are omitted because they are either not applicable or because the information required therein is included in Notes to Consolidated Financial Statements. 38 INDEPENDENT AUDITORS' REPORT To the Board of Directors Enhance Financial Services Group Inc. We have audited the accompanying consolidated balance sheets of Enhance Financial Services Group Inc. and Subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Enhance Financial Services Group Inc. and Subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Deloitte & Touche LLP March 19, 1999 New York, New York 39 ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except share amounts)
December 31, December 31, 1998 1997 ---- ---- Assets Investments: Fixed maturities, held to maturity, at amortized cost $ 196,768 $ 210,436 (market value $205,792 and $219,763) Fixed maturities available for sale, at market 694,374 608,077 (amortized cost $657,644 and $577,388) Common stock - at market (cost $498) 839 833 Investment in affiliates 96,867 38,862 Short-term investments 50,794 50,827 Cash and cash equivalents 5,542 5,686 ----------- ----------- Total Investments 1,045,184 914,721 Federal income taxes recoverable 9,717 3,366 Premiums and other receivables 35,950 29,958 Accrued interest and dividends receivable 15,241 12,959 Deferred policy acquisition costs 103,794 95,645 Prepaid reinsurance premiums 7,000 6,281 Reinsurance recoverable on unpaid losses 2,500 2,688 Receivable from affiliates 16,710 10,640 Receivable for securities 9,590 702 Other assets 90,731 70,549 ----------- ----------- Total Assets $ 1,336,417 $ 1,147,509 =========== =========== Liabilities and Shareholders' Equity Liabilities Losses and loss adjustment expenses $ 36,239 $ 33,675 Reinsurance payable on paid losses and loss adjustment expenses 5,994 3,479 Deferred premium revenue 315,215 287,535 Accrued profit commissions 2,511 3,768 Deferred income taxes 79,569 64,680 Long-term debt 75,000 75,000 Short-term debt 54,290 43,500 Payable for securities 11,557 5,318 Accrued expenses and other liabilities 49,843 41,144 Payable to affiliates 43,553 8,017 ----------- ----------- Total Liabilities $ 673,771 $ 566,116 ----------- ----------- Shareholders' Equity Common stock - $.10 par value Authorized - 100,000,000 shares Issued - 39,812,937 and 38,671,870 shares $ 3,981 $ 3,867 Additional paid-in capital 249,851 228,507 Retained earnings 418,214 344,402 Accumulated other comprehensive income 23,186 19,396 Treasury stock (32,586) (14,779) ----------- ----------- Total Shareholders' Equity $ 662,646 $ 581,393 ----------- ----------- Total Liabilities and Shareholders' Equity $ 1,336,417 $ 1,147,509 =========== ===========
See notes to consolidated financial statements 40 ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands except per share amounts)
Years ended December 31, -------------------------------------------- 1998 1997 1996 ---- ---- ---- Revenues Net premiums written .......................... $ 129,299 $ 100,506 $ 95,662 Increase in deferred premium revenue .......... (26,962) (15,051) (18,229) --------- --------- --------- Premiums earned ............................. 102,337 85,455 77,433 Net investment income ......................... 53,423 50,618 47,462 Net realized gains on sale of investments ..... 2,434 657 4,008 Assignment sales .............................. 45,376 29,200 -- Other income .................................. 3,914 4,463 2,738 --------- --------- --------- Total revenues .............................. 207,484 170,393 131,641 --------- --------- --------- Expenses Losses and loss adjustment expenses ........... 10,324 9,755 9,184 Policy acquisition costs ...................... 35,007 30,020 26,703 Profit commissions ............................ 1,073 719 850 Other operating expenses - insurance .......... 13,683 12,225 10,537 - non-insurance ...... 39,873 25,141 2,660 --------- --------- --------- Total expenses .............................. 99,960 77,860 49,934 --------- --------- --------- Income from operations ........................ 107,524 92,533 81,707 Equity in income of affiliates ................ 14,066 8,778 274 Foreign currency loss ......................... (283) (38) (69) Interest expense .............................. (8,500) (7,317) (5,522) --------- --------- --------- Income before income taxes .................. 112,807 93,956 76,390 Income taxes .................................. 30,350 25,150 20,686 --------- --------- --------- Net income .................................. $ 82,457 $ 68,806 $ 55,704 ========= ========= ========= Earnings per share - Basic ...................... $ 2.20 $ 1.86 $ 1.56 --------- --------- --------- - Diluted .................... $ 2.10 $ 1.78 $ 1.52 --------- --------- --------- Weighted average shares outstanding - Basic ..... 37,520 37,069 35,750 --------- --------- --------- - Diluted ... 39,275 38,627 36,706 --------- --------- ---------
See notes to consolidated financial statements 41 ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (in thousands except share amounts)
Common Stock Treasury Stock ----------------------- ------------------------ Additional Paid-In Shares Amount Shares Amount Capital ------ ------ ------ ------ ------- Balance, December 31, 1995 36,604,100 $ 3,660 2,125,350 ($ 18,043) $ 191,035 Comprehensive income: -- Net income for the period -- -- -- -- -- Unearned compensation adjustment (net of tax of $31) -- -- -- -- -- Unrealized losses during the period (net of tax of $3,697) -- -- -- -- -- Reclassification adjustment for losses included in net income (net of tax of $1,928) -- -- -- -- -- Total comprehensive income: -- -- -- -- -- Amortization of unearned compensation -- -- -- -- 282 Dividends paid ($0.20 per share) -- -- -- -- -- Exercise of stock options 462,550 46 -- -- 4,699 Registration costs of common stock -- -- -- -- (184) Reissuance of treasury stock -- -- (1,200,000) 10,323 4,162 Purchase of treasury stock -- -- 3,200 (38) -- ---------- ---------- --------- --------- ---------- Balance, December 31, 1996 37,066,650 3,706 928,550 (7,758) 199,994 ---------- ---------- --------- --------- ---------- Comprehensive income: Net income for the period -- -- -- -- -- Unearned compensation adjustment (net of tax of $7) -- -- -- -- -- Unrealized gains during the period (net of tax of $7,106) -- -- -- -- -- Reclassification adjustment for gains included in net income (net of tax of $87) -- -- -- -- -- Total comprehensive income: -- -- -- -- -- Dividends paid ($0.22 per share) -- -- -- -- -- Exercise of stock options 598,992 60 -- -- 7,281 Issuance of common stock 1,006,228 101 -- -- 21,232 Purchase of treasury stock -- -- 355,850 (7,021) -- ---------- ---------- --------- --------- ---------- Balance, December 31, 1997 38,671,870 3,867 1,284,400 (14,779) 228,507 ---------- ---------- --------- --------- ---------- Comprehensive income: Net income for the period -- -- -- -- -- Unearned compensation adjustment (net of tax of $202) -- -- -- -- -- Unrealized foreign currency translation adjustment (net of tax of $159) -- -- -- -- -- Unrealized gains during the period (net of tax of $2,183) -- -- -- -- -- Reclassification adjustment for gains included in net income (net of tax of $718) -- -- -- -- -- Total comprehensive income: -- -- -- -- -- Dividends paid ($0.23 per share) -- -- -- -- -- Exercise of stock options 665,674 66 -- -- 9,854 Issuance of common stock 475,393 48 -- -- 11,490 Purchase of treasury stock -- -- 666,394 (17,807) -- ---------- ---------- --------- --------- ---------- Balance, December 31, 1998 39,812,937 $ 3,981 1,950,794 $ (32,586) $ 249,851 ---------- ---------- --------- --------- ---------- Accumulated Other Comprehensive Income ---------------------------------------- Foreign Currency Unrealized Unearned Translation Holding Gains Retained Compensation Adjustment (Losses) Earnings Total ------------ ---------- -------- -------- ----- Balance, December 31, 1995 ($ 104) $ 0 $ 12,104 $ 235,285 $ 423,937 Comprehensive income: Net income for the period -- -- -- 55,704 -- Unearned compensation adjustment (net of tax of $31) 84 -- -- -- -- Unrealized losses during the period (net of tax of $3,697) -- -- (7,247) -- -- Reclassification adjustment for losses included in net income (net of tax of $1,928) -- -- 3,779 -- -- Total comprehensive income: -- -- -- -- 52,320 Amortization of unearned compensation -- -- -- -- 282 Dividends paid ($0.20 per share) -- -- -- (7,198) (7,198) Exercise of stock options -- -- -- -- 4,745 Registration costs of common stock -- -- -- -- (184) Reissuance of treasury stock -- -- -- -- 14,485 Purchase of treasury stock -- -- -- -- (38) ---------- ---------- ---------- ---------- ---------- Balance, December 31, 1996 (20) -- 8,636 283,791 488,349 ---------- ---------- ---------- ---------- ---------- Comprehensive income: Net income for the period -- -- -- 68,806 -- Unearned compensation adjustment (net of tax of $7) 20 -- -- -- -- Unrealized gains during the period (net of tax of $7,106) -- -- 10,894 -- -- Reclassification adjustment for gains included in net income (net of tax of $87) -- -- (134) -- -- Total comprehensive income: -- -- -- -- 79,586 Dividends paid ($0.22 per share) -- -- -- (8,195) (8,195) Exercise of stock options -- -- -- -- 7,341 Issuance of common stock -- -- -- -- 21,333 Purchase of treasury stock -- -- -- -- (7,021) ---------- ---------- ---------- ---------- ---------- Balance, December 31, 1997 -- -- 19,396 344,402 581,393 ---------- ---------- ---------- ---------- ---------- Comprehensive income: Net income for the period -- -- -- 82,457 -- Unearned compensation adjustment (net of tax of $202) (493) -- -- -- -- Unrealized foreign currency translation adjustment (net of tax of $159) -- 714 -- -- -- Unrealized gains during the period (net of tax of $2,183) -- -- 5,318 -- -- Reclassification adjustment for gains included in net income (net of tax of $718) -- -- (1,749) -- -- Total comprehensive income: -- -- -- -- 86,247 Dividends paid ($0.23 per share) -- -- -- (8,645) (8,645) Exercise of stock options -- -- -- -- 9,920 Issuance of common stock -- -- -- -- 11,538 Purchase of treasury stock -- -- -- -- (17,807) ---------- ---------- ---------- ---------- ---------- Balance, December 31, 1998 $ (493) $ 714 $ 22,965 $ 418,214 $ 662,646 ---------- ---------- ---------- ---------- ----------
See notes to consolidated financial statements 42 ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years ended December 31, ------------------------------------ 1998 1997 1996 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 82,457 $ 68,806 $ 55,704 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization, net (7,696) (8,869) (8,333) Gain on sale of investments, net (2,434) (657) (4,008) Equity in income of affiliates (14,066) (8,778) (274) Compensation, restricted stock award program -- 20 84 Change in assets and liabilities, net of effects of purchase of Singer: Premiums receivable (5,992) (4,775) (1,255) Accrued interest and dividends receivable (2,282) (1,525) (695) Accrued expenses and other liabilities 8,699 12,072 2,812 Deferred policy acquisition costs (8,149) (8,320) (6,128) Deferred premium revenue, net 26,961 15,050 18,153 Accrued profit commissions (1,257) 718 (669) Losses and loss adjustment expenses,net 5,267 5,745 (2,870) Payable to (receivable from) affiliate 29,466 (5,671) -- Payable (receivable) for securities (2,649) 4,903 (17,611) Other assets (18,932) (15,700) (2,741) Income taxes, net 6,281 14,789 9,999 --------- --------- --------- Net cash provided by operating activities 95,674 67,808 42,168 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (2,616) (2,027) (599) Proceeds from sales and maturities of investments 309,582 412,892 663,573 Purchase of investments (364,674) (444,793) (717,735) Sales(purchases) of short-term investments, net 33 (16,211) 10,856 Investment in affiliates (32,401) (10,640) (16,667) Cash of previously unconsolidated subsidiary -- 147 -- --------- --------- --------- Net cash used in investing activities (90,076) (60,632) (60,572) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Receivable from affiliates -- -- (21,260) Capital stock 9,920 7,341 4,843 Short-term debt 10,790 1,000 27,575 Dividends paid (8,645) (8,195) (7,198) Principal payment long-term debt -- -- (3,400) Reissuance of treasury stock -- -- 14,485 Purchase of treasury stock (17,807) (7,021) (38) --------- --------- --------- Net cash provided by (used in) financing activities (5,742) (6,875) 15,007 --------- --------- --------- Net change in cash and cash equivalents (144) 301 (3,397) Cash and cash equivalents, beginning of year 5,686 5,385 8,782 --------- --------- --------- Cash and cash equivalents, end of year $ 5,542 $ 5,686 $ 5,385 ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for income taxes $ 3,000 $ 10,678 $ 4,608 ========= ========= ========= Cash paid during the year for interest $ 8,591 $ 8,136 $ 6,326 ========= ========= =========
See notes to consolidated financial statements 43 ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1998, 1997 and 1996 Note 1 - Organization Enhance Financial Services Group Inc. ("Enhance Financial", and together with its consolidated subsidiaries, the "Company") is a holding company which was incorporated in the State of New York in December 1985 and commenced operations in November 1986. The Company principally engages, through its indirect wholly-owned, New York-domiciled insurance subsidiaries Enhance Reinsurance Company ("Enhance Re") and Asset Guaranty Insurance Company ("Asset Guaranty") (together, the "Insurance Subsidiaries"), which are owned by a wholly-owned subsidiary of Enhance Financial, Enhance Investment Corporation ("EIC"), in the reinsurance of financial guaranties of municipal and asset backed debt obligations issued by monoline financial guaranty insurers. In addition, the Company is engaged in other insurance, reinsurance and non-insurance businesses that utilize the Company's expertise in performing sophisticated analyses of complex, credit-based risks. The Company's other insurance businesses involve the issuance of direct financial guaranties of smaller municipal debt obligations, trade credit reinsurance, financial responsibility bonds and excess-SIPC/excess-ICS and related type bonds. These other insurance businesses are conducted by the Company's Insurance Subsidiaries, Van-American Companies, Inc. and subsidiaries ("Van-Am", see Note 5), and Enhance Reinsurance (Bermuda) Limited ("EnRe Bermuda"), a Bermuda domiciled insurer. The Company, through a consolidated subsidiary, Singer Asset Finance Company, LLC ("Singer", see Note 5) and partially-owned affiliates, Credit-Based Asset Servicing and Securitization LLC ("C-BASS", see Note 5) and Sherman Financial Group LLC ("Sherman" see Note 5 ), is also engaged in the origination, purchase, servicing and/or securitization of special assets, including lottery awards, structured settlement payments, sub-performing/non-performing residential mortgages and unsecured delinquent consumer assets including credit cards receivables. Note 2 - Significant Accounting Policies The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"), which, for the Insurance Subsidiaries, differ in certain material respects from the accounting practices prescribed or permitted by regulatory authorities (see Note 3). The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The significant accounting policies of Enhance Financial and its subsidiaries are as follows: Consolidation The accompanying financial statements include the accounts of Enhance Financial, EIC, the Insurance Subsidiaries, Singer, Van-Am and EnRe Bermuda (collectively the "Company"). All 44 significant intercompany accounts and transactions have been eliminated. Investments in immaterial wholly-owned subsidiaries and in investments in which the Company owns from 20% to 50% of those companies are accounted for in accordance with the equity method of accounting (see Note 5). Investments In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting for Certain Investments in Debt and Equity Securities," management classifies all securities at the time of purchase as "held to maturity" or "available for sale." Fixed maturity securities held to maturity are those securities which the Company intends and has the ability to hold until maturity and are carried at amortized cost. All other fixed maturity securities are classified as available for sale and carried at fair value. Unrealized gains and losses, net of taxes, on the available for sale portfolio are charged or credited to accumulated other comprehensive income. Common stocks are carried at fair value. Short-term investments are carried at cost, which approximates market. Unrealized gains and losses, net of taxes, on common stocks are reflected in accumulated other comprehensive income. Realized gains or losses on sales of investments are determined on the basis of specific identification. Derivatives The Company uses forward currency contracts to hedge foreign currency exchange risk associated with fixed maturity investments denominated in foreign currencies. Gains and losses on open forward currency exchange contracts, which qualify as accounting hedges are deferred and recognized as an adjustment of the carrying amount of the hedged assets. Gains and losses on expired contracts are recognized currently. The Company uses forward treasury lock agreements to hedge interest rate risk associated with unsecuritized assets held and anticipated acquisitions of assets by Singer. Gains and losses on such instruments that qualify as accounting hedges are deferred until the underlying hedged asset is sold, at which time the gain or loss on the related hedge is recognized in income. The counterparties to the Company's foreign currency contracts and forward treasury lock agreements are substantial and creditworthy multinational commercial banks or other financial institutions which are recognized market makers. Premium Revenue Recognition Premiums are earned in proportion to the level amortization of insured principal over the contract period. Deferred premium revenue represents that portion of premiums which will be earned over the remainder of the contract period. When insured issues are refunded or called, the remaining deferred premium revenue is generally earned at that time, since the risk to the Company is considered to have been eliminated. 45 Reinsurance Ceded In the normal course of business, the Insurance Subsidiaries reinsure portions of their direct and assumed exposures with other insurance companies through contracts designed to limit losses from certain risks and to protect capital and surplus. The following summarizes the effect of reinsurance on premiums written and earned:
In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Written Earned Written Earned Written Earned Direct $ 30,484 $ 19,704 $ 25,477 $ 13,950 $ 16,946 $ 9,676 Assumed 99,922 84,248 82,675 75,665 81,642 70,145 Ceded (1,107) (1,615) (7,646) (4,160) (2,926) (2,388) --------- --------- --------- -------- -------- -------- Net premiums $ 129,299 $ 102,337 $ 100,506 $ 85,455 $ 95,662 $ 77,433 ========= ========= ========= ======== ======== ========
The effect of reinsurance on losses and loss adjustments expenses for the years ended December 31, 1998, 1997 and 1996 was a decrease of $1,230,000, $335,000 and $678,000, respectively. In the event that any or all of the reinsurers were unable to meet their obligations, the Insurance Subsidiaries would be liable for such defaulted amounts. Assignment Sales The Company acquires from individuals the right to receive lottery awards and structured settlement payments and securitizes these payment streams. Income is recognized at the time of sale through the securitization process for the difference between the net sales proceeds and the purchase price paid to individuals, less commissions. Deferred Policy Acquisition Costs Deferred policy acquisition costs comprise those expenses that vary with and are primarily related to the production of insurance premiums, including: commissions paid on reinsurance assumed, salaries and related costs of underwriting and marketing personnel, rating agency fees, premium taxes and certain other underwriting expenses, offset by ceding commission income on premiums ceded to reinsurers. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed or be less than recoverable amounts, after considering investment income. Losses and Loss Adjustment Expenses ("LAE") Reserves for losses and LAE are established based on the Company's best estimate of specific and non-specific losses, including expenses associated with settlement of such losses, on its 46 insured and reinsured obligations. The Company records a provision for losses and related LAE when reported by primary insurers or when, in the Company's opinion, an insured risk is in default or a default is probable and the amount of the loss is reasonably estimable. In the case of obligations with fixed periodic payments, the provision for losses and LAE represents the present value of the Company's ultimate expected losses, adjusted for estimated recoveries under salvage or subrogation rights. The estimates for losses and LAE are periodically evaluated by the Company, and changes in estimates are reflected in income currently. The Company believes that the reserves are adequate to cover the ultimate cost of all claims net of reinsurance recoveries. However, the reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not exceed such estimates. The Company discounts certain financial guaranty liabilities at annual rates ranging from 5.14% to 6.36%. These discounted liabilities at December 31,1998 and 1997 were $17.5 million and $19.0 million, respectively, net of discounts of $11.0 million and $2.5 million, respectively. Federal Income Taxes In accordance with SFAS No. 109, "Accounting for Income Taxes," deferred federal income taxes are provided for temporary differences between the tax and financial reporting basis of assets and liabilities that will result in deductible or taxable amounts in future years when the reported amount of the asset or liability is recovered or settled. In the case of the Company, such temporary differences relate principally to premium revenue recognition and deferred acquisition costs. The Internal Revenue Code permits municipal bond insurance companies to deduct from taxable income, subject to certain limitations, the amounts added to the statutory mandatory contingency reserve during the year. The deduction taken is allowed only to the extent that U.S. Treasury non-interest-bearing tax and loss bonds are purchased at their par value prior to the original due date of the Company's consolidated federal tax return and held in an amount equal to the tax benefit attributable to such deductions. The amounts deducted must be included in taxable income when the contingency reserve is released, at which time the Company may redeem the tax and loss bonds to satisfy the additional tax liability. The purchases of tax and loss bonds are recorded as payments of federal income taxes and are not reflected in the Company's current tax provision. Post-Retirement And Post-Employment Benefits The Company provides various post-retirement and post-employment benefits, including pension, health and life insurance benefits covering substantially all employees who meet certain age and service criteria. The Company accounts for these benefits under the accrual method of accounting. Amounts related to anticipated obligations under the defined benefit pension plan and post-retirement benefits are recorded based on actuarial determinations. Stock Compensation Plans The Company has in effect a stock option program for key employees and a directors' stock option program for the benefit of directors who are not employees of the Company. In March 1998, the board of directors adopted the Director Stock Ownership Plan. Under these programs, awards are granted to eligible employees and directors of the Company in the form of Incentive Stock Options, where they qualify under the Internal Revenue Code, or Non-Qualified Stock 47 Options. The Company follows the intrinsic value based method of accounting for stock based compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Company has provided pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied (see Note 12). Earnings Per Share In accordance with SFAS No. 128, "Earnings per Share," the Company reports "basic" and "diluted" earnings per share ("EPS"). Basic EPS is determined by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities such as employee stock options were exercised. Diluted EPS is computed using the treasury stock method to determine the weighted average number of common stock equivalents outstanding during each year. For all periods presented common stock equivalents are comprised of outstanding options pursuant to the Company's stock option programs. Following is a reconciliation of weighted average common shares outstanding to weighted average common and common equivalent shares outstanding for the years ended December 31, 1998, 1997 and 1996. In thousands 1998 1997 1996 ------ ------ ------ Weighted average common shares outstanding 37,520 37,069 35,750 Dilutive effect of common stock options 1,755 1,558 956 ------ ------ ------ Weighted average common and common equivalent shares outstanding 39,275 38,627 36,706 ====== ====== ====== New Accounting Pronouncements During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of Enterprise and Related Information". This pronouncement requires a company to present disaggregated information based on the internal segments used in managing its business. The adoption of this statement did not impact the Company's financial position or results of operations, but it did affect the presentation of the Company's segment disclosures (see Note 17). Effective in 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." This pronouncement established new rules for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The adoption of this statement had no impact on the Company's financial position or results of operations. SFAS No. 130 requires the Company's unrealized gains and losses and changes in foreign currency translation adjustment to be included in other comprehensive income. Prior years financial statements have been reclassified to conform to these requirements. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivatives Instruments and Hedging Activities," which becomes effective for the Company January 1, 2000. This pronouncement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company will be required to recognize all derivatives 48 as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for a change in fair value of a derivative in earnings or other comprehensive income will depend on the intended use of the derivative and the resulting designation. Derivatives can be designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment, (b) a hedge of the exposure to variable cash flows of a forecast transaction. or (c) a hedge of foreign currency exposure of a net investment in foreign operations, an unrecognized firm commitment, an available-for-sale security, or a foreign currency denominated forecasted transaction. The Company is currently reviewing the impact of the implementation of SFAS No. 133 on its financial statements. In March 1998, the National Association of Insurance Commissioners adopted the Codification of Statutory Accounting Principles (the "Codification"). The Codification is intended to standardize regulatory accounting and reporting for the insurance industry and is proposed to be effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices, and it is uncertain when or if, the State of New York will require adoption of the Codification for the preparation of statutory financial statements. The Company has not finalized the quantification of the effects of Codification on its statutory financial statements Cash and Cash Equivalents For purposes of the statements of cash flows, the Company considers all highly liquid short-term investments with an original maturity of three months or less to be cash equivalents. Stock Split All references to number of common shares and per-share information reflect the two-for-one stock split which was effective on June 26, 1998. Reclassifications Certain of the prior years' amounts have been reclassified to conform to the current year presentation. Note 3 -Insurance Regulatory Matters The consolidated financial statements are prepared on the basis of GAAP which, for the Insurance Subsidiaries, differ in certain material respects from accounting practices prescribed or permitted by insurance regulatory authorities. The significant differences result from statutory accounting practices which treat premiums earned, policy acquisition costs, deferred income taxes, investments in fixed maturities and loss reserves differently. At December 31, 1998, the statutory basis policyholders' surplus of Enhance Re and Asset Guaranty, as reported to insurance regulatory authorities, was $225.7 million and $98.5 million, respectively. Statutory net income of Enhance Re and Asset Guaranty was $51.7 million and $11.0 million, respectively, for the year ended December 31, 1998. At December 31, 1997, the statutory basis policyholders' surplus of Enhance Re and Asset Guaranty, as reported to insurance regulatory authorities, was $228.3 million and $94.9 million, respectively. Statutory net income 49 of Enhance Re and Asset Guaranty was $40.7 million and $11.7 million, respectively, for the year ended December 31, 1997. Statutory net income of Enhance Re and Asset Guaranty was $46.5 million and $8.8 million, respectively, for the year ended December 31, 1996. The New York Insurance Law requires financial guaranty insurers to maintain a minimum policyholders' surplus of $65 million. When added to the minimum policyholders' surplus of $3.4 million separately required for the other lines of insurance which it is licensed to write, each of the Insurance Subsidiaries is required to have an aggregate minimum policyholders' surplus of $68.4 million. Under the New York Insurance Law, the Insurance Subsidiaries may declare or distribute dividends only out of earned surplus. The maximum amount of dividends which may be paid by the Insurance Subsidiaries to Enhance Financial without prior approval of the Superintendent of Insurance is subject to restrictions relating to statutory surplus and net investment income as defined by statute. Enhance Re declared a dividend of $22 million and paid $21 million, and Asset Guaranty declared and paid a dividend of $3 million to Enhance Financial for the year ended December 31, 1998. At December 31, 1998, the Insurance Subsidiaries had an additional $13.4 million available for dividend distribution. The New York Insurance Law establishes single-risk limits applicable to all obligations issued by a single entity and backed by a single revenue source. Under the limit applicable to municipal bonds, the insured average annual debt service for a single risk, net of reinsurance and collateral, may not exceed 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of reinsurance and collateral, is limited to 75% of the insurer's policyholders' surplus and contingency reserves. Additional single risk limits, which generally are more restrictive than the municipal bond single risk limit, are also specified for several other categories of insured obligations. Note 4 - Investments The following is a summary of the Company's investments in fixed maturities at December 31, 1998 and 1997:
Gross Gross In thousands Amortized Unrealized Unrealized 1998 Cost Gains Losses Fair Value ---- ----- ------ --------- HELD TO MATURITY Private placements $ 96,289 $ -- $ -- $ 96,289 Municipal obligations 93,290 8,401 -- 101,691 Corporate securities 4,695 394 -- 5,089 U.S. Government obligations 2,494 229 -- 2,723 -------- ------- ------ -------- Total held to maturity $196,768 $ 9,024 $ -- $205,792 ======== ======= ====== ======== AVAILABLE FOR SALE Municipal obligations $489,477 $31,233 $ 35 $520,675 Mortgage-backed securities 95,956 2,644 3,640 94,960 Corporate securities 46,732 2,349 605 48,476
50 Foreign securities 22,203 4,497 3 26,697 U.S. Government obligations 3,276 290 -- 3,566 -------- ------- ------ -------- Total available for sale $657,644 $41,013 $4,283 $694,374 ======== ======= ====== ========
Gross Gross In thousands Amortized Unrealized Unrealized 1997 Cost Gains Losses Fair Value ---- ----- ------ --------- HELD TO MATURITY Private placements $105,125 $ -- $ -- $105,125 Municipal obligations 96,959 8,877 -- 105,836 Corporate securities 5,832 324 -- 6,156 U.S. Government obligations 2,520 126 -- 2,646 -------- ------- ---- -------- Total held to maturity $210,436 $ 9,327 $ -- $219,763 ======== ======= ==== ======== AVAILABLE FOR SALE Municipal obligations $415,131 $23,917 $ 6 $439,042 Mortgage-backed securities 71,361 2,375 -- 73,736 Corporate securities 44,836 2,077 2 46,911 Foreign securities 33,282 2,663 516 35,429 U.S. Government obligations 12,778 183 2 12,959 -------- ------- ---- -------- Total available for sale $577,388 $31,215 $526 $608,077 ======== ======= ==== ========
The amortized cost and estimated fair value of fixed maturities at December 31, 1998 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In thousands Amortized Cost Fair Value -------------- ---------- Fixed maturities, held to maturity Due in one year or less $ 16,926 $ 16,963 Due after one year through five years 95,837 99,167 Due after five years through ten years 51,825 54,669 Due after ten years 32,180 34,993 -------- -------- $196,768 $205,792 ======== ======== Fixed maturities, available for sale Due in one year or less $ 2,550 $ 2,581 Due after one year through five years 31,742 33,473 Due after five years through ten years 144,473 152,887 Due after ten years 478,879 505,433 -------- -------- $657,644 $694,374 ======== ======== 51 Proceeds from sales of available for sale investments in fixed maturities during 1998, 1997 and 1996 were approximately $301 million, $407 million and $640 million, respectively. Gross gains of $5.0 million and gross losses of $2.6 million were realized on those sales in 1998. Gross gains of $4.8 million and gross losses of $4.2 million were realized on those sales in 1997. Gross gains of $7.7 million and gross losses of $3.7 million were realized on those sales in 1996. Sources of the Company's consolidated net investment income are as follows: In thousands Years Ended December 31, 1998 1997 1996 ------- ------- ------- Fixed maturities $53,312 $50,258 $46,102 Short-term investments and cash equivalents 2,148 1,872 3,184 Other 416 572 188 ------- ------- ------- Total investment income 55,876 52,702 49,474 Less investment expenses 2,453 2,084 2,012 ------- ------- ------- Net investment income $53,423 $50,618 $47,462 ======= ======= ======= 52 The net unrealized appreciation of investments included as a component of other comprehensive income at December 31, 1998 and 1997 is as follows (in thousands): 1998 1997 ---- ---- Difference between market value and amortized cost of available for sale portfolio Fixed maturities $ 36,730 $ 30,689 Equity securities 341 335 -------- -------- 37,071 31,024 Deferred tax expense (14,106) (11,628) -------- -------- Net unrealized appreciation of investments $ 22,965 $ 19,396 ======== ======== Unrealized appreciation of investments in equity securities at December 31, 1998 and 1997 includes gross unrealized gains of $341,000 and $335,000, respectively. Under agreements with its primaries and in accordance with statutory requirements, the Insurance Subsidiaries maintain funds (fixed maturities and cash equivalents) in trust accounts principally for the benefit of reinsured companies and for the protection of policyholders in states in which the Insurance Subsidiaries are not licensed. The Company maintains full control over the management of assets held in trust accounts. The carrying amount of such restricted balances amounted to approximately $312 million and $286 million at December 31, 1998 and December 31, 1997, respectively. Note 5 - Investment in Affiliates The Company owns 360,000 shares of EIC Corporation Ltd. ("EIC"), an insurance holding company which, through its wholly-owned insurance subsidiary licensed in Bermuda, insures foreign trade receivables. The Company's investment represented an equity interest of approximately 41% at the date of acquisition and approximately 36.5% at December 31, 1998. The Company accounts for its investment in EIC in accordance with the equity method of accounting. In 1997, as part of the recapitalization of Van-Am, the Company contributed $2.0 million to Van-Am. The Company owns a controlling equity interest in the outstanding stock of Van-Am and accounts for its investment on a consolidated basis. Due to intense pricing competition in Van-Am's core business and a poor strategic fit with the Company's other operations, the Company has decided to exit the surety line of business and sell its interest in Van Am, if possible. If the Company is unable to sell its interest in Van Am, the Company plans to run-off its insurance liabilities, which may take ten or more years. An estimated $2.3 million of expenses associated with this action have been recognized in the 1998 fourth quarter. In 1995, the Company acquired all of the outstanding shares of Litton Loan Servicing, Inc. ("LLSI"), a Houston-based loss mitigation residential mortgage servicer. The purchase price approximated the fair market value of the acquired assets and liabilities at the date of acquisition. 53 In 1996, the Company and MGIC Investment Corporation formed C-BASS, with members of management thereof. C-BASS evaluates, purchases, services and securitizes sub-performing , non-performing, and seller financed residential mortgages and real estate and subordinated residential mortgage-backed securities. The Company owns approximately a 48% interest in C-BASS, which is being accounted for on the equity basis of accounting. In 1998, the Company contributed its interest in LLSI to C-BASS as part of its initial capital commitment. Due to the nature of servicing sub-performing mortgages, LLSI is an integral part of the operational activities of C-BASS. At December 31, 1998, the Company had contributed $55.5 million of capital to C-BASS. The following table sets forth combined C-BASS financial data for the three preceding years (In millions): 1998 1997 1996 ------ ------ ------ Mortgage-related assets $550.1 $189.6 $ 83.2 Other assets 73.4 40.0 20.0 ------ ------ ------ Total assets 623.5 229.6 103.2 ====== ====== ====== Funding arrangements 360.8 121.9 53.7 Other liabilities 107.6 45.0 15.2 ------ ------ ------ Total liabilities 468.4 166.9 68.9 ====== ====== ====== Total revenues 69.7 36.2 6.7 Total expenses 43.7 21.0 6.5 ------ ------ ------ Net income $ 26.0 $ 15.2 $ 0.2 ====== ====== ====== In January 1998, C-BASS entered into a revolving credit facility agreement with a major commercial bank. At March 19, 1999, Enhance Financial had guaranteed $25 million under this facility. In 1995, the Company acquired, for cash, a 50% joint venture interest in Singer, which originates, securitizes and sells various types of special assets such as lottery awards, structured settlement payments and similar obligations. In 1997, the Company acquired the remaining 50% of Singer in a series of all-stock transactions for an aggregate purchase price valued at $21.3 million. The excess (approximately $20.4 million) of the Company's aggregate cost over the fair value of the net assets of Singer represents goodwill and is being amortized on a straight line basis over 20 years. In 1997, the Company purchased at book value a 25% interest in Seguradores Brasilieras de Fiancas S.A. ("SBF"), a Brazilian-based surety insurance company. SBF is a joint venture among the Company, Swiss Re and Banco Pactual S.A. through which the Company anticipates developing and marketing innovative credit-based insurance products throughout Latin America. The Company's investment in SBF at December 31, 1998 was approximately $4.5 million. In July 1998, the Company formed AGS Financial LLC ("AGS"), a New York-based venture with the management thereof. AGS provides structured finance, asset servicing and specialized investment-banking services in Latin American markets. At December 31, 1998, the Company had contributed of $300,000 of its required initial capital contribution commitment of $3.1 million. 54 In November 1998, the Company acquired through merger all of the outstanding shares of Alegis Group, Inc. ("Alegis"), the parent holding company of a Houston-based servicer and collector of delinquent consumer assets for an aggregate purchase price of approximately $11.7 million which approximated the fair market value of Alegis (see Note 8). In December 1998, the Company and MGIC formed a joint venture, Sherman Financial Group LLC ("Sherman") with members of management thereof, to provide analytic and due diligence services to purchasers of unsecured delinquent consumer assets and purchases, services and securitizes unsecured delinquent consumer assets. The Company owns a 45.5% interest in Sherman, which is being accounted for on the equity basis of accounting. As part of its commitment to capitalize Sherman, the Company will contribute its entire interest in Alegis to Sherman. Total assets of the Company's unconsolidated subsidiaries and affiliates accounted for by the equity method of accounting at December 31, 1998 and 1997 were $707.2 million and $293.4 million respectively. Total liabilities at December 31, 1998 and 1997 were $507.3 million and $194.7 million, respectively. Total net income for the years' ended December 31, 1998 and 1997 was $30.5 million, and $17.1 million, respectively. Note 6 - Income Taxes The Company files a consolidated federal income tax return with its includable subsidiaries. Subject to the provisions of a tax sharing agreement, income tax allocation is based upon separate return calculations. The components of the Company's consolidated provision for income taxes are as follows: In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Current income taxes $10,815 $10,311 $ 9,992 Deferred income taxes 19,535 14,839 10,694 ------- ------- ------- Tax provision $30,350 $25,150 $20,686 ======= ======= ======= A reconciliation from the tax provision calculated at the federal statutory rate of 35% to the actual tax is as follows: In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Tax provision at statutory rate $ 39,482 $ 32,884 $ 26,736 Tax exempt interest and dividends (9,796) (7,878) (6,492) Other, net 664 144 442 -------- -------- -------- Actual tax provision $ 30,350 $ 25,150 $ 20,686 ======== ======== ======== 55 The components of the net deferred income tax liability as of December 31, 1998 and 1997 are as follows: In thousands December 31, 1998 December 31, 1997 Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- Contingency reserves $ 49,129 $ 43,027 Deferred policy acquisition costs 36,327 33,547 Deferred premium revenue 10,060 10,446 Unrealized capital gains 14,106 11,628 Capitalized expenditures $ 990 $ 1,183 Assignment sales income 16,689 8,438 Tax and loss bonds 29,267 24,797 Alternative minimum tax credit carryforward 8,545 6,334 Losses and LAE reserves 4,241 5,509 Deferred income 1,455 1,883 Other 3,900 1,656 5,816 3,116 -------- -------- --------- --------- $ 48,398 $127,967 $ 45,522 $ 110,202 ======== ======== ========= ========= Note 7 - Long-Term Debt And Credit Facility The carrying value of the Company's indebtedness is as follows: In thousands December 31, 1998 1997 -------- -------- Debentures, due 2003 $ 75,000 $ 75,000 Short term debt 54,290 43,500 -------- -------- Total $129,290 $118,500 ======== ======== The debentures were issued at par and bear interest at 6.75% payable in March and September each year. The debentures are non-callable obligations of Enhance Financial. Enhance Financial maintains an unsecured credit facility through a credit agreement (the "Credit Agreement") with major commercial banks providing for borrowing by Enhance Financial of up to $100 million to be used for general corporate purposes. Advances under the Credit Agreement bear interest at variable LIBOR-based rates. The average interest rate paid on such advances in 1998 was 6.09%. The Credit Agreement prohibits the Company from incurring additional indebtedness to the extent the resulting total would exceed 25% of the Company's total capitalization as defined and includes certain convenants, none of which significantly restricts the Company's operating activities or dividend-paying ability. The total outstanding under the Credit Agreement at December 31, 1998 was $53.5 million. In 1995, the Company entered into a reverse interest-rate swap transaction based on a notional amount of $50 million over the term equal to the remaining term of Enhance Financial's 6.75% Debentures. On June 1, 1995, the Company terminated the swap and realized a gain on termination in the amount of $4.6 million. The gain has been deferred and is being amortized over the original term of the swap. 56 Note 8 - Shareholders' Equity And Dividends In December 1996, the board of directors terminated the then existing repurchase program and authorized the repurchase of up to 1,500,000 shares of its common stock from that date. Enhance Financial purchased 666,394, 355,850 and 3,200 shares of its common stock at an average price of $26.72, $19.73 and $11.91 per share in 1998, 1997, and 1996 respectively. In connection with its repurchase program, Enhance Financial entered into a forward purchase agreement during 1997 regarding 256,394 shares of its common stock at a forward purchase price of $21.25 per share. The agreement settles quarterly on a net basis in shares of Enhance Financial stock or in cash at Enhance Financials' election. To the extent that the market price of Enhance Financial common stock on a settlement date was higher (lower) than the forward purchase price, the net differential was received (paid) by Enhance Financial. During 1998, settlements resulted in Enhance Financial receiving 106,394 shares, which were recorded as treasury shares. The agreement terminated in June 1998 after Enhance Financial repurchased the full amount under the program. During 1998, Enhance Financial issued 454,473 shares of common stock in connection with its acquisition of Alegis Group Inc. (see Note 5). During 1997, Enhance Financial issued 1,006,228 shares of common stock in connection with its acquisition of the remaining 50% ownership interest in Singer (see Note 5). In 1996, Swiss Reinsurance Company ("Swiss Re") acquired from Enhance Financial and one of its shareholders, respectively 1,200,000 and 800,000 shares of Enhance Financial common stock at a purchase price of $12.24 per share. In 1997, Swiss Re acquired an additional 1,400,000 shares of Enhance Financial common stock in the open market. Under the terms of the Credit Agreement, the maximum amount of dividends which may be paid by Enhance Financial as of December 31, 1998 was $10.1 million. In connection with the Company's two-for-one stock split in June 1998, an additional 40,000,000 shares of common stock were authorized. Note 9 - Fair Values Of Financial Instruments The following estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Fixed Maturity Securities - The fair values of fixed maturity securities are based on quoted market prices or dealer quotes. For private placements, fair value approximates amortized cost. Short-Term Investments - Fair values of short-term investments are assumed to equal cost. Deferred Premium Revenue - The fair value of the Company's deferred premium revenue, net of prepaid reinsurance premium, is based on the estimated cost of entering into a cession of the 57 entire portfolio with third-party reinsurers under market conditions. This figure was determined by using the statutory basis unearned premiums adjusted for ceding commission based on current market rates. Loss And Loss Adjustment Reserves - The carrying amount, net of reinsurance recoverable on unpaid losses, is composed of the present value of the expected cash flows for specifically identified claims combined with a general estimate for non-specific reserves. Therefore, the carrying amount is a reasonable estimate of the fair value of the reserve. Long-Term Debt - The fair value is estimated based on the quoted market prices for the same or similar issue or on the current rates offered to the Company for debt of the same remaining maturities. Short-Term Debt -The fair value of short-term debt, which bears interest at variable rates, is assumed to equal the carrying value of the debt. Derivative Instruments - The fair values of foreign currency contracts are based on the estimated termination values as of the balance sheet date. The fair values of forward treasury lock agreements (notional amount of $40 million at December 31,1998) are determined by the Company using relevant market information and appropriate valuation methodologies. The carrying amounts and estimated fair values of these financial instruments are as follows:
In thousands December 31, 1998 December 31, 1997 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------ ---------- ------ ---------- ASSETS: Fixed maturity securities $891,142 $ 900,166 $818,513 $827,840 Common stock 839 839 833 833 Short-term investments 50,794 50,794 50,827 50,827 LIABILITIES: Deferred premium revenue . 308,215 267,574 281,254 242,708 Loss and loss adjustment Expense reserve 33,739 33,739 30,987 30,987 Long-term debt 75,000 78,083 75,000 75,458 Short-term debt 54,290 54,290 43,500 43,500 DERIVATIVE INSTRUMENTS: Foreign currency contracts 256 256 -- -- Forward treasury lock agreements (664) (664) -- --
Note 10 - Insurance In Force The Company principally insures and reinsures financial guaranties issued to support public and private borrowing arrangements, including commercial paper, bond financings, and similar transactions. Financial guaranties are conditional commitments which guaranty the performance of a customer to a third party. The Company's potential liability in the event of nonperformance by the issuer of the insured obligation is represented by its proportionate share of the aggregate outstanding principal and 58 interest payable ("insurance in force") on such insured obligation. At December 31, 1998, the Company's aggregate insurance in force was $75.7 billion. The Company's insured portfolio as of December 31, 1998 was broadly diversified by geographic and bond market sector with no single credit representing more than 0.9% of the Company's net insurance in force. The composition of the Company's insurance in force by type of issue and by state of issue was as follows: Type of Issue In billions December 31, 1998 1997 ------- ------- General obligation and other tax backed $ 21.0 $ 18.8 Non-municipal 15.3 13.5 Utilities 11.2 10.3 Health care 7.1 6.8 Airport/Transportation 7.7 6.8 Housing 1.5 1.5 Other municipal 5.1 2.4 Other insurance businesses 6.8 4.3 ------- ------- Total $ 75.7 $ 64.4 ======= ======= State of Issue In billions December 31, 1998 1997 ------- ------- California $ 8.9 $ 7.7 New York 8.1 6.2 Florida 4.7 4.1 Texas 4.3 3.7 Pennsylvania 3.7 2.9 Illinois 3.3 2.5 Other (each less than 3.3% for 1998 and 2.5% for 1997) 42.7 37.3 ------- ------- Total $ 75.7 $ 64.4 ======= ======= The Company manages its exposure to credit risk through a structured underwriting process which includes detailed credit analysis, review of primaries' underwriting guidelines, surveillance policies and procedures, and the use of reinsurance. Note 11 - Employee Benefits The Company maintains a non-contributory defined benefit pension plan for the benefit of all eligible employees. Employer contributions are based upon a fixed percentage of employee salaries determined at the discretion of the Company. Plan assets consist of domestic equity and high quality fixed income securities. The actuarially computed net pension cost for 1998, 1997 and 1996, using the projected unit credit actuarial method of attribution includes the following components: 59 In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Service Cost $ 1,022 $ 900 $ 1,298 Interest Cost 485 494 485 Expected return on plan assets (415) (377) (322) Amortization of transition obligation 2 2 2 Amortization of prior service cost 53 53 53 Recognized net actuarial gain (129) (101) (107) ------- ----- ------- Net periodic benefits cost $ 1,018 $ 971 $ 1,409 ======= ===== ======= The following table sets forth the funding status of the plan and the accrued pension cost recognized in the Company's consolidated balance sheets at December 31, 1998 and 1997: In thousands December 31, 1998 1997 Change in benefit obligation Benefit obligation at beginning of year $ 8,131 $ 6,475 Service cost 1,022 900 Interest cost 485 494 Actuarial (gain) losses (1,092) 931 Benefits paid (1,463) (669) ------- ------- Benefit obligation at year end 7,083 8,131 ------- ------- Change in plan assets Fair value of plan assets at beginning of year 4,726 4,437 Actual return on plan assets 810 958 Employer contribution 565 -- Benefits paid (1,463) (669) ------- ------- Fair value of plan assets at end of year 4,638 4,726 ------- ------- Funded Status (2,445) (3,405) Unrecognized transition obligation 13 14 Unrecognized prior service cost 907 961 Unrecognized net actuarial gain (3,624) (2,266) ------- ------- Accrued benefit cost $(5,149) $(4,696) ======= ======= Actuarial assumptions utilized to determine the projected benefit obligation and estimated unrecognized net actuarial gain were as follows: Years ended December 31, 1998 1997 1996 ------ ------ ------ Discount rate 7.0% 7.0% 7.5% Expected return on plan assets 8.5% 8.5% 8.5% Rate of compensation increase 6.0% 6.0% 6.0% 60 In addition to pension benefits, the Company provides certain health care benefits for retired employees. Substantially all employees of Enhance Financial and the Insurance Subsidiaries may become eligible for these benefits if they reach retirement age while working for the Company. The net post-retirement benefit cost for 1998, 1997, and 1996 was $140,000, $127,000 and $118,000, respectively, and includes service cost, interest cost and amortization of the transition obligation and prior service cost. At December 31, 1998 and 1997 the accumulated post-retirement benefit obligation was $715,000 and $592,000, respectively, and was not funded. The discount rate used in determining the accumulated post-retirement benefit obligation was 7% and the health care cost trend rate was 12%, graded to 6% over 7 years. A one-percentage point change in assumed healthcare cost trend rates would have the following effects (In thousands): 1-Percentage 1-Percentage Point Increase Point Decrease Effect on total of service and interest cost components $29 ($22) Effect on post-retirement benefit obligation $144 ($113) In January 1996, the Company implemented a 401(k) retirement savings plan covering substantially all employees of the Company. Under this plan, the Company provides a matching contribution of 50% on contributions up to 6% of base salary made to the plan by eligible employees. The Company's matching contributions were $120,000, $106,000 and 98,000 in 1998, 1997 and 1996, respectively. Note 12 - Stock Option Programs The Company maintains a stock option program for its key employees. Substantially all options issued under the program vest in four equal annual installments commencing one year after the date of grant. The Company also maintains a directors' option program pursuant to which directors of Enhance Financial and the Insurance Subsidiaries who are not employees of the Company are granted non-qualified stock options. Options under this program vest in two equal annual installments commencing on December 31 next following the date of grant. In March 1998, the board of directors adopted the Director Stock Ownership Plan, which as amended, allows each outside director to elect to receive up to 100% of his or her director fees in the form of shares of common stock valued at the closing price of the common stock on the New York Stock Exchange on that date. Each eligible director is entitled to make a new election annually for that coming year's fee. All options are exercisable at the option price, being the fair value of the stock at the date of grant. The board of directors has authorized a maximum of 9,900,000 shares of common stock to be awarded as options, of which 6,055,604 options for shares (net of expirations and cancellations) had been awarded as of December 31, 1998. Information regarding activity in the option programs follows: 61 Option Price Per 1998 Options Number of Shares Share ------------ ---------------- ----- Outstanding at beginning of year 5,635,108 $ 7.25 - $29.062 Granted - Employees 1,168,980 $24.937 - $34.281 - Directors 91,000 $30.00 Exercised (666,374) $ 7.25 - $20.75 Expired or canceled (173,110) $ 8.00 - $28.813 --------- Outstanding at year-end 6,055,604 $ 7.25 - $34.281 --------- Exercisable at year-end - Employees 3,234,202 $ 7.25 - $28.844 - Directors 306,166 $ 8.563 - $29.75 Option Price Per 1997 Options Number of Shares Share ------------ ---------------- ----- Outstanding at beginning of year 5,106,220 $ 7.25 - $18.25 Granted - Employees 1,220,374 $19.44 - $28.844 - Directors 91,000 $29.75 Exercised (598,792) $ 7.25 - $17.00 Expired or canceled (183,694) $ 8.00 - $19.44 --------- Outstanding at year-end 5,635,108 $ 7.25 - $29.75 --------- Exercisable at year-end - Employees 3,117,688 $ 7.25 - $19.44 - Directors 256,666 $ 8.56 - $18.25 Option Price Per 1996 Options Number of Shares Share ------------ ---------------- ----- Outstanding at beginning of year 4,831,442 $ 7.25 - $13.31 Granted - Employees 800,220 $13.44 - $17.00 - Directors 52,000 $18.25 Exercised (462,550) $ 7.25 - $10.13 Expired or canceled (114,892) $ 8.00 - $11.94 -------- Outstanding at year-end 5,106,220 $ 7.25 - $18.25 -------- Exercisable at year-end - Employees 2,642,914 $ 7.25 - $11.94 - Directors 286,666 $ 8.26 - $13.31 The Company applies the provisions of APB Opinion No. 25 "Accounting for Stock Issued to Employees" in accounting for its stock option program. Accordingly, no compensation expense has been recognized for options granted under its stock option program, and the Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Had compensation cost for the Company's current and past stock option programs been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 1998 1997 1996 ---- ---- ----- Net income - as reported $82,457 $68,806 $55,704 - pro forma $80,906 $67,475 $55,046 Basic earnings per share - as reported $2.20 $1.86 $1.56 - pro forma $2.16 $1.82 $1.54 62 Diluted earnings per share - as reported $2.10 $1.78 $1.52 - pro forma $2.06 $1.75 $1.50 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average grant date fair value of option grants were $16.62, $12.01, and $5.44 in 1998, 1997 and 1996, respectively. The following assumptions were used for option grants awarded in 1998, 1997 and 1996:
Options Granted 1998 1997 1996 ---- ---- ---- Dividend yield 0.6% to 1.0% 0.8% to 1.1% 1.1% to 1.5% Volatility 24.1% to 75.1% 18.7% to 30.3% 20.5% to 30.3% Risk-free interest rate 4.3% to 5.8% 5.8% to 6.7% 6.2% to 6.8% Assumed annual forfeiture rate 3.0% 3.0% 3.0% Expected life 10 years 10 years 10 years
Note 13 - Lease Commitments The Company has committed to lease office space under non-cancelable leases which expire in August 1999, November 1999, April 2000, August 2000, June 2001, August 2001, July 2003 and June 2005. The leases provided for escalations resulting from increased assessments for taxes, utilities and maintenance. Future minimum rental payments on all leases, before any deductions for estimated sublease income, are as follows: In thousands Years Ended December 31, Operating Leases ---------------- 1999 $ 2,825 2000 1,337 2001 449 2002 492 2003 572 Thereafter 936 ----- $ 6,611 Rent expense, net of sublease income, was $1,528,000, $1,699,000, and $1,139,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 63 Note 14 - Parent Company Financial Information The following are the condensed balance sheets of Enhance Financial as of December 31, 1998 and 1997 and its condensed statements of income and cash flows for the years ended December 31, 1998, 1997 and 1996. Condensed Balance Sheets In thousands December 31, 1998 1997 ---- ---- ASSETS Cash $ 2,715 $ -- Investments 7,095 12,706 Investment in affiliated companies 784,235 658,609 Other assets 4,865 46,161 -------- -------- $798,910 $717,476 -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY: Long-term debt $ 75,000 $ 75,000 Other liabilities 61,264 61,083 Shareholders' equity 662,646 581,393 -------- -------- $798,910 $717,476 -------- -------- 64 Condensed Statements Of Income In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Total revenues $ 812 $ 510 $ 1,312 Total expenses 17,514 14,652 12,343 --------- -------- -------- (16,702) (14,142) (11,031) Equity in income of affiliates 102,459 77,500 61,727 --------- -------- -------- Income before income taxes 85,757 63,358 50,696 Income tax (expense) benefit (3,300) 5,448 5,008 --------- -------- -------- Net income $ 82,457 $ 68,806 $ 55,704 ========= ======== ======== Condensed Statements Of Cash Flows In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Cash flows from operating activities: Net income $ 82,457 $ 68,806 $55,704 Adjustments to reconcile net income to net cash from operating activities Equity in income of affiliates (102,459) (77,500) (61,727) Other 55,239 29,799 (22,188) --------- -------- -------- Net cash provided by (used) in operating activities 35,237 21,105 (28,211) --------- -------- -------- Cash flows from investing activities: Investment in affiliates net of dividends received (32,401) (7,186) (3,423) Sale of investments 741 (2,396) 750 Sales of short-term investments, net 4,880 (4,648) (5,529) --------- -------- -------- Net cash used in investing activities (26,780) (14,230) (8,202) --------- -------- -------- Cash flows from financing activities: Capital stock 9,920 7,341 4,843 Short-term debt 10,790 1,000 27,500 Dividends paid (8,645) (8,195) (7,198) Principal payment - senior notes -- -- (3,400) Reissuance of treasury stock -- -- 14,485 Purchase of treasury stock (17,807) (7,021) (38) ------- ------ --- Net cash provided by (used in) financing activities (5,742) (6,875) 36,192 --------- -------- -------- Net increase (decrease) in cash 2,715 -- (221) Cash, beginning of year -- -- 221 --------- -------- -------- Cash, end of year $ 2,715 $ -- $ -- ========= ======== ======== 65 Note 15 - Major Customers The Company derives a substantial portion of its premium writings from a small number of primary insurers. Specifically: o In 1998 four primary insurers accounted for 19%, 19%, 19% and 5% of gross premiums written. o In 1997 four primary insurers accounted for 17%, 16%, 9% and 7% of gross premiums written. o In 1996 four primary insurers accounted for 19%, 13%, 10% and 7% of gross premiums written. This customer concentration results from the small number of primary insurance companies which are licensed to write financial guaranty insurance. Note 16- Losses and Loss Adjustment Expenses Activity in the liability for losses and loss adjustment expenses ("LAE") is summarized as follows: In thousands Years Ended December 31, 1998 1997 1996 ---- ---- ---- Balance at January 1, $33,675 $28,081 $30,799 Less reinsurance recoverables 2,688 1,823 1,853 ------- ------- ------- Net balance at January 1, 30,987 26,258 28,946 ------- ------- ------- Net incurred related to: Current year 6,000 6,002 6,087 Prior years 4,324 3,753 3,097 ------- ------- ------- Net incurred 10,324 9,755 9,184 ------- ------- ------- Net paid related to: Current year 352 720 587 Prior years 7,220 4,306 11,285 ------- ------- ------- Net paid 7,572 5,026 11,872 ------- ------- ------- Net balance at December 31, 33,739 30,987 26,258 Plus reinsurance recoverables 2,500 2,688 1,823 ------- ------- ------- Balance at December 31, $36,239 $33,675 $28,081 ======= ======= ======= The terms "current year" and "prior years" in the foregoing table refer to the year in which case reserves were established. 66 Note 17 - Segment Reporting The Company has two reportable segments: insurance and asset-based businesses. The insurance segment provides credit-related insurance coverage to meet the needs of customers in a wide variety of domestic and international markets. The Company's largest insurance business is the provision of reinsurance to the monoline primary financial guaranty insurers for both municipal bonds and non-municipal obligations. The Company also provides trade credit reinsurance, financial responsibility bonds, excess-SIPC insurance and direct financial guaranty insurance. The asset-based businesses segment deals primarily with credit-based servicing and securitization of assets in underserved markets, in particular, the origination, purchase, servicing and securitization of special assets, including lottery awards, structured settlement payments, sub-performing/non-performing and seller-financed residential mortgages and delinquent consumer assets. The Company's reportable segments are strategic business units which are managed separately as each business requires different marketing and sales expertise. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operating earnings, which it defines as net income excluding the impact of capital and foreign exchange gains and losses, and certain non-recurring items, net of taxes. Summarized financial information concerning the Company's operating segments is presented in the following tables: 1998 ---- In thousands Insurance Asset-Based Totals --------- ----------- ------ Revenues from external customers $ 104,820 $ 46,807 $ 151,627 Interest revenue 53,423 0 53,423 Interest expense 7,223 1,277 8,500 Equity in income of affiliates 1,623 12,443 14,066 Income tax expense 23,558 6,792 30,350 Operating earnings 66,500 16,021 82,521 Investments in affiliates 96,867 0 96,867 Deferred policy acquisition cost 103,794 0 103,794 Identifiable assets 1,242,758 93,659 1,336,417 1997 ---- In thousands Insurance Asset-Based Totals --------- ----------- ------ Revenues from external customer $ 88,966 $30,152 $ 119,118 Interest revenue 50,618 0 50,618 Interest expense 5,881 1,436 7,317 Equity in income of affiliates 733 8,045 8,778 Income tax expense 19,486 5,664 25,150 Operating earnings 60,029 8,374 68,403 Investments in affiliates 38,862 0 38,862 Deferred policy acquisition cost 95,645 0 95,645 Identifiable assets 1,049,596 97,913 1,147,509 67 1996 ---- In thousands Insurance Asset-Based Totals --------- ----------- ------ Revenues from external customers 80,171 0 80,171 Interest revenue 47,462 0 47,462 Interest expense 5,522 0 5,522 Equity in income of affiliates 274 0 274 Income tax expense 20,686 0 20,686 Operating earnings 53,144 0 53,144 Investments in affiliates 24,181 0 24,181 Deferred policy acquisition cost 87,325 0 87,325 Identifiable assets 983,443 0 983,443 The following are reconciliations of reportable segment revenues and profit to Enhance Financial's consolidated totals: In thousands 1998 1997 1996 --------- -------- -------- Revenues Total revenues from external customers for reportable segments $ 151,627 $119,118 $ 80,171 Total interest revenue for reportable segments 53,423 50,618 47,462 Realized gains 2,434 657 4,008 --------- -------- -------- Total consolidated revenues $ 207,484 $170,393 $131,641 ========= ======== ======== Net income Operating earnings for reportable segments $ 82,521 $ 68,403 $ 53,144 Capital and foreign exchange gains net of tax 1,398 403 2,560 Non-recurring Van-Am expense, net of tax (1,462) -- -- --------- -------- -------- Net income $ 82,457 $ 68,806 $ 55,704 ========= ======== ======== The Company's revenues from external customers, by product line, are as follows: In thousands 1998 1997 1996 --------- -------- -------- Insurance: Financial guaranty reinsurance $ 66,264 $ 49,913 $ 47,408 Financial guaranty direct 10,246 6,319 3,526 Trade credit reinsurance 15,973 19,165 16,581 Other 12,337 13,569 12,656 Asset-Based 46,807 30,152 -- --------- -------- -------- Total Revenues from External Customers $151,627 $119,118 $ 80,171 ======== ======== ======== 68 Note 18- Quarterly Financial Information (Unaudited) In millions except per share amounts
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year -------- -------- -------- -------- ---- 1998 Net premiums written $ 33.7 $ 27.3 $ 27.6 $ 40.7 $ 129.3 Premiums earned 23.7 24.4 29.0 25.2 102.3 Investment and other income 14.2 15.0 17.4 13.2 59.8 Assignment sales 10.4 12.1 12.7 10.2 45.4 Losses and loss adjustment expenses 2.3 1.6 4.6 1.8 10.3 Equity in income of affiliates 2.6 3.8 3.2 4.5 14.1 Income before income taxes 27.1 28.2 30.8 26.7 112.8 Net income 19.2 20.5 22.7 20.1 82.5 Earnings per share - Basic $ 0.51 $ 0.55 $ 0.61 $ 0.53 $ 2.20 ------- ------- ------- ------- ------- - Diluted $ 0.49 $ 0.52 $ 0.58 $ 0.51 $ 2.10 ------- ------- ------- ------- -------
1997 Net premiums written $ 21.6 $ 25.7 $ 25.5 $ 27.7 $ 100.5 Premiums earned 19.5 21.3 21.3 23.4 85.5 Investment and other income 10.5 13.9 13.2 18.1 55.7 Assignment sales 2.5 9.9 7.6 9.2 29.2 Losses and loss adjustment expenses 2.0 2.2 2.7 2.9 9.8 Equity in income of affiliates 0.1 0.2 3.8 4.7 8.8 Income before income taxes 18.4 23.4 23.6 28.6 94.0 Net income 13.9 17.0 17.5 20.4 68.8 Earnings per share - Basic $ 0.38 $ 0.46 $ 0.47 $ 0.55 $ 1.86 ------- ------- ------- ------- ------- - Diluted $ 0.37 $ 0.44 $ 0.45 $ 0.52 $ 1.78 ------- ------- ------- ------- -------
Item 9. - Changes in and Disagreements with Accountants on Accounting and Disclosure Not applicable. 69 PART III Item 10. Directors and Executive Officers of the Registrant. Set forth below is certain information concerning directors and executive officers of Enhance Financial. Each director holds office (subject to Enhance Financial's by-laws) until the next annual meeting of shareholders and until his or her successor has been elected and qualified. The information concerning the directors has been furnished by them to Enhance Financial. Position with Enhance Name Age(1) Financial - ------- -------- --------------------------- Allan R. Tessler 62 Chairman of the Board Wallace O. Sellers 69 Vice Chairman of the Board Daniel Gross 56 President, Chief Executive Officer and Director Samuel Bergman 51 Executive Vice President and Secretary Ronald M. Davidow 48 Executive Vice President and Chief Financial Officer Arthur Dubroff 48 Executive Vice President Elaine J. Eisenman 50 President, Credit-Based Businesses, Alliances and Ventures Tony M. Ettinger 42 Executive Vice President Brian Kleinberg (2) 41 Executive Vice President Paul C. Kwiatkoski 43 Executive Vice President Stephen Steinberg 54 Executive Vice President Brenton W. Harries 71 Director David R. Markin 68 Director Robert P. Saltzman 56 Director Richard J. Shima 59 Director Spencer R. Stuart 76 Director Adrian U. Sulzer 52 Director Frieda K. Wallison 56 Director Jerry Wind 61 Director - ------------------------- (1) As of March 15, 1999. 70 (2) Commenced employment with the Company in January 1999. Mr. Tessler has held the position with Enhance Financial set forth above since its inception. He has also since 1987 been Chairman of the Board and Chief Executive Officer of International Financial Group, Inc., a merchant banking concern, and since 1992 served as Co-Chairman of the Board and Co-Chief Executive Officer of Data Broadcasting Corporation ("DBC"), a provider of market data services to the investment community. Mr. Tessler is also Chairman of the Board of Checker Holdings Inc. and of Jackpot Enterprises Inc. ("Jackpot") and a director of The Limited, Inc., Allis-Chalmers Corporation and Marketwatch.com. Mr. Sellers has held the position with Enhance Financial set forth above since 1995, and he also serves as a consultant to the Company. Prior thereto, he served as President, Chief Executive Officer and a director of Enhance Financial and Chairman of the Board and Chief Executive Officer of the Insurance Subsidiaries from their inception. Mr. Sellers also serves as a director of Danielson Holding Corporation. Mr. Gross has held the position with Enhance Financial set forth above and has served as Chief Executive Officer of the Insurance Subsidiaries since 1995. Prior thereto he held senior executive positions with Enhance Financial and Enhance Re from their inception and was among the founders of the Company in 1986. Previously, he held various insurance industry positions, including serving as co-founder and Chairman of F.G. Holding Company, Kramer Capital Consultants and various senior executive capacities for Colonial Penn Group. Mr. Gross also serves as a director of MGIC. Mr. Bergman has been Executive Vice President of the Company since 1991. He has been Secretary of Enhance Financial since 1991 and Secretary of each of the Insurance Subsidiaries since their inception. He was a member of the law firm of Shea & Gould from 1980 to 1991. Messrs. Davidow and Kwiatkoski have each served as senior executive officers of the Insurance Subsidiaries since such companies' inception, and as officers of Enhance Financial since 1990. Mr. Dubroff has held the position with Enhance Financial set forth above since 1996. From 1993 to 1996, Mr. Dubroff served in various senior management capacities at First Data Corporation, a provider of high-volume information processing and related services. Mr. Dubroff served as a director of Enhance Financial from 1986 to 1991 and from 1992 to 1996 and of Enhance Re from 1986 to 1992. Mr. Dubroff also serves on the board of directors of the Kobren Insight Funds. Ms. Eisenman has held the position with Enhance Financial set forth above since January 1998, having previously served as an independent consultant to the Company. From 1994 to 1997 she served as Senior Vice President - Worldwide Staffing, Development and Succession of American Express Company. From 1990 to 1994 she served as Vice President and General Manager of the Eastern Region of Personnel Decisions International, Inc. Ms. Eisenman also serves as a director of UST, Inc. 71 Mr. Ettinger has held the position with Enhance Financial set forth above since March 1999. Prior thereto since 1995, he was Executive Vice President of Enhance Financial. From 1992 to 1994, he rendered independent, strategic management consulting services to major financial services institutions. From 1989 to 1991 he was a General Partner of Hannibal Management, L.P., an investment partnership focused on undervalued, healthy community thrift institutions. From 1985 to 1989, he was Vice President, Head of Mergers and Acquisitions and Corporate Development, and holding company Chief Operating Officer for seven financial services subsidiaries of the Mutual Insurance Company of New York. Mr. Kleinberg has held the position with Enhance Financial set forth above as well as Chief Executive Officer of Singer since January 1999. From 1980 to 1998, Mr. Kleinberg served in various executive positions with American Express Company, most recently as Executive Vice President, American Express Financial Advisors, overseeing their Financial Direct Group and prior thereto as Executive Vice President and General Manager, Travel Related Services, responsible for new customers and products in the Consumer Card Services Group. Mr. Steinberg has held the position with Enhance Financial set forth above since April 1998. From 1993 to 1997, Mr. Steinberg served as Senior Vice President and head of Systems and Technology for CapMAC Holdings Inc., the parent company of CapMAC. From 1972 to 1992, Mr. Steinberg served in various senior technology positions at Citibank, N.A., in Treasury Operations, the Private Banking Group, and the North American Investment Bank. Mr. Harries has served as a director of Enhance Financial since 1991, having previously served as a director of the Insurance Subsidiaries since 1986. He has been retired since 1986, having previously served from 1985 as President of Global Electronic Markets Company, a joint venture of McGraw-Hill and Citicorp dealing in electronic trading of commodities. Mr. Harries also serves as a trustee of the Alliance Funds, Inc. and the Hudson River Trust. Mr. Markin has served as a director of Enhance Financial since 1986. He has served as President of Checker Motors Corporation for more than five years. From 1989 to December 1996, he also served as President and Chief Executive Officer of International Controls Corp. and its successor corporation, Great Dane Holdings, Inc. Mr. Markin serves as a director of Jackpot and DBC. Mr. Saltzman has served as a director of Enhance Financial since 1996. He has been President and Chief Executive Officer of Jackson Life Insurance Company since 1994. He previously served from 1983 as Executive Vice President of SunAmerica Inc. and as President of its subsidiary life insurance companies. Mr. Shima has served as a director of Enhance Financial since 1993. He has been an independent consultant since 1993, having previously thereto from 1992 served as Managing Director of Russell Miller, Inc., an investment banking concern specializing in the insurance industry. Mr. Shima also serves as a director of CTG Resources, Inc. and a trustee of the Evergreen Mutual Funds. Mr. Stuart has served as a director of Enhance Financial since 1992, having also served as 72 a director of Asset Guaranty from its inception until 1995. He has for over ten years served as an independent consultant regarding organizational and personnel matters. He served from 1990 to 1992 as Chairman of the Council of Management Advisors of Dean Witter Reynolds Inc. He is the founder and honorary chairman of Spencer Stuart Executive Recruiting Consultants. Mr. Sulzer has served as a director of Enhance Financial since 1996. He has since 1991 served in various management capacities with Swiss Re, a shareholder of Enhance Financial, currently serving since October 1998 as a member of the managing board of NCM, Amsterdam, a 50% Swiss Re-owned credit insurance company, and since 1997 as Co-Head of Underwriting in Swiss Re's New Markets Division. Previously thereto, from 1991 he served as head of Swiss Re's Credit and Bonding Department. Mr. Sulzer also serves as a director of Societa Italiana Cauzioni, Rome, Italy; American Credit Indemnity, Baltimore, Maryland; and Xenum Finance, Zurich, Switzerland. Ms. Wallison has served as a director of Enhance Financial since 1992, having also served as a director of each of the Insurance Subsidiaries since its inception until 1995. She currently is a private investor, having retired from the law firm of Jones, Day, Reavis & Pogue, where since 1983 she had been a member, resident in its Washington, D.C. office. Mr. Wind has served as a director of Enhance Financial since 1996. He has been on the faculty of the Wharton School of the University of Pennsylvania since 1967, currently serving as The Lauder Professor and Professor of Marketing. He also serves as a business consultant to several publicly and privately held, U.S. and non-U.S. corporations and has served on the editorial boards of and as a contributor to numerous journals on marketing. 73 Item 11. Executive Compensation. Summary Compensation Table. The following table sets forth certain information regarding compensation paid during each of the Company's last three fiscal years to the Company's Chief Executive Officer and each of the Company's four other most highly compensated executive officers, based on salary and bonus earned during 1998. Except as described below under "Agreements with Executive Officers," "Management Severance Protection Program" and "Other Senior Executive Officer Compensation," the Company has not entered with any executive officer into (i) an employment agreement or (ii) any compensatory plan or arrangement which is activated upon the resignation, termination or retirement of the executive officer or upon a change in control of the Company or change in the executive officer's responsibilities following a change in control.
Long-Term Annual Compensation Compensation ------------------- ------------ Securities Underlying Name and Principal Position Year Salary Bonus Options/SARs - --------------------------- ---- ------ ----- ------------ Daniel Gross 1998 $530,000 $1,060,000 200,000 President and Chief 1997 500,000 1,150,000 350,000 Executive Officer 1996 480,000 675,000 150,000 Tony M. Ettinger 1998 288,850 360,000 70,000 President, Credit-Based 1997 273,863 260,000 40,000 Businesses, Alliances and Ventures 1996 261,041 132,500 33,000 Samuel Bergman 1998 331,250 210,000 30,000 Executive Vice President 1997 313,281 200,000 28,000 and Secretary 1996 301,042 145,000 28,000 Elaine J. Eisenman (1) 1998 283,550 215,000 77,000(2) Executive Vice President Paul C. Kwiatkoski 1998 270,300 190,000 30,000 Executive Vice President 1997 255,000 165,000 27,000 1996 250,000 95,000 30,000
- ---------- (1) Became an officer of the Company in January 1998. (2) Includes a grant of a stock option for 32,000 shares of Common Stock granted to Ms. Eisenman upon commencement of her employment. 74 Option/SAR Grants During 1998. The following table provides information regarding stock options/SARs granted to the named executive officers during 1998:
Individual Grants ------------------------------------------------------------------------------ Number of Percent of Securities Total Options Underlying Granted to Name and Options Employees in Exercise or Expiration Grant Date Principal Position Granted(1) Fiscal Year Base Price Date Present Value(2) - ------------------ ---------- ----------- ---------- ---- ---------------- Daniel Gross 200,000 17.1 $24.94 12/31/08 $3,320,000(3) President and Chief Executive Officer Tony M. Ettinger 70,000 6.0 24.94 12/31/08 1,162,000(3) President, Credit-Based Businesses, Alliances and Ventures Samuel Bergman 30,000 2.6 24.94 12/31/08 498,000(3) Executive Vice President and Secretary Elaine J. Eisenman 32,000 2.7 28.84 01/12/08 437,120(4) Executive Vice 45,000 3.8 24.94 12/31/08 747,000(3) President Paul C. Kwiatkoski 30,000 2.6 24.94 12/31/08 498,000(3) Executive Vice President
- -------------------- (1) Stock options granted pursuant to the 1997 Incentive Plan. Such stock options vest, subject to continuation of employment, in 25% increments during the consecutive four-year period commencing on the last date of the month of grant. The stock options are not transferable except by the laws of descent and distribution and, accordingly, may be exercised during the life of the optionee only by the optionee or the optionee's legal representative and after the optionee's death only by the beneficiary previously designated by the optionee. (2) The present value is, in each case, based upon the Black-Scholes option valuation model. The valuation assumes no specific time of exercise since this is viewed by the Company as entirely indeterminate, but takes into account the term of the option, ten years in each case. The actual value, if any, an executive may realize will depend on the excess of the stock price over the exercise price on the date the option is exercised, so that there is no assurance 75 the value realized will be at or near the value estimated by the Black-Scholes model. (3) The Black-Scholes option valuation assumes a volatility of 74.2, a risk-free rate of return of 4.5%, a dividend yield of 0.69% and a discount due to the risk of forfeiture of 3.0%. (4) The Black-Scholes option valuation assumes a volatility of 29.7, a risk-free rate of return of 5.4%, a dividend yield of 0.99% and a discount due to the risk of forfeiture of 3.0%. Aggregated Option/SAR Exercises During 1998 and Fiscal Year-End Option Values The following table provides information as to the named executive officers regarding stock option exercises and the number and value of stock options/SARs held by them at December 31, 1998.
No. of Securities Underlying Value of Unexercised Unexercised Stock In-the Money Options/SARs at Options/SARs at December 31, 1998 December 31, 1998(1) ----------------- -------------------- Shares Name and Acquired Value Principal Position on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable - ------------------ ----------- -------- ----------- ------------- ----------- ------------- Daniel Gross -0- -0- 727,500 567,500 $13,060,663 $3,755,048 President and Chief Executive Officer Tony M. Ettinger -0- -0- 64,000 127,750 953,390 807,683 President, Credit-Based Businesses, Alliances and Ventures Samuel Bergman 5,200 $169,000 171,000 75,000 3,223,089 539,422 Executive Vice President and Secretary Elaine J. Eisenman -0- -0- 8,000 69,000 9,248 255,557 Executive Vice President Paul C. Kwaitkoski -0- -0- 121,750 71,250 2,246,994 479,284 Executive Vice President
----------------------- (1) Calculated on the basis of (a) the excess of the closing price of the Common Stock as reported by the New York Stock Exchange on December 31, 1998 over the stock option exercise price multiplied by (b) the number of shares of Common Stock underlying the stock option. 76 Enhance Reinsurance Pension Plan The Company maintains a defined benefit pension plan named the "Enhance Reinsurance Pension Plan" (the "Pension Plan") which is intended to be a tax-qualified plan under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"). All employees of the Company (other than Singer and Van-American Companies, Inc.) who have attained age 21 and who have completed at least one year of service are eligible to participate in the Pension Plan. The Pension Plan provides a normal retirement benefit at normal retirement (the earlier of the date on which a participant (a) has attained age 65 or completed five years of participation or (b) has attained age 62 or completed 10 years of participation) equal to 2.25% of the participant's compensation multiplied by his or her years of service up to his or her first 15 years, plus 1.75% of the participant's compensation multiplied by his or her years of service for his or her next 10 years, plus 1% of the participant's compensation multiplied by his or her years of service for his or her next five years. Compensation is defined as the average of the participant's three highest consecutive years of earnings. (See Note 2 to the table below regarding the maximum compensation considered "earnings" for the foregoing purposes. No such maximum applies with respect to the determination of compensation for purposes of the Summary Compensation Table above.) A participant whose service terminates prior to normal retirement is eligible for a benefit at the normal retirement date based on the participant's compensation and years of service at the date of termination multiplied by the vested percentage. The actuarial equivalent of such vested benefit may be distributed in a lump sum prior to normal retirement age. The vested percentage of a participant increases 20% per year beginning after two years of service, such that his or her vested percentage is 100% after six years. For purposes of determining a participant's retirement benefit and vested percentage, "years of service" and "years of participation," while not synonymous, include service with the Company and certain service with predecessor employers. The following table illustrates annual pension benefits payable under the Pension Plan assuming retirement at normal retirement age at various levels of compensation and years of service. Such benefits are based on a straight life annuity and are not subject to any deduction for Social Security or other offset amounts. PENSION PLAN TABLE
Highest Average Earnings Years of Service -------- ----------------------------------------------------------------------------- 15 20 25 30 35* ----------------------------------------------------------------------------- $100,000 $ 33,750 $ 42,500 $ 51,250 $ 56,250 $ 56,250 125,000 42,188 53,125 64,063 70,313 70,313 150,000 50,625 63,750 76,875 84,375 84,375 175,000(2) 59,063 74,375 89,688 98,438 98,438 200,000(2) 67,500 85,000 102,500 112,500 112,500 225,000(2) 75,938 95,625 115,313 126,563 126,563 250,000(2) 84,375 106,250 128,125 140,625(1) 140,625(1) 300,000(2) 101,250 127,500 153,750(1) 168,750(1) 168,750(1) 400,000(2) 135,000(1) 170,000(1) 205,000(1) 225,000(1) 225,000(1)
77 450,000(2) 151,875(1) 191,250(1) 230,625(1) 253,125(1) 253,125(1) 500,000(2) 168,750(1) 212,500(1) 256,250(1) 281,250(1) 281,250(1)
- ---------- * Plan limits service to 30 years for benefit purposes. (1) These are hypothetical benefits based upon the Pension Plan's normal retirement benefit formula. The maximum annual benefit permitted under Section 415 of the Code in 1998 and 1999 is $130,000. (2) The benefits shown corresponding to these compensation ranges are hypothetical benefits based upon the Pension Plan's normal retirement benefit formula. Under Section 401(a)(17) of the Code, a participant's compensation in excess of a specified maximum (as such may change from time to time in the future, the "Code Maximum") is disregarded for purposes of determining highest average earnings. (Such specified maximum amount (as adjusted to reflect cost of living increases) was $235,840 for the plan year beginning November 1, 1993, decreasing to $150,000 for plan years beginning November 1, 1994, November 1, 1995 and November 1, 1996 and has increased to $160,000 for plan years beginning thereafter.) In addition, Enhance Financial has adopted, effective July 1, 1999, a non-qualified restoration pension plan (the "Restoration Plan"). All employees of the Company eligible to participate in the Pension Plan and who receive total annual compensation in excess of the Code Maximum and above are eligible to participate in the Restoration Plan. The Restoration Plan provides a retirement benefit supplemental to benefits provided by the Pension Plan equal to 1.75% of the participant's compensation above the Code Maximum multiplied by his or her years of service up to his or her first 25 years, plus 1.0% of the participant's compensation above the Code Maximum multiplied by his or her years of service for his or her next five years. Compensation is defined as the average of the participant's three highest consecutive years of earnings. The vested percentage of a participant will be the lower of (a) 20% per year of service beginning after two years of service such that his or her vested percentage is 100% after six years, and (b) such other rate per year as will cause a given participant to be fully vested at age 60. For purposes of determining a participant's retirement benefit and vested percentage, "years of service" and "years of participation," while not synonymous, include service with the Company and certain service with predecessor employers. Also, for purposes of the Restoration Plan, in addition to each such executive officer's actual years of service, upon becoming fully vested under the terms of the Pension Plan, Mr. Ettinger will be credited with five additional years of service and each other participant in the Restoration Plan who is or subsequently becomes an executive officer of Enhance Financial at the level of Executive Vice President and above, will be credited with additional years of employment services under the Restoration Plan equal to the excess of five over the actual years of employment service credited to that officer under the Restoration Plan prior to its effective date. As of December 31, 1998, Messrs. Gross, Ettinger, Bergman and Kwiatkoski and Ms. Eisenman had eleven, three, six, fourteen and zero years of service, respectively, under the 78 Pension Plan and the Restoration Plan and eleven, three, six, eleven and zero years of participation, respectively, under the Pension Plan. Agreements with Executive Officers Enhance Financial and Arthur Dubroff, Executive Vice President and Chief Financial Officer, are parties to an employment agreement which provides for the payment of an annual base salary to Mr. Dubroff of not less than $275,000 plus an annual target bonus of 45% of such base salary. Under the employment agreement, Mr. Dubroff was granted in 1996, 1997 and 1998 options to purchase 150,000, 40,000 and 40,000 shares of Common Stock, respectively. If Mr. Dubroff's employment is terminated by Enhance Financial within a 12-month period following a change of control (as defined), Enhance Financial is required to pay Mr. Dubroff a prorated portion of his annual bonus and, for the greater of the remainder of the term of his employment agreement and 12 months from the date of termination of his employment, his base salary. The employment agreement terminates on December 31, 1999. Enhance Financial and Brian C. Kleinberg, Executive Vice President of Enhance Financial and Chief Executive Officer of Singer are parties to an agreement which provides for the payment of an annual base salary of $300,000 per year, plus an annual target bonus of not less than 50% of his then base salary (or such higher rate consistent with Enhance Financial's senior executive compensation programs); provided that his bonus for 1999 will equal or exceed $250,000 (to be prorated should his employment be terminated prior to the expiration of twelve months by Enhance Financial other than for cause or by Mr. Kleinberg for cause). Under the employment agreement, Mr. Kleinberg was granted options to purchase 85,000 shares of Common Stock. Also, in connection with the Management Severance Protection Program described below, for 1999 Mr. Kleinberg's prior year's annual bonus is to equal the average of the bonuses awarded to Enhance Financial's Executive Vice Presidents for 1998. In addition, in March 1999, Enhance Financial granted Mr. Kleinberg a stock option under the 1997 Incentive Plan for 25,000 shares in lieu of establishing at the start of 1999 a cash incentive compensation program for Mr. Kleinberg based on the performance of the Singer businesses in 1999 and in order to compensate Mr. Kleinberg for a portion of the anticipated 1999 income which he forewent by having departed his prior employment to become an employee of the Company. Management Severance Protection Program In 1998, the Company established a management severance protection program (the "Management Severance Protection Program") which provides for the payments and benefits to be accorded to officers in the event of the termination of their employment by the Company under certain circumstances. The program has been designed to attract new, highly qualified officers by establishing a competitive level of severance, to reduce uncertainty and to retain officers who may otherwise depart upon a potential change in ownership, to maintain the objectivity of Enhance Financial's senior officers in the face of potential job loss in a "change of control" (as defined below) transaction and to minimize the need for negotiation of individual severance arrangements upon the termination of an officer's employment with the Company. Under the Management Severance Protection Program, an officer of Enhance Financial 79 with a title of at least Vice President who is terminated by the Company without cause or who departs with good reason (an "Involuntary Termination Event") is entitled to cash severance equal to a number of months (up to one year) of base salary plus, in the case of senior officers with a title of at least Senior Vice President, a prorated bonus based on such officers' prior year's annual bonus, such number of months of salary and proration of bonus to be based on such officers' tenure with the Company. In addition, covered officers will receive outplacement assistance and remain covered under the Company's welfare benefit programs for a period of time after such termination. Senior executive officers of Enhance Financial are entitled to cash severance in a lump sum equal to two or three times pay (depending on level of seniority) if such senior officer undergoes an Involuntary Termination Event within a specified time after a change of control. Such senior officers will also receive bonus for the year of termination pro rata through the date of such termination. In addition, such senior officers are entitled to receive outplacement assistance, will remain covered under the Company's welfare benefit and perquisite programs and will be entitled to continue to participate in the Company's 401(k) program (including the receipt of Company matching contributions) for a period of time following termination. As used in the Management Severance Protection Program, a "change of control" means (a) the acquisition by one person or entity of at least 35% of Enhance Financial's outstanding voting stock, (b) a change in the majority of the board of directors of Enhance Financial, (c) the consummation of a merger, consolidation or reorganization unless more than 65% of the continuing interest in the surviving entity is retained by Enhance Financial's shareholders immediately prior to such transaction or (d) a liquidation, dissolution or sale of all or substantially all of the assets of the Company. In addition, pursuant to the Management Severance Protection Program, all options and other long-term incentives previously granted to employees and directors of the Company become immediately vested upon a change in control, without regard to the termination of such employee or director. Other Senior Executive Officer Compensation The Company has established a flexible perquisite allowance program to encourage senior executive officers of the Company to avail themselves of a range of business-related benefits for which they are not otherwise eligible for reimbursement by the Company, including but not limited to, club memberships, parking at the Company's offices, automobile transportation service to and from the Company's offices, personal development and individual financial services. Beginning in 1999, in January of each year, the President of Enhance Financial is to be paid $30,000 and each President of a business unit and Executive Vice President of Enhance Financial is to be paid $15,000 pursuant to this program on a non-accountable basis. In addition, the Company has arranged and will pay premium for supplemental long-term disability insurance for the President and each Executive Vice President in addition to the $7,500 maximum monthly benefit available to all employees of the Company, up to an aggregate $25,000 maximum monthly benefit. The amount of such additional coverage for each executive officer 80 which will be paid by the Company will vary depending on the premium for such executive officer's coverage as set by the insurance provider. In addition, this insurance provides benefits for partial disability and cost of living increases in payments under the policy. Directors' Compensation Fee Compensation. Directors who are employees of the Company receive no fees or other compensation for services rendered as members of the board of directors of Enhance Financial. Mr. Tessler received a basic fee of $105,000 in 1998, and each other director of Enhance Financial who is not employed by the Company received a basic fee of $16,000. In addition, each such outside director who also served as chair of any committee of the board received in 1998 an additional $5,000 for all committees chaired by such director. Each outside director also received an additional $2,000 for each regular meeting of the board of directors attended plus $1,250 for each committee meeting attended which was held on a day other than a day on which the board met. No directors' fees were payable to corporate shareholders in respect of directorships occupied by their designees. All directors are reimbursed for travel and related expenses incurred in attending meetings of the board or committees. In March 1998, the board of directors adopted the Director Stock Ownership Plan, which, as amended, allows each outside director to elect to receive up to 100% of the aforesaid fees in the form of shares of Common Stock valued at the closing price of the Common Stock on the New York Stock Exchange on that date. Each outside director is entitled to make a new election annually for the coming year's fees. Non-Employee-Director Stock Option Plan. Pursuant to the Directors' Option Plan, on each December 31, each outside director of Enhance Financial or either Insurance Subsidiary is granted a non-qualified stock option to purchase 7,000 shares of Common Stock at an exercise price equal to the closing price of the Common Stock on the New York Stock Exchange on that date. There are reserved for issuance upon the exercise of options under the Directors' Option Plan 800,000 shares of Common Stock (subject to anti-dilutive adjustment), of which options for 442,666 shares were subject to outstanding options after the option grants made on December 31, 1998. Stock options granted under the Directors' Option Plan become exercisable as to one half the shares subject thereto on each of the first and second anniversaries of grant, subject to continuation of service on the board of directors and other terms of the stock option grants; expire on the tenth anniversary of the date of grant; are not transferable except by the laws of descent and distribution; and, accordingly, may be exercised during the life of the optionee only by the optionee or the optionee's legal representative and after the optionee's death only by the beneficiary previously designated by the optionee. The unvested portion of an outstanding stock option lapses upon the resignation or removal of the optionee from the boards of directors of Enhance Financial and the Insurance Subsidiaries. Compensation Committee Interlocks and Insider Participation The persons who served as members of the Compensation and Nominating Committee 81 during 1998 are Spencer R. Stuart (Chairman), Brenton W. Harries, David R. Markin, Richard J. Shima and Allan R. Tessler. The only person of the foregoing who is currently or has at any time been an officer or employee of the Company is Mr. Tessler, who serves as Chairman of the Board of Enhance Financial. Non-Competition Agreements Messrs. Tessler, Sellers and Gross are parties to non-competition agreements with Enhance Financial prohibiting them from, among other things, competing with the Company for a period of two years following their respective cessation of employment by or service to the Company. Item 12. Security Ownership of Certain Beneficial Owners and Management. The following table sets forth certain information with respect to the beneficial ownership of the Common Stock as of March 26, 1999 by (a) each shareholder known to Enhance Financial to be the beneficial owner, within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), of more than 5% of the outstanding shares of Common Stock; (b) each director of Enhance Financial; (c) each of the five most highly compensated executive officers of Enhance Financial; and (d) all executive officers and directors of Enhance Financial as a group. Unless otherwise indicated, the address of each such person is c/o Enhance Financial Services Group Inc., 335 Madison Avenue, New York, New York 10017.
Name and Address Number of Shares (1) Percent of Class -------------------- ---------------- Swiss Reinsurance Company 3,400,000(2) 9.0 Mythenquai 50/60 8022 Zurich, Switzerland Morgan Stanley Dean Witter & Co. 2,773,160(3) 7.3 1585 Broadway New York, New York 10036 Legg Mason, Inc. 2,213,235(4) 5.8 100 Light Street Baltimore, Maryland 21202 Allan R. Tessler ............................. 498,500(5)(6) 1.3 Wallace O. Sellers ........................... 835,800(5)(6) 2.2 Daniel Gross ................................. 1,147,500(5) 2.9 Samuel Bergman ............................... 179,700(5) * Elaine Eisenman .............................. 9,200(5) * Tony M. Ettinger ............................. 64,200(5) * Paul C. Kwiatkoski ........................... 160,490(5) * Brenton W. Harries ........................... 29,500(5) * David R. Markin .............................. 238,477(6)(7) * Robert P. Saltzman ........................... 127,500(6)(8) * Richard J. Shima ............................. 25,606(6) *
82 Spencer R. Stuart ............................ 30,606(6)(9) * Adrian U. Sulzer ............................. 7,500(6) * Frieda K. Wallison ........................... 33,772(6) * Jerry Wind ................................... 18,031(6) * All executive officers and directors as a group 3,776,682(10) 9.1
- ---------- * Less than 1% (1) The table in this section is based upon information supplied by directors, officers, and principal shareholders and Schedules 13D and 13G, if any, filed with the Securities and Exchange Commission. Unless otherwise indicated in the footnotes to the table and subject to the community property laws where applicable, each of the shareholders named in this table has sole voting and investment power with respect to the shares shown as beneficially owned by him or her. (2) See "Certain Relationships and Related Transactions" for information regarding an agreement between Enhance Financial and Swiss Reinsurance Company ("Swiss Re") regarding future sales and purchases by Swiss Re of voting shares of Enhance Financial. (3) On February 10, 1999, Morgan Stanley Dean Witter & Co. ("MSDW&Co") and its wholly-owned subsidiary, Morgan Stanley Dean Witter Investment Management Limited ("DWIM") jointly filed a Schedule 13G describing their respective ownership of shares of Common Stock at December 31, 1998 as follows: MSDW&Co has shared voting power over 2,428,177 shares of Common Stock and shared dispositive power over 2,773,160 shares of Common Stock, and DWIM has shared voting power over 1,767,632 shares of Common Stock and shared dispositive power over 2,097,532 shares of Common Stock. Accounts managed on a discretionary basis by DWIM, are known to have the right to receive or the power to direct the receipt of proceeds for the dividends from the sale of such shares of Common Stock. No such account holds more than 5% of outstanding shares of the Common Stock. (4) On February 16, 1999, Legg Mason, Inc. filed a Schedule 13G describing its ownership of shares of Common Stock at December 31, 1998 as follows: Legg Mason, Inc. has sole voting and dispositive power over 2,126,500 shares of Common Stock and shared voting and dispositive power over 86,735 shares of Common Stock. Such shares of Common Stock are held by various identified subsidiaries of Legg Mason, Inc. and by various of their clients, all of which have the power to dispose of the shares held by them. (5) Includes the shares set forth in: (a) Column A below issuable to the named officer upon the exercise of currently exercisable stock options granted under Enhance Financial's employee stock option programs, and (b) Column B below owned by the named officer's spouse and children or in trusts of which such officer is a trustee (as to which shares such officer disclaims beneficial ownership). 83 Name A B ---- - - Allan R. Tessler 43,000 4,000 Wallace O. Sellers 307,300 517,000 Daniel Gross 727,500 204,000 Samuel Bergman 171,000 8,700 Elaine J. Eisenman 8,000 -0- Tony M. Ettinger 64,000 -0- Paul C. Kwiatkoski 121,750 400 (6) Includes shares issuable upon the exercise of the presently exercisable portion of options granted to such director under the Directors' Option Plan, as follows: Allan R. Tessler -- 11,500 shares; Wallace O. Sellers -- 7,500 shares; Brenton W. Harries -- 27,500 shares; David R. Markin -- 27,500 shares; Robert P. Saltzman -- 7,500 shares; Richard J. Shima -- 19,500 shares; Spencer R. Stuart -- 27,500 shares; Adrian U. Sulzer -- 7,500 shares; Frieda K. Wallison -- 27,500 shares; and Jerry Wind -- 7,500 shares. (7) Includes 200,000 shares held in a limited partnership in which Mr. Markin and his wife are the limited partners and a trust controlled by Mr. Markin is the general partner. (8) Held in a living trust account of which Mr. Saltzman and his wife are co-trustees. (9) Mr. Stuart's wife holds a durable power of attorney granting her joint voting and dispositive power over the shares owned by Mr. Stuart. (10) Includes 263,666 shares issuable to the directors of Enhance Financial who are not employees of the Company (as of the date of grant) upon the exercise of the presently exercisable portion of stock options granted to them under the Directors' Option Plan; 1,702,800 shares issuable to the executive officers upon the exercise of presently exercisable options granted to them under the 1987 Incentive Plan and the 1997 Incentive Plan; and 734,100 shares owned by spouses of executive officers in trusts of which such officers are trustees or by executive officers or their spouses as custodians for their children. Such persons disclaim beneficial ownership of such shares owned by their spouses, individually or as custodians, or by such trusts. Item 13. Certain Relationships and Related Transactions. U S WEST The certificate of incorporation of Enhance Financial grants to U S WEST, Inc. ("U S WEST") the right to preclude the Company from entering into certain activities or owning an equity interest in any entity that engages in any such activity unless they are determined by U S WEST's legal counsel not to be prohibited to U S WEST and its subsidiaries under the Modification of Final Judgment (the "Judgment") entered in 1984 in connection with the settlement of the legal action entitled United States v. Western Electric Company, Inc. These activities consist of providing information services or long distance telephone service or manufacturing telecommunications equipment. 84 Although the Company has not entered, and does not intend to enter, into any of the specified activities, and, accordingly, the aforesaid provision has not had, and is not expected to have, any material effect on the business of the Company, since US WEST or its subsidiaries cease to own shares of Common Stock, Enhance Financial intends to propose at the 1999 Annual Meeting of Shareholders the elimination of the aforesaid provision from the certificate of incorporation, which will require the vote of the holders of a majority of shares of Common Stock outstanding. Swiss Re Enhance Financial and Swiss Re are parties to an agreement pursuant to which Swiss Re has agreed that, subject to certain exceptions, neither Swiss Re nor any of its affiliates will until the year 2006 (a) acquire, alone or as part of a group, any voting securities of Enhance Financial (or securities convertible into such voting securities) which would result in Swiss Re (together with its affiliates) or such group owning beneficially more than 15% of Enhance Financial voting securities outstanding or (b) dispose of Enhance Financial voting securities to any person or group which disposition would give such person or group beneficial ownership of or the right to acquire more than 15% of Enhance Financial voting securities outstanding. Pursuant to a registration rights agreement, dated October 31, 1986, as amended, between Swiss Re and Enhance Financial, Swiss Re has one demand and unlimited piggyback registration rights, subject to certain limitations. Substantially all the expenses of any future demand or piggyback registration are to be borne by Enhance Financial. The registration rights agreement contains cross-indemnification covenants by Enhance Financial, on the one hand, and Swiss Re, on the other hand, for damages sustained and expenses incurred resulting from material misstatements or omissions in connection with any such offering. Seguradora Brasileira de Fiancas Since November 1997, Enhance Financial and Swiss Re have each owned 25% equity interests in Seguradora Brasileira de Fiancas which they purchased for respective initial investments of $3.3 million. It is anticipated that the Company and Swiss Re will from time to time make additional investments in such company as its capital needs may require. See Item 1. "Business - Description of Business - Other Businesses and Investments." 85 PART IV Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) The following documents are filed as a part of this report: (1) Financial Statements - See Part II, Item 8. (2) Financial Statement Schedules: All schedules are omitted, as the required information is nonapplicable or the information is presented in the financial statements or related notes. (3) Exhibits: 3.1.1 Restated certificate of incorporation of the registrant filed with the State of New York on February 18, 1992. (Incorporated by reference to Exhibit 3.3.1 to the Annual Report on Form 10-K for the year ended December 31, 1991 of the registrant.) 3.1.2 Certificate of amendment to the restated certificate of incorporation of the registrant filed with the State of New York on June 6, 1996. (Incorporated by reference to Exhibit 3.1.2 to the Annual Report on Form 10-K for the year ended December 31, 1996 of the registrant (the "1996 Form 10-K").) 3.1.3 Certificate of amendment to the restated certificate of incorporation of the registrant filed with the State of New York on June 3, 1998. (Incorporated by reference to Exhibit 3.3. to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998 of the registrant (the "1998(Q2) Form 10-Q").) 3.2 By-laws of the registrant, as amended through December 3, 1991. (Incorporated by reference to Exhibit 3.2 to Amendment No. 1 filed with the Securities and Exchange Commission (the "Commission") on January 21, 1992 ("Amendment No. 1") to the registrant's Registration Statement on Form S-1 (File No. 33-44322) filed with the Commission on December 11, 1991 (the "1991 Registration Statement").) 4.1 Specimen certificate evidencing shares of Common Stock. (Incorporated by reference to Exhibit 4.1 to Amendment No. 4 to the 1991 Registration Statement, filed with the Commission on February 12, 1992 ("Amendment No. 4").) 4.2.1 Credit Agreement dated as of June 30, 1998 (the "Credit Agreement"), among the registrant; Fleet National Bank, as lender, Administrative Agent and Administrator; and The Bank of Tokyo-Mitsubishi, Ltd., New York Branch; The First National Bank of Chicago; and Deutsche Bank AG, New York and/or Cayman Island Branches, as lenders. (Incorporated by reference to Exhibit 4.2 to 86 the 1998(Q2) Form 10-Q.) 4.2.2 Amendment No.1 and Waiver Agreement, dated as of December 31, 1998, to the Credit Agreement. 4.2.3 Amendment No. 2, dated as of February 15, 1999, to the Credit Agreement. 4.3.1 Form of Indenture dated as of February ____, 1993 (the "Indenture") between the registrant and Chase, as Trustee. (Incorporated by reference to Exhibit 4.1 to Amendment No. 2 filed with the Commission on February 10, 1993 ("Amendment No. 2") to the Registration Statement on Form S-1 (File No. 33-55958) filed with the Commission on December 18, 1992 (the "1992 Registration Statement"). 4.3.2 Form of Enhance Financial Services Group Inc. ____% Debentures due 2003. (Incorporated by reference to Exhibit 4.3.3 to Amendment No. 2 to the 1992 Registration Statement.) 10.1.1 Non-competition agreement dated as of March 5, 1986 between the registrant and Allan R. Tessler. (Incorporated by reference to Exhibit 10.2.1 to the 1991 Registration Statement.) 10.1.2 Non-competition agreement dated as of March 5, 1986 between the registrant and Wallace O. Sellers. (Incorporated by reference to Exhibit 10.2.2 to the 1991 Registration Statement.) 10.1.3 Non-competition agreement dated as of March 5, 1986 between the registrant and Daniel J. Gross. (Incorporated by reference to Exhibit 10.2.3 to the 1991 Registration Statement.) 10.2.1 1987 Long Term Incentive Plan for Key Employees, as amended (the "1987 Incentive Plan"). (Incorporated by reference to Exhibit 10.2.2 to the 1996 Form 10-K.) 10.2.2 1997 Long Term Incentive Plan for Key Employees (the "1997 Incentive Plan"). (Incorporated by reference to Exhibit 10.2.3 to the Annual Report on Form 10-K for the year ended December 31, 1997 of the registrant.) 10.2.3 Form of option grant certificate under the 1997 Incentive Plan for options granted in December 1998. 10.3.1 Non-Employee-Director Stock Option Plan, as amended (the "Directors' Option Plan"). (Incorporated by reference to Annex A to the definitive proxy statement of the registrant on Form 14A, as filed with the Securities and Exchange Commission on May 4, 1998.) 87 10.3.2 Form of option grant certificate under the Directors' Option Plan for options granted in 1992. (Incorporated by reference to Exhibit 10.6.5 to the 1992 Registration Statement.) 10.3.3 Director Stock Ownership Plan, as amended. 10.4 Initial Purchasers' Registration Rights Agreement dated as of March 5, 1986 among the registrant and certain of its employees. (Incorporated by reference to Exhibit 10.7 to the 1991 Registration Statement.) 10.5.1 Subscribers' Registration Rights Agreement dated as of October 31, 1986 among the registrant and certain of its shareholders (the "Registration Rights Agreement"). (Incorporated by reference to Exhibit 10.8.1 to Amendment No. 1 to the 1991 Registration Statement.) 10.5.2 Amendment No. 1 dated as of April 1, 1987 to the Registration Rights Agreement. (Incorporated by reference to Exhibit 10.8.2 to the 1991 Registration Statement.) 10.5.3 Amendment No. 2 dated as of May 10, 1988 to the Registration Rights Agreement. (Incorporated by reference to Exhibit 10.8.3 to the 1991 Registration Statement.) 10.5.4 Combined Amendments to Registration Rights Agreements dated as of June 29, 1990 (including Amendment No. 3 to the Registration Rights Agreement). (Incorporated by reference to Exhibit 10.8.4 to the 1991 Registration Statement.) 10.5.5 Amendment No. 4 dated as of December 19, 1991 to the Registration Rights Agreement. (Incorporated by reference to Exhibit 10.8.5 to Amendment No. 1 to the 1991 Registration Statement.) 10.5.6 Amendment No. 6 dated February 23, 1996 to the Registration Rights Agreement. (Incorporated by reference to Exhibit 10.4 to the Registration Statement on Form S-3 (File No. 333-2064) filed with the Commission on March 8, 1996 (the "1996 Registration Statement")). 10.6 Employment agreement dated July 16, 1996 between the registrant and Arthur Dubroff. (Incorporated by reference to Exhibit 10.6 of the 1996 Form 10-K.) 10.7 Agreement dated January 4, 1999 between the registrant and Brian C. Kleinberg. 10.8 Stock purchase agreement dated February 9, 1996 among the registrant, The Manufacturers Life Insurance Company, Manulife (International) Limited and Swiss Reinsurance Company. (Incorporated by reference to Exhibit 10.1 to the 1996 Registration Statement.) 21.1 Subsidiaries of the registrant. 88 24.1 Power of Attorney. (Included on signature page of this report.) 27 Financial Data Schedule. (b) Reports on Form 8-K. The Company did not file any reports on Form 8-K during the fourth quarter of 1998. 89 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, on March 30, 1999. ENHANCE FINANCIAL SERVICES GROUP INC. By: /s/ Daniel Gross ------------------------------------- Daniel Gross President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Daniel Gross and Samuel Bergman, and each of them individually, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and his name, place and stead in any and all capacities, to sign any or all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below on March 30, 1999 by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Daniel Gross ---------------------------------------- Daniel Gross President and Chief Executive Officer and a director (principal executive officer) /s/ Arthur Dubroff ---------------------------------------- Arthur Dubroff Executive Vice President (principal financial officer and principal accounting officer) 90 /s/ Brenton W. Harries ---------------------------------------- Brenton W. Harries Director /s/ David R. Markin ---------------------------------------- David R. Markin Director /s/ Wallace O. Sellers ---------------------------------------- Wallace O. Sellers Director /s/ Richard J. Shima ---------------------------------------- Richard J. Shima Director /s/ Robert P. Saltzman ---------------------------------------- Robert P. Saltzman Director /s/ Spencer R. Stuart ---------------------------------------- Spencer R. Stuart Director /s/ Adrian U. Sulzer ---------------------------------------- Adrian U. Sulzer Director /s/Allan R. Tessler ---------------------------------------- Allan R. Tessler Director /s/ Frieda K. Wallison ---------------------------------------- Frieda K. Wallison Director /s/ Jerry Wind ---------------------------------------- Jerry Wind Director 91 EX-4.2.2 2 AMENDMENT NO. 1 AMENDMENT NO. 1 AND WAIVER AGREEMENT AMENDMENT NO. 1 AND WAIVER AGREEMENT dated as of December 31, 1998, among ENHANCE FINANCIAL SERVICES GROUP INC., a corporation duly organized and validly existing under the laws of the State of New York (together with its successors and assigns, the "Company"); each of the lenders that is a signatory hereto (together with its successors and assigns, individually, a "Bank", and, collectively, the "Banks"); and FLEET NATIONAL BANK, as Swingline Bank (in such capacity, together with its successors and permitted assigns in such capacity, the "Swingline Bank") and as agent for the Banks (in such capacity, together with its successors in such capacity, the "Agent"). The Company, the Banks, the Swingline Bank and the Agent are parties to a Credit Agreement dated as of June 30, 1998 (as in effect on the date hereof, the "Credit Agreement"), providing, subject to the terms and conditions thereof, for extensions of credit to be made by the Banks to the Company in an aggregate principal not exceeding $100,000,000. The Company has requested the Banks to amend the Credit Agreement to permit the formation by the Company of a holding company subsidiary and to waive compliance by the Company with the covenant in subsection (d) of Section 8.08 of the Credit Agreement as a result of non-insurance equity investments by the Company. The Company, the Banks, the Swingline Banks and the Agent are in agreement with such requests and accordingly, the parties hereto hereby agree as follows: Section 1. Definitions. Except as otherwise defined in this Amendment No. 1 and Waiver Agreement, terms defined in the Credit Agreement are used herein as defined therein. Section 2. Amendments. Subject to the satisfaction of the conditions precedent specified in Section 4 below, but effective as of the date hereof, the Credit Agreement shall be amended as follows: (a) Section 1.01 (Certain Defined Terms) of the Credit Agreement is amended by replacing the definition of "Applicable Insurance Regulatory Authority" with the following: "Applicable Insurance Regulatory Authority" shall mean, with respect to any Insurance Subsidiary, the insurance department or similar insurance regulatory or administrative authority or agency of the state or other jurisdiction in which such Insurance Subsidiary is domiciled. -2- and by adding the following new definition: "Enhance Investment" shall mean Enhance Investment Corporation, a Delaware corporation and a Wholly Owned Subsidiary of the Company. (b) Subsection (e) of Section 8.05 (Prohibition of Fundamental Changes) is deleted and replaced with the following: "(e) Except as expressly permitted by this Section 8.05, the Company shall not, nor shall it permit any of its Material Subsidiaries to, sell, transfer, convey or otherwise dispose of either directly or indirectly (x) all or any portion of the capital stock of any of its Material Subsidiaries or (y) all or substantially all of the Properties of any of its Material Subsidiaries in one transaction or a series of related transactions; provided, however, the Company may transfer all of the capital stock of any of its Insurance Subsidiaries to Enhance Investment." Section 3. Waivers. (a) The Banks hereby waive, effective as of the date hereof, the Event of Default that has occurred as of December 31, 1998 and will continue under the Credit Agreement because of the Company's non-compliance with the 6% equity Investment limitation in Section 8.08(d) thereof, it being understood that such waiver shall be effective only from the date hereof to and including February 15, 1999, and is granted only on the condition that the actual percentage of equity Investments during such period does not exceed 10%. (b) The foregoing waiver shall be effective only for the specific Event of Default specified in subsection (a) above and shall not entitle the Company to any future waiver in similar or other circumstance. Section 4. Representations and Warranties. The Company represents and warrants to the Banks that the representations and warranties set forth in Section 7 of the Credit Agreement are true and complete on the date hereof as if made on and as of the date hereof and as if each reference in said Section 7 to "this Agreement" included reference to this Amendment No. 1 and Waiver Agreement. Section 5. Conditions Precedent. As provided in Section 2 above, the amendments to the Credit Agreement set forth in said Section 2 shall become effective, as of the date hereof, upon (i) execution and delivery of this Amendment No. 1 and Waiver Agreement by the Company, the Swingline Bank, the Agent and each of the Banks, (ii) execution and delivery to the Agent, for the benefit of the Agent and the Banks, of a guaranty agreement in substantially the form of Exhibit A to this Amendment No. 1 and Waiver Agreement, and (iii) payment to the -3- Agent for the ratable benefit of the Banks of an amendment fee of $5,000 and a waiver fee of $5,000. Section 6. Miscellaneous. Except as herein provided, the Credit Agreement shall remain unchanged and in full force and effect. This Amendment No. 1 and Waiver Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same amendatory instrument and any of the parties hereto may execute this Amendment No. 1 and Waiver Agreement by signing any such counterpart. This Amendment No. 1 and Waiver Agreement shall be governed by, and construed in accordance with, the laws of the State of New York. (Remainder of Page Intentionally Left Blank) S-1 IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 1 and Waiver Agreement to be duly executed and delivered as of the day and year first above written. ENHANCE FINANCIAL SERVICES GROUP INC. By /s/ Samuel Bergman --------------------------------------- Title: EVP S-2 BANKS FLEET NATIONAL BANK By /s/ Jan-Gee W. McCollam --------------------------------------- Title: Senior Vice President THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By --------------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By --------------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By --------------------------------------- Title: and By --------------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By --------------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By /s/ John R. Beckwith --------------------------------------- Title: Attorney-In-Fact THE FIRST NATIONAL BANK OF CHICAGO By --------------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By --------------------------------------- Title: and By --------------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By --------------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By --------------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By /s/ Timothy Stambaugh --------------------------------------- Title: Senior Vice President DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By --------------------------------------- Title: and By --------------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By --------------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By --------------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By --------------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By /s/ John S. McGill --------------------------------------- Title: John S. McGill Vice President and By /s/ Clinton M. Johnson --------------------------------------- Title: CLINTON M. JOHNSON Director S-3 SWINGLINE BANK FLEET NATIONAL BANK, as Swingline Bank By /s/ Jan-Gee W. McCollam --------------------------------------- Title: Senior Vice President Administrative Agent FLEET NATIONAL BANK, as Administrative Agent By /s/ Jan-Gee W. McCollam --------------------------------------- Title: Senior Vice President EXHIBIT A to AMENDMENT NO. 1 AND WAIVER AGREEMENT GUARANTY AGREEMENT THIS GUARANTY AGREEMENT ("Agreement") is executed as of December 31, 1998 by ENHANCE INVESTMENT CORPORATION, a Delaware corporation (the "Guarantor"), for the benefit of each of the banks and other financial institutions (together with its successors and assigns, individually a "Bank" and, collectively, the "Banks") that are or may hereafter become a party to the Credit Agreement defined below, and Fleet National Bank, as Swingline Bank (in such capacity, together with its successors and assigns in such capacity, the "Swingline Bank") and as agent for the Banks (in such capacity, together with its successors in such capacity, the "Agent"). For purposes of this Guaranty Agreement, the term "Banks" shall include the Swingline Bank. Preamble 1. Enhance Financial Services Group, Inc. (the "Company"), the Banks and the Agent are parties to a Credit Agreement dated as of June 30, 1998 (as at any time renewed, extended, amended, supplemented or otherwise modified, the "Credit Agreement") providing, subject to the terms and conditions thereof, for extensions of credit to be made by the Banks to the Company in an aggregate principal not exceeding $100,000,000. The Company has requested the Banks to amend the Credit Agreement to permit the formation by the Company of a holding company subsidiary to hold certain insurance subsidiaries. The Company, the Banks, and the Agent are in agreement with such request but only if such holding company subsidiary unconditionally guarantees payment of the indebtedness and obligations of the Company to the Banks, and the Agent, as set forth herein. 2. The Guarantor is the holding company subsidiary formed by the Company, is a wholly owned subsidiary of the Company and expects to receive material and substantial, direct or indirect, benefit from the Banks' extending credit to the Company. NOW, THEREFORE, as an inducement to the Banks to amend the Credit Agreement as requested and to continue to extend credit to the Company pursuant to the Credit Agreement, and for other good and valuable consideration, the receipt and legal sufficiency of which are hereby acknowledged, the Guarantor hereby agrees as follows: -2- Article I Nature and Scope of Guaranty Section 1.01. Guaranty of Obligation. The Guarantor hereby irrevocably and unconditionally guarantees to the Banks, and the Agent and their respective successors and assigns the due and punctual payment of the "Guaranteed Debt" (hereinafter defined). The Guarantor hereby irrevocably and unconditionally covenants and agrees that it is liable for the Guaranteed Debt as primary obligor. Section 1.02. Definition of Guaranteed Debt. As used herein, the term "Guaranteed Debt" means: (a) all principal, interest, attorneys' fees, commitment fees, liabilities for costs and expenses and other indebtedness, obligations and liabilities of the Company to each of the Banks and the Agent at any time created or arising (including, without limitation, obligations incurred or accrued during the pendency of any bankruptcy or insolvency proceeding, regardless of whether allowed or allowable in such proceeding) in connection with the Credit Agreement and under any documents and instruments executed in connection therewith, including without limitation this Guaranty Agreement, and under any renewals, modifications, increases and extensions thereof or of any promissory notes issued pursuant thereto; and (b) all costs, expenses and fees, including but not limited to court costs and reasonable attorneys' fees, arising in connection with the collection of any or all amounts, indebtedness, obligations and liabilities of the Company to the Banks, and the Agent described in Section 1.02(a) above. Section 1.03. Indebtedness Not Reduced by Offset. The Guaranteed Debt, and the liabilities and obligations of the Guarantor to the Banks and the Agent hereunder, shall not be reduced, discharged or released because or by reason of any existing or future offset or claim of the Company, or any other party, against any of the Banks or the Agent; provided, however, nothing in this Agreement shall be construed as a waiver by the Guarantor of any rights or claims which the Guarantor may have against the Banks or the Agent under this Agreement or otherwise, but any recovery upon such rights and claims shall be had from the Banks and the Agent separately. Without limiting the foregoing or the Guarantor's liability hereunder, to the extent that the Agent or any of the Banks advance funds or extend credit to the Company, and do not receive payments or benefits thereon in the amounts and at the times required or provided by applicable agreements or laws, the Guarantor, subject to the terms and conditions hereof, is absolutely liable to make such payments to (and confer such benefits on) the Banks, and the Agent, on a timely basis. -3- Section 1.04. "Company" to Include New Corporations and Partnerships. The term "Company" as used herein shall include any new or successor corporation or entity technically formed as a result of any merger, consolidation, or reorganization of the Company permitted by the Credit Agreement. Section 1.05. Payment by the Guarantor. If all or any part of the Guaranteed Debt shall not be punctually paid when due, whether upon demand or at maturity or earlier by acceleration or otherwise, the Guarantor shall, subject to the terms and conditions hereof, immediately upon demand by the Agent, and without presentment, protest, notice of protest, notice of non-payment, notice of intention to accelerate or acceleration or any other notice whatsoever, pay in lawful money of the United States of America, the amount due on the Guaranteed Debt to the Agent on behalf of the Banks or itself at the Agent's principal office. Such demand(s) may be made at any time coincident with or after the time for payment of all or part of the Guaranteed Debt, and may be made from time to time with respect to the same or different items of Guaranteed Debt. Such demand shall be deemed made, given and received in accordance with Section 4.04 hereof. Section 1.06. No Duty to Pursue Others. It shall not be necessary for the Agent or any of the Banks (and the Guarantor hereby waives any rights which the Guarantor may have to require the Agent or any of the Banks) in order to enforce payment by the Guarantor, first to (i) institute suit or exhaust its remedies against the Company or others liable on the Guaranteed Debt or any other Person, (ii) enforce the Agent's or any Banks' rights against any security which shall ever have been given to secure the Guaranteed Debt, (iii) enforce the Agent's or the Banks' rights against any other guarantors of the Guaranteed Debt, (iv) join the Company or any others liable on the Guaranteed Debt in any action seeking to enforce this Agreement, (v) exhaust any remedies available to the Agent or any of the Banks against any security which shall ever have been given to secure the Guaranteed Debt, or (vi) resort to any other means of obtaining payment of the Guaranteed Debt. The Banks, and the Agent shall not be required to mitigate damages or take any other action to reduce, collect or enforce the Guaranteed Debt. Section 1.07. Waiver of Notices. etc. The Guarantor hereby waives notice of (i) any loans or advances made by the Agent or any of the Banks to the Company, (ii) acceptance of this Agreement, (iii) any amendment or extension of any instrument or document pertaining to all or any part of the Guaranteed Debt, (iv) the execution and delivery by the Company, the Agent or any of the Banks of any loan or credit agreement or of the Company's execution and delivery of any promissory notes or other documents in connection therewith, (v) the occurrence of any breach by the Company of any agreement among the Company, the Banks, and the Agent, or any of them, (vi) the transfer or disposition of the Guaranteed Debt, or any part thereof, by the Agent or any Banks, (vii) sale or foreclosure (or posting or advertising for sale or foreclosure) of any collateral for the Guaranteed Debt, (viii) protest, proof of non-payment or default by the Company, or (ix) any other action at any time taken or omitted by the Agent or any of the Banks, and, generally, all demands and notices of every kind in -4- connection with this Agreement, any documents or agreements evidencing, securing or relating to any of the Guaranteed Debt and the obligations hereby guaranteed other than demands and notices specifically required by this Agreement. Section 1.08. Nature Guaranty. This Agreement is an irrevocable, absolute, guaranty of payment and not a guaranty of collection. This Agreement may not be revoked by the Guarantor and shall continue to be effective with respect to any Guaranteed Debt arising or created after any attempted revocation by the Guarantor. The fact that at any time or from time to time the Guaranteed Debt may be increased, reduced or paid in full shall not release, discharge or reduce the obligation of the Guarantor with respect to Guaranteed Debt thereafter incurred (or other Guaranteed Debt thereafter arising). This Agreement may be enforced by the Agent (for itself and on behalf of the Banks and any subsequent holder of the Guaranteed Debt) and shall not be discharged by the assignment or negotiation of all or part of the Guaranteed Debt. Section 1.09. Payment of Expenses. In the event that the Guarantor should breach or fail to timely perform any provisions of this Agreement, the Guarantor shall, immediately upon demand by the Agent, pay to the Agent all costs and expenses (including court costs and reasonable attorneys' fees) incurred by the Banks, and the Agent in the enforcement hereof or the preservation of the Agent's or any Lender's rights hereunder. The covenant contained in this Section 1.09 shall survive the payment of the Guaranteed Debt. Section 1.10. Effect of Bankruptcy. In the event that, pursuant to any insolvency, bankruptcy, reorganization, receivership or other debtor relief law, or any judgment, order or decision thereunder, the Agent or any of the Banks must rescind or restore any payment, or any part thereof, received by the Agent or any of the Banks in satisfaction of the Guaranteed Debt, as set forth herein, any prior release or discharge from the terms of this Agreement given to the Guarantor by the Agent or any of the Banks shall be without effect, and this Agreement shall remain in full force and effect. It is the intention of the Company and the Guarantor that the Guarantor's obligations hereunder shall not be discharged except by the Guarantor's performance of such obligations and then only to the extent of such performance or by the indefeasible payment in full of the Guaranteed Debt in cash. Article II Events and Circumstances Not Reducing or Discharging the Guarantor's Obligations The Guarantor hereby consents and agrees to each of the following, and agrees that the Guarantor's obligations under this Agreement shall not be released, diminished, impaired, reduced or adversely affected by any of the following, and waives any common law, equitable, statutory or other rights (including without limitation rights to notice) which the Guarantor might otherwise have as a result of or in connection with any of the following: -5- Section 2.01. Modifications, etc. Any renewal, extension, increase, modification, alteration or rearrangement of all or any part of the Guaranteed Debt or any loan agreement, security agreement, collateral document or other document, instrument, contract or understanding among any of the Company, the Banks, and the Agent, or any other parties, pertaining to the Guaranteed Debt; Section 2.02. Adjustment, etc. Any adjustment, indulgence, forbearance or compromise that might be granted or given by the Agent or any of the Banks to the Company or the Guarantor; Section 2.03. Condition of the Company or the Guarantor. The insolvency, bankruptcy, arrangement, adjustment, composition, liquidation, disability, dissolution or lack of power of the Company or any other party at any time liable for the payment of all or part of the Guaranteed Debt; or any dissolution of the Company or the Guarantor, or any sale, lease or transfer of any or all of the assets of the Company or the Guarantor, or any changes in the shareholders, partners or members of the Company or the Guarantor; or any reorganization of the Company or the Guarantor; Section 2.04. Invalidity of Guaranteed Debt. The invalidity, illegality or unenforceability of all or any part of the Guaranteed Debt, or any document or agreement executed in connection with the Guaranteed Debt, for any reason whatsoever, including without limitation the fact that (i) the Guaranteed Debt, or any part thereof, exceeds the amount permitted by law, (ii) the act of creating the Guaranteed Debt or any part thereof is ultra vires, (iii) the officers or representatives executing the documents creating the Guaranteed Debt acted in excess of their authority, (iv) the Guaranteed Debt violates applicable usury laws, (v) the Company has valid claims or offsets (whether at law, in equity or by agreement) which render the Guaranteed Debt wholly or partially uncollectible from the Company, (vi) the creation, performance or repayment of the Guaranteed Debt (or the execution, delivery and performance of any document or instrument representing part of the Guaranteed Debt or executed in connection with the Guaranteed Debt, or given to secure the repayment of the Guaranteed Debt) is illegal, uncollectible or unenforceable, or (vii) the documents or instruments pertaining to the Guaranteed Debt have been forged or otherwise are irregular or not genuine or authentic; Section 2.05. Release of Obligors. Any full or partial release of the liability of the Company on the Guaranteed Debt or any part thereof, or of any co-guarantors, or any other Person (as defined in the Credit Agreement) now or hereafter liable, whether directly or indirectly, jointly, severally, or jointly and severally, to pay, perform, guarantee or assure the payment of the Guaranteed Debt or any part thereof, it being recognized, acknowledged and agreed by the Guarantor that the Guarantor may be required to pay the Guaranteed Debt in full without assistance or support of any other party, and the Guarantor has not been induced to enter into this on the basis of a contemplation, belief, understanding or agreement that other -6- parties will be liable to perform the Guaranteed Debt, or that the Agent or any Lender will look to other parties to perform the Guaranteed Debt; Section 2.06. Other Security. The taking or accepting of any other security, collateral or guaranty, or other assurance of payment, for all or any part of the Guaranteed Debt; Section 2.07. Release of Collateral. etc. Any release, surrender, exchange, subordination, deterioration, waste, loss or impairment (including without limitation negligent, willful, unreasonable or unjustifiable impairment) of any collateral, property or security, at any time existing in connection with, or assuring or securing payment of, all or any part of the Guaranteed Debt; Section 2.08. Care and Diligence. The failure of the Agent or any of the Banks or any other party to exercise diligence or reasonable care in the preservation, protection, enforcement, sale or other handling or treatment of all or any part of such collateral, property or security; Section 2.09. Status of Liens. The fact that any collateral, security, security interest or lien contemplated or intended to be given, created or granted as security for the repayment of the Guaranteed Debt shall not be properly perfected or created, or shall prove to be unenforceable or subordinate to any other security interest or lien, it being recognized and agreed by the Guarantor that the Guarantor is not entering into this Agreement in reliance on, or in contemplation of the benefits of, the validity, enforceability, collectibility or value of any of the collateral for the Guaranteed Debt; Section 2.10. Offset. The Guaranteed Debt, and the liabilities and obligations of the Guarantor to the Banks and the Agent hereunder, shall not be reduced, discharged or released because of or by reason of any existing or future right of offset or claim of the Company, or any other party, against any of the Banks or the Agent subject to the proviso in Section 1.03 hereof; Section 2.11. Merger. The reorganization, merger or consolidation of the Company into or with any other corporation, partnership or other entity; Section 2.12. Preference. Any payment by the Company to the Agent or any of the Banks is held to constitute a preference under bankruptcy laws, or for any reason the Agent or any of the Banks is required to refund such payment or pay such amount to the Company or someone else; or Section 2.13. Other Actions Taken or Omitted. Any other action taken or omitted to be taken with respect to, the Guaranteed Debt, or the security and collateral therefor, whether or not such action or omission prejudices the Guarantor or increases the likelihood that the Guarantor will be required to pay the Guaranteed Debt pursuant to the terms hereof; it is the -7- unambiguous and unequivocal intention of the Guarantor that, the Guarantor shall be obligated to pay the Guaranteed Debt when due, notwithstanding any occurrence, circumstance, event, action, or omission whatsoever, whether contemplated or uncontemplated, and whether or not otherwise or particularly described herein, except for the full and final payment and satisfaction of the Guaranteed Debt. Article III Representations, Warranties and Covenants To induce the Banks, and the Agent to extend credit to the Company, the Guarantor represents, warrants and covenants to the Banks, and the Agent that: Section 3.01. Benefit. The Guarantor has received, or expects to receive, material and substantial, direct or indirect, benefit from the making of this Agreement and the Guaranteed Debt; Section 3.02. Familiarity and Reliance. The Guarantor is familiar with, and has independently reviewed books and records regarding, the financial condition of the Company and is familiar with the value of any and all collateral intended to be created as security for the payment of the Guaranteed Debt; however, the Guarantor is not relying on such financial condition or the collateral as an inducement to enter into this Agreement; Section 3.03. No Representation by Banks. Neither the Agent nor any of the Banks nor any other party has made any representation, warranty or statement to the Guarantor in order to induce the Guarantor to execute this Agreement; Section 3.04. Solvency, etc. On the date hereof and after giving effect to all the transactions contemplated hereby, (i) the assets of the Guarantor, at a fair valuation, will exceed its liabilities, including contingent liabilities, (ii) the remaining capital of the Guarantor will not be unreasonably small to conduct its business, and (iii) the Guarantor will not have incurred debts, and does not intend to incur debts, beyond its ability to pay such debts as they mature. For purposes of this Section 3.04, "debt" means any liability on a claim, and "claim" means (i) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, secured, or unsecured; or (ii) right to an equitable remedy for breach of performance if such breach gives rise to a payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured; Section 3.05. Binding Obligation. This Agreement constitutes the valid and binding legal obligation of the Guarantor, enforceable in accordance with its terms and the execution and delivery will not conflict with or result in a breach of or constitute a default under any instrument to which the Guarantor is a party or by which the Guarantor or the Guarantor's -8- property is bound, or violate any applicable provision of law or any judgment, order, writ, injunction, decree, rule or regulation of any court, administrative agency or other governmental agency or authority; Section 3.06. Obstacles to Guaranty. The execution, delivery and performance by the Guarantor of this Agreement will not conflict with or result in any breach of any provision of, or constitute a default under, or breach of any provision of, or result in the imposition of any lien or charge upon any asset of the Guarantor, or result in the acceleration of any obligation under the terms of any agreement or document binding upon the Guarantor. No consent of any party, and no approval or authorization of any governmental authority is required in connection with the execution, delivery, performance, validity or enforceability of this Agreement, other than any approval, authorization or consent which has as of the date hereof been obtained; Section 3.07. Survival. All representations and warranties made by the Guarantor herein shall survive the execution hereof; and Section 3.08. Litigation. There is no suit, action or proceeding pending or, to the knowledge of the Guarantor, threatened against or affecting the Guarantor, before or by any court, administrative agency or other governmental authority. Article IV Miscellaneous Section 4.01. Waiver of Subrogation. Until the payment and performance in full of all of the Guaranteed Debt, the Guarantor hereby irrevocably waives any claim or other rights which it may now have or hereafter acquire against the Company or any other guarantor that arise from the existence, payment, performance or enforcement of such Guarantor's obligations under this Agreement, the Credit Agreement or any other Loan Document, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution, indemnification, any right to participate in any claim or remedy of the Agent or any of the Banks against the Company or any guarantor or any collateral which the Banks, and the Agent now has or hereafter acquires, whether or not such claim, remedy or right arises in equity, or under contract, statute or common law, including without limitation, the right to take or receive from the Company, directly or indirectly, in cash or other property or by set-off or in any other manner, payment or security on account of such claim or other rights. If any amount shall be paid to the Guarantor in violation of the preceding sentences and the Guaranteed Debt shall not have been paid in full, such amount shall be deemed to have been paid to the Guarantor for the benefit of, and held in trust for the benefit of, the Banks, and the Agent, and shall forthwith be paid to the Agent to be credited and applied upon the Guaranteed Debt, whether matured or unmatured, in accordance with the terms of the other Loan Documents. The Guarantor acknowledges that it will receive direct and indirect benefits from -9- the financing arrangements contemplated by the Credit Agreement and that the waiver set forth in this Section 4.01 is knowingly made in contemplation of such benefits. Section 4.02. Subordination. All debt and other liabilities of the Company to the Guarantor are expressly subordinate and junior to the Guaranteed Debt. Section 4.03. Waiver. No failure to exercise, and no delay in exercising, on the part of the Agent or any of the Banks, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right. The rights of the Banks, and the Agent hereunder shall be in addition to all other rights provided by law. No modification or waiver of any provision of this Agreement, nor consent to departure therefrom, shall be effective unless in writing signed by the Guarantor, the Banks, and the Agent, and no such consent or waiver shall extend beyond the particular case and purpose involved. No notice or demand given in any case shall constitute a waiver of the right to take other action in the same, similar or other instances without such notice or demand. Section 4.04 Notices. Any notices or other communications required or permitted to be given by this Agreement shall be in writing and shall be deemed to have been given three (3) days after deposit in the mail, designated as certified mail, return receipt requested, postprepaid, or one (1) day after being entrusted to a reputable commercial overnight delivery service, or upon transmission of a telecopy addressed to the party to which such notice is directed at its address determined as provided in this Section 4.04. All notices and other communications under this Agreement shall be given to the parties hereto at the following addresses: Guarantor: 300 Delaware Avenue 9th Floor Wilmington, DE 19801 Attn: Francis B. Jacobs II President Telephone No.: (302) 552-3104 Telecopy No.: (302) 552-3128 -10- with a copy to: Enhance Financial Services Group, Inc. 335 Madison Avenue 25th Floor New York, NY 10017-4605 Attn.: Arthur Dubroff Executive Vice President and Chief Financial Officer Telephone No.: (212) 983-3100 Telecopy No.: (212) 682-5377 Agent and Banks: Fleet National Bank 777 Main Street Hartford, CT 06115 Attn: Jan-Gee McCollam Senior Vice President Telephone No.: (860) 986-4535 Telecopy No.: (860) 986-1264 Any party may change its address for purposes of this Agreement by giving notice of such change to the other party pursuant to this Section 4.04. Section 4.05. Governing Law. This Agreement has been prepared, and is intended to be performed in the State of New York, and the substantive laws of such state shall govern the validity, construction, enforcement and interpretation of this Agreement. For purposes of this Agreement and the resolution of disputes hereunder, the Guarantor hereby irrevocably submits and consents to, and waives any objection to, the non-exclusive jurisdiction of any state court of the State of New York and of any United States Federal court sitting in New York. Section 4.06. Invalid Provisions. If any provision of this Agreement is held to be illegal, invalid, or unenforceable under present or future laws effective during the term of this Agreement, such provision shall be fully severable and this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Agreement, and the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance from this Agreement, unless such continued effectiveness of this Agreement, as modified, would be contrary to the basic understandings and intentions of the parties as expressed herein. If, in any action or proceeding involving any state, federal or foreign bankruptcy, insolvency, reorganization or other law affecting the rights of creditors generally, the obligations of the Guarantor under this Agreement would otherwise by held or determined -11- to be avoidable, invalid or unenforceable on account of the amount of the Guarantor's liability under this Agreement, then, notwithstanding any other provisions of this Agreement to the contrary, the amount of such liability shall, without any further action by the Guarantor, the Agent or any Bank, be automatically limited and reduced to the highest amount that is valid and enforceable as determined in such action or proceeding. Section 4.07. Entirety and Amendments. This Agreement embodies the entire agreement between the parties and supersedes all prior agreements and understandings, if any, relating to the subject matter hereof, and this Agreement may be amended only by an instrument in writing executed by an authorized officer of the party against whom such amendment is sought to be enforced. Section 4.08. Parties Bound: Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, assigns and legal representatives; provided, however, that the Guarantor may not, without the prior written consent of the Banks, and the Agent, assign any of its rights, powers, duties or obligations hereunder. Section 4.09. Headings. Section headings are for convenience of reference only and shall in no way affect the interpretation of this Agreement. Section 4.10. Multiple Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. Section 4.11. Rights and Remedies. If the Guarantor becomes liable for any indebtedness owing by the Company to the Agent or any of the Banks, by endorsement or otherwise, other than under this Agreement, such liability shall not be in any manner impaired or affected hereby and the rights of the Banks, and the Agent hereunder shall be cumulative of any and all other rights that the Banks, and the Agent may ever have against the Guarantor. The exercise by the Agent or any of the Banks of any right or remedy hereunder or under any other instrument, or at law or in equity, shall not preclude the concurrent or subsequent exercise of any other right or remedy. Section 4.12. ENTIRE AGREEMENT. THIS AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENT OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. SECTION 4.13. WAIVER OF JURY. THE GUARANTOR IRREVOCABLY WAIVES TRIAL BY JURY IN ANY COURT AND IN ANY SUIT, ACTION OR -12- PROCEEDING OR ANY MATTER ARISING IN CONNECTION WITH OR IN ANY WAY RELATED TO THE FINANCING TRANSACTIONS CONTEMPLATED BY THIS GUARANTY OR ANY AGREEMENT, INSTRUMENT OR WRITING RELATED THERETO AND THE ENFORCEMENT OF ANY OF BANKS' RIGHTS AND REMEDIES. EXECUTED as of the day and year first above written. ENHANCE INVESTMENT CORPORATION By: ----------------------------------- Name: Title: EX-4.2.3 3 AMENDMENT NO. 2 AMENDMENT NO. 2 AMENDMENT NO. 2 ("Amendment No. 2"), dated as of February 15, 1999, among ENHANCE FINANCIAL SERVICES GROUP INC., a corporation duly organized and validly existing under the laws of the State of New York (together with its successors and assigns, the "Company"); each of the lenders that is a signatory hereto (together with its successors and assigns, individually, a "Bank", and, collectively, the "Banks"); and FLEET NATIONAL BANK, as Swingline Bank (in such capacity, together with its successors and permitted assigns in such capacity, the "Swingline Bank") and as agent for the Banks (in such capacity, together with its successors in such capacity, the "Agent"). The Company, the Banks, the Swingline Bank and the Agent are parties to a Credit Agreement dated as of June 30, 1998, which Credit Agreement was amended by Amendment No. 1 and Waiver Agreement dated as of December 31, 1998 (as so amended and in effect on the date hereof, the "Credit Agreement"). The Company has requested the Banks to amend the covenant in the Credit Agreement relating to the Company's investments to take into account the Company's projected equity investments. The Banks are in agreement with such request upon certain terms and conditions. Accordingly, the parties hereto hereby agree as follows: Section 1. Definitions. Except as otherwise defined in this Amendment No. 2, terms defined in the Credit Agreement are used herein as defined therein. Section 2. Amendments. Subject to the satisfaction of the conditions precedent specified in Section 3 below, but effective as of the date hereof, the Credit Agreement shall be amended as follows: (a) Section 1.01 (Certain Defined Terms) is amended by adding the following new definition: "Combined Statutory Surplus" means, at any date, the combined "statutory surplus as regards policyholders" of each Insurance Subsidiary of Enhance Investment that appears on the Statutory Statement of such Insurance Subsidiary and is computed pursuant to the instructions of the National Association of Insurance Commissioners or any successor thereto. In the Statutory Statement prescribed for each Insurance Subsidiary for the year ended December 31, 1997, such amount for the year ended December 31, 1997 appears on line 32, column 1 on page 4. -2- (b) Subsection (d) of Section 8.07 (Indebtedness) is deleted and replaced with the following: "(d) additional Indebtedness of the Company and its Material Subsidiaries provided that on the date such Indebtedness is incurred and after giving effect thereto and to the concurrent retirement of any other Indebtedness of the Company and its Material Subsidiaries, total consolidated Indebtedness of the Company and its Subsidiaries (including Indebtedness created or incurred under any other subsection of this Section 8.07) does not exceed 25% of Total Capitalization or 60% of Combined Statutory Surplus; and" (c) Subsection (d) of Section 8.08 (Investments) is deleted and replaced with the following: "(d) equity Investments if, after giving effect to such Investments, the aggregate amount of equity Investments of the Company and of its Material Subsidiaries (including, without limitation, Investments in Subsidiaries of the Company that are not Wholly Owned Subsidiaries of the Company) (i) in any one Person, including Affiliates thereof, does not exceed at any time 75% of the aggregate amount of equity Investments of the Company and its Material Subsidiaries and (ii) does not exceed at any time during the periods set forth below, the following percentages of the aggregate amount of the consolidated Investments (both debt and equity) of the Company and its Material Subsidiaries: -------------------------------------------------------------------- Maximum Aggregate Equity During the Fiscal Year Ending: Investments as Percentage of ------------------------------ Consolidated Investments ------------------------ -------------------------------------------------------------------- December 31, 1998 and December 31, 1999 10.0% -------------------------------------------------------------------- December 31, 2000 12.0% -------------------------------------------------------------------- December 31, 2001 and thereafter 14.5% -------------------------------------------------------------------- For purposes of this subsection (d), the amount of equity Investments shall not include any increases in the value of such equity Investments resulting from undistributed earnings on such equity Investment. -3- (d) Section 8.09 (Restricted Payments) is amended by deleting the last proviso therein and replacing it with the following: "provided further, that no Restricted Payments shall be permitted if and for so long as the claims-paying ability rating, as rated by S&P (if rated by S&P), of ERC falls below AA+ (or is withdrawn) or of any other Insurance Subsidiary of the Company falls below AA- (or is withdrawn)." (e) Section 8.16 (Claims-Paying Rating) is deleted and replaced with the following: "8.16 Claims-Paying Rating. The Company will not allow the claims-paying rating, as rated by S&P, of ERC to be less than AA+ (or to be withdrawn) or of any other Insurance Subsidiary to be less than AA- (or to be withdrawn) at any time." Section 3. Conditions Precedent. The amendments to the Credit Agreement set forth in Section 2 above shall become effective, as of the date hereof, upon execution and delivery of this Amendment No. 2 by the Company, the Swingline Bank, the Agent and each of the Banks and (ii) payment to the Agent for the ratable benefit of the Banks of an amendment fee of $10,000. Section 4. Representations and Warranties of the Company. The Company represents to the Banks, the Swingline Bank and the Agent as follows: (a) The execution, delivery and performance by the Company of this Amendment No. 2 has been duly authorized by all necessary corporate action and does not and will not (i) require any consent or approval of its shareholders; (ii) violate any provisions of its certificate of incorporation or by-laws; (iii) violate any provision of or require any filing, registration, consent or approval under, any law, rule, regulation (including without limitation, Regulation U and X), order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to and binding upon the Company or any Subsidiary, it being understood that the Company may be required to file a copy of Amendment No. 2 with the Securities and Exchange Commission in connection with the Company's periodic filing requirements; (iv) result in a breach of or constitute a default or require any consent under any indenture, mortgage or loan or credit agreement or any other material agreement, lease or instrument to which the Company or any Subsidiary is a party or by which it or any of its Property may be bound; or (v) result in, or require, the creation or imposition of any Lien upon or with respect to any of the Property now owned or hereafter acquired by the Company. -4- (b) The representations and warranties contained in Section 7 of the Credit Agreement, as amended by this Amendment No. 2, are true, correct and complete in all material respects on and as of the date hereof as though made on and as of the date hereof. (c) No Event of Default or Default has occurred and is continuing or would result from the signing of this Amendment No. 2 or the transactions contemplated hereby. (d) There has been no material adverse change in the consolidated financial condition, operations, business or prospects of the Company and its Subsidiaries, taken as a whole, since the date of the last financial statements furnished to the Banks. (e) No information, exhibit or report furnished in writing by or on behalf of the Company or any officer, director, employee or agent of the Company to any of the Banks or the Agent in connection with the negotiation of, or pursuant to the terms of this Amendment No. 2, contained when made any material misstatement of fact or omitted to state a material fact necessary to make the statements contained therein not misleading. Section 5. Miscellaneous. (a) The Company acknowledges that the date references in subsection (d) of Section 8.08 of the Credit Agreement, as amended by Amendment No. 2, which dates are later than the present Commitment Termination Date, are set forth for administrative convenience only in the event the Commitment Termination Date is extended, at the request of the Company and in the sole discretion of each Bank, pursuant to Section 2.08 of the Credit Agreement. The Company agrees that inclusion of such dates in the Credit Agreement shall not be interpreted as the agreement of any Bank to any such extension request made by the Company. (b) Except as herein provided, the Credit Agreement shall remain unchanged and in full force and effect. This Amendment No. 2 may be executed in any number of counterparts, all of which taken together shall constitute one and the same amendatory instrument and any of the parties hereto may execute this Amendment No. 2 by signing any such counterpart. This Amendment No. 2 shall be governed by, and construed in accordance with, the laws of the State of New York. (c) The Company agrees to pay on demand all reasonable costs and expenses of the Agent in connection with the preparation, execution, delivery and administration of this Amendment No. 2 and any other instruments and documents to be delivered hereunder (including, without limitation, the reasonable fees and expenses of counsel to the Agent) in accordance with the terms of Section 11.03 of the Credit Agreement. -5- (d) This Amendment shall be governed by, and construed in accordance with, the laws of the State of New York. (Remainder of Page Intentionally Left Blank) S-1 IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 2 to be duly executed and delivered as of the day and year first above written. ENHANCE FINANCIAL SERVICES GROUP INC. By /s/ Jeffrey A. Figurelli ----------------------------------- Title: Senior Vice President S-2 BANKS FLEET NATIONAL BANK By /s/ Jan-Gee W. McCollam ----------------------------------- Title: Senior Vice President THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By ----------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By ----------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By ----------------------------------- Title: and By ----------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By ----------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By /s/ John R. Beckwith ----------------------------------- Title: Attorney-In-Fact THE FIRST NATIONAL BANK OF CHICAGO By ----------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By ----------------------------------- Title: and By ----------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By ----------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By ----------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By /s/ Timothy A. Stambaugh ----------------------------------- Title: Senior Vice President DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By ----------------------------------- Title: and By ----------------------------------- Title: S-2 BANKS FLEET NATIONAL BANK By ----------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD, NEW YORK BRANCH By ----------------------------------- Title: THE FIRST NATIONAL BANK OF CHICAGO By ----------------------------------- Title: DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLAND BRANCHES By /s/ John S. McGill ----------------------------------- Title: John S. McGill Vice President and By /s/ Gayma Z. Shivnarain ----------------------------------- Title: Gayma Z. Shivnarain Vice President S-3 FLEET NATIONAL BANK, as Swingline Bank By /s/ Jan-Gee W. McCollam ----------------------------------- Title: Vice President AGENT FLEET NATIONAL BANK, as Agent By /s/ Jan-Gee W. McCollam ----------------------------------- Title: Vice President EX-10.2.3 4 OPTION GRANT CERTIFICATE Form OPTION GRANT CERTIFICATE ENHANCE FINANCIAL SERVICES GROUP INC., a New York corporation (the "Company"), hereby grants to __________________(the "Executive") an Incentive Stock Option (the "Option") to purchase _______ shares (the "Option Shares") of common stock, par value $.10 per share ("Common Stock"), pursuant to the Company's 1997 Long-Term Incentive Plan for Key Employees (as such may be amended from time to time, the "Plan"). 1. Basic Terms of Option. (a) Term of Option. The option shall expire December 31, 2008. (b) Exercise Price. The exercise price shall be $______ per Option Share (the "Purchase Price"). (c) Vesting. The Option shall become exercisable in equal installments in accordance with Article 3. (d) Method of Exercise. The Option may be exercised by the Executive in accordance with the terms hereof and of the Plan for any and all Option Shares by written notice (the "Exercise Notice") from the Executive to the Company or its designee in such form as the Company shall prescribe. Payment of the Purchase Price may be made in the form of cash or shares of Common Stock, as permitted by the Plan, and shall accompany the Exercise Notice to the Company; provided that, if such Exercise Notice indicates that the Executive is simultaneously using the stock option exercise program of a financial services provider or other brokerage concern approved by the Company, the Purchase Price shall be payable on the fifth business day following the date of delivery of the Exercise Notice. 2. Option Shares. (a) Status of Option Shares. Effective upon the exercise of the Option in whole or in part and the receipt by the Company of the Purchase Price for the Option Shares being purchased, the Executive shall be the holder of record of such shares and shall have all of the rights of a shareholder with respect thereto (including the right to vote such shares at any meeting at which the holders of the Common Stock may vote, the right to receive all dividends declared and paid upon such shares and the right to exercise any rights or warrants issued in respect of any such shares). The Company shall, upon receipt of the Purchase Price, issue in the name of the Executive a certificate representing the Option Shares purchased from time to time. (b) Option Shares Unregistered. As of the date of grant of the Option, the Option Shares have been registered under the Securities Act of 1933, as amended (the "Act"). However, the Company has no obligation to maintain the effectiveness of the registration of the Option Shares under the Act. Unless the Option Shares issuable upon a given exercise are then subject to an effective registration statement under the Act, the certificate representing such shares shall bear the following legend or such other legend as the Company's counsel may deem appropriate: "The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended, and may in no event be offered, sold, transferred or assigned unless and until the shares have been so registered or, in the opinion of counsel to Enhance Financial Services Group Inc., an exemption from such registration is available." (c) Investment Intent. If the certificate representing the Option Shares issuable upon a given exercise is required to bear the legend set forth above (or a legend to like effect), the Executive shall, by such exercise of the Option, be deemed conclusively to represent and to agree with the Company that he or she is acquiring the Option Shares then being purchased for his or her own account and not for the account of others, for investment only and not with a view to public sale or distribution. (d) Restriction Relating to Certain Mergers. In the event of a merger or consolidation of the Company with a third party which is proposed to be accounted for as a pooling of interests, the Executive shall, if so requested by the Company and notwithstanding any other provision of this Certificate, agree not to sell, assign, or gift or in any other way reduce his or her risk relative to the Option Shares and all other shares of Common Stock owned by the Executive for such period after the consummation of such merger or consolidation as the Company shall, upon the advice of its outside accountants, conclusively determine as necessary to ensure that such merger or consolidation may be validly accounted for as a pooling of interests. (e) Prior Conditions. The Company shall not be required to issue or deliver any certificate representing Option Shares prior to (i) the admission of such shares to listing on any stock exchange on which the Common Stock may then be listed, (ii) the completion of any registration or any other qualification of such shares under any federal or state law or any rulings or regulations of any governmental regulatory body, (iii) the obtaining of any consent or approval or other clearance from any governmental agency which the Company shall, in its sole discretion, determine to be necessary or advisable, and (iv) the payment to the Company, upon its request, of any amount requested by the Company for the purposes of satisfying its liability, if any, to withhold taxes of any kind or any other applicable assessment (plus interest or penalties thereon, 2 if any, caused by a delay in making such payment) incurred by reason of the exercise of the Option. 3. Vesting of Option. (a) Vesting Conditions. If the Executive remains in the continuous employ of the Company or a Subsidiary through the close of business on each date indicated in Column I below, the Option shall thereupon vest (on a cumulative basis) as to the portion of the Option Shares indicated opposite such date in Column II below: (I) (II) the % (or additional %) If employment of the Option continuous through then which vests is ------------------ --------------- December 31, 1999 25% December 31, 2000 25% December 31, 2001 25% December 31, 2002 25% (b) Effect of Termination of Employment. Should the Executive's employment with the Company and its Subsidiaries be terminated for any reason whatsoever before all installments of the Option shall have vested pursuant to Paragraph 3(a), then any portion of the Option which is not vested at the time of such termination shall automatically terminate on the date of the termination of employment, and all rights and interests of the Executive in and to such unvested portion of the Option shall thereupon terminate. Should the Executive's employment be terminated before any given date set forth in Paragraph 3(a) upon his or her death, Disability or Retirement, then the installments of the Option which are vested at the time of such termination shall remain exercisable in accordance with the terms hereof as if such termination of employment shall not have occurred. Should the Executive's employment be terminated by the Company or a Subisidiary other than for Cause, the vested portion of the Option not subsequently exercised on or before the 90th day after such termination shall thereupon automatically terminate. Should the Executive's employment be terminated under any other circumstances, the vested portion of the Option shall thereupon automatically terminate. (c) Effect of Leave of Absence. A leave of absence from the Company or any Subsidiary which is approved by the Board or the President of the Company with specific reference to the grant evidenced by this Certificate shall not be considered a termination of the Executive's employment with the Company for purposes of this Article 3 or any other provision of this Certificate, provided that each date set forth in -3- the table in Paragraph 3(a) which shall follow the commencement of the leave of absence shall be automatically deferred for a period equal to the period of the leave of absence. (d) Board's Right to Waiver or Acceleration. Any provision of this Article 3 to the contrary notwithstanding, the Board reserves the right, in its sole discretion, to waive any condition to the vesting of the Option and accelerate the date on which any installment of the Option shall vest in the event of a change in control of the Company or a public offering of shares of Common Stock or otherwise. 4. Definitions. Unless defined below or elsewhere in this Certificate, the capitalized terms used in this Certificate shall have the meanings ascribed thereto in the Plan. (a) "Cause" shall consist of the failure of the Executive to perform or observe the provisions of any employment agreement with the Company or a Subsidiary, dishonesty or insubordination in the performance of his or her duties, misappropriation of funds, material and willful misconduct, habitual insobriety or conviction of a crime involving moral turpitude. (b) "Disability" means a disability which entitles the Executive to benefits under the long-term disability insurance program of the Company or a Subsidiary applicable to the Executive, or which would entitle the Executive to such benefits after any applicable waiting period. (c) "Retirement" means termination of the Executive's employment with the Company and its Subsidiaries (other than for Cause or upon death or Disability) on or after the later to occur of (i) the conclusion of ten years of continuous employment by the Company or any Subsidiary or (ii) the date on which the Executive attains age 55. 5. General Provisions. (a) Administration and Construction. The provisions hereof shall be administered and construed by the Board (or any authorized committee thereof), whose decisions shall be conclusive and binding on the Company, the Executive and anyone claiming under or through either of them. Without limiting the generality of the foregoing, any determination as to whether or not an event has occurred or failed to occur which causes any unvested portion of the Option to be forfeited or become vested pursuant hereto, shall be made in the good faith but otherwise absolute discretion of the Board. By the Executive's acceptance of this Certificate, the Executive and each person claiming under or through the Executive irrevocably consents and agrees to all actions, -4- decisions and determinations to be taken or made by the Board in good faith pursuant to this Certificate and the Plan. (b) Option Not Assignable or Transferable. The Option is not assignable or transferable other than by will or the laws of descent and distribution, either voluntarily, or, to the full extent permitted by law, involuntarily, by way of encumbrance, pledge, attachment, levy or charge of any nature. Any rights of the Executive hereunder shall be exercisable during the Executive's lifetime only by the Executive's or by his or her guardian or legal representative. (c) No Employment Rights. No provision of this Certificate or of the Plan shall confer upon the Executive any right to continue in the employ of the Company or a Subsidiary or shall in any way affect the right of the Company or a Subsidiary to dismiss, or otherwise terminate the employment of, the Executive at any time for any reason or no reason, or shall impose upon the Company or any Subsidiary any liability for any forfeiture of any unvested portion of the Option which may result under this Certificate if the Executive's employment is so terminated. (d) Recapitalization. If the Executive receives, with respect to the Option, any other option or warrant to purchase securities of the Company, of a Subsidiary or of any other entity as a result of any recapitalization, merger, consolidation, combination, or exchange of shares or a similar corporate change, any such other option or warrant received by the Executive shall likewise be subject to the terms and conditions of this Certificate and shall be included in the term "Option." Similarly, any securities or other property as to which such other option or warrant is exercisable shall be included in the term "Option Shares." In the event of any such corporate change, the Purchase Price set forth in Paragraph 1(b) shall be appropriately adjusted by the Board such that the aggregate price for all such Option Shares is not changed. (e) Legal Representative. In the event of the Executive's death or a judicial determination of the Executive's incompetence, reference in this Certificate to the Executive shall be deemed to refer to the Executive's legal representative or, where appropriate, to the Beneficiary. (f) Holidays. If any event provided for in this Certificate is scheduled to take place on a legal holiday, such event shall take place on the next succeeding day that is not a legal holiday. (g) Notices to the Company. Any notice or other communication to the Company pursuant to any provision of this Certificate shall be deemed to have been delivered when delivered in person to the Corporate Secretary of the Company or when deposited in the United States mail, first class postage prepaid, addressed to the Corporate Secretary of the Company at 335 Madison Avenue, New York, New York 10017 or at -5- such other address of which the Company may from time to time give the Executive written notice in accordance with Paragraph 5(h). (h) Notices to the Executive. Any notice or other communication to the Executive pursuant to any provision of this Certificate shall be deemed to have been delivered when delivered to the Executive in person or when deposited in the United States mail, first class postage prepaid, addressed to the Executive at his or her address on the security holder records of the Company or at such other address of which the Executive may from time to time give the Company written notice in accordance with Paragraph 5(g). (i) Agreement Subject to Plan. This Option Grant Certificate is being executed and delivered pursuant to and is subject in all events to the Plan, a copy of which has previously been delivered to the Executive or is being delivered to the Executive concurrently with this Certificate and which is incorporated in this Certificate by reference. Each provision of this Certificate shall be administered and construed in accordance with the Plan, and any provision that cannot be so administered or construed shall to that extent be disregarded. ENHANCE FINANCIAL SERVICES GROUP INC. Date: As of December 9, 1998 By: ------------------------------ Executive Vice President -6- EX-10.3.3 5 DIRECTOR STOCK OWNERSHIP PLAN - -------------------------------------------------------------------------------- ENHANCE FINANCIAL SERVICES GROUP INC. DIRECTOR STOCK OWNERSHIP PLAN Amended and Restated as of September 17, 1998 - -------------------------------------------------------------------------------- Table of Contents Page ---- 1. Purpose of Plan ...................................................... 1 2. Definitions .......................................................... 1 3. Effective Date ....................................................... 2 4. Administration ....................................................... 2 (a) Duties ........................................................... 2 (b) Advisors ......................................................... 3 (c) Indemnification .................................................. 3 (d) Meetings ......................................................... 3 (e) Determinations ................................................... 3 5. Common Stock; Adjustment Upon Certain Events ......................... 4 (a) Common Stock to be Delivered; Fractional Shares .................. 4 (b) Adjustments ...................................................... 4 (c) Capital Structure ................................................ 4 6. Awards ............................................................... 4 (a) Common Stock Election ............................................ 4 (b) Form Of Election ................................................. 5 (c) Issue Date ....................................................... 5 (d) Issuance of Shares to Related Persons ............................ 5 (e) Common Stock ..................................................... 5 7. Non-Transferability .................................................. 5 8. Termination, Amendment And Modification .............................. 6 9. General Provisions ................................................... 6 (a) Representations and Additional Legends ........................... 6 (b) Right To Terminate Directorship .................................. 6 (c) Trusts, etc. ..................................................... 6 (d) Severability of Provisions ....................................... 7 (e) Headings and Captions ............................................ 7 (f) Costs ............................................................ 7 (g) Controlling Law .................................................. 7 10. Listing of Common Stock and Related Matters .......................... 7 11. Withholding Taxes .................................................... 7 ENHANCE FINANCIAL SERVICES GROUP INC. DIRECTOR STOCK OWNERSHIP PLAN (Amended and Restated as of September 17, 1998) 1. Purpose of Plan. The purpose of this Director Stock Ownership Plan, (this "Plan") is to enhance the profitability and value of Enhance Financial Services Group Inc. for the benefit of its shareholders by enabling the Company to offer shares of Common Stock to Non-Employee Directors, in lieu of cash payment of their Director Fees, thereby attracting, retaining and rewarding Non-Employee Directors, and strengthening the mutuality of interests between Non-Employee Directors and the Company's shareholders. Capitalized terms used herein shall have the meanings ascribed to them in Section 2 hereof. 2. Definitions. For purposes of this Plan, the following terms will have the following meanings when used herein with initial capital letters: "Board" means the Board of Directors of the Company. "Code" means the Internal Revenue Code of 1986, as amended (or any successor statute). "Committee" means a committee or subcommittee of the Board, appointed from time to time by the Board, which committee or subcommittee shall be intended to consist of two or more directors who are non-employee directors as defined in Rule 16b-3. "Common Stock" means the common stock of the Company, par value $.10 per share. "Company" means Enhance Financial Services Group Inc., a New York corporation, and any successor thereto. "Director Fees" means, for any calendar year, the sum of: (i) any retainer fees to which a Non-Employee Director is entitled for service on the Board as a director and (ii) any other fees to which a Non-Employee Director is entitled including, without limitation, fees for attending meetings of the Board or any committee of the Board of which the Non-Employee Director is a member or fees paid for services as chair of any committee of the Board. "Effective Date" has the meaning given to it in Section 3. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Fair Market Value" for purposes of this Plan, unless otherwise required by any applicable provision of the Code or any regulations issued thereunder, means the last sales price reported for the Common Stock on such date: (i) as reported on the principal national securities exchange on which it is then traded, (ii) if not traded on any such national securities 1 exchange, as quoted on an automated quotation system sponsored by the National Association of Securities Dealers, Inc., or (iii) if the Common Stock is not readily tradable on a national securities exchange or any automated quotation system sponsored by the National Association of Securities Dealers, Inc., the value determined in good faith by the Board. "Immediate Family" of a Participant means any of such Participant's parents, spouse, children or grandchildren (including pursuant to adoption or in-law. "Issue Date" has the meaning given to it in Section 6(c). "Non-Employee Director" means a member of the Board who is not an employee of the Company or of any Subsidiary. "Participant" means a Non-Employee Director who has elected to receive Common Stock under this Plan. "Plan" has the meaning given to it in Section 1. "Related Person" means, as to a given Participant, (i) any of such Participant's Immediate Family, (ii) an entity controlled by such Participant or any member of such Participant's Immediate Family or (iii) a trust or other entity for the exclusive economic benefit of such Participant or members of such Participant's Immediate Family. "Rule 16b-3" means Rule 16b-3 under Section 16(b) of the Exchange Act as then in effect or any successor provisions. "Securities Act" means the Securities Act of 1933, as amended. "Subsidiary" means a corporation or other form of business association whose capital stock (or other ownership interests) having more than 50% of the voting power is owned or controlled, directly or indirectly, by the Company. 3. Effective Date. This Plan shall become effective as of March 13, 1998 (the "Effective Date"). 4. Administration. (a) Duties. This Plan shall be administered by the Board. If and to the extent the Board so directs, this Plan shall be administered by the Committee and all references to the Board in this Plan shall be deemed to refer to the Committee. The Board shall have full authority to interpret this Plan and to decide any questions and settle all controversies and disputes that may arise in connection with this Plan; to establish, amend and rescind rules for carrying out this Plan; to administer this Plan, subject to its provisions; and to make all other determinations and to take all such steps in connection with this Plan and the Common Stock issued under this Plan as the Board, in its sole discretion, deems necessary or desirable. To the extent applicable, this Plan is intended to comply with the applicable requirements of Rule 2 16b-3 and shall be limited, construed and interpreted in a manner so as to comply therewith. If for any reason the appointed Committee does not meet the requirements of Rule 16b-3, such noncompliance with the requirements of Rule 16b-3 shall not affect the validity of the interpretations or other actions of the Committee. If and to the extent that no Committee exists which has the authority to administer this Plan, the functions of the Committee shall be exercised by the Board. (b) Advisors. The Board and the Committee may employ such legal counsel, consultants and agents as it may deem desirable for the administration of this Plan, and may rely upon any advice or opinion received from any such counsel or consultant and any computation received from any such consultant or agent. Expenses incurred by the Board and the Committee in the engagement of such counsel, consultant or agent shall be paid by the Company. (c) Indemnification. To the maximum extent permitted by applicable law, no officer or former officer of the Company or member or former member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to this Plan or any Common Stock issued under this Plan. To the maximum extent permitted by applicable law and the Certificate of Incorporation and By-Laws of the Company and to the extent not covered by insurance, each officer or former officer and member or former member of the Board or the Committee shall be indemnified and held harmless by the Company against any cost or expense (including reasonable fees of counsel reasonably acceptable to the Company) or liability (including any sum paid in settlement of a claim with the approval of the Company), and advanced amounts necessary to pay the foregoing at the earliest time and to the fullest extent permitted, arising out of any act or omission to act in connection with this Plan or any Common Stock issued under this Plan, except to the extent arising out of such officer's or former officer's, member's or former member's own fraud or bad faith. Such indemnification shall be in addition to any rights of indemnification the officers, directors or members or former officers, directors or members may have under applicable law or under the Certificate of Incorporation or By-Laws of the Company. Notwithstanding anything else herein, this indemnification will not apply to the actions or determinations made by an individual with regard to Common Stock issued to him or her under this Plan. (d) Meetings. The Board or the Committee shall adopt such rules and regulations as it shall deem appropriate concerning the holding of its meetings and the transaction of its business. All determinations by the Board or the Committee shall be made by the affirmative vote of a majority of its members. Any such determination may be made at a meeting duly called and held at which a majority of the members of the Board or the Committee, as applicable, are in attendance in person or through telephonic communication. Any determination set forth in writing and signed by all the members of the Board or the Committee, as applicable, shall be as fully effective as if it had been made by a majority vote of the members at a meeting duly called and held. (e) Determinations. Each determination, interpretation or other action made or taken pursuant to the provisions of this Plan by the Board or the Committee shall be final, conclusive and binding for all purposes and upon all persons, including, without limitation, 3 the Participants, the Company, directors, officers and other employees of the Company, and their respective heirs, executors, administrators, personal representatives and other successors in interest of each of the foregoing. 5. Common Stock; Adjustment Upon Certain Events. (a) Common Stock to be Delivered; Fractional Shares. Shares of Common Stock to be issued under this Plan shall be made available from issued shares of Common Stock reacquired by the Company and held in treasury. No fractional shares of Common Stock will be issued. The Company shall pay a Participant cash in lieu of any fractional share of Common Stock to which such Participant would otherwise be entitled, the amount of which shall be based on the Fair Market Value of a share of Common Stock and determined in accordance with Section 6(e). (b) Adjustments. The existence of this Plan and the Common Stock issued hereunder shall not affect in any way the right or power of the Board or the shareholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other change in the Company's capital structure or its business, any merger or consolidation of the Company, any issue of bonds, debentures, preferred or prior preference stocks ahead of or affecting Common Stock, the dissolution or liquidation of the Company or any sale or transfer of all or part of its assets or business, or any other corporate act or proceeding. (c) Capital Structure. In the event of (i) any change in the capital structure or business of the Company by reason of any stock dividend or extraordinary dividend, stock split or reverse stock split, recapitalization, reorganization, merger, consolidation, or exchange of shares, reclassification of its capital stock, any sale or transfer of all or part of the Company's assets or business, or any similar change affecting the Company's capital structure or business and (ii) the determination by the Board that adjustment is appropriate under this Plan, then the aggregate number and kind of shares of Common Stock which thereafter may be issued under this Plan shall be appropriately adjusted consistent with such change in such manner as the Board may deem equitable to prevent substantial dilution or enlargement of the rights granted to, or available for, Participants under this Plan or as otherwise necessary to reflect the change, and any such adjustment determined by the Board in good faith shall be binding and conclusive on the Company and all Participants and directors and their respective heirs, executors, administrators, successors and assigns. 6. Awards. (a) Common Stock Election. Each Non-Employee Director may elect, as provided in Section 6(b), to receive any of the following as payment for Director Fees: (i) shares of Common Stock equal to 100% of the Director Fees as described in Section 6(e), (ii) a cash payment equal to 100% of the Director Fees, or (iii) a cash payment equal to 50% of the Director Fees and shares of Common Stock equal to 50% of the Director Fees as described in Section 6(e). 4 (b) Form of Election. Any election under Section 6(a) shall be made in writing to the Board (on a form prescribed by the Board) on or prior to the date of the last regularly scheduled meeting of the Board immediately preceding the commencement of the calendar year during which the Director Fees will be earned; provided, however, that with respect to the 1998 calendar year, any election under Section 6(a) shall be made in writing to the Board on or prior to the first regularly scheduled meeting of the Board occurring in the second calendar quarter with respect to Director Fees earned in the 1998 calendar year subsequent to March 31, 1998. All Director Fees earned prior to March 31, 1998 will be payable in cash. An election under this Section 6(b) is irrevocable and, except with respect to the 1998 calendar year, is valid only for the calendar year commencing immediately following the date of the election. If no election is made or if a new election is not made with respect to any subsequent calendar year, all Director Fees earned during such subsequent calendar year will be paid in cash. An individual who becomes a Non-Employee Director after the date by which an election would otherwise be required to be made hereunder with respect to a calendar year may not elect to receive shares of Common Stock under this Plan for such calendar year. Elections made by Non-Employee Directors are not intended to result in any tax-deferral of Director Fees. (c) Issue Date. Shares of Common Stock under this Plan will be issued in accordance with each Non-Employee Director's annual election on or as of the date (the "Issue Date") of the regular meeting held in the quarter for which Director Fees attributable to such shares are payable. (d) Issuance of Shares to Related Persons. On or prior to any Issue Date, a Participant may elect in writing to have all but not less than all shares of Common Stock to be issued to such Participant on such Issue Date under an election pursuant to Section 6(a) to be issued instead in the name of a Related Person of such Participant. An election under this Section 6(d) may be amended, modified or revoked at any time upon written notice to the Company and is valid only for the Issue Date(s) specified in such election or, if no Issue Date(s) are specified, then such election shall be effective for the remainder of the effective period of the election under Section 6(a). If no election is made or if a new election is not made with respect to any Issue Date(s) not included in an effective election, all shares of Common Stock to be issued in respect of all subsequent Issue Dates shall be issued in the name of the Participant. (e) Common Stock. On or as of each Issue Date, each Non-Employee Director or his or her designated Related Person shall be issued the number of shares of Common Stock determined by dividing: (i) that portion of the Director Fees payable to him or her on such Issue Date that the Non-Employee Director elected to receive in Common Stock, by (ii) the Fair Market Value of the Common Stock on the Issue Date. 7. Non-Transferability. No rights or interests of a Participant under this Plan with respect to an election to receive Common Stock may be anticipated, alienated, hypothecated, attached, sold, assigned, pledged, encumbered, charged or otherwise transferred in any manner by a Participant otherwise than pursuant to Section 6(d) or by will or by the laws of descent and distribution prior to the date on which the shares of Common Stock are issued, or, 5 if later, the date on which any applicable restriction thereon lapses. Any attempt to anticipate, alienate, hypothecate, attach, sell, assign, pledge, encumber, charge or otherwise transfer any such rights or interests shall be void, and no such rights or interests shall in any manner be used for the payment of, subject to, or otherwise encumbered by or hypothecated for the debts, contracts, liabilities, engagements or torts of any person who shall be entitled to such rights or interests, nor shall it be subject to attachment or legal process for or against such person. 8. Termination, Amendment and Modification. This Plan shall continue in effect without limit unless and until the Board otherwise determines. The termination of this Plan shall not terminate any outstanding election that by its terms continues beyond such termination date. The Board at any time or from time to time may amend this Plan in any manner it deems appropriate. Notwithstanding the foregoing, solely to the extent required by law, the Board may not effect any amendment that would require the approval of the shareholders of the Company under applicable law or under any regulation of a principal national securities exchange or automated quotation system sponsored by the National Association of Securities Dealers, Inc. on which the Common Stock is traded unless such approval is obtained. Except as otherwise required by law, no termination, amendment or modification of this Plan may, without the consent of the Participant, alter or impair the rights and obligations arising under any then outstanding election. 9. General Provisions. (a) Representations and Additional Legends. The Board or the Committee may require each person receiving shares of Common Stock under this Plan to represent to and agree with the Company in writing that the Participant is acquiring the shares for investment and without a view to distribution thereof. In addition to any legend required by this Plan, the certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer. All certificates for shares of Common Stock delivered under this Plan shall be subject to such stock transfer orders and other restrictions as the Board or Committee may deem advisable under the rules, regulations and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Common Stock is then listed or any national securities association system upon whose system the Common Stock is then quoted, any applicable Federal or state securities law, and any applicable corporate law, and the Board or Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (b) Right to Terminate Directorship. This Plan shall not impose any obligations on the Company to retain any Participant as a director, nor shall it impose any obligation on the part of any Participant to remain as a director of the Company. (c) Trusts, etc. Nothing contained in this Plan and no action taken pursuant to this Plan (including, without limitation, the issuance of any Common Stock hereunder) shall create or be construed to create a trust of any kind, or a fiduciary relationship, between the Company, on the one hand, and any Participant, any Participant's Related Persons or the executor, administrator or other personal representative or designated beneficiary of such 6 Participant, or any other persons, on the other hand. If and to the extent that any Participant, any Participant's Related Person or such Participant's or Related Person's executor, administrator or other personal representative, as the case may be, acquires a right to receive any payment from the Company pursuant to this Plan, such right shall be no greater than the right of an unsecured general creditor of the Company. (d) Severability of Provisions. If any provision of this Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions of this Plan, and this Plan shall be construed and enforced as if such provision had not been included. (e) Headings and Captions. The headings and captions herein are provided for reference and convenience only. They shall not be considered part of this Plan and shall not be employed in the construction of this Plan. (f) Costs. The Company shall bear all expenses of administering this Plan, including expenses of issuing Common Stock. (g) Controlling Law. This Plan shall be construed and enforced according to the laws of the State of New York, without giving effect to rules governing the conflict of laws. 10. Listing of Common Stock and Related Matters. If at any time the Board or the Committee shall determine in its sole discretion that the listing, registration or qualification of the Common Stock covered by this Plan upon any national securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the issuance of Common Stock under this Plan, no Common Stock will be delivered, as the case may be, unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained, or otherwise provided for, free of any conditions not acceptable to the Board. 11. Withholding Taxes. The Company shall have the right to require, prior to the issuance or delivery of any shares of Common Stock, payment by the Participant of any federal, state or local taxes required by law to be withheld. 7 EX-10.7 6 LETTER January 4, 1999 Mr. Brian Kleinberg 357 Oxford Drive Short Hills, New Jersey 07078 Dear Brian: This letter supersedes our prior correspondence with respect to the commencement date of your employment by Enhance Financial Services Group Inc. ("Enhance") and its subsidiaries, Singer Asset Finance Company L.L.C. and Enhance Consumer Finance, LLC (jointly, "Singer/ECF") and the compensation payable to you. You shall commence service as Executive Vice President of Enhance and CEO of Singer/ECF (collectively, the "Company") on the date of this letter. The period from that date until March 31, 1999 shall constitute a transition period, during which you shall be required to devote such time as necessary to the performance of your duties in such capacities but in all events less than 30 hours per week on average. Commencing April 1, 1999, you shall devote all your business time and effort to the performance of such duties without regard to any such specific maximum. As full compensation for serving in the foregoing capacities you shall receive the following: 1. Base salary at the rate of $300,000 per year. 2. An annual target bonus for calendar periods of not less than 50% of then base salary, such rate to be increased consistent with the Company's senior executive compensation programs, provided that for 1999 bonus shall equal or exceed $250,000, to be prorated should your employment be terminated prior to the expiration to twelve months (i) by the Company other than for cause or (ii) by you for cause. 3. A stock option for 85,000 shares of Enhance common stock pursuant to the 1997 Long Term Incentive Plan for Key Employees of Enhance, at an exercise price equal to the NYSE closing price of such stock on the date of the commencement of your employment. Of said stock option, 6,000 shares shall be automatically forfeited to Enhance on April 1, 1999 should your predecessor employer, American Express, not have communicated to you prior to said date that it has conclusively determined you to be ineligible for continued benefits under paragraphs 2(b), 2(d) and 4 of your letter severance agreement dated December 14, 1998 with said company. 4. A sign-on bonus of $150,000, payable within 30 days after the commencement of your employment. 5. Additional compensation based on specific financial goals of Singer/ECF as outlined by the Company prior to the commencement of your employment and to each anniversary thereof. 6. All additional benefits and perquisites made available to other senior executive officers of the Company for which you are eligible. In addition, you shall participate in the Management Severance Protection Program of Enhance. For 1999, the "prior year's annual bonus," as contemplated by and where applicable under such program, shall be equal to the average of the bonuses awarded to Enhance's executive vice presidents for 1998. Very truly yours, /s/Elaine Eisenman Elaine Eisenman AGREED TO: /s/ Brian Kleinberg 01/28/99 - ------------------------------------------------ Brian Kleinberg Date 2 EX-21.1 7 LIST Exhibit 21.1 The following is a list of all subsidiaries of the registrant. The names of particular subsidiaries have been omitted since such unnamed subsidiaries, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary as of the end of the year covered by this report as permitted by Item 601(b)(21) of Regulation S-K promulgated under the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended. Name Jurisdiction of Organization - ---- ---------------------------- Enhance Investment Corporation ................... Delaware Van-American Companies, Inc....................... Delaware Singer Asset Finance Company, L.L.C. ............. Delaware EX-27 8 EXHIBIT 27
5 This Schedule Contains Summary Financial Information Extracted from Financial Statements of Enhance Financial Services Group Inc. as of and for the year ended December 31, 1998. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 5,542 1,039,642 56,842 0 0 0 0 0 1,357,242 0 75,000 0 0 3,981 668,065 1,357,242 0 207,484 0 (35,007) (53,556) 0 (8,500) 112,807 30,350 82,457 (0) (0) (0) 82,457 2.20 2.10
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