-----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, EC+wlSWY/cnrkksUoNLb2W4OYZY9TXnhHa7+R5c2QxPDIztWN2fKgmc12BlnOd1s 64wjnlq/OvVfbFhwNUkutw== 0000891554-98-000326.txt : 19980401 0000891554-98-000326.hdr.sgml : 19980401 ACCESSION NUMBER: 0000891554-98-000326 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KAYE GROUP INC CENTRAL INDEX KEY: 0000907575 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 133719772 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21988 FILM NUMBER: 98581573 BUSINESS ADDRESS: STREET 1: 122 EAST 42ND ST CITY: NEW YORK STATE: NY ZIP: 10168 BUSINESS PHONE: 2123382100 MAIL ADDRESS: STREET 1: 122 EAST 42ND STREET STREET 2: 122 EAST 43ND STREET CITY: NEW YORK STATE: NY ZIP: 10168 FORMER COMPANY: FORMER CONFORMED NAME: OLD LYME HOLDING CORP DATE OF NAME CHANGE: 19930621 10-K 1 FORM 10-K FOR THE FISCAL YEAR ENDED 12/31/97 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT - 1934 For the Fiscal Year Ended December 31, 1997 Commission File Number 0-21988 Kaye Group Inc. (exact name of registrant as specified in its charter) Delaware 13-3719772 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 122 East 42nd Street, New York, NY 10168 (Address and Zip Code of Principal Executive Offices) Registrant's Telephone Number: (212) 338-2100 Securities Registered Under Section 12(b) of the Exchange Act: Title of Each Class Name of Exchange ------------------- ---------------- Common Stock $.01 par value NASDAQ National Market Securities Registered Under Section 12(g) of the Exchange Act: None Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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___ Check if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this form, and no disclosure will 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 aggregate market value of the registrant's common stock held by non-affiliates of the registrant as of March 13, 1998 was approximately $16,331,392. Number of shares of the registrant's common stock outstanding as of March 13, 1998: 8,474,435. DOCUMENTS INCORPORATED BY REFERENCE The registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997 (incorporated by reference under Part III). Total number of pages including cover and under pages 85. Index to Exhibits is on page 37. 2 KAYE GROUP INC. TABLE OF CONTENTS Part I Item 1. Business 4 Item 2. Properties 18 Item 3. Legal Proceedings 18 Item 4. Submission of Matters to a Vote of Security Holders 19 Part II Item 5. Market for Common Equity and Related Stockholder Matters 20 Item 6. Selected Financial Data 21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 8. Financial Statements and Supplementary Data 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 36 Part III Item 10. Directors and Executive Officers of the Registrant 36 Item 11. Executive Compensation 36 Item 12. Security Ownership of Certain Beneficial Owners and Management 36 Item 13. Certain Relationships and Related Transactions 36 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 37 Financial Statements F-1 3 Item 1. Business Business Segments Kaye Group Inc. (the "Company") a Delaware corporation, formerly Old Lyme Holding Corporation ("Holding"), is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments - - the Insurance Brokerage Companies Operations ("Brokerage Operations"), comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations. In addition, Corporate Operations include those activities that benefit the Company in its entirety and cannot be specifically identified to either the Brokerage Operations or the Property and Casualty Companies Operations. Such activities include debt servicing and public company expenses, including investor relations costs. The Company's activities are conducted in New York City, and in offices located in the states of California, Connecticut and Rhode Island. Insurance Brokerage Companies Operations The Retail Brokerage Business operates insurance brokerage businesses through four subsidiaries of the Company, the "Retail Brokerage Companies". It offers commercial clients a full range of insurance brokerage services including procurement of property/casualty insurance, risk management consulting, bonding, insurance coverage loss prevention engineering, and group employee benefit consulting services. In addition, personal lines and life and health insurance coverage are placed on behalf of individual clients. The Retail Brokerage Business' primary strategy is to service middle market companies and organizations just below the Fortune 500 level for which other national brokers intensely compete. Within this middle market, the Retail Brokerage Business has developed particular expertise and knowledge of the risks facing a number of industry sectors including health care, real estate, retail, manufacturing, churches, law firms, homes for the aged and fine arts. During 1997, the Retail Brokerage Business serviced approximately 10,000 insureds. The Retail Brokerage Business is compensated for its services primarily in the form of commissions paid by insurance companies. The commission is usually a percentage of the premium paid by the insured. Commission rates depend upon the type of insurance, the particular insurance company, and the role in which the Retail Brokerage Business acts. In some cases a commission is shared with other agents or brokers who have acted jointly with the Retail Brokerage Business in connection with the transaction. The Retail Brokerage Business may also receive from an insurance company a contingent 4 commission that is generally based on the profitability and volume of business placed with it by the Retail Brokerage Business over a given period of time. The Retail Brokerage Business may also receive fees in connection with consulting services relating to the marketing of insurance. Program Brokerage Corporation or "PBC" (the "Program Brokerage Business") is a subsidiary of the Company and operates a wholesale insurance brokerage business which offers retail insurance agents and brokers innovative solutions to the twin insurance problems of price and availability of coverage. It accomplishes this by organizing pools of similar risks into specially designed Alternative Risk Transfer ("A.R.T.") programs for affinity groups (the "Programs"). The Program Brokerage Business is one of the leaders in the application of purchasing groups in the commercial insurance market. Approximately two-thirds of PBC's premium volume is generated by approximately 400 unrelated retail insurance agents and brokers serving approximately 4,300 insureds during 1997. The remaining one-third is derived from the Retail Brokerage Business. Approximately one-half of PBC's premium volume is directly or indirectly placed with two affiliates, Old Lyme Insurance Company of Rhode Island, Inc. ("OLRI") and Old Lyme Insurance Company, Ltd. (Bermuda) ("OLB"). Property and Casualty Companies Operations The Company conducts its property and casualty underwriting business through two insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI is a property and casualty insurance company licensed in Rhode Island and eligible as a surplus lines insurer in New York and New Jersey. OLB is a property and casualty insurance company organized and licensed under the laws of Bermuda. In states where the Insurance Companies are not admitted insurers or surplus lines insurers, the Insurance Companies underwrite risks through various reinsurance agreements. The Insurance Companies underwrite property risks (loss or physical damage to property) and OLRI underwrites casualty risks (legal liability for personal injury or damaged property of others) for insureds in the United States. Insurance is sold principally through the Programs marketed by PBC which insure various types of businesses and properties that have similar risk characteristics, such as apartments, condominiums, cooperatives, restaurants, building maintenance companies, retail stores, funeral homes and pharmacies, among others. The Insurance Companies' strategy is to underwrite only the first "layer" of the property and casualty insurance provided under the Programs. Exposure to individual insureds on individual losses is thereby generally limited to between $1,000 and $25,000 per claim (inclusive of allocated loss expenses), depending on the Program. Under the Programs, the Insurance Companies' policies are sold in conjunction with policies issued by unaffiliated Program insurers that provide coverage for losses above the first layer of 5 risk underwritten by the Insurance Companies. In addition, the Insurance Companies have issued policies on a selected basis with limits up to $1,000,000, retaining the first $50,000 of exposure and reinsuring the remaining limits with an unaffiliated reinsurer, National Reinsurance Corporation (A.M. Best Company ("A.M.Best"), a major rating agency for insurers, rating of A+). The Property and Casualty Companies Operations includes Claims Administration Corporation ("CAC") a subsidiary of the Company which is responsible for the administration of a large majority of the claims submitted to the Insurance Companies. The administration of claims includes investigation, engagement of legal counsel, approval of settlements and the making of payments to, or on behalf of insureds. CAC also provide claims administration service to the unaffiliated Program insurers for a fee. CAC is party to an agreement with an unaffiliated company, whereby it agrees to acquire certain retail service warranty contract obligations for a fee. CAC earns approximately 17% of its revenue pursuant to this agreement. History of the Company 1952 to 1993 Prior to the initial public offering ("IPO") of Holding's common stock in August 1993, the Retail Brokerage Companies, PBC, the Insurance Companies and CAC were part of a single combined insurance and brokerage business owned by Kaye International L.P. ("KILP") and certain individuals. KILP, via several stock and asset acquisitions and mergers, traces its origins back to 1952. Prior to the IPO, KILP developed the concept of the "deductible" primary "layer" of insurance coverage administered through Programs. This business was conducted through the Insurance Companies. In August 1993, after years of successful growth, the Insurance Companies, PBC and CAC were organized under Holding, of which approximately 33% was sold to the public. At the time of the IPO, management of Holding believed that its historical marketing efforts and ability to expand its business were hampered by its small capital base and its lack of a letter rating from A.M. Best. Approximately $13,000,000 of the proceeds of the IPO were contributed to OLRI to increase its capital and surplus to permit it to (i) increase its underwriting capabilities, (ii) obtain a letter rating from A.M. Best, and (iii) enable OLRI to meet certain regulatory capital and surplus requirements. As a result of the proceeds being contributed, OLRI significantly increased its underwriting capacity. This enabled it to ultimately obtain an A.M. Best rating of A-(Excellent) (which it currently maintains) and meet all regulatory capital and surplus requirements. The business of OLRI however depends on the creation of new Programs and the addition of insureds into existing Programs. OLRI relies on PBC to develop new Programs. PBC is also OLRI's most important and significant producing broker, historically producing almost all of the Insurance Companies' net premiums earned. 6 1994 In 1994, the Retail Brokerage Business completed the integration of its 1992 acquisition of Amalgamated Programs Corporation and related entities ("Amalgamated") and continued to downsize to adjust to the continuing "soft market" in property and casualty premium rates. At the time, the officers of the general partners of KILP (which included members of Holding's Board of Directors) concluded that the combination of Holding and the Retail Brokerage Business would be advantageous for both OLRI and KILP. This conclusion was based on three factors: (a) improved operating results derived from the Amalgamated integration and "soft market" downsizing, (b) the improved outlook for the Retail Brokerage Business and (c) the fact that the Retail Brokerage Business accounted for approximately one-half of PBC's premium volume. In evaluating the combination, Holding's Board of Directors also considered the fact that the market for Holding's common stock following the IPO was relatively illiquid. The Board believed that the combination of the Retail Brokerage Business with Holding would increase the size of Holding, make it a more financially diverse company and potentially attract a broader spectrum of investors. 1995 The combination ("Transaction") was effective October 2, 1995 and was accounted for as a transfer and exchange between companies under common control. Accordingly, the assets and liabilities of the Retail Brokerage Business were combined with those of Holding at their historical cost in a manner similar to a "pooling of interests", (See Note 2 to the consolidated financial statements of the Company). The combination was accomplished as follows: 1. Holding transferred to then recently formed Kaye Holding Corp. ("KHC") all of the outstanding stock of the Insurance Companies and its two other subsidiaries, PBC and CAC and its other assets in exchange for (i) 82,400 shares of KHC common stock, representing 82.4% of the total outstanding KHC common stock, and (ii) the assumption by KHC of certain of Holding's liabilities. 2. KILP transferred all of its interest in the limited partnerships conducting the Retail Brokerage Business (the "Retail Partnerships") and certain related assets to KHC in exchange for (i) 17,200 shares of KHC common stock, representing 17.2% of the total outstanding KHC common stock, and (ii) the assumption by KHC of certain KILP liabilities. 3. Certain individuals transferred to KHC all of their interests in the corporate general partners of the Retail Partnerships (the "Retail Brokerage Companies") in exchange for 400 shares of KHC common stock, representing 0.4% of the total outstanding KHC common stock. 7 4. KHC contributed its interests in the Retail Partnerships to the Retail Brokerage Companies thereby causing the dissolution of the Retail Partnerships. As a result, the Retail Brokerage Companies, as a group, own all of the assets and are subject to all of the liabilities, of the Retail Brokerage Business. 1997 On December 30, 1997, stockholders of the Company approved a restructuring that merged KHC into the Company. This eliminated the minority interest in KHC held by KILP and simplified the corporate structure and reporting of the Company. The chart below reflects the current structure of the Company: - --------------- ---------------- KILP, related entity Public and individuals - --------------- ---------------- 72.9% 27.1% --------------- KAYE GROUP INC. --------------- 100.0% 100.0% - --------------------------------- -------------------------------------- Insurance Brokerage Companies: Property and Casualty Companies: Kaye Insurance Associates, Inc. Old Lyme Insurance Company of Rhode Kaye Corporation of Connecticut Island, Inc. Kaye-Western Insurance & Risk Old Lyme Insurance Company, Ltd. and Services, Inc. Park Brokerage, Ltd. Kaye Services Corp. Claims Administration Corporation Program Brokerage Corporation - --------------------------------- -------------------------------------- 8 Affinity Group Marketing Affinity group marketing (including A.R.T. programs) contributes 67% of the Company's 1997 consolidated revenues, excluding investment income. Retail Brokerage Operations The Retail Brokerage Business generally services middle market entities just below the Fortune 500 level. Within this market, it has developed particular expertise and knowledge of the risks facing a number of industry sectors. Based on this expertise and knowledge, the Retail Brokerage Business has established programs for hospitals and physicians, churches, law firms, mental health practitioners, homes for the aged and fine arts, among others. Approximately 38% of the Retail Brokerage Business' 1997 revenues relate to such affinity groups. Of this 38%, approximately 90% of the related premium volume is placed with unrelated insurance markets. The remaining 10% is placed with PBC. (This 10% represents approximately one-third of PBC's premium volume.) No premiums are placed with the Insurance Companies directly by the Retail Brokerage Business. PBC and Insurance Companies Operations PBC designs A.R.T. programs for affinity groups and markets via a network of retail insurance brokers, including the Retail Brokerage Companies. PBC's distribution network includes approximately 400 unrelated retail agents and brokers. These unrelated agents and brokers account for two-thirds of PBC's premium volume. The Insurance Companies underwrite a portion of the Programs and only underwrite programs designed by PBC. During the past five years the original 1:2 ratio of insurance premiums produced by unrelated retail brokers to insurance premiums produced by the Retail Brokerage Companies (the "Production Ratio"), respectively, has reversed. But production from both sources has grown. PBC's total premium volume for 1997 of $54,100,000 has increased 28% since 1995. It is expected that the Production Ratio will approach 3:1 during 1998, consistent with PBC's strategy of growing the unrelated retail agents and broker distribution network. Once PBC establishes an A.R.T. program, it acts as the placing broker with respect to insurance under the Programs. In such a role, PBC is a party to agreements with various unaffiliated insurers as well as the Insurance Companies. PBC receives commissions from the Insurance Companies and the unaffiliated Program insurers. Pursuant to subbrokerage agreements, PBC pays commissions to retail brokers based upon all business produced by such agents and brokers (including business placed by PBC with the unaffiliated Program insurers). 9 The Insurance Companies' strategy in most cases is to underwrite only the first "layer" per claim (the deductible range) (inclusive of allocated loss expenses) of the property and casualty insurance provided under the programs developed by PBC. This limits its exposure to individual insureds on individual losses to the deductible range depending on the Program. Under the Programs, the Insurance Companies' policies are sold in conjunction with policies issued by unaffiliated insurers that provide coverage for losses above the first "layer" of risk underwritten by the Insurance Companies. The Insurance Companies believe that their rates for the first "layer" of risk, when combined with the rates of such other unrelated insurers for the coverage above such layer, are generally competitive with the rates that other insurance companies would charge to provide comparable insurance coverage. The Insurance Companies currently participate in 14 A.R.T programs. The three major programs are as follows: 1. The Residential Real Estate Program, started in 1990, provides property and casualty insurance for residential real estate including rental apartments, cooperatives, and condominiums. Policies protect the owner from property losses and casualty claims, such as claims brought by a tenant or member of the public injured on the premises. This program is offered principally in the New York City area and has approximately 1,000 insureds. 2. The Restaurant Program, started in 1985, insures restaurants against casualty claims (most typically brought by an injured restaurant patron) and property losses. Many of the restaurants that participate in this Program are "white tablecloth" restaurants. The Restaurant Program has approximately 900 insureds. 3. The Real Estate Umbrella Program insures residential and commercial real estate owners against certain types of casualty losses. Insureds are provided with an extra level of protection in conjunction with a standard umbrella policy. Coverage is provided for losses that are included within the broad terms of the policy, but are excluded under the general casualty policy. This Program also provides high umbrella casualty limits primarily provided by unrelated Program insurance companies to individual real estate owners. OLRI has a maximum exposure of $10,000 per claim. The Real Estate Umbrella Program has approximately 1,400 insureds. The other Programs include the Comprehensive Office Program, the Retail Stores Liability Program, the Catalog Showroom Property Program, the Building Maintenance Contractors Program, the Contractors Umbrella Program, the Drug Store Program, the Funeral Directors Program, the Bars, Restaurants and Taverns Program, the New England Restaurant Program, the Waste Haulers Program, and the Home Owner Program. The other Programs have approximately 1,000 insureds. 10 The Home Owner Program provides various types of property insurance to a group of affiliated home owners. Limits for certain coverage offered by OLRI under this program are as high as $100,000. This program accounted for approximately 2% of net premiums earned in 1997. The Restaurant Program, Residential Real Estate Program and Real Estate Umbrella Program accounted for approximately 87% of the net premiums earned by the Insurance Companies in 1997. The following table sets forth the percentage of net premiums earned attributable to the programs and all other business during the years ended December 31, 1997, 1996 and 1995. Net Premiums Earned Years Ended December 31, 1997 1996 1995 ---- ---- ---- Residential Real Estate .................... 46% 49% 40% Restaurant Program ......................... 25% 24% 32% Real Estate Umbrella Program ............... 16% 14% 15% Other ...................................... 13% 13% 13% --- --- --- 100% 100% 100% === === === Acquisitions During 1997, the Company acquired certain assets and liabilities of Western Insurance Associates, Inc. ("Western"). This acquisition was accounted for as a purchase and achieved critical mass for the brokerage operations located in Pasadena, California. In addition, this acquisition was synergistic as Western's competitive advantage is in the production of business from affinity groups, including churches and homes for the aged. The Company believes that the effect of past, present and future acquisitions will be to expand its insurance program services to affinity groups, thus providing earnings to all operations. The Company is considering and intends to consider from time to time additional acquisitions and divestitures on terms it deems consistent with its strategies. The Company at this time is engaged in preliminary discussions with a number of candidates for possible future acquisitions but has not signed contracts or agreements in principle to make additional acquisitions. No assurances can be given that any additional acquisitions or divestitures will be completed, or if completed, will be advantageous to the Company. 11 Seasonality The Brokerage Operations' revenues vary significantly from quarter to quarter as a result of the timing of policy renewals and their related billings. This is due to the revenue recognition method for brokerage commissions which requires that a full year's commissions be recognized immediately upon the billing date of the business. However, premium revenues of the Insurance Companies are recognized ratably over the term of the related policies. As a result, there is little variation from quarter to quarter in the Property and Casualty Companies Operations revenues. Consolidated revenues by quarter for 1997, 1996 and 1995 were earned as follows. Amounts shown represent a percentage of the related full year consolidated revenues. 1997 1996 1995 ---- ---- ---- First Quarter 22% 22% 23% Second Quarter 23% 22% 21% Third Quarter 28% 28% 25% Fourth Quarter 27% 28% 31% Competition The Company is the 17th largest insurance broker in the United States according to "Business Insurance", a leading insurance industry publication. It operates in a highly competitive industry and faces competition from regional brokers, regional offices of worldwide brokers and insurers. The insurance brokerage business is highly competitive. The Company believes that it is well positioned to compete within its designated market because of the expertise and knowledge it has developed in servicing middle market companies, the Programs it has developed and the proprietary database of affinity group underwriting and claims information it has developed. Many insurance companies which compete with OLRI have a higher A.M. Best - -rating (OLRI is rated A-(Excellent)), and are larger and have greater financial, marketing and management resources than the Insurance Companies. Competition is based on many factors, including perceived overall financial strength of the insurer, premiums charged, policy terms and conditions, services offered, reputation and experience. Due to its size, management and operational flexibility, the Company can respond quickly to, and take advantage of, changing circumstances encountered in the marketplace. 12 In the event that admitted insurers (including the unaffiliated Program insurers) begin to offer the coverage in New York which the Company offers as a surplus lines insurer, it is possible that OLRI may be unable to receive placements on a surplus lines basis, because brokers are generally required first to obtain three "declinations" from admitted carriers before they can offer the business to a surplus lines underwriter. In addition, in soft insurance markets, other insurance companies may be more willing to offer low deductibles which cover the first layer of risk at prices competitive with or lower than those under the Programs. Ceded Reinsurance OLRI has from time to time obtained reinsurance for portions of, or specific risks under, the first layer of risks underwritten by OLRI. Such reinsurance is not and has not been material to OLRI. Reinsurance has been placed with National Reinsurance Corporation, Transatlantic Reinsurance Company and USF Reinsurance Company, which are rated A or better by A.M. Best . However, if reinsurance should become more widely available at economical prices, OLRI may increase the amount of reinsurance it purchases (see Note 13 to the consolidated financial statements of the Company). Losses and Loss Expenses The Insurance Companies are directly liable for losses and loss expense payments under the terms of insurance policies that they write, and under the reinsurance agreements to which they are party. In many cases, several years may elapse between the occurrence of an insured loss, the reporting of the loss to the Insurance Companies and the Insurance Companies payment of that loss. The Insurance Companies reflect their liability for the ultimate payment of all incurred losses and loss expenses by establishing loss and loss expense reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events that have occurred. When a claim involving a probable loss is reported, the Insurance Companies establish a loss reserve for the estimated amount of the Insurance Companies' ultimate loss and loss expense payments. The estimate reflects an informed judgment based on established reserving practices and the experience and knowledge of CAC's claims examiners regarding the nature and value of the claim, as well as the estimated expense of settling the claim, including legal and other fees, and general expenses of administering the claims adjustment process. The Insurance Companies also establish reserves on an aggregate basis to provide for losses incurred but not reported ("IBNR reserves"), as well as future developments on losses reported to the Insurance Companies. The amount of an insurer's incurred losses in a given period is determined by adding losses and loss expenses paid during the period to case loss and loss expense reserves and IBNR reserves (collectively "loss reserves") at the end of the period, and then subtracting loss reserves existing at the beginning of the period. 13 As part of the reserving process, historical data is reviewed and consideration is given to the anticipated effect of various factors, including anticipated legal developments, changes in social attitudes, inflation and economic conditions. Reserve amounts are necessarily based on Management's estimates, and as other data becomes available and is reviewed, these estimates are revised, resulting in increases or decreases to existing reserves. OLRI receives claims related to lead paint exposures it insures under various Residential Real Estate Programs. There are uncertainties in estimating the amount of reserves due to factors including: difficulty in properly allocating responsibility and/or liability for the lead paint exposure; changes in the underlying laws and the judicial interpretation of those laws; questions regarding the interpretation and application of insurance and reinsurance coverage. OLRI has reserves established for these claims on a case basis and an incurred but not reported basis. The reserves provided are established based on Management's estimate of ultimate liabilities. However, due to the nature of the exposures, such reserves cannot be, and are not established using standard actuarial techniques. To further review the adequacy of the reserves, the Insurance Companies engage independent actuarial consultants to perform annual case and ultimate loss reserve analysis. The following table sets forth a reconciliation of the change in the reserves for outstanding losses and loss expenses, including paid losses and loss expenses, for each year in the three year period ended December 31, 1997. Years Ended December 31, ------------------------ 1997 1996 1995 ---- ---- ---- (in thousands) Balance at January 1, $ 15,227 $ 12,671 $ 14,118 Less reinsurance recoverables (882) -------- -------- -------- Net balance 14,345 12,671 14,118 -------- -------- -------- Incurred related to: Current year 8,824 6,621 4,986 Prior year (108) 415 (136) -------- -------- -------- Total incurred 8,716 7,036 4,850 -------- -------- -------- Paid related to: Current year 1,802 1,832 2,138 Prior year 4,944 3,530 4,159 -------- -------- -------- Total paid 6,746 5,362 6,297 -------- -------- -------- Net balance at December 31, 16,315 14,345 12,671 Plus reinsurance recoverables 2,811 882 -------- -------- -------- Balance $ 19,126 $ 15,227 $ 12,671 ======== ======== ======== 14 The following table presents the development of unpaid losses and loss expense reserves for the past ten years for the Insurance Companies. During the ten year period covered by this table, OLB changed its fiscal year-end from July 31 to April 30 and then to December 31 for the year ended December 31, 1990. In addition, Bermuda domiciled insurance companies, unlike U.S. domiciled insurers, are not required to file calendar year loss development information with regulatory authorities. Accordingly, the loss development information included in the following table with respect to OLB prior to 1992, reflects development data converted from the policy year loss development data maintained by OLB through the use of mathematical models. The top line of the table shows the estimated reserve for unpaid losses and loss expenses at the balance sheet date for each of the indicated years. These figures represent the estimated amount of unpaid losses and loss expenses for claims arising in the current and all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported. The table also shows the re-estimated amount of the previously recorded reserve based on experience as of the end of each succeeding year. The estimate changes as more information becomes available, principally about the frequency of claims for individual years. The table is presented net of reinsurance which is immaterial for all years presented except for 1997. The reinsurance recoverable on unpaid losses at December 31, 1997 is $2,811,000. 15 KAYE GROUP INC. LOSS DEVELOPMENT SCHEDULE (In thousands)
Year Ended 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ---------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Reserves for outstanding losses and loss expenses on December 31, $4,360 $6,866 $8,418 $12,555 $16,244 $18,444 $17,929 $14,118 $12,672 $15,227 $19,126 Cumulative amount paid as of: One year later $1,251 $2,018 $2,505 $4,374 $5,569 $6,379 $6,965 $4,161 $3,697 $4,943 Two years later 2,351 3,513 5,266 7,545 9,258 11,704 10,002 6,802 6,882 Three years later 2,907 5,208 7,041 9,245 12,695 13,833 12,278 9,455 Four years later 3,662 6,113 7,600 11,378 13,813 14,973 14,120 Five years later 4,090 6,269 8,539 11,705 14,146 15,784 Six years later 4,112 6,881 8,660 11,768 14,385 Seven years later 4,204 6,892 8,681 11,877 Eight years later 4,204 6,895 8,701 Nine years later 4,204 6,903 Ten years later 4,204 Re-estimated liability as of: One year later $3,875 $6,891 $9,127 $13,665 $16,117 $18,140 $17,856 $14,254 $12,257 $15,494 Two years later 4,483 6,692 9,767 13,003 15,182 18,511 18,184 13,487 $12,454 Three years later 4,726 7,343 9,288 11,850 15,609 18,636 16,552 13,990 Four years later 4,850 7,228 9,002 12,410 15,462 18,177 18,157 Five years later 4,703 7,120 9,060 12,468 15,312 18,252 Six years later 4,507 7,140 8,973 12,224 14,982 Seven years later 4,357 7,063 8,893 12,121 Eight years later 4,312 6,964 8,847 Nine years later 4,204 7,012 Ten years later 4,204 Cumulative Redundancy (Deficiency): $156 ($146) ($429) $434 $1,262 $192 ($228) $128 $218 ($267) - ------------------------
16 Regulation The Company is subject to a substantial degree of regulation that is designed to protect the interests of insurance policyholders. As a Rhode Island property and casualty insurance company, OLRI is subject to the primary regulatory oversight of the Rhode Island Department of Business Regulation through its Insurance Division. On March 28, 1996, the Division advised the Company that it is reviewing the treatment of certain reinsurance arrangements between OLRI and OLB in OLRI's 1995 Statutory Annual Statement filed with the Division. The Company believes that it treated this arrangement appropriately in its annual statement and it does not believe that there will be any material modifications to OLRI's surplus at December 31, 1995. As a Bermuda property and casualty insurance company, OLB is subject to regulation of the primary regulatory body of Bermuda. Such regulation relates to, among other things, authorized lines of business, capital and surplus requirements and general standards of solvency, the filing of annual and other financial reports prepared on the basis of statutory accounting practices, the filing and form of actuarial reports, the establishment and maintenance of reserves for unearned premiums, losses and loss expenses, underwriting limitations, investment parameters, transactions with affiliates, dividend limitations, changes in control and a variety of other financial and non-financial matters. The National Association of Insurance Commissioners has developed risk-based capital formulas to be applied to all domestic insurance companies. These formulas calculate a minimum required statutory net worth, based on the underwriting, investment and other business risks inherent in an insurance company's operations. Any insurance company that does not meet threshold risk-based capital levels ultimately will be subject to statutory receivership proceedings. The statutory net worth of OLRI is adequate in light of its current and anticipated future business and has met its risk-based capital and surplus requirements at December 31, 1997. The minimum risk-based capital requirement for OLRI, as of December 31, 1997 was $6,804,698 and the Company exceeded that threshold by $16,857,689. Employees As of December 31, 1997, the Company had 347 employees. The Company is not unionized. The Company believes that its employee relationships are satisfactory. 17 Item 2. Properties The Company owns approximately 7,500 square feet of space in an office condominium building in Warwick, Rhode Island which is utilized by employees of PBC and OLRI. The Company also leases space located in New York, New York; Pasadena, California, and Westport, Connecticut. The Company's total leased space at each location is 84,398 sq. ft., 9,443 sq. ft., and 10,370 sq. ft., respectively. The Company's current space leases are suitable for its current needs. Item 3. Legal Proceedings The Company is a party to lawsuits arising in the normal course of business. Virtually all pending lawsuits in which the Insurance Companies are a party, involve claims under policies underwritten or reinsured by such Companies. Management believes these lawsuits have been adequately provided for in its established loss and loss expense reserves and that the resolution of these lawsuits will not have a material adverse effect on the Company's financial condition or results of operations. The Insurance Brokerage Companies are subject to various claims and lawsuits from both private and governmental parties, which include claims and lawsuits in the ordinary course of business. The majority of pending lawsuits involve insurance claims, errors and omissions, employment claims, and breaches of contract. The Company believes that the resolution of these lawsuits will not have a material adverse effect on the Company's financial condition or results of operations. As licensed brokers, the Insurance Brokerage Companies are or may become party to administrative inquiries and at times to administrative proceedings commenced by state insurance regulatory bodies. Certain subsidiaries have been involved since 1992 in an administrative investigation by the New York Insurance Department ("Department") relating to how property insurance policies were issued for the Residential Real Estate Program. As a result, the manner in which policies are structured for certain clients in this Program has been altered, which has not had a material adverse effect on this Program. While the Company has had discussions with the Department regarding settlement of such investigation, if such discussions are not successful, the Department could institute formal proceedings against the subsidiaries seeking fines or license revocation. KILP has agreed to indemnify the Company for any fines or settlement payments in excess of $300,000 relating to such investigation. Management does not believe the resolution of such issue will have a material adverse effect on the Company. 18 Item 4. Submission of Matters to a Vote of Security Holders On December 30, 1997, the Company held a special meeting of stockholders to consider and act upon the following matters: 1. Approval of the Merger Agreement and the merger of Kaye Holding Corp., a Delaware corporation ("KHC"), with and in to Kaye Group Inc. ("Kaye"), with Kaye being the survivor (the "Merger") (Proposal No. 1), whereby on the effective date of the Merger, each share of KHC's Common Stock, par value $.01 per share ("KHC Common Stock"), issued and outstanding immediately prior to the effective date, other than shares held by Kaye, will be converted into 82.63835 shares of Kaye Common Stock, par value $.01 per share ("Kaye Common Stock"); and 2. Approval of a Stock Performance Plan (the "Plan") (Proposal No. 2). The votes cast for the Merger and the Plan proposed were: MERGER PLAN ------ ---- For 6,636,840 6,603,123 Against 3,021 375,621 Abstain 0 500 Broker Non-votes 339,403 20 19 PART II Item 5. Market for Common Equity and Related Stockholder Matters In August 1993, in connection with the consummation of the IPO, the Company's Common Stock was listed on the NASDAQ National Market System under the symbol "OLHC". On October 2, 1995, in connection with the combination of the Retail Brokerage Business of Kaye with Holding, Holding changed its name to Kaye Group Inc. and is now listed under its new symbol "KAYE". The following table sets forth the high and low prices for the Common Stock as reported on NASDAQ for the indicated periods and the dividends paid per share during such periods. Price Range Dividends ------------------------ Paid High Low Per Share ---- --- --------- 1997: First Quarter $5 3/8 $4 1/2 $ .025 cash Second Quarter 5 1/8 4 3/8 $ .025 cash Third Quarter 9 5 1/8 $ .025 cash Fourth Quarter 9 6 3/8 $ .025 cash 1996: First Quarter $8 $7 $ .025 cash Second Quarter 7 1/2 5 5/8 $ .025 cash Third Quarter 7 4 5/8 $ .025 cash Fourth Quarter 6 1/2 4 5/8 $ .025 cash The approximate number of holders of record of the Company's Common Stock as of March 10, 1998 was 45. The approximate number of beneficial holders as of March 10, 1998 was 500. See "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Dividends" for a discussion of dividends paid by the Company. 20 Item 6. Selected Financial Data The following table should be read in conjunction with, and is supplemented in its entirety by, the consolidated financial statements and the notes thereto. Financial data has been restated to take into effect the Transactions effective October 2, 1995. The financial data for the years 1993 through 1997 has been derived from the audited consolidated financial statements of the Company.
Years ended December 31, - -------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------------------------------- (in thousands, except per share data) Revenues: Operating revenues $54,216 $50,341 $51,582 $52,906 $54,598 Net investment income 4,312 3,576 3,912 3,455 2,752 Net realized gains (losses) on investments 21 72 (47) (50) 611 -------- -------- -------- -------- -------- Total revenues 58,549 53,989 55,447 56,311 57,961 -------- -------- -------- -------- -------- Net income $4,357 $3,071 $5,181 $4,347 $1,186 - -------------------------------------------------------------------------------------------------------------------------------- Earnings per share: Basic $0.62 $0.44 $0.74 $0.62 $0.20 Diluted $0.62 $0.44 $0.74 $0.62 $0.20 - -------------------------------------------------------------------------------------------------------------------------------- PRO FORMA NET INCOME Income before minority interest, income taxes and cumulative effect of change in accounting principles $7,555 $5,211 $6,309 $6,516 $2,476 Provision for income taxes 2,267 1,484 1,995(1) 1,861(1) 699(1) -------- -------- -------- -------- -------- Income before minority interest and cumulative effect of change in accounting principles 5,288 3,727 4,314 4,655 1,777 Minority interest (931) (656) (759) (1,011) (313) Cumulative effect of change in accounting principles, net of charge in lieu of income taxes (2) 1,090 -------- -------- -------- -------- -------- Pro forma net income $4,357 $3,071 $3,555 $4,734 $1,464 - -------------------------------------------------------------------------------------------------------------------------------- PRO FORMA EARNINGS PER SHARE Income before cumulative effect of change in accounting principles $0.62 $0.44 $0.51 $0.52 $0.25 Cumulative effect of change in accounting principles, net of charge in lieu of income taxes 0.15 -------- -------- -------- -------- -------- Pro forma earnings per share (8) $0.62 $0.44 $0.51 $0.67 $0.25 - -------------------------------------------------------------------------------------------------------------------------------- Weighted average of shares outstanding - basic 7,024 7,020 7,020 7,020 5,924 - -------------------------------------------------------------------------------------------------------------------------------- Weighted average of shares and share equivalents outstanding - diluted 7,083 7,021 7,023 7,035 5,924 - --------------------------------------------------------------------------------------------------------------------------------
21 Item 6. Selected Financial Data (Continued)
Years ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands, except per share data and ratios) Balance Sheet data: Total assets $141,025 $156,102 $174,000 $185,976 $206,153 Long -term debt (3) 5,810 12,787 13,679 11,618 13,995 Stockholders' equity 35,168 24,984 22,882 16,676 13,688 Net book value per share (4) 4.15 3.56 3.26 2.38 1.95 Cash dividend per share (5) 0.10 0.10 0.10 0.10 0.03 GAAP operating data: Loss ratio 38.2% 36.4% 28.8% 31.8% 42.9% Expense ratio 41.0% 42.5% 41.1% 32.9% 32.9% Combined ratio 79.2% 78.9% 69.9% 64.7% 75.8% Statutory operating data (6): Net underwriting gain $5,890 $4,455 $7,104 $7,105 $2,599(7) Policyholders' surplus 25,566 25,485 26,231 22,274 21,528 Loss ratio 36.6% 34.1% 24.4% 30.2% 40.8% Expense ratio 38.6% 40.0% 37.1% 35.5% 33.7% Combined ratio 75.2% 74.1% 61.5% 65.7% 74.5%
(1) Charge in lieu of income taxes, see note 3 (l) to the Consolidated Financial Statements of the Company. (2) Commission income, together with the related accounts receivable from clients and premiums payable to insurance carriers, is recorded principally as of the billing date. Beginning in 1994, commission income related to installment billing arrangements is recorded in total at the date of the initial billing. This change was made because in the opinion of management, it results in a better matching of revenues with the related costs. Prior to this change, commissions were recorded as each installment was billed. As a result of this change, additional commissions of $1,471,000 were recorded in 1994 that would have been recorded under the old policy in 1995. The Company was unable to determine the effects of this change in years prior to 1994 and, therefore, pro forma disclosure of this change in prior years cannot be made. Accordingly, the effect of the change in accounting on prior years of $ 1,652,000 was treated as a cumulative effect adjustment on the 1994 consolidated statement of income. (3) Excludes that portion of long-term debt maturing in less than one year. (4) Based upon 8,474,435 shares outstanding at December 31, 1997 and 7,020,000 outstanding at December 31, 1996, 1995, 1994, and 1993. (5) Dividends paid and declared since the date of the IPO of August 17, 1993. (6) Based upon statutory accounting practices and derived from the statutory financial statements of the Insurance Companies, which excludes the effects of CAC. (7) As a result of a substantial amount of new business written with effective dates in the latter half of 1993, net underwriting gain for 1993 was significantly affected by the statutory accounting practices of charging commission expense to income immediately while premiums are earned over the term of the underlying policies. (8) Earnings per share for basic and diluted are the same based on the weighted average shares outstanding, including share equivalents outstanding. 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations General Kaye Group Inc. (the "Company"), a Delaware corporation, formerly Old Lyme Holding Corporation ("Holding"), is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments - - the Insurance Brokerage Companies Operations comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations ("Property and Casualty Companies" or "Insurance"), which comprises the Insurance Companies and Claims Administration (see Note 1 to the consolidated financial statements of the Company). The revenues and expenses of the Property and Casualty Companies segment will not be comparable to the amounts reported previously by Holding. Historically, the commission income of the Program Brokerage Business was recorded as a reduction of acquisition costs in the consolidated statements of income of Holding. As a result of the combination (see Note 2 to the consolidated financial statements of the Company), management includes the commission income and the other revenues and operating costs of the Program Brokerage Business in the Insurance Brokerage Companies segment for all periods presented. Overview The Insurance Brokerage Companies derive their revenue principally from commissions associated with the placement of insurance coverage for corporate clients. These commissions are paid by the insurance carriers and are usually a fixed percentage of the total premiums. Certain of these commissions are contingent upon the level of volume and profitability of the related coverage to the insurance companies. There is normally a lag between receipt of funds from the insured and payment to the insurance company. Investment of these funds over this period generates additional revenue in the form of interest income. The Insurance business underwrites property and casualty risks for insureds in the United States and is sold principally through specially designed Programs, covering various types of businesses and properties which have similar risk characteristics. The Insurance business generally underwrites the first layer of insurance under the Programs and unaffiliated Program insurers provide coverage for losses above the first layer of risk. Substantially all of the Insurance business revenues are derived from premiums on this business, plus the investment income generated by the investment portfolio of the Insurance business. 23 Corporate Operations include those activities that benefit the Company in its entirety and cannot be specifically identified to either the Insurance Brokerage Companies or the Property and Casualty Companies. Such activities include debt servicing and public company expenses, including investor relations costs. The Company has foreign operations in Bermuda. For further discussion see Note 23 to the consolidated financial statements of the Company. A comprehensive analysis of the results of operations of the Company would not be meaningful without consideration of the charge in lieu of taxes. The provision for income taxes, as reported in the historical financial statements, does not provide for any income taxes on certain subsidiaries of the Company prior to the combination on October 2, 1995. Prior to the combination on October 2, 1995, the Retail Partnerships and the Retail Brokerage Companies were either limited partnerships or S Corporations under the Internal Revenue Code, and therefore, the individual partners or shareholders, rather than the companies were liable for income taxes. Accordingly, the Company has presented a calculation of pro forma net income for the year ended December 31, 1995, which reflects a charge in lieu of income taxes, as if all subsidiaries were included in the Company's consolidated Federal income tax return for all years presented (see Note 2 of the consolidated financial statements of the Company). Management believes this presentation will better present current and future comparisons of the effective tax rate and income tax expense of the Company. 24 Results of Operations Year ended December 31, 1997 compared with year ended December 31, 1996 Insurance Brokerage Companies Income before income taxes increased by $1,962,000 to $767,000 in 1997 from a loss of $1,195,000 in 1996. The improved operating result was due to increased revenues, a significant decrease in other operating expenses and lower interest expense partially offset by a modest increase in salaries and benefits, as discussed below. Total revenues in 1997 were $32,689,000 compared with $31,595,000 in 1996, or an increase of $1,094,000 (3%). The largest component of revenues, commissions and fees-net, was up by $555,000 (2%). Commissions and fees-net increased due to new business of $5,948,000 and the acquisition of Western (see Note 17 to the consolidated financial statements of the Company) which contributed $992,000. Decreases in commissions and fees-net was the result of attrition of $4,421,000, increased commission expense of $896,000 primarily due to additional new business acquired, and a reduction in wholesale contingency commissions of $1,068,000. Attrition includes lost accounts, reduction of service to existing accounts, and lower premiums and commission rates. The attrition in business was equivalent to approximately 13% of the Company's 1996 volume which results in a business retention of approximately 87%. This is well within normal industry expectations given the usual attrition in a highly competitive environment. Investment income increased in 1997 by $539,000 (52%) due to collection efficiencies resulting in a longer holding period for fiduciary investments. Salaries and benefits increased by $299,000 (2%) to $18,868,000 in 1997 compared to $18,569,000 in 1996. This increase was the result of the acquisition of Western partially offset by a modest reduction in work force due to continued operating efficiencies, lower executive compensation and reduced costs for prior years' acquisitions. The Company's board of directors' compensation committee and executive management have reviewed and adjusted executive and management compensation, respectively, to reflect a continued movement toward performance based pay. Other operating expenses decreased by $967,000 (7%) to $12,654,000 in 1997 compared with $13,621,000 in 1996. This decrease was mainly due to reduced account servicing expenses, the completion of amortization of organization costs in the latter part of 1996, expiration of certain management service contracts in 1996 and the third quarter of 1997, and reduced insurance cost. Interest expense decreased by $200,000 as a result of the early payment of the $6,000,000 note payable to KILP in August 1997. 25 Property and Casualty Companies Income before income taxes increased in 1997 by $668,000 (9%) to $7,719,000 from $7,051,000 in 1996. The increase in operating results was due to increased net premiums earned (net of related expenses) and investment income partially offset by a decrease in other income, as discussed below. Net premiums earned for 1997 increased by $3,520,000 (18%) to $22,847,000 from $19,327,000 in 1996. The Company's efforts to broaden the distribution network of the Programs and coverage types has contributed to growth in the Residential Real Estate and Restaurant Programs and the formation of several new programs. Net investment income in 1997 increased by $231,000 (9%) to $2,692,000 from $2,461,000 in 1996 as a result of the increase in invested assets. Net realized gain on investment transactions for 1997 decreased by $51,000 to $21,000 compared to $72,000 in 1996. The realization of investment gains and losses is determined by market conditions and management's decision regarding the holding period of the portfolio. Other income for 1997 decreased by $200,000 to $245,000 from $445,000 in 1996. This decrease is mainly due to the run-off of certain reinsurance contracts during the first half of 1996. Losses and loss expenses increased in 1997 by $1,680,000 (24%) to $8,716,000 from $7,036,000 in 1996. The loss ratio for 1997 and 1996 was 38% and 36%, respectively. This increase was the result of growth in general liability coverage and reserve strengthening. The increase in absolute dollars was generally the result of increased net premiums earned. Acquisition costs and general and administrative expenses increased in 1997 by $1,152,000 (14%) to $9,370,000 from $8,218,000 in 1996. The expense ratio (acquisition costs and general and administrative expenses) for 1997 and 1996 was 41% and 43%, respectively. This decrease was due to a modest decrease in general and administrative expenses in 1997. The increase in absolute dollars was due mainly to additional acquisition costs related to increased net premiums earned and the write-off of certain deferred acquisition costs resulting from the termination of a deposit reinsurance contract. General and administrative expenses had a modest decrease as a result of lower professional fees. Corporate Net expenses before income taxes increased in 1997 by $286,000 (44%) to $931,000 from $645,000 in 1996. This increase was the result of costs incurred for acquisition activities and investor relations. 26 Year ended December 31, 1996 compared with year ended December 31, 1995 Insurance Brokerage Operations Loss before income taxes increased by $489,000 to $1,195,000 in 1996 from $706,000 in 1995. The benefit of decreased salaries and related taxes and fringes was offset by lower revenues as discussed below. Total revenues in 1996 were $31,595,000 compared with $34,970,000 in 1995, or a reduction of $3,375,000 (10%). The largest component of revenues, commission and fees-net, was down $3,373,000 (10%) due in part to nonrecurring items in 1995 of $1,102,000 which consisted of $605,000 relating to the sale of expiration lists of Kaye Administrators, the Home Owners Program was extended by an additional six months for commissions of $305,000, and a special contingent commission of $192,000. The remaining reduction in commissions was mainly due to lost business of approximately $3,200,000 in commercial lines, group and life, personal lines and fees earned from public adjusters partially offset by new business of $1,600,000. This loss in business, equivalent to approximately 9% of the Company's 1995 volume, results in a business retention of approximately 91%. This is well within normal industry expectations given the usual attrition in a highly competitive environment. Salaries and benefits decreased by $2,556,000 (12%) to $18,569,000 in 1996 compared to $21,125,000 in 1995. The decrease is a result of a reductions in work force, lower compensation earned under incentive contracts, termination of the Company's defined benefit pension plan, refunds received on group medical insurance, utilization of forfeitures in the 401K plan and the one time incentive payment in 1995 relating to the sale of Kaye Administrators. Other operating expenses (including depreciation) decreased by $330,000 (2%) to $13,621,000 in 1996 compared with $13,951,000 in 1995. The decrease was primarily due to lower professional fees as a result of the settlement of a former employee lawsuit partially offset by additional depreciation costs related to the capital leasing of new computers, and outside rating service fees related to the Residential Real Estate Program, general insurance and employment agency fees. Property and Casualty Insurance Operations Income before income taxes decreased in 1996 by $1,631,000 to $7,051,000 from $8,682,000 in 1995. This decrease was the result of reduced investment income and the increase in the combined ratio in 1996 to 79% from 70% in 1995 partially offset by an increase in net premiums earned, as discussed below. 27 Net premiums earned for 1996 increased by $2,482,000 (15%) to $19,327,000 from $16,845,000 in 1995. This increase was primarily attributable to growth in the Residential Real Estate Program partially offset by lost business due to increased competition in the Restaurant Program. Net investment income decreased by $358,000 (13%) to $2,461,000 in 1996 from $2,819,000 in 1995 as a result of additional bond amortization for those bonds which had early call features. Losses and loss expenses increased in 1996 by $2,186,000 to $7,036,000 from $4,850,000 in 1995. The loss ratio for 1996 was 36% compared to 29% in 1995. The increase in loss ratio is due to the change in the mix of business during 1996 from property and umbrella coverages to other general liability coverage, including exposure to lead paint, which experiences a higher loss ratio. Acquisition costs and general and administrative expenses increased in 1996 by $1,290,000 to $8,218,000 from $6,928,000 in 1995. The expense ratio for 1996 and 1995 were 43% and 41%, respectively. The increase in expense ratio was mainly due to professional fees. Corporate Net expenses before income taxes decreased in 1996 by $1,022,000 to $645,000 from $1,667,000 in 1995. The decrease in expenses was the result of nonrecurring reorganization costs incurred in 1995. Effective Tax Rate (See Note 8) The pro forma presentation for 1995 includes the effect of a tax benefit from the Retail Brokerage Business which was not combined into the Company until October 2, 1995, resulting in an effective tax rate of 32% for 1995. The effective tax rate for 1997 and 1996 was 30% and 29%, respectively. The difference between the statutory tax rate and the effective tax rate in 1997 and 1996 was primarily related to tax exempt interest. The rate increase for 1997 was primarily due to additional state and local taxes while the decrease in 1996 was primarily due to a one time charge for reorganization costs in 1995 of $863,000 most of which are not deductible for income tax purposes. Financial Condition and Liquidity Management believes the Company's operating cash flow, cash equivalents and short term investments will provide sufficient sources of liquidity and capital to meet the Company's anticipated needs in the next twelve months and the foreseeable future. The Company has no material capital commitments. 28 Total assets decreased by $15,077,000 (10%) to $141,025,000 at December 31, 1997 from $156,102,000 at December 31, 1996. Total liabilities decreased by $19,923,000 (16%) to $105,857,000 at December 31, 1997 from $125,780,000 at December 31, 1996. Premiums and other receivables and premiums payable declined in the brokerage segment due to the timing of certain premium billings. The Company in August 1997 paid in full the note payable to KILP of $6,000,000 from net cash provided by operating activities. Stockholders' equity increased by $10,184,000 (41%) to $35,168,000 at December 31, 1997 from $24,984,000 at December 31, 1996. The increase in equity, which resulted from net income of $4,357,000, the change in unrealized appreciation of investments (net of deferred taxes) of $338,000 and the effect of the merger (discussed below) resulting in the elimination of minority interest of $6,191,000, was partially offset by dividends paid of $702,000. On December 30, 1997 the stockholders of the Company approved a restructuring that merged Kaye Holding Corp. ("KHC") into the Company. This eliminated KILP's minority interest in KHC of $6,191,000 at December 31, 1997 and increased stockholders' equity of the Company by the same amount. KILP is the Company largest shareholder. The merger was accounted for as a transfer and exchange between entities under common control. Accordingly, common stock of Kaye Group Inc. issued in exchange for the KHC shares was accounted for by using the closing NASDAQ market price on October 24, 1997 ($7.00) (the effective date of the merger). This increased the number of shares of common stock by 1,454,435 at the par value $.01 per share or $14,544. Paid-in capital was increased by $10,166,000 which was the difference between the market value price per share and the par value per share. Minority interest in KHC was eliminated as a result of the merger and retained earnings of Kaye Group Inc. was reduced to account for the difference between the market value of the shares issued and the book value of the minority interest in KHC. The Company's cash and cash equivalents increased by $3,348,000 for the year ended December 31, 1997. Operating activities provided cash of $15,845,000, primarily as a result of net income from operations and a net increase in accrued liabilities. Investing activities used cash of $2,204,000 for the purchase of new computer software and the enhancement of our California operations through the asset acquisition of Western. Financing activities used cash of $10,293,000 to pay dividends, notes payable on computer equipment, the early payment of the note to KILP and payments made under deposit reinsurance contracts, offset by proceeds received to finance the Company's new computer software. The Company has calculated risk-based capital and the result is that the statutory net worth of Old Lyme Rhode Island is adequate in light of the current requirements. 29 The Company is subject to a substantial degree of regulation, which is designed to protect the interests of insurance policyholders. As a Rhode Island property and casualty insurance company, OLRI is subject to the primary regulatory oversight of the Rhode Island Department of Business Regulation through its Insurance Division. On March 28, 1996, the Division advised the Company that it is reviewing the treatment of certain reinsurance arrangements between OLRI and OLB in OLRI's 1995 Statutory Annual Statement filed with the Division. The Company believes that it treated this arrangement appropriately in its annual statement and it does not believe that there will be any material modifications to OLRI's surplus at December 31, 1995. The Company's primary source of cash is derived from insurance premiums, insurance brokerage commissions and fees, proceeds from the sale of investments, and investment income. The Company's principal uses of cash are payments of insurance premiums, commissions to brokers who produce the business, losses and loss expenses and operating expenses, and purchases of investments and fixed assets. The Company has minimized its investment risk by investing in high quality tax exempt municipal bonds, U.S. Government and government agency securities and corporate bonds rated A or better by an accredited rating agency and by maintaining an average duration of approximately four years, taking into account the effects of certain early call features. The Company currently intends to continue these investment strategies. The table below sets forth the composition of the Company's portfolio of fixed maturity investments by rating as of December 31, 1997 (in thousands): Market Value as Percentage of Amortized Reflected on Total at Market Rating (a) Cost Balance Sheet Value ---------- ---- ------------- ----- AAA(b) $26,959 $27,297 66.1% AA 5,480 5,587 13.5% AA- 2,058 2,091 5.1% A+ 2,369 2,376 5.7% A 3,905 3,962 9.6% ------- ------- ----- $40,771 $41,313 100.0% ======= ======= ===== (a) Ratings are assigned primarily by Standard & Poors Corporation with the remaining ratings assigned by Moody's Investors Services, Inc. and converted to the equivalent Standard & Poors ratings. (b) Includes U.S. Government Obligations. 30 The amortized cost and estimated market value of fixed maturities at December 31, 1997, by contractual maturity date, are listed below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. Investments Available for Sale --------------------------------- Amortized Aggregate Fair Cost Value --------- -------------- Due in one year or less $3,602 $3,585 Due after one year through five years 15,341 15,594 Due after five years through ten years 19,255 19,520 Due after ten years 2,573 2,614 ------- ------- Total $40,771 $41,313 ======= ======= The Company maintains a substantial level of cash and liquid short term investments which are used to meet anticipated payment obligations. At December 31, 1997 and 1996, the Company had cash and short term investments of $34,737,000 and $29,295,000, respectively of which $22,322,000 and $23,879,000 represents premiums collected and held in a fiduciary capacity which are generally not available for operating needs of the Company. Of the Company's total invested assets, certain amounts are pledged or deposited into trust funds to collateralize the Company's obligations under reinsurance agreements. Investment results of the Company for each of the three years in the period ended December 31, 1997 are shown in the following table (in thousands): At or for the years ended December 31, -------------------------------- 1997 1996 1995 -------- -------- -------- Average cash and cash equivalents and invested assets (1) $ 76,534 $ 68,692 $ 64,261 Investment income $ 4,312 $ 3,576 $ 3,912 Average yield on total investments 5.6% 5.2% 6.1% Net realized investment gains (losses) $ 21 $ 72 $ (47) (1) Based upon the average of the beginning and end of the period amortized cost for fixed maturities and cost for equity securities. 31 The Company has a $7,031,250 revolving line of credit with a bank, collateralized by the stock of the Insurance Companies. The proceeds are available for general operating needs and acquisitions. As of December 31, 1997, there was no unused portion of the revolving line of credit. Under the terms of the revolving line of credit, principal payments commenced during 1997 with $68,750 paid during the year and $468,750 due per quarter, through June 30, 2001. The Company's insurance subsidiaries require capital to support premium writing. The guidelines set forth by the NAIC suggest that a property and casualty insurer's ratio of annual statutory net premiums written to policyholders' surplus should not exceed 3 to 1. At December 31, 1997, the Insurance Companies, with a combined statutory surplus of $25,566,000, had a ratio of combined annual statutory net premiums written to their combined statutory surplus of approximately .87 to 1. Dividends On December 19, 1997, the Board of Directors declared a quarterly dividend of $.025 per share, payable January 20, 1998 to stockholders of record on December 31, 1997. The Company is largely dependent upon dividends from its subsidiary to pay dividends to the stockholders. The Company's insurance subsidiaries are subject to regulations that restrict their ability to pay dividends. Under Rhode Island Insurance law, OLRI may pay cash dividends only from earned surplus determined on a statutory basis, subject to the maintenance of minimum capital and surplus of $3,000,000. Further, OLRI is restricted (on the basis of the lesser of 10% of OLRI's statutory surplus at the end of the preceding twelve-month period or 100% of OLRI's net income, excluding realized capital gains, for the preceding twelve-month period) as to the amount of dividends it may declare or pay in any twelve-month period without prior approval of the Department of Business Regulation of Rhode Island. Without special permission, at December 31, 1997, $2,366,000 was available for distribution. OLB is required to maintain a minimum statutory capital and surplus based upon the higher of $1,000,000 or an amount derived by applying a variable rate to its current premium volume or outstanding losses at December 31, 1997. At December 31, 1997, $904,000 was available for distribution from OLB and its subsidiary, Park Brokerage Ltd. The continued payment and the amount of any cash dividends will depend upon, among other factors, the Company's operating results, overall financial condition, capital requirements and general business conditions. 32 Other In October 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. This statement establishes new financial accounting and reporting standards for stock-based employee compensation plans, including stock option and stock purchase plans. Compensation resulting from the award of stock-based compensation must be determined based on the fair value of consideration received or fair value of the equity instrument issued, whichever is more reliably measurable. Such compensation expense, net of income taxes, may be recognized in the statement of income over the service period of the employee (generally the vesting period). In lieu of recording such compensation expense, entities are permitted to disclose its pro forma impact net of income taxes, on reported net income and earnings per share. Entities choosing such disclosure will continue to measure compensation expense from stock-based compensation in the statement of income based on the intrinsic value method prescribed in Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees". In 1996, the Company adopted the disclosure provision of stock-based compensation in accordance with SFAS No. 123. The adoption of this statement does not have an impact on the Company's financial position or results of operations. In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. The statement establishes a new standard for computing and presenting earnings per share data. The statement is effective for financial statements issued for both interim and annual periods ending after December 15, 1997. This statement supersedes APB Opinion No. 15, Earnings Per Share, and requires dual presentation of basic and diluted earnings per share on the face of the income statement. Basic earnings per share exclude dilution and are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share include the effect of all potentially dilutive securities. All prior period earnings per share presented were restated. Also in February 1997, the Securities and Exchange Commission ("SEC") issued Financial Reporting Release No. 48, Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments ("FRR No. 48"). FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the notes to financial statements. As of December 31, 1997, the Company has no derivative financial instruments. 33 Additionally, the amendments expand existing disclosure requirements to include quantitative and qualitative discussions with respect to market risk inherent in market risk sensitive instruments such as equity and fixed maturity securities, as well as derivative instruments which investors can use to better understand and evaluate market risk exposures of registrants. These disclosures will be effective in 1998. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for the reporting and display of comprehensive income and its components in the consolidated financial statements. The purpose of reporting comprehensive income is to report the change in equity of a business enterprise for the period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. These items include currency translation adjustments and unrealized appreciation of investments, which are currently reported as separate components of equity in the balance sheet. The statement is effective in 1998 and will change the presentation of information in the financial statements but will not have any effect on the financial position or results from operations of the Company. Also in June 1997, the FASB issues SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. This statement requires that companies report certain information about their operating segments in the financial statements including, information about the products and services from which revenues are derived, the geographic areas of operations, and information about major customers. Operating segments are determined by the way management decides how to allocate resources and how it assesses performance. Descriptive information about the method used to identify the reportable operating segments must also be disclosed. The statement also requires a reconciliation of revenues, net income, and assets and other amounts disclosed for the segments to the corresponding amounts in the consolidated financial statements. The statement is effective for year end 1998 and is not expected to change the Company's current segmentation of its business. The financial position and operating results of the Company will not be affected by this statement. Year 2000 Issue The year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Many computer programs have date-sensitive computer software that may not recognize the date with the year 2000. This could result in system failures or miscalculations causing disruptions of operations. The Company has determined that it will be required to modify or replace significant portions of software it uses so that the affected software will properly recognize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the year 2000 issue will be mitigated. However, if such modifications and conversions are not made, or are 34 not completed in a timely manner, the year 2000 issue may have a material impact on the operations of the Company. The Company has assessed the problem, has an action plan in place with resources dedicated to resolution and the work is in progress. The Company will utilize both internal and external resources, reprogram, or replace, and test the software for year 2000 modifications. The Company has purchased and will be implementing new operational and accounting software which is year 2000 compliant. Certain other software that was developed internally is being reprogrammed. Other software purchased such as word-processing and spreadsheet programs are guaranteed to be year 2000 compliant by the manufacturers. We will test this software accordingly. While the cost for the new operational and accounting software is material, only a small portion of such cost is related to year 2000 programming. Other costs to the Company related to year 2000 compliance will not be material. Management has concluded that year 2000 procedures will be completed in a timely fashion. It is not anticipated that the year 2000 issue will have a material affect on future financial results. The Company will initiate formal communications with all of its significant insurance markets to determine the extent to which the Company is vulnerable to those third parties' year 2000 concerns. It should be noted, however, that there can be no guarantee that the systems of other companies will be timely converted, or that their conversion will be comparable with information included in the Company's systems, without having a material adverse effect on the Company. Safe Harbor Disclosure The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This SEC Form 10-K or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere in documents filed by the Company with the Securities and Exchange Commission) include, but are not limited to, uncertainties relating to general economic conditions and cyclical industry conditions, uncertainties relating to government and regulatory policies, volatile and unpredictable developments (including storms and catastrophes), the legal environment, the uncertainties of the reserving process and the competitive environment in which the Company operates. The words "believe", "expect", "anticipate", "project", "plan", and similar expressions, identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 35 Item 8. Financial Statements and Supplementary Data See page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant Reference is made to the Registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, and which is incorporated herein by reference. Item 11. Executive Compensation Reference is made to the Registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, and which is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Reference is made to the Registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, and which is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions Reference is made to the Registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, and which is incorporated herein by reference. 36 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Financial statements and schedules. 1. Financial Statements: Report of Independent Accountants Consolidated Balance Sheets at December 31, 1997 and 1996 Consolidated Statements of Income for the years ended December 31, 1997, 1996, and 1995 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996, and 1995 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996, and 1995 Notes to Consolidated Financial Statements 2. Financial Statement Schedules: Schedule II -- Condensed Financial Information of Registrant: Balance Sheets at December 31, 1997 and 1996 Statements of Income for the years ended December 31, 1997, 1996, and 1995 Statements of Cash Flows for the years ended December 31, 1997, 1996, and 1995 Notes to Condensed Financial Statements Schedule IV -- Reinsurance for the years ended December 31, 1997, 1996, and 1995 Schedule VI -- Supplemental Information Concerning Property and Casualty Insurance Operations for the years ended December 31, 1997, 1996, and 1995 37 The information for Schedule I is contained in the Notes to the Consolidated Financial Statements. The information for Schedule III is included in Schedule VI. The information required for Schedule V is not applicable. 3. Exhibits: Exhibit Number Description 2 Acquisition Agreement, dated as of August 3, 1995, among Kaye Group Inc. (formerly known as Old Lyme Holding Corporation), Kaye International, L.P., certain individuals and Kaye Holding Corp.,( a copy of which was filed with the Commission on March 31, 1995 (Registration No. 33-64664), and which is incorporated herein by this reference). 3(i) Certificate of Incorporation of Kaye Group Inc. (formerly known as Old Lyme Holding Corporation) (a copy of which was filed with the Commission on June 17, 1993 as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (Registration No. 33-64664), and which is incorporated herein by this reference). 3(ii) By-laws of Kaye Group Inc. (formerly known as Old Lyme Holding Corporation) (a copy of which was filed with the Commission on June 17, 1993 as Exhibit 3.2 to the Company's Registration Statement on Form S-1 (Registration No. 33-64664), and which is incorporated herein by this reference). 4.1 Form of certificate representing shares of Common Stock of the Company (a copy of which was filed with the Commission on March 31, 1995 (Registration No. 33-64664), and which is incorporated herein by this reference). 10.1 Kaye Group Inc. (formerly known as Old Lyme Holding Corporation) 1993 Stock Option Plan (a copy of which was filed with the Commission on August 17, 1993 as Exhibit 10.6 to Amendment No. 3 to the Company's Registration Statement on Form S-1 (Registration No. 33-64664), and which is incorporated herein by this reference). 10.1(i) Kaye Group Inc. Supplemental Stock Option Plan (a copy of which was filed with the Commissioner on March 31, 1997) (Registration No.33- 64664), as Exhibit 10.1(i) to the Company's Form 10-K, and which is incorporated herein by this reference). 38 10.2 Registration Agreement among Kaye Group Inc. (formerly known as Old Lyme Holding Corporation), Kaye International, L.P. and Old Lyme Holdings of Rhode Island, Inc. (a copy of which was filed with the Commission on August 17, 1993 as Exhibit 10.7 to Amendment No. 3 to the Company's Registration Statement on Form S-1 (Registration No. 33- 64664), and which is incorporated herein by this reference). 10.11 Credit Agreement among Fleet National Bank ( formerly known as Shawmut Bank Connecticut, N.A.) and Kaye Group Inc. (formerly known as Old Lyme Holding Corporation) dated June 30, 1994 (a copy of which was filed with the Commission on March 31, 1995 (Registration No.33- 64664), as Exhibit 10.16 to the Company's Form 10-Q, and which is incorporated herein by this reference). 10.12 First Amendment to the Credit Agreement, dated March 15, 1995 (a copy of which was filed with the Commission on March 31, 1995 as Exhibit 10.17 to the Company's Form 10-Q, and which is incorporated herein by this reference). 10.13 Second Amendment to the Credit Agreement, dated May 19, 1995 (a copy of which was filed with the Commission on June 30, 1995 as Exhibit 10.19 to the Company's Form 10-Q, and which is incorporated herein by this reference). 10.14 Loan Agreement between Kaye International L.P. and Kaye Group Inc. (formerly known as Old Lyme Holding Corporation, dated May 24, 1995 (a copy of which was filed with the Commission on June 30, 1995, as Exhibit 10.18 to the Company's Form 10-Q, and which is incorporated herein by this reference). 10.15 Credit Agreement between Kaye Holding Corp. and Fleet National Bank (formerly known as Shawmut Bank Connecticut, N.A., dated October 2, 1995 (a copy of which was filed with the Commission on March 31, 1995, (Registration No.33-64664), as Exhibit 10.15 to the Company's Form 10-K, and which is incorporated herein by this reference). 10.15(i) First Amendment to Credit Agreement between Kaye Holding Corp. and Fleet National Bank (formerly known as Shawmut Bank Connecticut, N.A., dated March 31, 1996 (a copy of which was filed with the Commission on May 13, 1996, (Registration No.33-64664), as Exhibit 10.22 to the Company's Form 10-Q, and which is incorporated herein by this reference). 39 10.15(ii) Second Amendment to Credit Agreement between Kaye Holding Corp. and Fleet National Bank (formerly known as Shawmut Bank Connecticut, N.A.) (a copy of which was filed with the Commission on March 31, 1997, (Registration No.33-64664), as Exhibit 10.15(ii) to the Company's Form 10-K, and which is incorporated herein by this reference). 10.15(iii) Third amendment to Credit Agreement between Kaye Holding Corp. and Fleet National Bank, dated September 30, 1997. 10.16 Stockholders Agreement among Kaye Holding Corp., Kaye International, L.P., Kaye Group Inc., Howard Kaye, Lawrence Greenfield, Walter Kaye, Stanley Feinberg, Bruce D. Guthart, Edward Berliner, Michel Zaleski, Ned Sherwood and Marc N. Silverman, dated October 2, 1995, (a copy of which was filed with the Commission on March 31, 1995, (Registration No.33-64664), as Exhibit 10.16 to the Company's Form 10-K, and which is incorporated herein by this reference). *10.17 Executive Employment Agreement between Kaye Group Inc. and Bruce D. Guthart, dated as of January 2, 1997 (a copy of which was filed with the Commission on March 31, 1997, (Registration No.33-64664), as Exhibit 10.17 to the Company's Form 10-K, and which is incorporated herein by this reference). *10.18 Employment Agreement between Kaye Group Inc. and Michael P. Sabanos, dated as of May 15, 1996 (a copy of which was filed with the Commission on March 31, 1997, (Registration No.33-64664), as Exhibit 10.18 to the Company's Form 10-K, and which is incorporated herein by this reference). *10.20 Executive Employment Agreement between Kaye Insurance Associates, Inc. and Richard Bass, dated as of October 31, 1991 (a copy of which was filed with the Commission on March 31, 1997, (Registration No.33- 64664), as Exhibit 10.20 to the Company's Form 10-K, and which is incorporated herein by this reference). *10.20(i) Amendment to Executive Employment Agreement between Kaye Insurance Associates, Inc. and Richard Bass, dated as of December 11, 1995 (a copy of which was filed with the Commission on March 31, 1997, (Registration No.33-64664), as Exhibit 10.20 (i) to the Company's Form 10-K, and which is incorporated herein by this reference). 40 *10.21 Kaye Group Inc. Stock Performance Plan dated as of October 2, 1997. (a copy of which was filed with the Commission on December 8, 1997, as Annex B to Schedule 14(a), Information to the Company's Proxy Statement, pursuant to Section 14(a), and which is incorporated herein by this reference). 11 Statement regarding computation of earnings per share. 23 Consent of Independent Accountants 27 Financial Data Schedule Location of Documents Pertaining to Executive Compensation Plans and Arrangements Name of Document Item in Exhibit Index *Executive Compensation and Arrangement * * Documents noted by "*" in exhibits (b) Reports on Form 8-K Exhibit 99.2 Kaye Group Inc. (the "Company") announced on October 28, 1997 the merger of Kaye Holding Corp. into Kaye Group Inc. A press release announcing the merger was issued by the Company on October 28, 1997. 41 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. KAYE GROUP INC. By: /s/ Bruce D. Guthart ------------------------------- Bruce D. Guthart, Chairman Dated: March 27, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ Bruce D. Guthart Director, Chairman, President - ----------------------- Chief Executive Officer Bruce D. Guthart (Principal Executive Officer) March 27, 1998 /s/ Howard Kaye Director March 27, 1998 - ----------------------- Howard Kaye /s/ Michael P. Sabanos Director, Senior Vice President, - ----------------------- Chief Financial Officer (Principal Michael P. Sabanos Financial Officer and Accounting Officer) March 27, 1998 /s/ Robert Barbanell Director March 27, 1998 - ----------------------- Robert Barbanell /s/ Richard Butler Director March 27, 1998 - ----------------------- Richard Butler /s/ David Ezekiel Director March 27, 1998 - ----------------------- David Ezekiel /s/ Elliot Cooperstone Director March 27, 1998 - ----------------------- Elliot Cooperstone /s/ Ned Sherwood Director March 27, 1998 - ----------------------- Ned Sherwood 42 Item 8. Financial Statements and Supplementary Data INDEX TO FINANCIAL STATEMENTS AND SCHEDULES Page Index to Notes to Consolidated Financial Statement F-2 Report of Independent Accountants F-3 Consolidated Balance Sheets at December 31, 1997 and 1996 F-4 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 F-8 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995 F-9 Notes to Consolidated Financial Statements F-10 Financial Statement Schedules: Schedule II - Condensed Financial Information of Registrant: Balance Sheets at December 31, 1997 and 1996 F-38 Statements of Income for the years ended December 31, 1997, 1996 and 1995 F-39 Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 F-40 Notes to Condensed Financial Statements F-41 Schedule IV - Reinsurance for the years ended December 31, 1997, 1996 and 1995 F-42 Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations for the years ended December 31, 1997, 1996 and 1995 F-43 The information for Schedule I is contained in the Notes to the Consolidated Financial Statements. The information for Schedule III is included in Schedule VI. The information required for Schedule V is not applicable. F-1 INDEX TO NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Footnote Description Page - -------- ----------- ---- 1 Business F-10 2 Organization and Basis of Presentation F-12 3 Significant Accounting Policies F-13 4 Changes in Accounting Policies F-18 5 Funds Held in Fiduciary Capacity F-18 6 Investments F-19 7 Notes Payable F-22 8 Income Taxes F-23 9 Lease Commitments and Rentals F-25 10 Pension and Retirement Plans F-26 11 Management Services Agreement F-26 12 Contingent Liabilities F-27 13 Reinsurance F-27 14 Losses and Loss Expenses F-29 15 Statutory Financial Information and Dividend Restrictions F-29 16 Related Party Transactions F-31 17 Acquisitions F-31 18 Preferred Stock F-31 19 Common Stock Warrants and Dividends Declared F-32 20 Stock Performance and Stock Option Plans F-32 21 Quarterly Financial Information (Unaudited) F-34 22 Premiums F-35 23 Business Segments F-35 24 Supplemental Cash Flow Disclosures F-37 F-2 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Kaye Group Inc.: We have audited the accompanying consolidated financial statements and the financial statement schedules of KAYE GROUP INC. listed in the index on page F-1 of this Form 10-K. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of KAYE GROUP INC. as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. New York, New York February 25, 1998 F-3 KAYE GROUP INC. CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1996 (in thousands, except par value per share)
1997 1996 ======== ======== ASSETS: INSURANCE BROKERAGE COMPANIES Current assets: Cash and cash equivalents (including short term investments, and funds held in a fiduciary capacity of $22,322 and $23,879) $24,833 $24,789 Premiums and other receivables 32,790 56,255 Prepaid expenses and other assets 1,385 1,587 -------- -------- Total current assets 59,008 82,631 Fixed assets (net of accumulated depreciation of $4,553 and $7,646) 3,145 2,349 Expiration lists (net of accumulated amortization of $1,969 and $1,600) 4,702 2,092 Deferred income taxes 966 1,354 Other assets 181 237 -------- -------- Total assets - insurance brokerage companies 68,002 88,663 -------- -------- PROPERTY AND CASUALTY COMPANIES Investments available-for-sale: Fixed maturities, at market value (amortized cost: 1997, $40,771; 1996, $39,216) 41,313 39,145 Equity securities, at market value (cost:1997, $1,629; 1996, $2,246) 1,767 2,316 Short term investments, at cost, which approximates market value 3,430 1,336 -------- -------- Total investments 46,510 42,797 Cash and cash equivalents 6,409 2,714 Accrued interest and dividends 882 969 Premiums receivable 2,344 4,079 Premiums receivable - insurance brokerage companies 3,185 2,904 Prepaid reinsurance premiums 262 283 Reinsurance recoverable on unpaid losses and loss expenses 2,811 882 Funds held under deposit contracts, at market value (amortized cost: 1997, $173; 1996, $3,842) 173 3,847 Deferred acquisition costs 3,939 4,073 Deferred income taxes 379 639 Other assets 1,810 2,266 Intercompany receivable 556 -------- -------- Total assets - property and casualty companies 68,704 66,009 -------- -------- CORPORATE Cash and cash equivalents 65 456 Prepaid expenses and other assets 107 443 Investments available-for-sale: Equity securities, at market value (cost:1997, and 1996, $557) 442 513 Fixed maturities, at market value (amortized cost :1996, $9) 9 Deferred income taxes 41 9 Intercompany receivable 3,664 -------- -------- Total assets - corporate 4,319 1,430 -------- -------- Total assets $141,025 $156,102 ======== ========
See notes to consolidated financial statements F-4 KAYE GROUP INC. CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1996 (in thousands, except par value per share)
1997 1996 ========= ========= LIABILITIES: INSURANCE BROKERAGE COMPANIES Current liabilities: Premiums payable $40,872 $63,081 Premiums payable - property and casualty companies 3,185 2,904 Accounts payable and accrued liabilities 7,983 6,074 Notes payable 434 595 Deferred income taxes 1,063 1,122 Intercompany payable 3,342 344 --------- --------- Total current liabilities 56,879 74,120 Notes payable 654 537 Note payable - KILP 6,000 Other liabilities 1,466 --------- --------- Total liabilities-insurance brokerage companies 58,999 80,657 --------- --------- PROPERTY AND CASUALTY COMPANIES Liabilities: Unpaid losses and loss expenses 19,126 15,227 Unearned premium reserves 12,578 13,176 Deposit contracts 122 3,448 Accounts payable and accrued liabilities 6,661 4,991 Reinsurance payable 228 170 Intercompany payable 322 --------- --------- Total liabilities - property and casualty companies 39,037 37,012 --------- --------- CORPORATE Current liabilities: Accounts payable and accrued liabilities 774 704 Intercompany payable 212 Note payable 1,875 850 Income taxes payable 16 95 --------- --------- Total current liabilities 2,665 1,861 Note payable-long-term 5,156 6,250 --------- --------- Total liabilities-corporate 7,821 8,111 --------- --------- Total liabilities 105,857 125,780 --------- --------- COMMITMENTS AND CONTINGENCIES MINORITY INTEREST IN EQUITY OF KAYE HOLDING CORP 5,338 --------- --------- STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value; 1,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 20,000 shares authorized; 1997, 8,474; 1996, 7,020 shares issued and outstanding 85 70 Paid - in capital 17,942 7,776 Appreciation (depreciation) of investments available-for-sale, net of deferred income tax liability (benefit) ( 1997, $192; 1996, ($16)) 373 (31) Retained earnings 16,768 17,169 --------- --------- Total stockholders' equity 35,168 24,984 --------- --------- Total liabilities and stockholders' equity $141,025 $156,102 ========= =========
See notes to consolidated financial statements F-5 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 1997, 1996 and 1995 (in thousands, except per share amounts)
1997 1996 1995 ======== ======== ======== INSURANCE BROKERAGE COMPANIES Revenues: Commissions and fees - net $27,294 $27,201 $31,142 Commissions and fees - net - Property and Casualty Companies 3,830 3,368 2,800 Interest and dividends 1,565 1,026 1,028 -------- -------- -------- Total revenues 32,689 31,595 34,970 -------- -------- -------- Expenses: Salaries and benefits 18,868 18,569 21,125 Other operating expenses 12,654 13,621 13,951 -------- -------- -------- Total operating expenses 31,522 32,190 35,076 -------- -------- -------- Interest expense 400 600 600 -------- -------- -------- Income (loss) before income taxes-insurance brokerage companies 767 (1,195) (706) -------- -------- -------- PROPERTY AND CASUALTY COMPANIES Revenues: Net premiums written 22,270 20,689 15,160 Change in unearned premiums 577 (1,362) 1,685 -------- -------- -------- Net premiums earned 22,847 19,327 16,845 Net investment income 2,692 2,461 2,819 Net realized gains on investments 21 72 1 Other income 245 445 795 -------- -------- -------- Total revenues 25,805 22,305 20,460 -------- -------- -------- Expenses: Losses and loss expenses 8,716 7,036 4,850 Acquisition costs and general and administrative expenses 9,370 8,218 6,928 -------- -------- -------- Total expenses 18,086 15,254 11,778 -------- -------- -------- Income before income taxes-property and casualty companies 7,719 7,051 8,682 -------- -------- -------- CORPORATE Revenues: Net investment income 55 89 17 -------- -------- -------- Expenses: Other operating expenses 438 220 133 Cost of combining operations 863 -------- -------- -------- Total operating expenses 438 220 996 -------- -------- -------- Interest expense 548 514 688 -------- -------- -------- Net expenses before income taxes-corporate (931) (645) (1,667) -------- -------- --------
See notes to consolidated financial statements F-6 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 1997, 1996 and 1995 (in thousands, except per share amounts)
1997 1996 1995 ======= ======= ======= Income before minority interest and income taxes $7,555 $5,211 $6,309 ------- ------- ------- Provision for income taxes: Current 1,921 364 1,276 Deferred 346 1,120 1,689 Tax effect of change in tax status (2,944) ------- ------- ------- Total income taxes 2,267 1,484 21 ------- ------- ------- Income before minority interest 5,288 3,727 6,288 Minority interest 931 656 1,107 ------- ------- ------- Net income $4,357 $3,071 $5,181 ======= ======= ======= EARNINGS PER SHARE Basic $0.62 $0.44 $0.74 ======= ======= ======= Diluted $0.62 $0.44 $0.74 ======= ======= ======= PRO FORMA NET INCOME Income before minority interest and income taxes $7,555 $5,211 $6,309 Provision for income taxes/charge in lieu of income taxes 2,267 1,484 1,995 ------- ------- ------- Income before minority interest 5,288 3,727 4,314 Minority interest 931 656 759 ------- ------- ------- Net income $4,357 $3,071 $3,555 ======= ======= ======= PRO FORMA EARNINGS PER SHARE Basic $0.62 $0.44 $0.51 ======= ======= ======= Diluted $0.62 $0.44 $0.51 ======= ======= ======= Weighted average of shares outstanding - basic 7,024 7,020 7,020 ======= ======= ======= Weighted average shares outstanding and share equivalents outstanding - diluted 7,083 7,021 7,023 ======= ======= =======
See notes to consolidated financial statements F-7 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1997, 1996 and 1995 (IN THOUSANDS)
1997 1996 1995 ======== ======== ======== CASH FLOWS FROM OPERATING ACTIVITIES: Net income $4,357 $3,071 $5,181 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred acquisition costs 134 (370) 826 Amortization of bond premium - net 650 751 430 Deferred income taxes 346 1,120 (1,268) Net realized (gains) losses on investments (21) (72) 47 Depreciation and amortization expense 1,667 2,000 1,999 Minority interest 931 656 1,107 Change in assets and liabilities: Accrued interest and dividends 87 22 (102) Premiums and other receivables 23,011 19,217 11,426 Prepaid expenses and other assets (1,785) 760 (1,043) Unpaid losses and loss expenses 3,899 2,556 (1,447) Unearned premium reserves (598) 1,362 (1,685) Premiums payable (21,870) (14,865) (13,639) Income taxes payable (79) 1,356 (2,221) Accounts payable and accrued liabilities 5,116 (767) 972 -------- -------- -------- Net cash provided by operating activities 15,845 16,797 583 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Investments available-for-sale : Purchase of fixed maturities (11,907) (14,291) (12,506) Purchase of equity securities (500) (825) (45) Purchase of short term investments (2,094) (2,450) Maturities of fixed maturities 4,487 3,318 1,755 Sales of fixed maturities 5,297 8,707 9,635 Sales of equity securities 1,100 201 Sales of short term investments 1,814 Funds held under deposit contracts Purchase of fixed maturities (976) (469) (1,650) Sales (purchases) of short term investments 2,344 (815) 2,199 Sales of fixed maturities 1,851 2,535 2,922 Maturities of fixed maturities 452 480 829 Purchase of fixed assets (1,481) (888) (396) Purchase of expiration list (777) -------- -------- -------- Net cash provided by (used in) investing activities (2,204) (434) 494 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments under deposit contracts (3,326) (1,553) (4,007) Notes payable-repayment (6,757) (416) (6,145) Proceeds from borrowings 642 553 7,268 Payment of dividends (702) (702) (702) Payment of dividends to minority shareholders (150) (150) Increase in net advances from KILP (392) -------- -------- -------- Net cash used in financing activities (10,293) (2,268) (3,978) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS 3,348 14,095 (2,901) Cash and cash equivalents at beginning of period 27,959 13,864 16,765 -------- -------- -------- Cash and cash equivalents at end of period $31,307 $27,959 $13,864 ======== ======== ========
See notes to consolidated financial statements F-8 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the years ended December 31, 1997, 1996, and 1995 (in thousands, except per share amounts)
Common Stock ---------------------- Unrealized Minimum Total Outstanding Par Paid-In Appreciation/ Pension Retained Stockholders' Shares Value Capital (Depreciation) Liability Earnings Equity ----------- ----- ------- -------------- --------- -------- ------------- Balance, January 1, 1995 7,020 $70 $38,588 ($1,220) ($404) ($20,358) $16,676 Change in unrealized appreciation, net of deferred income tax of ($750) 1,456 1,456 Net income 5,181 5,181 Decrease in net advances from KILP (133) (133) Dividends declared (per share-$0.10) (702) (702) Effect of combining operations (30,679) 30,679 0 Minimum pension liability 404 404 ----- --- ------- ------- ----- -------- ------- Balance, December 31, 1995 7,020 70 7,776 236 0 14,800 22,882 Change in unrealized depreciation, net of deferred income tax benefit of $138 (267) (267) Net income 3,071 3,071 Dividends declared (per share-$0.10) (702) (702) ----- --- ------- ------- ----- -------- ------- Balance, December 31, 1996 7,020 70 7,776 (31) 0 17,169 24,984 Change in unrealized appreciation, net of deferred income tax of ($174) 338 338 Net income 4,357 4,357 Dividends declared (per share-$0.10) (702) (702) Shares issued to purchase minority interest, net of deferred income tax of $34 1,454 15 10,166 66 (4,056) 6,191 ----- --- ------- ------- ----- -------- ------- Balance, December 31, 1997 8,474 $85 $17,942 $373 $0 $16,768 $35,168 ===== === ======= ======= ===== ======== =======
See notes to consolidated financial statements F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 1997, 1996, and 1995 1) Business Kaye Group Inc. (the "Company") a Delaware corporation, formerly Old Lyme Holding Corporation ("Holding"), is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments - - the Insurance Brokerage Companies Operations ("Brokerage Operations"), comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations. In addition, Corporate Operations include those activities that benefit the Company in its entirety and cannot be specifically identified to either the Insurance Brokerage Companies or the Property and Casualty Companies Operations. Such activities include debt servicing and public company expenses, including investor relations costs. Insurance Brokerage Companies Operations The Retail Brokerage Business operates an insurance brokerage business through four subsidiaries of the Company, the "Retail Brokerage Companies". It offers commercial clients a full range of insurance brokerage services including procurement of property/casualty insurance, risk management consulting, bonding, insurance coverage loss prevention engineering, and group employee benefit consulting services. In addition, personal lines and life and health insurance coverage are placed on behalf of individuals. The Retail Brokerage Business' primary strategy is to service middle market companies and organizations just below the Fortune 500 level for which other national brokers intensely compete. Within this market, the Retail Brokerage Business has developed particular expertise and knowledge of the risks facing a number of industry sectors including health care, real estate, manufacturing, churches, law firms, homes for the aged and fine arts. During 1997, the Retail Brokerage Business serviced approximately 10,000 insureds. The Retail Brokerage Business is compensated for its services primarily in the form of commissions paid by insurance companies. The commission is usually a percentage of the premium paid by the insured. Commission rates depend upon the type of insurance, the particular insurance company, and the role in which the Retail Brokerage Business acts. In some cases a commission is shared with other agents or brokers who have acted jointly with the Retail Brokerage Business in connection with the transaction. The Retail Brokerage Business may also receive from an insurance company a contingent commission that is generally based on the profitability and volume of business placed with it by the Retail Brokerage Business over a given period of time. The Retail Brokerage Business F-10 may also receive fees in connection with consulting services relating to the marketing of insurance. Program Brokerage Corporation or "PBC" (the Program Brokerage Business) is a subsidiary of the Company and operates a wholesale insurance brokerage business which offers retail insurance agents and brokers innovative solutions to the twin insurance problems of price and availability of coverage. It accomplishes this by organizing pools of similar risks into specially designed Affinity Group Insurance Programs (the "Programs"). Approximately two thirds of PBC's premium volume is generated by approximately 400 unrelated retail insurance agents and brokers serving approximately 4,300 insureds during 1997. The remaining one third is derived from the Retail Brokerage Business. Approximately half of PBC's premium volume is directly or indirectly placed with two affiliates, Old Lyme Insurance Company of Rhode Island, Inc. ("OLRI") and Old Lyme Insurance Company, Ltd. (Bermuda) ("OLB"). Property and Casualty Companies Operations The Company conducts its property and casualty underwriting business through two insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI is a property and casualty insurance company licensed in Rhode Island and eligible as a surplus lines insurer in New York and New Jersey. OLB is a property and casualty insurance company organized and licensed under the laws of Bermuda. In states where the Insurance Companies are not admitted insurers or surplus lines insurers, the Insurance Companies underwrite risks through various reinsurance agreements. The Insurance Companies underwrite property risks (loss or physical damage to property) and OLRI underwrites casualty risks (legal liability for personal injury or damaged property of others) for insureds in the United States. Insurance is sold principally through the Programs marketed by PBC which insure various types of businesses and properties that have similar risk characteristics, such as apartments, condominiums, cooperatives, restaurants, building maintenance companies, churches, funeral homes and pharmacies, among others. The Insurance Companies' strategy is to underwrite only the first "layer" of the property and casualty insurance provided under the Programs. Its exposure to individual insureds on individual losses is thereby generally limited to between $1,000 and $25,000 per claim (inclusive of allocated loss expenses), depending on the Program. Under the Programs, the Insurance Companies' policies are sold in conjunction with policies issued by unaffiliated Program insurers that provide coverage for losses above the first layer of risk underwritten by the Insurance Companies. In addition, the Insurance Companies have issued policies on a selected basis with limits up to $1,000,000, retaining the first $50,000 of exposure and reinsuring the remaining limits with an unaffiliated reinsurer. F-11 Property and Casualty Companies Operations includes Claims Administration Corporation ("CAC"), a subsidiary of the Company which is responsible for the administration of a large majority of the claims submitted to the Insurance Companies. The administration of claims includes investigation, engagement of legal counsel, approval of settlements and the making of payments to, or on behalf of insureds. CAC also provide claims administration service to the unaffiliated Program insurers for a fee. 2) Organization and Basis of Presentation In 1994 the Retail Brokerage Business completed the integration of its 1992 acquisition of Amalgamated Programs Corporation and related entities ("Amalgamated") and continued to downsize to adjust to the continuing "soft market" in property and casualty premium rates. At the time, the officers of the general partners of Kaye International L.P. ("KILP") (which included members of Holding's Board of Directors) concluded that the combination of Holding and the Retail Brokerage Business would be advantageous for both OLRI and KILP. This conclusion was based on three factors: (a) improved operating results derived from the Amalgamated integration and "soft market" downsizing, (b) the improved outlook for the Retail Brokerage Business and (c) the fact that the Retail Brokerage Business accounted for approximately half of the PBC's premium volume. The combination was effective October 2, 1995 and was accounted for as a transfer and exchange between companies under common control. Accordingly, the assets and liabilities of the Retail Brokerage Business were combined with those of Holding at their historical cost in a manner similar to a "pooling of interests". The combination was accomplished as follows: 1. Holding transferred to Kaye Holding Corp. ("KHC") all of the outstanding stock of the Insurance Companies and its two other subsidiaries, PBC and CAC and its other assets in exchange for (i) 82,400 shares of KHC common stock, representing 82.4% of the total outstanding KHC common stock, and (ii) the assumption by KHC of certain of Holding's liabilities. 2. KILP transferred all of its interest in the limited partnerships conducting the Retail Brokerage Business (the "Retail Partnerships") and certain related assets to KHC in exchange for (i) 17,200 shares of KHC common stock, representing 17.2% of the total outstanding KHC common stock, and (ii) the assumption by KHC of certain KILP liabilities. 3. Certain individuals transferred to KHC all of their interests in the corporate general partners of the Retail Partnerships (the "Retail Brokerage Companies") in exchange for 400 shares of KHC common stock, representing 0.4% of the total outstanding KHC common stock. 4. KHC contributed its interests in the Retail Partnerships to the Retail Brokerage Companies thereby causing the dissolution of the Retail Partnerships. As a result, the F-12 Retail Brokerage Companies, as a group, own all of the assets and are subject to all of the liabilities, of the Retail Brokerage Business. On December 30, 1997, the stockholders of the Company approved a restructuring that merged KHC into the Company. This eliminated KILP's minority interest in KHC of $6,191,000 at December 31, 1997 and increased stockholders' equity of the Company by the same amount. KILP is the Company's largest shareholder. The merger was accounted for as a transfer and exchange between entities under common control. Accordingly, common stock of Kaye Group Inc. issued in exchange for the KHC shares was accounted for by using the closing NASDAQ market price on (the effective date of the merger) October 24, 1997 ($7.00). This increased the number of shares of common stock by 1,454,435 at the par value $.01, per share, or $14,544. Paid-in capital was increased by $10,166,000 which was the difference between the market value price per share and the par value per share. Minority interest in KHC was eliminated as a result of the merger and retained earnings of Kaye Group Inc. was reduced to account for the difference between the market value of the shares issued, and the book value of the minority interest in KHC. 3) Significant Accounting Policies (a) Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") and include the accounts of the Company for all periods presented and restated effective in 1995 to give effect to the combination as a transfer and exchange between companies under common control. Accordingly, the assets and liabilities of the Retail Brokerage Business have been combined with Holding at the historical costs in a manner similar to a pooling of interests. The historical Consolidated Financial Statements reflect the combination as if the pooling of interests was consummated at the beginning of the earliest year presented and give retroactive effect to the restructuring for all periods prior to the IPO. All significant intercompany balances and transactions within segments have been eliminated. The preparation of 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 revenue and expenses during the reporting period. Actual results could differ from those estimates. Effective upon the closing of the October 2, 1995 combination (see Note 2), the entities comprising the Retail Brokerage Business ceased being either limited partnerships or S corporations and became taxable corporations (see Note 8 ). Accordingly, the accumulated deficit of the Retail Brokerage Business at October 1, 1995 of $30,679,000 was reclassed to paid-in capital, and a deferred tax benefit of $2,944,000 was recorded as the tax effect of the change in tax status in the accompanying 1995 Consolidated Statement of Income (see Note 8). F-13 The accompanying consolidated financial statements have been prepared on a segmented basis. See Note 1 for segments and their respective operations. Income (loss) before income taxes of the two operating segments includes expenses incurred by Corporate on behalf of the segments, which are allocated to operations of the segments. The allocation is based upon total revenues of each segment except for the allocation of the incentive bonus which is allocated based on the percentage of profits contributed to the Company. Identifiable assets by segment are those assets used in the Company's operations in each business segment. Corporate assets are principally cash and cash equivalents and investments in equity securities. Certain prior year information has been reclassified to conform with the 1997 presentation. (b) Commission Income Commission income together with the related accounts receivable from clients and premiums payable to insurance carriers, is recorded principally as of the billing date. Commission income related to installment billing arrangements is recorded at the date of the initial billing. Contingent commissions, commissions on premiums billed directly by insurance carriers and commission adjustments (including cancellations) are recorded when collected or known. (c) Fixed Assets Furniture, equipment, computer hardware and software, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed using the straight-line method. Fixed assets are depreciated over periods ranging from three to seven years, and leasehold improvements are amortized over the remaining terms of the leases which expire commencing 1997 through 2001. (d) Intangible Assets Acquired expiration lists are carried at cost, less accumulated amortization which is computed using the straight-line method over a period of not more than fifteen years. Corporate organizational costs are carried at cost, less accumulated amortization and are amortized using the straight-line method over a period of five years. Such costs were fully amortized at December 31, 1996. F-14 (e) Investments Fixed maturity securities, funds held under deposit contracts and equity securities, which include common and preferred stocks, are stated at market value. The difference between the cost and market value of fixed maturity and equity securities is reflected as unrealized appreciation or depreciation, net of applicable deferred income taxes, as a separate component of stockholders' equity. Realized gains or losses from the sale of investments are determined on the basis of specific identification and are reflected as a component of revenues. Investment income is recognized when earned. The fair value of fixed maturities is based on the closing price of the investments on December 31. The fair value of equity securities is based on the closing sale price on December 31. If a decline in fair value of an investment is considered to be other than temporary, the investment is reduced to its net realizable value and the reduction is accounted for as a realized investment loss. In evaluating whether a decline is other than temporary, management considers the duration and extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer, including events that may impact the issuer's operations and impair the earnings potential of the investment, and management's ability and intent to hold an investment for a sufficient period to allow for an anticipated recovery in fair value. (f) Insurance Premiums Earned Insurance premiums are recognized as revenues ratably over the terms of the related policies in force. Unearned premiums are established to cover the unexpired portion of premiums written and are calculated using the daily pro rata method. Premiums earned are net of reinsurance ceded. (g) Deferred Acquisition Costs Deferred acquisition costs represent costs to acquire or renew insurance policies or contracts and are deferred and amortized over the applicable premium recognition period, generally one year. These deferred costs have been limited to the amount expected to be recovered from future earned premiums. Acquisition costs of $7,269,000, $6,086,000, and $5,193,000 were amortized to expense in 1997, 1996 and 1995, respectively. (h) Unpaid Losses and Loss Expenses The estimated liability for unpaid losses and loss expenses is based on an evaluation of claims reported by policyholders. A provision, which is based on historical experience and modified for current trends, is also included for losses and loss expenses which have been incurred but not reported. The methods of determining such estimates and establishing the F-15 resulting reserves are continually reviewed and modified to reflect current conditions, and any adjustments are reflected currently in results of operations. The Company has received claims related to lead paint exposures it insures under various residential real estate programs. There are uncertainties in estimating the amount of reserves due to factors including: difficulty in properly allocating responsibility and/or liability for the lead paint exposure; changes in the underlying laws and the judicial interpretation of those laws; questions regarding the interpretation and application of insurance and reinsurance coverage. The Company has reserves established for these claims on a case basis and an incurred but not reported basis. The reserves provided were established based on Management's estimate of ultimate liabilities. However, due to the nature of the exposures such reserves cannot be, and are not established using standard actuarial techniques. (i) Reinsurance Assumed reinsurance premiums written, commission, and unpaid losses are accounted for based principally on the reports received from the ceding insurance companies and in a manner consistent with the terms of the related reinsurance agreements. Liabilities for unpaid losses, loss expenses and unearned premiums are stated gross of ceded reinsurance recoverables. Deferred acquisition costs are stated net of the amounts of reinsurance ceded, as are premiums written and earned, losses and loss expenses incurred, and amortized acquisition costs. Assumed reinsurance contracts which do not involve the transfer of risk to the Company are recorded as deposit contracts (see Note 13). (j) Income Taxes The Company recognizes deferred tax assets or liabilities for temporary differences between the financial reporting and tax basis of assets and liabilities based on enacted tax rates. The principal temporary differences relate to deferred acquisition costs, unearned premiums, discount for tax purposes of the unpaid losses and loss expense reserves, amortization of expiration lists and deferred compensation, accrual adjustment for commission income and unrealized gains or losses on investments (see Note 8). (k) Cash and Cash Equivalents Cash and cash equivalents include money market funds and certificates of deposit, including funds held in a fiduciary capacity for Insurance Brokerage Companies, with a maturity of three months or less. (l) Pro forma Net Income Prior to the Transaction certain entities were partnerships or S Corporations under the Internal Revenue code and therefore not liable for Federal income taxes. Also, OLB, as a Bermuda domiciled company, was not liable for income taxes. The charge in lieu of F-16 income taxes information is presented as if the income of these entities were taxed to those entities rather than to partners or stockholders not otherwise included in the Company's consolidated group. (m) Earnings Per Share Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128 Earnings Per Share which requires an enterprise to present basic and diluted earnings per share on the face of the income statement. Basic earnings per share, which is calculated by dividing net income by the weighted average number of common shares outstanding, replaces primary earnings per share from the prior standard. For all periods previously reported by the Company, basic earnings per share is the same as primary earnings per share, since the impact of the Company's common stock equivalents for those periods did not reach the significance threshold prescribed to require adjustment under the prior standard. Diluted earnings per share include the effect of all potentially dilutive securities. Earnings per common share has been computed below in accordance with SFAS No. 128, based upon weighted average common and dilutive shares outstanding (in thousands, except per share accounts): 1997 1996 1995 ---- ---- ---- Net income (numerator) $4,357 $3,071 $5,181 ------ ------ ------ Pro Forma net income (numerator) $4,357 $3,071 $3,555 ------ ------ ------ Weighted average common shares and effect of dilutive shares used in the computation of earnings per share: Average shares outstanding-basic (denominator) 7,024 7,020 7,020 Effect of dilutive shares 59 1 3 ------ ------ ------ Average shares outstanding - diluted (denominator) 7,083 7,021 7,023 ------ ------ ------ Earnings per common share: Basic $0.62 $0.44 $0.74 Diluted $0.62 $0.44 $0.74 Pro Forma earnings per share Basic $0.62 $0.44 $0.51 Diluted $0.62 $0.44 $0.51 Options and the warrant to purchase 284,000, 419,000, and 300,000 common shares at prices from $7.06 to $11.63, $7.06 to $11.63, and $9.75 to $11.63 per share were outstanding at December 31, 1997, 1996, and 1995, respectively, but were not included in the computation of earnings per diluted share for the respective years, because the options' exercise price was greater than the average market price of the common F-17 shares. The options, which expire through December 31, 2007, December 27, 2006, and October 20, 2005, respectively, were still outstanding at the end of 1997. 4) Changes in Accounting Policies In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for the reporting and display of comprehensive income and its components in the consolidated financial statements. The purpose of reporting comprehensive income is to report the change in equity of a business enterprise for the period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. These items include currency translation adjustments and unrealized appreciation of investments, which are currently reported as separate components of equity in the balance sheet. The statement is effective in 1998 and will change the presentation of information in the financial statements but will not have any effect on the financial position or results from operations of the Company. Also in June 1997, the FASB issued SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. This statement requires that companies report certain information about their operating segments in the financial statements including, information about the products and services from which revenues are derived, the geographic areas of operations, and information about major customers. Operating segments are determined by the way management decides how to allocate resources and how it assesses performance. Descriptive information about the method used to identify the reportable operating segments must also be disclosed. The statement also requires a reconciliation of revenues, net income, and assets and other amounts disclosed for the segments to the corresponding amounts in the consolidated financial statements. The statement is effective for year end 1998 and is not expected to change the Company's current segmentation of its business. The financial position and operating results of the company will not be affected by this statement. 5) Funds Held in Fiduciary Capacity Premiums collected by the Insurance Brokerage Companies but not yet remitted to insurance carriers are approximately $22,322,000 and 23,879,000 at December 31, 1997 and 1996 respectively, some of which are restricted as to use by law in certain states in which the Insurance Brokerage Companies operate. These balances are held in cash and cash equivalents or short term investments. The offsetting obligation is recorded in premiums payable. F-18 6) Investments Net investment income for the years ended December 31, 1997, 1996 and 1995 is derived from the following sources (in thousands): 1997 1996 1995 ------- ------- ------- Insurance Brokerage Companies Short term investments $1,565 $1,026 $1,028 ------- ------- ------- Property and Casualty Companies Fixed maturities 2,083 2,099 2,373 Equity securities 119 114 115 Short term investments 382 82 207 Other 143 191 185 ------- ------- ------- Total Investment income 2,727 2,486 2,880 Investment expenses (35) (25) (61) ------- ------- ------- 2,692 2,461 2,819 ------- ------- ------- Corporate Short term investments 55 89 65 ------- ------- ------- Net investment income $4,312 $3,576 $3,912 ======= ======= ======= Net realized gains or losses and the increase or decrease in unrealized appreciation (depreciation) on investments for the years ended December 31, 1997, 1996 and 1995 are summarized below (in thousands):
1997 1996 1995 ------- ------- ------- Net realized gains (losses): Fixed maturities: Gross realized gains $26 $82 $112 Gross realized losses (5) (10) (167) ------- ------- ------- 21 72 (55) ------- ------- ------- Equity securities - Gross realized gains 8 ------- ------- ------- Net realized gains (losses) on investments $21 $72 $(47) ======= ======= ======= Change in unrealized appreciation (depreciation): Fixed maturities $608 $(543) $2,656 Equity securities 14 48 26 ------- ------- ------- Net change in unrealized appreciation (depreciation) $622 $(495) $2,682 ======= ======= =======
F-19 The composition, cost (amortized cost for fixed maturities) and estimated market values of the Company's investments at December 31, 1997 and 1996 are presented below. Equity security investments with a cost of $36,000 and a fair value of $19,000 are included in other assets of the Insurance Brokerage Companies in the accompanying consolidated balance sheet at December 31, 1996.
Gross Unrealized Holding Aggregate -------------------------- Fair Cost Gains Losses Value ------- ------- ------- ------- (in thousands) 1997 Investments available for sale: Fixed Maturities: U.S. Government (a) $3,641 $10 $(24) $3,627 States (b) 34,013 591 (3) 34,601 Corporate 3,117 16 (48) 3,085 ------- ------- ------- ------- Total fixed maturities $40,771 $617 $(75) $41,313 ------- ------- ------- ------- Equity Securities: Common Stock $703 111 $(115) $699 Preferred Stock 1,483 27 1,510 ------- ------- ------- ------- Total equity securities $2,186 $138 $(115) $2,209 ------- ------- ------- ------- Funds held under deposit contracts - Cash and cash equivalents $173 $173 ------- ------- ------- 1996 Investments available for sale: Fixed Maturities: U.S. Government (a) $6,167 $98 $(80) $6,185 States (b) 31,231 213 (252) 31,192 Corporate 1,827 34 (84) 1,777 ------- ------- ------- ------- Total fixed maturities $39,225 $345 $(416) $39,154 ------- ------- ------- ------- Equity Securities: Common Stock $145 $56 $201 Preferred Stock 2,694 14 $(61) 2,647 ------- ------- ------- ------- Total equity securities $2,839 $70 $(61) $2,848 ------- ------- ------- ------- Funds held under deposit contracts: Fixed Maturities U.S. Government (a) $517 $5 $522 States (b) 507 507 Corporate 300 300 ------- ------- ------- Total fixed maturities 1,324 5 1,329 Cash and cash equivalents 2,518 2,518 ------- ------- ------- Total funds held under deposit contracts $3,842 $5 $3,847 ======= ======= =======
(a) Includes U.S. Government agencies and authorities (b) Includes municipalities and subdivisions F-20 The amortized cost and estimated market value of fixed maturities at December 31, 1997, by contractual maturity date, are listed below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. Investments Available for Sale ------------------------------- (in thousands) Amortized Aggregate Fair Cost Value --------- -------------- Due in one year or less $3,602 $3,585 Due after one year through five years 15,341 15,594 Due after five years through ten years 19,255 19,520 Due after ten years 2,573 2,614 ------- ------- Total $40,771 $41,313 ======= ======= Fixed maturities, equity securities, and cash carried at market value of $3,511,000, and $3,417,000 in 1997 and 1996, respectively, were on deposit with governmental authorities, as required by law. Fixed maturity investments and cash equivalents carried at market value of $11,733,000 and $6,670,000 in 1997 and 1996, respectively, have been deposited in trust funds or pledged to collateralize the obligations of OLB and OLRI to ceding companies under reinsurance agreements, including intercompany reinsurance agreements, and to policy holders under policies (see Note 13). The Company's short term investment of cash is maintained principally with five banks and an institutional money market fund. To control this risk, the Company utilizes only high credit quality financial institutions. Additionally, under the insurance laws of the State of Rhode Island, where OLRI is domiciled, insurers and reinsurers are restricted as to the types of investments they may purchase and the concentration of risk they may accept in any one issuer or group of issuers. The Company complies with such laws which insure that the concentration of risk in its investment portfolio is at an acceptable and authorized level. F-21 7) Notes Payable Notes payable consist of the following in thousands at December 31,: 1997 1996 ------ ------ Insurance Brokerage: Finance company notes, due through 2000, interest at prime rate plus 1/2% $179 $578 Finance company notes, due through 2002, interest at 7.75% 546 Capital lease due through 8/30/99, interest at 7.375% 363 554 Subordinated promissory note payable to KILP, due the later of 8/30/97 or 30 days after repayment of the revolving line of credit 6,000 ------ ------ 1,088 7,132 Less current portion 434 595 ------ ------ Notes payable - long term $654 $6,537 ====== ====== Corporate: Revolving line of credit, due through 2001 interest at 5.9375% plus 2.5% $7,031 $7,100 Less current portion 1,875 850 ------ ------ Notes payable - long term $5,156 $6,250 ====== ====== The Company has a $7,031,250, revolving line of credit (the "Loan") with a bank, collateralized by the stock of the Insurance Companies. The proceeds are available for general corporate purposes, which may include acquisitions by the Company or a subsidiary and the making of a loan to an affiliate. Any borrowings will bear interest at the bank's equivalent of the prime rate of interest as maintained from time to time or at the Company's option, a LIBOR based rate plus 2.5%. A commitment fee is assessed in the amount of 1/4% per annum on the unused balance. Among other covenants, the agreement requires maintenance of minimum consolidated net worth, statutory surplus, ratios of net premiums written to surplus and minimum interest coverage. As of December 31, 1997, the Company is in compliance with the covenants of the debt agreement. The bank's commitment under the Loan has been renegotiated to decrease the quarterly reduction commitment to $468,750 from $625,000 commencing September 30, 1997 and to extend the due date one year to June 30, 2001. In addition, the interest rate increased from 1.5% to 2.5% plus LIBOR. All other terms and conditions remain unchanged. The revised available credit as of the end of each respective year is $4,687,500 in 1998, $2,812,500 in 1999, $937,500 in 2000, and none in 2001. The Company's required payments for the respective years are $1,875,000 in 1998 through 2000 and $1,406,250 in 2001. Interest expense under the Loan for the years ended December 31, 1997, 1996, and 1995 was approximately $548,000, $514,000, and $688,000, respectively. F-22 On August 29, 1997, the Company paid in full the note payable to KILP of $6,000,000. This note was subject to repayment restrictions stipulated in the Loan agreement. The due date of the note pursuant to the Loan agreement would have been in 2001. The bank consented to the payment on August 25, 1997. Interest expense for the year ended December 31, 1997, 1996, and 1995 was $400,000, $600,000, and $600,000, respectively. The aggregate maturities of all notes payable by year are as follows (in thousands): 1998 ...................................... $2,309 1999 ...................................... 2,222 2000 ...................................... 2,021 2001 ...................................... 1,535 Thereafter ............................... 32 Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the notes payable at December 31, 1997 and 1996 approximates their carrying value. Interest expense in the accompanying consolidated statements of income for the years ended December 31, 1997, 1996 and 1995 was $948,000, $1,114,000, and $1,288,000, respectively. 8) Income Taxes The Company's effective income tax rate for the years ended December 31, 1997, 1996 and 1995 differs from the statutory rate on ordinary income before income taxes as follows (in thousands):
1997 1996 1995 -------------------- -------------------- -------------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income ------ ------ ------ ------ ------ ------ Income taxes computed at the statutory rate $2,569 34.0% $1,772 34.0% $2,145 34.0% Increases (decrease) in taxes resulting from: Transactions (a) 969 15.4 Establishment of deferred taxes (b) (2,944) (46.7) Tax-exempt investment income (516) (6.8) (403) (7.7) (399) (6.3) Non-deductible costs of combining operations 293 4.6 State and local income taxes and other 214 2.8 115 2.2 (43) (0.7) ------ ---- ------ ---- ------ ---- Provision for income taxes $2,267 30.0% $1,484 28.5% $21 0.3% ====== ==== ====== ==== ====== ====
(a) Income (loss) of Retail Partnerships and Corporations taxed to their respective partners and shareholders (b) See Note 3(a) F-23 The Retail Partnerships and the Retail Brokerage Corporations were either limited partnerships or S Corporations under the Internal Revenue Code, and therefore, the individual partners or shareholders, rather than the companies, were liable for income taxes. Effective upon the closing of the October 2, 1995 combination (see Note 2), the entities comprising the Retail Brokerage Business ceased being either limited partnerships or S corporations and became taxable corporations. Accordingly, the accumulated deficit of the Retail Brokerage Business at October 1, 1995 of $30,679,000 was reclassed to paid-in capital, and a deferred tax benefit of $2,944,000 was recorded as the tax effect of the change in tax status in the accompanying 1995 Consolidated Statement of Income. The net deferred tax benefit relates to temporary differences (at October 2, 1995) between the financial reporting and tax basis of assets and liabilities of the Retail Brokerage Business, principally amortization of expiration lists and deferred compensation, deduction of previously accrued management bonuses, and accrual adjustments for commission income. The data reflecting a charge in lieu of income taxes is presented on a pro forma basis in the accompanying consolidated statements of income as if the income or loss, prior to the combination of the various partnerships and S corporations, were taxed to those entities rather than to their partners or shareholders. The source of the significant temporary differences and the related deferred tax effects are as follows: 1997 1996 1995 ------- ------- ------- (in thousands) Expiration lists $394 $393 $226 Other 47 (137) 553 Unearned premium reserves 40 (93) 115 Deferred compensation 850 255 Loss reserve discount (30) 37 193 Deferred acquisition costs (46) 126 (281) Accrual adjustment (59) (56) 628 ------- ------- ------- Deferred tax expense $346 $1,120 $1,689 ======= ======= ======= The components of the net deferred tax asset, in the accompanying consolidated balance sheets at December 31, 1997 and 1996, are as follows: 1997 1996 ------ ------ (in thousands) Deferred tax assets: Loss and loss expense reserves $1,048 $1,018 Expiration lists 941 1,335 Unearned premium reserves 837 877 Unrealized losses on investments and other 91 157 ------ ------ Total deferred tax asset 2,917 3,387 ------ ------ Deferred tax liabilities: Deferred acquisition costs 1,339 1,385 Unrealized gains on investments and other accrual adjustments 1,255 1,122 ----- ----- Total deferred tax liability 2,594 2,507 ------ ------ Net deferred tax asset $323 $880 ====== ====== F-24 Management believes it is more likely than not that all deferred tax assets are realizable based upon the past earnings history of the Company. OLB, as a Bermuda domiciled company is not subject to federal income taxes but, rather, the Company is subject to federal income taxes based on OLB's taxable income for the entire year. Accordingly, the Company includes the taxable income of OLB in its separate company income for tax purposes, but for segment reporting the income is included with the Property and Casualty Companies. OLB has received an undertaking from the Bermuda Government exempting it from all taxes computed on profit or income, or computed on any capital asset gain or appreciation until 2016. The Company and its wholly owned subsidiaries are party to a Tax Allocation Agreement (the "Agreement"). The Agreement requires these companies to file a U.S. consolidated income tax return. The Agreement provides that each member of the group will compute its separate tax liability or benefit on a separate return basis and pay or receive such amounts to or from the Company. For purposes of segment information, amounts due to or from the Company by its subsidiaries are included in the intercompany receivable/payable in the accompanying consolidated balance sheets. 9) Lease Commitments and Rentals Minimum annual rental commitments under various noncancelable operating leases for office space, automobiles and equipment are as follows (in thousands): Years Ending December 31, ------------------------- 1998............................. $2,587 1999............................. 2,518 2000............................. 2,400 2001............................. 2,113 Thereafter....................... 263 ------ 9,881 Sub-lease rental income...................... (186) ------ Net rental commitments....................... $9,695 ====== Leases for office space include various escalation clauses, none of which individually or in the aggregate are material. Escalation clauses are accounted for on a straight-line basis over the life of the lease. The leases also contain provisions for the payment of certain operating expenses and real estate taxes. Rent expense for the years ended December 31, 1997, 1996 and 1995, amounted to approximately $2,992,000, $2,857,000, and $2,946,000, respectively, net of sublease rental income of $193,000, $197,000, and $168,000, respectively. F-25 10) Pension and Retirement Plans Substantially all officers and employees of the Company are entitled to participate in a qualified retirement savings plan (defined contribution plan) and prior to 1995 were entitled to participate in a defined benefit pension plan. The costs to the Company to participate in these plans included in the accompanying consolidated statements of income was approximately $385,000, $55,000, and 688,000 for 1997, 1996 and 1995, respectively. The defined benefit pension plan (the "Plan") was frozen effective December 31, 1994, at which time participants became 100% vested in their accrued benefits. All pension benefits were frozen at then current levels. The termination resulted in an insignificant curtailment loss pursuant to Statement of Financial Accounting Standards No. 88 ("SFAS 88") in 1994. During 1995, the Plan's obligations were settled, resulting in a settlement loss pursuant to SFAS 88 in the amount of $494,000, which included the additional minimum liability charged directly to equity at December 31, 1994 in accordance with SFAS No. 87 "Employers Accounting for Pensions". 11) Management Services Agreement In September 1992, Kaye Insurance Associates, L.P. ("KIA"), a predecessor of one of the entities comprising the Retail Brokerage Business, entered into a management services agreement with APCO Corp. (the "Manager"), whereby the Manager was obliged to provide the administrative and operational functions for the Amalgamated Division, from which certain assets and liabilities were acquired in 1992. The Manager was owned by the individuals who sold the Amalgamated Division to KIA. In return for the Manager's services, commencing September 1, 1992 and continuing through August 31, 1997, KIA was obliged to pay annually to the Manager a base fee which is subject to certain adjustments as specified in the agreement. KIA incurred management service fees of $911,000, $1,536,000, and $1,732,000 for the years ended December 31, 1997, 1996, and 1995, respectively, which was included in other operating expenses of the Insurance Brokerage Companies. In addition, the Manager was entitled to receive an incentive bonus in an amount equal to a specified percentage (ranging from 16% to 19%) of gross income of the Amalgamated division, as defined in the agreement, for each of the five years of the period ended August 31, 1997. In accordance with the terms of the agreement, however, in no event should the cumulative amount paid by KIA, with respect to this incentive bonus, be less than $2,876,000 or exceed $4,220,000 subject to the continued employment of certain key personnel by the Manager. The cost of this bonus to KIA, which was charged to salaries and benefits as the related gross income earned, was $0, $364,000, and $1,027,000 for the years ended December 31, 1997, 1996 and 1995, respectively. These agreements expired on August 31, 1997. F-26 12) Contingent Liabilities In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. Subject to specified limits, the shareholders of predecessors to the Retail Brokerage Business are responsible for any costs arising from those claims which were asserted prior to November 1, 1991, the date on which KILP was formed. In the opinion of management, the ultimate resolution of all asserted and potential claims both prior and subsequent to the formation of KILP, will not have a material effect on the consolidated financial position of the Company. As licensed brokers, certain subsidiaries of the Company are or may become parties to administrative inquiries and at times to administrative proceedings commenced by state insurance regulatory bodies. Certain subsidiaries have been involved since 1992 in an administrative investigation by the New York Insurance Department ("Department") relating to how property insurance policies were issued for the Residential Real Estate Program. As a result, the manner in which policies are structured for certain clients in this Program has been altered, which has not had a material adverse effect on this Program. While the Company has been in discussions with the Department regarding settlement of such investigation, if such discussions are not successful, the Department could institute formal proceedings against the subsidiaries seeking fines or license revocations. KILP has agreed to indemnify the Company and its subsidiaries for any fines or settlement payments in excess of $300,000, relating to such investigation. Management does not believe the resolution of such issues will have a material adverse effect on the Company. 13) Reinsurance As of December 31, 1997 and 1996, included in the amounts reflected in the consolidated financial statements are unearned premiums of $4,963,000 and $5,173,000, respectively, and unpaid losses and loss expenses of $12,445,000 and $6,534,000, respectively, for reinsurance assumed from non-affiliates, although all such reinsurance assumed relates to business produced by the Insurance Brokerage Companies. The Insurance Companies have established trust funds and deposited fixed maturities and cash therein to satisfy the collateral requirements of certain reinsurance agreements. The trust funds established for the benefit of ceding companies amounted to approximately $11,812,000 as of December 31, 1997. In accordance with the normal practice of the insurance industry, OLRI assumes and cedes reinsurance with other insurers or reinsurers. The reinsurance arrangements provide greater diversification of business and minimize OLRI's maximum net loss arising from large risks. OLRI assumes reinsurance under reinsurance treaty arrangements generally with limits of $25,000 (inclusive of loss expenses) per occurrence. To limit OLRI's exposure for the reinsurance assumed, OLRI purchased an annual aggregate stop loss F-27 policy. This policy insures OLRI in the event the losses under the policy exceed a fixed percentage of premium earned. OLRI will be reimbursed up to $7,500,000. OLRI's ceded reinsurance is on an excess of loss basis with an unaffiliated company, National Reinsurance Corporation ("Nat Re"). OLRI issues policies on a selected basis with limits up to $1,000,000 retaining the first $50,000 of exposure and reinsuring $950,000 to Nat Re. The remaining reinsurance arrangements are on a quota share basis and excess of loss with non-affiliated insurers or reinsurers. The Insurance Companies also entered into reinsurance agreements, wherein they reinsured certain general liability and property risks. These reinsurance agreements include per claim and aggregate limits and provide funds that are placed into trusts for the benefit of the insurers. Since these reinsurance contracts do not transfer risk to the Insurance Companies, they are included in "Funds Held Under Deposit Contracts" in the accompanying consolidated balance sheets. A contingent liability exists with respect to reinsurance ceded, which would become an ultimate liability of OLRI in the event that the assuming companies were unable to meet their obligations under the reinsurance agreements in force at December 31, 1997. The amounts deducted from liabilities, revenues and expenses for reinsurance ceded by OLRI were as follows: 1997 1996 ---- ---- (in thousands) Liabilities - Unpaid losses and loss expenses $2,811 $882 Revenue and expenses: Premiums earned 558 520 Losses and loss expenses 1,929 764 F-28 14) Losses and Loss Expenses The following table sets forth a reconciliation of the changes in the reserves for outstanding losses and loss expenses, including paid losses and loss expenses, for each year in the three year period ended December 31, 1997. Years Ended December 31, ----------------------------------- 1997 1996 1995 -------- -------- -------- (in thousands) Balance at January 1, $15,227 $12,671 $14,118 Less reinsurance recoverables (882) -------- -------- -------- Net balance 14,345 12,671 14,118 -------- -------- -------- Incurred related to: Current year 8,824 6,621 4,986 Prior year (108) 415 (136) -------- -------- -------- Total incurred 8,716 7,036 4,850 -------- -------- -------- Paid related to: Current year 1,802 1,832 2,138 Prior year 4,944 3,530 4,159 -------- -------- -------- Total paid 6,746 5,362 6,297 -------- -------- -------- Net balance at December 31, 16,315 14,345 12,671 Add reinsurance recoverables 2,811 882 -------- -------- -------- Balance $19,126 $15,227 $12,671 ======== ======== ======== 15) Statutory Financial Information and Dividend Restrictions The Company's insurance subsidiaries file separate financial statements in accordance with accounting practices prescribed or permitted by the insurance regulatory authorities where they are domiciled. Statutory financial statements do not reflect deferred acquisition costs, deferred income taxes, market value changes and certain other items recognized under GAAP. OLB is required to maintain a minimum statutory capital and surplus based upon the higher of $1,000,000 or an amount derived by applying a variable rate to its current premium volume or outstanding losses at December 31, 1997. At December 31, 1997, $904,000 was available for distribution from OLB and its subsidiary, Park Brokerage Ltd. Pursuant to Rhode Island Insurance Law, OLRI may pay cash dividends only from earned surplus determined on a statutory basis, subject to the maintenance of minimum capital and surplus of $3,000,000. Further, OLRI is restricted (on the basis of the lesser of 10% F-29 of OLRI's statutory surplus at the end of the preceding twelve-month period or 100% of OLR's net income, excluding realized capital gains, for the preceding twelve-month period) as to the amount of the dividends it may declare or pay in any twelve-month period without prior approval of the Department of Business Regulation of Rhode Island. At December 31, 1997, $2,366,000 is available for distribution during 1998, without prior approval. Statutory information is as follows: Old Lyme Old Lyme Rhode Island Bermuda Combined ------------ ------- -------- (in thousands) Policyholders' surplus at December 31, 1997 $23,662 $1,904 $25,566 1996 $24,034 $1,451 $25,485 Net income for the years ended December 31, 1997 $5,178 $1,453 $6,631 1996 $2,459 $2,890 $5,349 1995 $6,243 $1,890 $8,133 The following is a reconciliation of net income and surplus regarding policyholders in accordance with statutory accounting principle ("SAP") as reported to the Rhode Island and Bermuda insurance regulatory authorities to net income and capital as determined in conformity with generally accepted accounting principles ("GAAP") basis.
Statutory Surplus / Stockholders' Equity Net Income for years ended as of December 31, December 31, ---------------------- ----------------------------------- 1997 1996 1997 1996 1995 -------- -------- -------- -------- -------- (in thousands) Consolidated amount in accordance with GAAP $35,168 $24,984 $4,357 $3,071 $5,181 Deficit (equity) in net assets and net loss of non-insurance companies (4,388) 5,768 2,086 3,217 2,354 -------- -------- -------- -------- -------- Combined amount in accordance with GAAP 30,780 30,752 6,443 6,288 7,535 Excess of statutory formula reserves over GAAP reserves (890) (621) Deferred acquisition costs (3,939) (4,073) 134 (370) 826 Non-admitted assets, deferred income taxes and other (385) (573) 54 (569) (228) -------- -------- -------- -------- -------- Combined amount in accordance with SAP $25,566 $25,485 $6,631 $5,349 $8,133 ======== ======== ======== ======== ========
F-30 16) Related Party Transactions The administrative support for OLB is provided by International Advisory Services, Ltd. ("IAS"), an insurance management company located in Bermuda. The principal stockholder of IAS is an officer of OLB and is a director of the Company. Management fees paid to IAS under a service contract for the years ended December 31, 1997, 1996 and 1995 were $37,500, $36,250, and $65,000, respectively. The principal stockholder of IAS, who is a director of the Company, is also a stockholder in a insurance brokerage company, H & H Reinsurance Brokers, Ltd. ("H & H Reinsurance"). H & H Reinsurance has a reinsurance contract between OLRI and unrelated insurance carriers, (Transatlantic Reinsurance Company and USF Reinsurance Company). H & H Reinsurance received commissions of $38,114, $7,000, and $24,587 in 1997, 1996, and 1995, respectively, as a result of such transaction. The Company had a $6,000,000 note payable to KILP which was paid in full during 1997 (see Note 7). KIA incurred a management fee of $175,000 annually to ZS Fund, L.P. which is one of the general partners of KILP. KIA had an accrued payable to ZS Fund, L.P. as of December 31, 1996 of $175,000. This management fee arrangement terminated on December 31, 1996. In January 1997, KIA entered into a management agreement with KILP, whereby the Company provides certain administrative services for a fee of $50,000 per year. At December 31, 1997, the Company recorded $50,000 for such services provided. 17) Acquisitions During 1997, the Company acquired certain assets and liabilities of Western Insurance Associates, Inc. ("Western") for cash of $777,000 and amounts payable in future periods of $2,285,000. The amounts payable are the Company's estimate of the probable costs it will incur. The total acquired expiration list was $3,062,000 at December 31, 1997. This acquisition was accounted for as a purchase. 18) Preferred Stock The Board of Directors is authorized to issue preferred stock in classes or series and to fix the designations, preferences, qualifications, limitations or restrictions of any class or series with respect to the rate and nature of dividends, the price and terms and conditions on which shares may be redeemed, the amount payable in the event of voluntary or involuntary liquidation, the terms and conditions for conversion or exchange into any other class or series of stock, voting rights and other terms. No preferred stock is currently outstanding. F-31 19) Common Stock Warrants and Dividends Declared The Company has issued a warrant to KILP to purchase 105,000 shares of its common stock. The exercise price of the warrant is the IPO price of such shares ($10.00), subject to certain anti-dilution adjustments. The warrant is exercisable through February 16, 1998. The Board of Directors of the Company declared annual dividends of $702,000 for the years ended December 1997 and 1996, respectively, of which $175,000 remains unpaid at December 1997 and 1996, respectively. 20) Stock Performance and Stock Option Plans On December 30, 1997, the Company adopted a Stock Performance Plan, under which up to 350,000 shares of the Company's common stock may be granted and awarded to key employees. The grant of stock under this plan is contingent upon criteria established by the Company's Compensation Committee of the Board of Directors. Awards are based on performance targets of the Company's stock based on increases in the market value of the Company's common stock from the price on the date the stock is initially granted by the Company. Shares must be granted, awarded, and vested before participants take full title to the performance stock. Awards vest on the occurrence of any of the following events, (i) fifteen years of continuous service with the Company from the date shares are granted to the participant, (ii) death or disability of the participant, (iii) immediately before a change of control (as defined under the plan), (iv) attaining the age of 65, or (v) immediately before a sale or merger (as defined under the plan). At December 31, 1997, no performance stock under this plan was granted or awarded. At December 31, 1997, the Company has a Stock Option Plan and a Supplemental Stock Option Plan (the "Plans"). Both plans are identical and are stock-based compensation plans, which are described below. The Company adopted the disclosure requirements of SFAS 123 effective January 1, 1996 and continues to account for its employee stock-based compensation plans under APB 25. Accordingly, the adoption of SFAS 123 had no impact on the Company's financial position or results of operations. Under the Plans a total of 700,000 shares of common stock are reserved for issuance. The Plans provide for the granting to directors, executives or other key employees (including officers) of the Company non-qualified stock options ("NQOs") or incentive stock options ("ISOs") within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended. The exercise price of all ISOs and NQOs under the Plans are generally at least the fair market value of the common stock of the Company on the date of grant. The Compensation Committee (the "Committee") determines the terms of the options including the exercise price, number of shares subject to option and exercisability. F-32 In addition, the Plans authorize grants of alternative cash settlement rights at the discretion of the Committee, which entitles participants to receive a payment in cash equal to the fair market value of such shares on the date of surrender less the purchase price required to purchase such shares. A summary of the status of the Plans as of December 31, 1997, 1996, and 1995 and changes during the years ended on those dates is presented below:
1997 1996 1995 ========================================================================================== Weighted-Average Weighted-Average Weighted-Average Exercise Exercise Exercise Fixed Options Shares Price Shares Price Shares Price ========================================================================================== Outstanding at beginning of year 528,550 $7.53 323,000 $9.33 194,550 $10.71 Granted 450,750 5.14 225,000 5.09 155,500 8.49 Exercised Forfeited (354,450) 6.87 (19,450) 9.24 (27,050) 10.10 -------- ------- ------- Outstanding at end of year 624,850 $6.12 528,550 $7.53 323,000 $9.33 ======== ======= ======= Options exercisable at year-end 143,450 124,150 64,480 ======== ======= ======= Weighted-average fair value of options granted during the year $1.29 $1.21 $2.31 ======== ======= =======
The following table summarizes information about the stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ---------------------------------------------------- -------------------------------- Number Weighted-Average Weighted-Average Number Weighted-Average Exercise Prices Outstanding Remaining Exercise Exercisable Exercise at 12/31/97 Contractual Life Price at 12/31/97 Price $11.63 500 6.08 years $11.63 300 $11.63 $10.91 5,000 6.08 10.91 3,000 10.91 $10.00 84,750 5.63 10.00 69,600 10.00 $ 8.43 43,850 7.83 8.43 19,550 8.43 $ 8.03 15,000 9.83 8.03 $ 7.88 15,000 7.70 7.88 6,000 7.88 $ 7.06 10,000 8.37 7.06 2,000 7.06 $ 6.64 5,000 10.00 6.64 $ 5.06 185,750 9.15 5.06 $ 5.00 250,000 9.20 5.00 43,000 5.00 $ 4.97 10,000 9.49 4.97 ------- ------- 624,850 8.56 $6.12 143,450 $8.20 ======= =======
The options vest and are exercisable at the rate of 20% per year and terminate ten years from date of grant. At December 31, 1997, 1996 and 1995, 143,450, 124,150, and 64,480 options were exercisable and there were 75,150, 171,450, and 27,000 options available for future grants, respectively. F-33 Had the compensation cost for the Company's stock based compensation plans been determined based on the fair value at the grant for awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 1997 1996 1995 ---- ---- ---- Net Income As reported $4,357 $3,071 $3,555 Pro forma 4,280 3,060 3,517 Earnings per share - basic As reported .62 .44 .51 Pro forma .61 .44 .50 Earnings per share - diluted As reported .62 .44 .51 Pro forma .60 .44 .50 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 1.6%, (ii) expected volatility range of 25%, (iii) risk-free interest rate of 6.4%, and (iv) expected life of 5 years. 21) Quarterly Financial Information (Unaudited) The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1997 and 1996 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown.
For the three months ended ==================================================================================================================================== (in thousands, except for per share) March 31, June 30, September 30, December 31, --------- -------- ------------- ------------ 1997 1996 1997 1996 1997 1996 1997 1996 ==================================================================================================================================== Revenues $ 12,866 $ 11,753 $ 13,545 $ 11,780 $ 16,466 $ 15,206 $ 15,672 $ 15,250 - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ 228 $ (27) $ 724 $ 175 $ 1,547 $ 1,246 $ 1,858 $ 1,677 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings per share: Basic $ 0.03 $ 0.00 $ 0.11 $ 0.02 $ 0.22 $ 0.18 $ 0.26 $ 0.24 Diluted 0.03 0.00 0.11 0.02 0.22 0.18 0.26 0.24 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted average shares outstanding: Basic 7,020 7,020 7,020 7,020 7,020 7,020 7,036 7,020 Diluted 7,020 7,020 7,020 7,020 7,161 7,020 7,164 7,021 ====================================================================================================================================
F-34 22) Premiums Of the Company's net premiums earned approximately 62%, 63%, and 55% related to the residential real estate program and 25%, 24%, and 32% related to the restaurant program for the years 1997, 1996, and 1995, respectively. Of the Company's net premiums earned approximately 82%, 83%, and 98% related to insureds located in New York State for the years 1997, 1996, and 1995, respectively. Premiums earned for the three years ended December 31, 1997, 1996 and 1995, which include in assumed premiums relating to reinsurance agreements with RLI of $4,272,000, $3,878,000, and $2,409,000 in 1997, 1996 and 1995, respectively, are summarized below: 1997 1996 1995 -------- -------- -------- (in thousands) Direct $ 11,496 $ 9,979 $ 13,063 Assumed 11,909 9,869 3,892 -------- -------- -------- Total 23,405 19,848 16,955 Ceded (558) (521) (110) -------- -------- -------- Net $ 22,847 $ 19,327 $ 16,845 ======== ======== ======== 23) Business Segments The Company operates in two business segments, the procuring of property and casualty insurance ("Insurance Brokerage Companies") and the underwriting of property and casualty risks ("Property and Casualty Companies"). The identifiable segment assets, operating profits and income before income taxes and minority interests are shown on the accompanying consolidated balance sheets and statements of income. The following table is a summary of certain other segment information for the years ended December 31, 1997, 1996 and 1995: Business Segments - 1997 - -------------------------------------------------------------------------------- Insurance Property & (in thousands) Brokerage Casualty Consolidated - -------------------------------------------------------------------------------- Depreciation expense $1,123 $24 $1,147 Amortization expense $ 520 $ 520 Capital expenditures $1,481 $1,481 F-35 Business Segments - 1996 - -------------------------------------------------------------------------------- Insurance Property & (in thousands) Brokerage Casualty Consolidated - -------------------------------------------------------------------------------- Depreciation expense $1,024 $23 $1,047 Amortization expense $ 953 $ 953 Capital expenditures $ 888 $ 888 Business Segments - 1995 - -------------------------------------------------------------------------------- Insurance Property & (in thousands) Brokerage Casualty Consolidated - -------------------------------------------------------------------------------- Depreciation expense $ 940 $18 $ 958 Amortization expense $1,041 $1,041 Capital expenditures $ 396 $ 396 The foreign operations set forth below, relate solely to the operations of OLB, and its wholly owned subsidiary Park Brokerage, and include reinsurance assumed from OLRI, as well as from third party insurance companies. All such risks assumed originate in the United States. 1997 =============================================== Foreign Domestic Total =============================================== (in thousands) Revenues $2,246 $56,303 $58,549 Income before minority interest and income taxes 1,398 6,157 7,555 Identifiable assets 3,575 137,450 141,025
1996 1995 ============================= =============================== Foreign Domestic Total Foreign Domestic Total ============================= =============================== (in thousands) Revenues $2,104 $51,885 $53,989 $2,828 $52,619 $55,447 Income before minority interest and income taxes 2,857 2,354 5,211 2,062 4,247 6,309 Identifiable assets 4,925 151,177 156,102 15,579 158,421 174,000
There were no material intercompany revenue transactions between OLB and OLRI. F-36 In 1997, OLRI entered into a novation reinsurance agreement with National Union Fire Insurance Company of Pittsburgh, PA. ("N.U."), pursuant to which OLRI paid $807,000 and transferred its $950,000 IBNR liability to N.U. In 1996, OLRI entered into the following reinsurance agreements: 1. Commutation Agreement: OLRI commuted all liabilities and obligations arising out of reinsurance agreements between OLRI and OLB for the sum of $3,337,729. This transaction increased OLRI's reserves by $4,466,384 and decreased statutory underwriting income by $1,128,655. 2. Novation Agreement: OLRI has agreed to replace OLB under all reinsurance agreements in either RLI and/or Mt. Hawley. OLB offered and OLRI accepted in full and final satisfaction arising out of OLB's participation in all reinsurance agreements with either RLI or Mt. Hawley, the sum of $1,203,974. This transaction increased OLR's premium written by $1,203,974, reserves by $1,611,098 and decreased statutory underwriting income by $407,124. 24) Supplemental Cash Flow Disclosures 1997 1996 1995 ---- ---- ---- Cash paid during the period for: Interest expense $948 $1,114 $1,288 Income taxes (refunded) $2,000 ($992) $3,521 Noncash investing and financing activities: Stock issued to purchase minority interest $10,181 Details of expiration list acquisition: Fair value $3,062 Amounts payable in future periods (2,285) ------- Cash paid for purchase of expiration list $777 ------- F-37 Schedule II KAYE GROUP INC. (Parent Company Only) Condensed Balance Sheets December 31, 1997 and 1996 (in thousands, except par value per share)
1997 1996 ======== ======== ASSETS Cash and cash equivalents $65 $1 Prepaid expenses and other assets 590 Due from subsidiaries 3,664 271 Investment in subsidiaries 38,670 24,983 -------- -------- Total assets $42,989 $25,255 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Accounts payable and other liabilities $774 $176 Note payable 1,875 Income taxes payable 16 95 -------- -------- Total current liabilities 2,665 271 Note payable - long term 5,156 -------- -------- Total liabilities 7,821 271 -------- -------- STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value; 1,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 20,000 shares authorized; 1997, 8,474; 1996, 7,020 shares issued and outstanding 85 70 Paid-in capital 17,942 7,776 Unrealized appreciation (depreciation) of investments, net of deferred income tax provision (benefit), (1997, $192; 1996, ($16)) 373 (31) Retained earnings 16,768 17,169 -------- -------- Total stockholders' equity 35,168 24,984 -------- -------- Total liabilities and stockholders' equity $42,989 $25,255 ======== ========
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-38 Schedule II KAYE GROUP INC. (Parent Company Only) Condensed Statements of Income For the years ended December 31, 1997, 1996 and 1995 (in thousands) 1997 1996 1995 ====== ====== ====== REVENUES: Equity in income of subsidiaries net of taxes $4,357 $3,071 $5,181 ------ ------ ------ NET INCOME $4,357 $3,071 $5,181 ====== ====== ====== The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-39 Schedule II KAYE GROUP INC. (PARENT COMPANY ONLY) Condensed Statements of Cash Flows For the years ended December 31, 1997, 1996 and 1995 (in thousands)
1997 1996 1995 ======== ======== ======== CASH FLOWS FROM OPERATING ACTIVITIES: Net income $4,357 $3,071 $5,181 -------- -------- -------- Adjustment to reconcile net income to net cash provided by (used in) operating activities: Equity in net income of subsidiaries (6,590) (3,071) (5,181) Dividends received from subsidiaries 6,350 702 702 Minority interest 931 Change in assets and liabilities: Prepaid expenses and other assets (199) Due from subsidiaries (3,892) (1,356) 2,222 Income taxes payable (137) 1,356 (2,221) -------- -------- -------- Net cash provided by operating activities 820 702 703 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of dividends (852) (702) (702) Notes payable-repayment (69) Contribution to subsidiaries (300) -------- -------- -------- Net cash used in financing activities (1,221) (702) (702) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS (401) 1 Cash and cash equivalents at beginning of period 466 1 -------- -------- -------- Cash and cash equivalents at end of period $65 $1 $1 ======== ======== ======== SUPPLEMENTAL CASH FLOW DISCLOSURES Cash paid during the period for: Interest expense $548 $514 $688 Income taxes (refunded) $2,000 ($992) $3,521 Noncash investing and financing activities: Stock issued to purchase minority interest $10,181
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-40 Schedule II KAYE GROUP INC. (Parent Company Only) Notes to Condensed Financial Statements 1. Condensed Financial Statements Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the Company's consolidated financial statements and the notes thereto. 2. Significant Accounting Policies The Parent Company carries its investment in subsidiaries under the equity method. F-41 Schedule IV KAYE GROUP INC. REINSURANCE For The Years Ended December 31, 1997, 1996 and 1995 (in thousands)
============================================================================================== Column A Column B Column C Column D Column E Column F ============================================================================================== Percentage Insurance Gross Ceded To Other Assumed from of Amount Premiums Earned Amount Companies Other Companies Net Amount Assumed to Net - ---------------------------------------------------------------------------------------------- 1997 $11,496 $558 $11,909 $22,847 52% 1996 $9,979 $511 $9,869 $19,327 51% 1995 $13,063 $110 $3,892 $16,845 23%
F-42 Schedule VI KAYE GROUP INC SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS For the years ended December 31, 1997, 1996 and 1995 (in thousands)
========================================================================================================================== Column A Column B Column C Column D Column E Column F Column G Column H ========================================================================================================================== Claims and Claim Reserves For Adjustment Expenses Unpaid Claims Discount Incurred Related to Affiliation Deferred And Claim If Any Net (1) (2) With Acquisition Adjustment Deducted In Unearned Earned Investment Current Prior Registrant Costs Expenses Column C Premiums Premiums Income Year Years - -------------------------------------------------------------------------------------------------------------------------- Foreign $240 $204 N/A $1,132 $2,118 $127 $326 ($47) Domestic 3,699 18,922 N/A 11,446 20,729 2,565 8,498 (61) ---------------------------------------------------------------------------------------------------------- 1997 $3,939 $19,126 N/A $12,578 $22,847 $2,692 $8,824 ($108) ========================================================================================================== Foreign $295 $160 N/A $1,311 $1,542 $271 $313 ($1,580) Domestic 3,778 15,067 N/A 11,865 17,785 2,190 6,308 1,995 ---------------------------------------------------------------------------------------------------------- 1996 $4,073 $15,227 N/A $13,176 $19,327 $2,461 $6,621 $415 ========================================================================================================== Foreign $325 $6,268 N/A $1,443 $1,399 $742 $338 ($38) Domestic 3,378 6,403 N/A 10,471 15,446 2,077 4,648 (98) ---------------------------------------------------------------------------------------------------------- 1995 $3,703 $12,671 N/A $11,914 $16,845 $2,819 $4,986 ($136) ========================================================================================================== =========================================================================== Column A Column I Column J Column K Column L =========================================================================== Paid Amortization Claims Affiliation Of Deferred and Claim Other With Acquisition Adjustment Premiums Operating Registrant Costs Expenses Written Expenses - --------------------------------------------------------------------------- Foreign $456 $234 $1,938 $113 Domestic 6,813 6,512 20,332 1,988 ----------------------------------------------------------- 1997 $7,269 $6,746 $22,270 $2,101 =========================================================== Foreign $347 $3,637 $1,411 $167 Domestic 5,739 1,725 19,278 1,965 ----------------------------------------------------------- 1996 $6,086 $5,362 $20,689 $2,132 =========================================================== Foreign $316 $2,629 $2,127 $161 Domestic 4,878 3,668 13,033 1,573 ----------------------------------------------------------- 1995 $5,194 $6,297 $15,160 $1,734 ===========================================================
F-43 EX-10.15(III) 2 3RD AMENDMENT AND WAIVER TO THE CREDIT AGMT. THIRD AMENDMENT AND WAIVER TO THE CREDIT AGREEMENT Dated as of September 30, 1997 This THIRD AMENDMENT AND WAIVER dated as of September 30, 1997 (this "Third Amendment") is between Kaye Holding Corp., a Delaware corporation (the "Borrower"), and FLEET NATIONAL BANK, a national banking association, formerly known as Fleet National Bank of Connecticut and Shawmut Bank Connecticut, N.A. (the "Bank"). PRELIMINARY STATEMENTS. The Borrower and the Bank entered into a Credit Agreement dated as of October 2, 1995, which Credit Agreement was amended by a First Amendment to the Credit Agreement dated as of March 31, 1996 and by a Second Amendment to the Credit Agreement dated as of May 15, 1996 (as so amended, the "Credit Agreement"). The Borrower and the Bank wish to amend the Credit Agreement further to: (i) extend the Revolving Loan Termination Date, (ii) increase the Applicable Eurodollar Margin, (iii) amend the schedule pursuant to which the Bank's Commitment with respect to the Revolving Loans shall be automatically reduced, (iv) amend the covenant applicable to minimum interest coverage for the fiscal quarter ended September 30, 1997, (v) waive the covenant applicable to minimum fixed charge coverage for the fiscal quarters ending March 31, 1997 and June 30, 1997 and amend such covenant for each fiscal quarter thereafter, (vi) consent to the prepayment of the unsecured debt of Kaye Insurance Associates, Inc. and waive the covenants applicable to such prepayment and to Distributions to permit such prepayment and, (vii) consent to the merger of Kaye Holding Corp. into Kaye Group Inc. and waive the covenant applicable to mergers to permit such merger. NOW THEREFORE, the Borrower and the Bank agree as follows: Section 1. Amendments to the Credit Agreement. Effective as of September 30, 1997 and subject to the satisfaction of the conditions precedent set forth in Section 3 hereof, the Credit Agreement is hereby amended as follows: (a) Section 1.1 (Definitions) of the Credit Agreement is amended by substituting for the defined terms "Applicable Eurodollar Margin" and "Revolving Loan Termination Date" the following: "Applicable Eurodollar Margin" means, for each Eurodollar Rate Loan comprising part of the same Borrowing, an amount equal to 2.50% "Revolving Loan Termination Date" means June 30, 2001; provided, however, if not fewer than sixty (60) days nor more than ninety (90) days prior to each -2- Anniversary Date, the Borrower requests the Bank to extend the Revolving Loan Termination Date for an additional year and if the Bank, in its sole discretion in writing within thirty (30) days of such request, grants such request, the Revolving Loan Termination Date means the date to which the Revolving Loan Termination Date has been so extended. If such day is not a Business Day, the Revolving Loan Termination Date shall be the next preceding Business Day. (b) Subsection (a) of Section 2.5 (Quarterly Reduction of Commitment) of the Credit Agreement is replaced with the following: "(a) On each March 31, June 30, September 30 and December 31, of each calendar year commencing on September 30, 1996 (the "Reduction Commencement Date") until the Revolving Loan Termination Date, the Commitment of the Bank shall be reduced automatically by an amount equal to the following: $625,000 for each of such dates from and including September 30, 1996 to and including June 30, 1997 and $468,750 for each of such dates thereafter." (c) Subsection (a) of Section 2.8 (Interest on the Revolving Loans) of the Credit Agreement is replaced with the following: "(a) Each Base Rate Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Base Rate Loan is made until it becomes due, at a rate per annum equal to the Base Rate for such day. Interest shall be payable on the last day of the Interest Period applicable thereto. Such interest shall accrue from and including the date of such Borrowing to but excluding the date of any repayment thereof and shall be computed on the basis of a fraction, the numerator of which is the actual number of days elapsed from the date of Borrowing and the denominator of which is three hundred sixty (360). Overdue principal of and, to the extent permitted by law, overdue interest on the Base Rate Loans shall bear interest for each day until paid at a rate per annum equal to the Default Rate." (d) Section 7.10 (Capital Expenditures) of the Credit Agreement is replaced with the following: "Make or permit to be made any Capital Expenditure in any fiscal year, or commit to make any Capital Expenditure in any fiscal year, which when added to the aggregate Capital Expenditures of the Borrower and its Subsidiaries theretofore made or committed to be made in that fiscal year, would exceed $1,500,000 excluding the aggregate amount of rentals and other costs paid and payable in such fiscal year with respect to leases (other than Capital Leases)." -3- (e) Section 7.14 (Minimum Interest Coverage) of the Credit Agreement is amended to provide that for the fiscal quarter ending September 30, 1997, and only for such quarter, the minimum interest coverage requirement set forth in Section 7.14 shall be 2.75 to 1. (f) Section 7.15 (Minimum Fixed Charge Coverage) of the Credit Agreement is amended to provide that the minimum fixed charge coverage requirement set forth in Section 7.15 for the fiscal quarter ending September 30, 1997 shall be 1.1 to 1 and for each fiscal quarter thereafter shall be 1.25 to 1. Section 2. Waivers and Consents (a) The Bank hereby waives those Events of Default that occurred under the Credit Agreement as a result of the failure of the Borrower to comply with Section 7.14 for the fiscal quarters ending March 31, 1997 and June 30, 1997. (b) The Bank hereby consents to the prepayment (the "Prepayment") by the Borrower of $6,000,000 principal amount of unsecured debt of Kaye Insurance Associates, Inc. which debt has been assumed by the Borrower, and waives any Events of Default occurring under the Credit Agreement as a result of the failure of the Borrower thereby to comply with Sections 7.1(e) and 7.18 of the Credit Agreement. (c) The Bank hereby consents to the merger of Kaye Holding Corp. into Kaye Group Inc. (the "Merger") and waives any Events of Default occurring under the Credit Agreement as a result of the failure of the Borrower thereby to comply with Section 7.6 of the Credit Agreement. (d) Subject to Section 3, the foregoing waivers shall be effective only for those Events of Default specified in subsections (a), (b) and (c) above and shall not entitle the Borrower to any future waiver in similar or other circumstances. Section 3. Conditions of Effectiveness. Subject to the receipt by the Bank of a counterpart of this Third Amendment duly executed by the Borrower, this Third Amendment shall become effective as of September 30, 1997; provided, however, that the effectiveness of the consent and waiver with respect to the Merger described in Section 2(c) shall be subject to the execution and delivery by Kaye Group Inc. of (i) a confirmation and assumption agreement satisfactory to the Bank confirming Kaye Group Inc.'s assumption of all of the Borrower's obligations under the Credit Agreement and the Pledge Agreements and (ii) a replacement Revolving Note naming Kaye Group Inc. as borrower. -4- Section 4. Representations and Warranties of the Borrower. The Borrower represents as follows: (a) The execution, delivery and performance by the Borrower of this Third Amendment and the Prepayment have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of its shareholders; (ii) violate any provisions of its articles 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, Regulations U and X), order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to and binding upon the Borrower or any Subsidiary; (iv) result in a breach of or constitute a default or require any consent under any indenture or loan or credit agreement (other than the Credit Agreement) or any other material agreement, lease or instrument to which the Borrower or any Subsidiary is a party or by which it or its Properties may be bound; or (v) result in, or require, the creation or imposition of any Lien upon or with respect to any of the Properties now owned or hereafter acquired by the Borrower. (b) The consummation of the Merger will not (i) result in a breach of or constitute a default or require any consent under any indenture or loan or credit agreement (other than the Credit Agreement) or any other material agreement, lease or instrument to which the Borrower or any Subsidiary is a party or by which it or its Properties may be bound; or (ii) result in, or require, the creation or imposition of any Lien upon or with respect to any of the Properties now owned or hereafter acquired by the Borrower. (c) No authorization, consent, approval, order, license or permit from, or filing, registration or qualification with, or exemption by, any governmental or public body or authority, or any subdivision thereof, or any other Person, is required to authorize, or is required in connection with the execution, delivery and performance by the Borrower of, or the legality, validity, binding effect or enforceability of, this Third Amendment. (d) This Third Amendment, when delivered, will constitute the legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with its terms, except to the extent that such enforcement may be limited by applicable bankruptcy, insolvency and other similar laws affecting creditors' rights generally and by general principles of equity. (e) The representations and warranties contained in Article 5 of the Credit Agreement are correct on and as of the date hereof as though made on and as of the date hereof. (f) Except for those waived by this Third Amendment, no Event of Default or Default has occurred and is continuing or would result from the signing of this Third Amendment, the Prepayment or the Merger or the transactions contemplated hereby. -5- (g) There has been no material adverse change in the financial condition, operations, Properties, business or business prospects of the Borrower and its Subsidiaries, if any, since the date of the last financial statements furnished to the Bank. (h) No actions, suits or proceedings or investigations (other than routine examinations performed by insurance regulatory authorities) are pending or, to the knowledge of the Borrower, threatened against or affecting the Borrower or any Subsidiary, or any Property of any of them before any court, governmental agency or arbitrator, which, if determined adversely to the Borrower or any Subsidiary, would, in any one case or in the aggregate, materially adversely affect the financial condition, operations, Properties, business or, to the knowledge of the Borrower, prospects of the Borrower and its Subsidiaries taken as a whole or the ability of the Borrower to perform its obligations under the Credit Agreement, as amended by this Third Amendment. (i) No information, exhibit or report furnished in writing by or on behalf of the Borrower or any officer or director of the Borrower to the Bank in connection with the negotiation of, or pursuant to the terms of, this Third Amendment 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. Reference to and Effect on the Credit Agreement. (a) Upon the effectiveness of this Third Amendment, on and after the date hereof, each reference in the Credit Agreement to "this Credit Agreement", "hereunder", "hereof", "herein" or words of like import and each reference in the Revolving Note to the Credit Agreement shall mean and be a reference to the Credit Agreement as amended hereby. (b) Except as specifically amended above, the Credit Agreement shall remain in full force and effect and is hereby ratified and confirmed. (c) The execution, delivery and effectiveness of this Third Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of the Bank under the Credit Agreement, nor constitute a waiver of any provision of the Credit Agreement. Section 6. Costs, Expenses and Taxes. The Borrower agrees to pay on demand all reasonable costs and expenses of the Bank in connection with the preparation, execution and delivery of this Third Amendment and any other instruments and documents to be delivered hereunder, including, without limitation, the reasonable fees and out-of-pocket expenses of counsel for the Bank with respect thereto and with respect to advising the Bank as to its rights and responsibilities hereunder. In addition, the Borrower shall pay any and all stamp and other -6- taxes payable or determined to be payable in connection with the execution and delivery of this Third Amendment and any other instruments and documents to be delivered hereunder, and agrees to save the Bank harmless from and against any and all liabilities with respect to or resulting from any delay in paying or omission to pay such taxes. Section 7. Execution in Counterparts. This Third Amendment may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. Section 8. Governing Law. This Third Amendment shall be governed by, and construed in accordance with, the laws of the State of Connecticut. Section 9. Defined Terms. Capitalized terms used herein which are not expressly defined herein shall have the meanings ascribed to them in the Credit Agreement. [Remainder of page intentionally left blank] -7- IN WITNESS WHEREOF, the parties hereto have caused this Third Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written. KAYE HOLDING CORP. By ---------------------------------- Name: Title: FLEET NATIONAL BANK By /s/ Vijay Nazareth Name: Vijay Nazareth Title: Vice President EX-11 3 CALCULATION OF EARNINGS PER SHARE EXIBIT 11 PAGE 1 OF 2 KAYE GROUP INC Earnings Per Share Calculation For the Year Ended December 31, 1997 Net Income $4,357,000(1) I. Weighted Average Shares: 1/01/97-12/30/97 (364/365 X 7,020,000) 7,000,767 12/31/97 (1/365 X 8,474,435) 23,217 ---------- Weighted Average Shares 7,023,984(2) ========== II. Basic E/P/S 0.6203(3) = (1) / (2) ========== III. Diluted E/P/S Weighted Average Shares 7,023,984(2) Dilution 58,753(4) ---------- 7,082,737(5) ========== Diluted E/P/S 0.6152(6) = (1) / (5) ========== EXHIBIT 11 PAGE 1 OF 2
IV. Options outstanding Dilutive Shares Weighted Units Price/Share Proceeds Average Proceeds ======= ================== ========== ======= ========= A. Options (8/17/93) 84,750 $ 10.000 $ 847,500 Warrants (8/17/93) 105,000 10.000 1,050,000 Options (1/24/94) 5,000 10.910 54,550 Options (2/3/94) 500 11.625 5,813 Options (9/13/95) 15,000 7.880 118,200 Options (10/20/95) 43,850 8.430 369,656 Options (5/15/96) 10,000 7.060 70,600 Options (12/27/96) 15,000 5.000 75,000 15,000 75,000 Options (2/1/97) 35,000 5.000 175,000 32,083 160,417 Options (2/25/97) 185,750 5.060 939,895 154,792 783,246 Options (4/15/97) 200,000 5.000 1,000,000 141,667 708,333 Options (7/1/97) 10,000 4.970 49,700 5,000 24,850 Options (10/31/97) 15,000 8.030 120,450 Options (12/31/97) 5,000 6.640 33,200 ------- ---------- ------- --------- 729,850 $4,876,363 348,542(7) 1,751,846(8) ======= ========== ======= ========= V. Average market value/share Average Average Average Close on High Low Close last day ======= ================== ========== ========= Jan 5.025 4.800 4.850 Feb 5.143 4.958 5.100 Mar 4.833 4.806 4.806 4.500 ---------- Hash total 3 mths 14.756 ========== April 4.725 4.644 4.650 May 4.982 4.946 4.982 June 5.000 4.917 4.964 5.000 ---------- Hash total 3 mths 14.596 ========== July 5.925 5.738 5.856 Aug 7.758 7.625 7.688 Sept 8.667 8.442 8.508 8.375 ---------- Hash total 3 mths 22.052 ========== Oct 7.913 7.663 7.722 Nov 7.015 6.787 6.838 Dec 6.633 6.546 6.579 6.625 ---------- Hash total 3 mths 21.139 ========== Hash total 12 mths 72.543 ========== / 12 Average price per share twelve mths 6.045 ========== VII. Diluted Year Ended ------------------ Total Proceeds from exercise $ 1,751,846(8) Divided by average price 6.045 Repurchase shares of 289,789 Shares issued (options) 348,542(7) ------------------ Dilution - Shares 58,753(4) ==================
EX-23 4 CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Kaye Group Inc. on Form S-8 of our report dated February 25, 1998, on our audits of the consolidated financial statements and financial statement schedules of Kaye Group Inc. as of December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996, and 1995, which is included in this Annual Report on Form 10-K. COOPERS & LYBRAND L.L.P. New York, New York March 27, 1998 EX-27 5 FDS
7 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 41,486 0 0 2,209 0 0 47,125 31,307 0 3,939 141,025 0 12,578 0 122 8,119 0 0 85 35,083 141,025 22,847 4,312 21 31,369 8,716 9,370 0 7,555 2,267 4,357 0 0 0 4,357 0.62 0.62 15,227 8,260 1,820 5,013 1,168 19,126 (267)
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