-----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, QZShZ2nzu4RXJCqNPtiUGxKSs6yMWXffl6hvHvrNxGsOFhfR7w6LUcQiRB1dIvSb WjdnGKMzYM+coWEt3URDjg== 0001047469-97-004785.txt : 19971117 0001047469-97-004785.hdr.sgml : 19971117 ACCESSION NUMBER: 0001047469-97-004785 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: RISK CAPITAL HOLDINGS INC CENTRAL INDEX KEY: 0000947484 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 061424716 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26456 FILM NUMBER: 97719227 BUSINESS ADDRESS: STREET 1: 20 HORSENECK LANE CITY: GREENWICH STATE: CT ZIP: 06830 BUSINESS PHONE: 2038624300 MAIL ADDRESS: STREET 1: 20 HORSENECK LANE CITY: GREENWICH STATE: CT ZIP: 06830 FORMER COMPANY: FORMER CONFORMED NAME: RISK CAPITAL RE INC DATE OF NAME CHANGE: 19950703 10-Q 1 FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997. Or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period __________________ to _____________________ Commission file number: 0-26456 RISK CAPITAL HOLDINGS, INC. (Exact name of registrant as specified in its charter) Delaware 06-1424716 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 20 Horseneck Lane Greenwich, Connecticut 06830 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 862-4300 - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes_ X_ No___ Indicate the number of shares outstanding of each of the issuer's classes of common stock. Class Outstanding at September 30, 1997 ----- ---------------------------------- Common Stock, $.01 par value 17,034,753
================================================================================ RISK CAPITAL HOLDINGS, INC. INDEX
PAGE NO. ----- PART I. Financial Information Item 1--Consolidated Financial Statements Review Report of Independent Accountants 1 Consolidated Statement of Income 2 For the three and nine month periods ended September 30, 1997 and 1996 Consolidated Balance Sheet 3 September 30, 1997 and December 31, 1996 Consolidated Statement of Changes in Stockholders' Equity For the nine month periods ended September 30, 1997 and 1996 4 Consolidated Statement of Cash Flows For the nine month periods ended September 30, 1997 and 1996 5 Notes to Consolidated Financial Statements 6 Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II. Other Information Item 6--Exhibits and Reports on Form 8-K 18 Signatures 19
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Risk Capital Holdings, Inc. We have reviewed the accompanying interim consolidated balance sheet of Risk Capital Holdings, Inc. and its subsidiary as of September 30, 1997, and the related consolidated statements of income, of changes in stockholders' equity and of cash flows for the period from January 1, 1997 to September 30, 1997. This financial information is the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated financial information for it to be in conformity with generally accepted accounting principles. We previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet as of December 31, 1996, and the related consolidated statements of income, of retained earnings, and of cash flows for the year then ended (not presented herein), and in our report dated February 7, 1997 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1996, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. PRICE WATERHOUSE LLP New York, New York October 29, 1997 RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF INCOME (in thousands, except per share data) (unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- --------------------------------- 1997 1996 1997 1996 ------------ -------------- ------------------ ------------- Premiums and Other Revenues Net premiums written............................. $ 34,906 $ 29,938 $ 98,862 $ 53,509 Increase in unearned premiums.................... (10,251) (17,310) (33,234) (35,270) ------------ -------------- ------------------ ------------ Net premiums earned.............................. 24,655 12,628 65,628 18,239 Net investment income............................ 3,798 3,289 10,774 9,833 Net investment gains/(losses).................... 4,062 (109) 3,617 145 ------------ -------------- ------------------ ------------ Total revenues................................... 32,515 15,808 80,019 28,217 Expenses Claims and claims expenses....................... 18,041 8,240 45,992 12,286 Commissions and brokerage........................ 6,217 3,752 17,740 5,241 Other operating expenses......................... 3,397 2,894 10,842 8,018 ------------ -------------- ------------------ ------------ Total expenses................................... 27,655 14,886 74,574 25,545 Income Before Income Taxes and Equity in Net Losses of Investees............................ 4,860 922 5,445 2,672 Federal income taxes: Current.......................................... 507 600 1,182 1,477 Deferred......................................... 930 (597) (7) (1,516) ------------ -------------- ------------------ ------------ Income tax expense (benefit)..................... 1,437 3 1,175 (39) ------------ -------------- ------------------ ------------ Income Before Equity in Net Loss of Investees.... 3,423 919 4,270 2,711 Equity in net loss of investees.................. (168) (473) ------------ -------------- ------------------ ------------ Net Income....................................... $ 3,255 $ 919 $ 3,797 $ 2,711 ------------ -------------- ------------------ ------------ ------------ -------------- ------------------ ------------ Per Share Data Primary and fully diluted Net income....................................... $ 0.19 $ 0.05 $ 0.22 $ 0.16 ------------ -------------- ------------------ ------------ ------------ -------------- ------------------ ------------ Operating income: net income excluding net investment gains/(losses) and equity in net loss of investees.............................. $ 0.05 $ 0.06 $ 0.11 $ 0.15 ------------ -------------- ------------------ ------------ ------------ -------------- ------------------ ------------ Average shares outstanding....................... 17,034,977 16,994,948 17,027,778 16,971,827 ------------ -------------- ------------------ ------------ ------------ -------------- ------------------ ------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2 RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET (in thousands, except per share data)
(unaudited) SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------ ------------ ASSETS Investments: Fixed maturities (amortized cost: 1997, $131,393; 1996, $140,128)................................................... $ 132,945 $ 140,381 Publicly traded equity securities (cost: 1997, $115,101; 1996, $108,580)............................................................. 174,302 117,360 Privately held securities (cost: 1997, $44,043; 1996, $23,363)............................................................... 57,760 28,847 Short-term investments............................................................................... 110,893 104,886 --------- --------- Total investments.................................................................................. 475,900 391,474 --------- --------- Cash................................................................................................. 4,090 1,466 Accrued investment income............................................................................ 2,706 2,151 Investment accounts receivable....................................................................... 1,738 560 Premiums receivable.................................................................................. 47,296 23,669 Prepaid reinsurance premiums......................................................................... 1,296 576 Reinsurance recoverable.............................................................................. 353 522 Deferred policy acquisition costs.................................................................... 15,500 7,018 Other assets......................................................................................... 8,309 5,050 --------- --------- Total Assets......................................................................................... $ 557,188 $ 432,486 --------- --------- --------- --------- LIABILITIES Claims and claims expenses........................................................................... $ 52,733 $ 20,770 Unearned premiums.................................................................................... 71,301 37,348 Reinsurance premiums payable......................................................................... 536 Contingent commissions payable....................................................................... 5,964 2,734 Investment accounts payable.......................................................................... 2,649 10,598 Deferred income tax liability........................................................................ 23,747 3,026 Other liabilities.................................................................................... 4,594 5,261 --------- --------- Total liabilities.................................................................................. 160,988 80,273 --------- --------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value: 20,000,000 shares authorized (none issued) Common stock, $.01 par value: 80,000,000 shares authorized (1997, 17,045,246; 1996, 17,031,246 shares issued)................................................. 170 170 Additional paid-in capital........................................................................... 340,715 340,435 Unrealized appreciation of investments, net of income tax............................................ 48,406 9,436 Deferred compensation under stock award plan......................................................... (1,841) (2,959) Retained earnings.................................................................................... 8,928 5,131 Less treasury stock, at cost (1997, 10,493 shares)................................................... (178) --------- --------- Total stockholders' equity........................................................................... 396,200 352,213 --------- --------- Total liabilities & stockholders' equity............................................................. $ 557,188 $ 432,486 --------- --------- --------- ---------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3 RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands)
(UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1997 1996 ---------- ---------- Common Stock Balance at beginning of year............................................................ $ 170 $ 169 Issuance of common stock................................................................ 1 ---------- ---------- Balance at end of period................................................................ 170 170 ---------- ---------- Additional Paid-in Capital Balance at beginning of year............................................................ 340,435 338,737 Issuance of common stock................................................................ 280 1,197 ---------- ---------- Balance at end of period................................................................ 340,715 339,934 ---------- ---------- Unrealized Appreciation of Investments, Net of Income Tax Balance at beginning of year............................................................ 9,436 3,731 Change in unrealized appreciation....................................................... 38,970 3,780 ---------- ---------- Balance at end of period................................................................ 48,406 7,511 ---------- ---------- Deferred Compensation Under Stock Award Plan Balance at beginning of year............................................................ (2,959) (3,441) Restricted common stock issued.......................................................... (280) (1,196) Compensation expense recognized......................................................... 1,398 1,559 ---------- ---------- Balance at end of period................................................................ (1,841) (3,078) ---------- ---------- Retained Earnings Balance at beginning of year............................................................ 5,131 1,019 Net income.............................................................................. 3,797 2,711 ---------- ---------- Balance at end of period................................................................ 8,928 3,730 ---------- ---------- Treasury Stock, At Cost Balance at beginning of year Purchase of treasury shares............................................................. (178) ---------- ---------- Balance at end of period................................................................ (178) ---------- ---------- Total Stockholders' Equity Balance at beginning of year............................................................ 352,213 340,215 Issuance of common stock................................................................ 280 1,198 Change in unrealized appreciation of investments, net of income tax..................... 38,970 3,780 Change in deferred compensation......................................................... 1,118 363 Net income.............................................................................. 3,797 2,711 Purchase of treasury stock.............................................................. (178) ---------- ---------- Balance at end of period................................................................ $ 396,200 $ 348,267 ---------- ---------- ---------- ----------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4 RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
(UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1997 1996 ---------- ---------- OPERATING ACTIVITIES Net income................................................................................ $ 3,797 $ 2,711 Adjustments to reconcile net income to net cash provided by operating activities: Liability for claims and claims expenses, net........................................... 31,963 11,125 Unearned premiums....................................................................... 33,953 35,270 Premiums receivable..................................................................... (23,627) (15,372) Funds held receivable................................................................... (625) (615) Accrued investment income............................................................... (555) 313 Contingent commissions payable.......................................................... 3,230 Reinsurance balances, net............................................................... (1,086) 279 Deferred policy acquisition costs....................................................... (8,482) (5,701) Net investment gains.................................................................... (3,617) (145) Deferred income tax asset............................................................... (261) (1,516) Other liabilities....................................................................... (667) (65) Other items, net........................................................................ (3,341) (1,758) ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES................................................. 30,682 24,526 ---------- ---------- INVESTING ACTIVITIES Purchases of fixed maturity investments................................................... (172,367) (199,355) Sales of fixed maturity investments....................................................... 172,973 188,449 Net (purchases)/sales of short-term investments........................................... (2,830) 81,096 Purchases of equity securities............................................................ (55,853) (103,876) Sales of equity securities................................................................ 30,740 9,017 Purchases of furniture and equipment...................................................... (543) (702) ---------- ---------- NET CASH USED FOR INVESTING ACTIVITIES.................................................... (27,880) (25,371) ---------- ---------- FINANCING ACTIVITIES Common stock issued....................................................................... 280 1,198 Purchase of treasury stock................................................................ (178) Deferred compensation on restricted stock................................................. (280) (1,196) ---------- ---------- NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES...................................... (178) 2 ---------- ---------- Increase (decrease) in cash............................................................... 2,624 (843) Cash beginning of year.................................................................... 1,466 982 ---------- ---------- Cash end of period........................................................................ $ 4,090 $ 139 ---------- ---------- ---------- ----------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5 RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Risk Capital Holdings, Inc. ("RCHI"), incorporated in March 1995 under the laws of the State of Delaware, is a holding company whose wholly owned subsidiary, Risk Capital Reinsurance Company ("Risk Capital Reinsurance"), a Nebraska corporation, was formed to provide, on a global basis, property and casualty reinsurance and other forms of capital, either on a stand-alone basis or as part of integrated capital solutions for insurance companies with capital needs that cannot be met by reinsurance alone. (RCHI and Risk Capital Reinsurance are collectively referred to herein as the "Company.") In September 1995, through its initial public offering, related exercise of the underwriters' over-allotment option and direct sales of an aggregate of 16,750,625 shares of RCHI's common stock, par value $.01 per share (the "Common Stock"), at $20 per share, and the issuance of warrants, RCHI was capitalized with net proceeds of approximately $335.0 million, of which $328.0 million was contributed to the statutory capital of Risk Capital Reinsurance. Class A warrants to purchase an aggregate of 2,531,079 shares of Common Stock and Class B warrants to purchase an aggregate of 1,920,601 shares of Common Stock were issued in connection with the direct sales. Class A warrants are immediately exercisable at $20 per share and expire September 19, 2002. Class B warrants are exercisable at $20 per share during the seven year period commencing September 19, 1998, provided that the Common Stock has traded at or above $30 per share for 20 out of 30 consecutive trading days. 2. GENERAL The accompanying interim consolidated financial statements have been prepared in conformity with generally accepted accounting principles and in the opinion of management, reflect all adjustments necessary (consisting of normal recurring accruals) for a fair presentation of results for such periods. These consolidated financial statements should be read in conjunction with the 1996 consolidated financial statements and related notes contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. 3. PER SHARE DATA Earnings per share are computed based on the weighted average number of shares of Common Stock and common stock equivalents outstanding during the period using the modified treasury stock method. Stock options and Class A and B warrants to purchase Common Stock are considered to be common stock equivalents. The common stock equivalents were anti-dilutive, and thus not included in the weighted average shares outstanding. 6 In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share." This statement replaces the historical presentation of "primary" earnings per share with the caption "basic" earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average number of shares outstanding for the period. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997, with early adoption prohibited. Upon adoption, all prior period earnings per share amounts will be restated. The Company's primary and fully diluted earnings per share amounts as previously reported are not expected to differ materially from the basic and diluted amounts required by SFAS No. 128. In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income". This statement establishes standards for the reporting of comprehensive income and its components. Comprehensive income is defined as the change in equity during a period resulting from transactions and other events from nonowner sources. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company will apply the provisions of the statement beginning in 1998. Currently, comprehensive income for the Company would consist of net income and the change in unrealized appreciation or depreciation of investments, net of income tax, as follows:
(IN THOUSANDS) --------------------------------- NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, -------------------- ---------------------- 1997 1996 1996 1995 (1) --------- --------- --------- ----------- Net income............................................................... $ 3,797 $ 2,711 $ 4,112 $ 1,019 Change in unrealized appreciation (depreciation), net of income tax...... 38,970 3,780 5,705 3,731 --------- --------- --------- ----------- Comprehensive income (loss).............................................. $ 42,767 $ 6,491 $ 9,817 $ 4,750 --------- --------- --------- ----------- --------- --------- --------- ----------- Per share amounts: Net income............................................................... $ 0.22 $ 0.16 $ 0.24 $ 0.06 Change in unrealized appreciation (depreciation), net of income tax...... 2.29 .22 0.34 0.22 --------- --------- --------- ----------- Comprehensive income (loss).............................................. $ 2.51 $ 0.38 $ 0.58 $ 0.28 --------- --------- --------- ----------- --------- --------- --------- -----------
- ------------------------ (1) For the period from June 23, 1995 (date of inception) to December 31, 1995 7 4. INVESTMENT INFORMATION The Company classifies all of its publicly traded fixed maturity and equity securities as "available for sale" and accordingly, they are carried at estimated fair value. The fair value of publicly traded fixed maturity securities and publicly traded equity securities is estimated using quoted market prices or dealer quotes. Short-term investments, which have a maturity of one year or less at the date of acquisition, are carried at cost, which approximates fair value. All of the Company's publicly traded equity securities and privately held securities were issued by insurance and reinsurance companies or companies providing services to the insurance industry. At September 30, 1997, the publicly traded equity portfolio consisted of 11 investments, with estimated fair values ranging individually from $2.8 million to $25.1 million. Investments in privately held securities, issued by privately and publicly held companies, may include both equity securities and securities convertible into, or exercisable for, equity securities (some of which may have fixed maturities). Privately held securities are subject to trading restrictions or are otherwise illiquid and do not have readily ascertainable market values. The risk of investing in such securities is generally greater than the risk of investing in securities of widely held, publicly traded companies. Lack of a secondary market and resale restrictions may result in the Company's inability to sell a security at a price that would otherwise be obtainable if such restrictions did not exist and may substantially delay the sale of a security which the Company seeks to sell. Such investments are classified as "available for sale" and carried at estimated fair value, except for investments in which the Company believes it has the ability to exercise significant influence (generally defined as investments in which the Company owns 20% or more of the outstanding voting common stock of the issuer), which are carried under the equity method of accounting. Under this method, the Company records its proportionate share of income or loss for such investments in results of operations. The estimated fair value of investments in privately held securities, other than those carried under the equity method, is initially equal to the cost of such investments until the investments are revalued based principally on substantive events or other factors which could indicate a diminution or appreciation in value, such as an arm's-length third party transaction justifying an increased valuation or adverse development of a significant nature requiring a write down. The Company periodically reviews the valuation of investments in privately held securities with Marsh & McLennan Risk Capital Corp., its equity investment advisor. 8 Privately held securities consisted of the following:
(IN THOUSANDS) --------------------------- SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ Equity Securities: Carried under the equity method: The ARC Group, LLC.................................................................. $ 9,855 Capital Protection Insurance Services, LLC.......................................... 144 First American Financial Corporation................................................ 6,362 Insurance Investment Group, L.P..................................................... $ 180 Island Heritage Insurance Company, Ltd.............................................. 4,019 4,269 New Europe Insurance Ventures....................................................... 743 Providers' Assurance Corporation.................................................... 3,749 Carried at fair value: Peregrine Russell Miller Insurance Fund of Asia Limited............................. 6,591 7,465 Terra Nova (Bermuda) Holdings, Ltd.................................................. 21,590 15,870 Sovereign Risk Insurance, Ltd....................................................... 237 Venton Holdings, Ltd................................................................ 4,470 1,063 ------------- ------------ Total privately held equities..................................................... $ 57,760 $ 28,847 ------------- ------------ ------------- ------------
At September 30, 1997, the Company had investment commitments relating to its privately held securities totaling approximately $18 million, compared to $22 million at December 31, 1996. Set forth below is certain information relating to each of the Company's investments in privately held securities which occurred during the third quarter of 1997: INSURANCE INVESTMENT GROUP, LP During the 1997 third quarter, the Company determined to terminate its participation in this investment and recorded a realized loss of $312,000 during the quarter, which represents the Company's initial funding amount of $180,000 and an estimate of additional costs the Company expected to incur in exiting the partnership. Sovereign Risk Insurance, Ltd. In July 1997, the Company purchased its 9.5% ownership interest in Sovereign Risk Insurance Ltd. ("Sovereign Risk") for $237,500. Sovereign Risk is located in Bermuda and was formed to provide underwriting services for political risk insurance coverages for ACE Insurance Company, Ltd., X.L. Insurance Company, Ltd. and Risk Capital Reinsurance. 5. STATUTORY DATA The statutory capital and surplus of Risk Capital Reinsurance at September 30, 1997 was $386.1 million, compared to $334.3 million at December 31, 1996. The statutory net loss for the nine month period ended September 30, 1997 was $4.3 million, compared to a net loss of $4.5 million in the prior year period. The growth in surplus during the first nine months of 1997 is primarily from unrealized appreciation of the Company's public equity portfolio. 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General THE COMPANY Risk Capital Holdings, Inc. ("RCHI") is the holding company for Risk Capital Reinsurance Company ("Risk Capital Reinsurance"), RCHI's wholly owned subsidiary which is domiciled in Nebraska. (RCHI and Risk Capital Reinsurance are collectively referred to herein as the "Company".) RCHI was incorporated in March 1995 and commenced operations during September 1995 upon completion of its initial public offering and related exercise of the underwriters' over-allotment option and direct sales of an aggregate of 16,750,625 shares of RCHI's common stock, par value $.01 per share, at $20 per share, and the issuance of warrants (collectively, the "Offerings"). RCHI received aggregate net proceeds from the Offerings of approximately $335.0 million, of which $328.0 million was contributed to the capital of Risk Capital Reinsurance. On November 6, 1995, Risk Capital Reinsurance was licensed under the insurance laws of the State of Nebraska. RECENT INDUSTRY PERFORMANCE The property and casualty reinsurance industry has been highly cyclical. This cyclicality has produced periods characterized by intense price competition due to excessive underwriting capacity as well as periods when shortage of capacity permitted favorable premium levels. Demand for reinsurance is influenced significantly by underwriting results of primary property and casualty insurers and prevailing general economic and market conditions, all of which affect liability retention decisions of primary insurers and reinsurance premium rates. The supply of reinsurance is related directly to prevailing prices and levels of surplus capacity, which, in turn, may fluctuate in response to changes in rates of return on investments being realized in the reinsurance industry. The cyclical trends in the industry and the industry's profitability can also be affected significantly by volatile and unpredictable developments, including changes in the propensity of courts to grant larger awards, natural disasters (such as catastrophic hurricanes, windstorms, earthquakes, floods and fires), fluctuations in interest rates and other changes in the investment environment that affect market prices of investments and the income and returns on investments, and inflationary pressures that may tend to affect the size of losses experienced by ceding primary insurers. Reinsurance treaties that are placed by intermediaries are typically for one year terms with a substantial number that are written or renewed on January 1 each year. Other significant renewal dates include April 1, July 1 and October 1. Thus far, the 1997 renewal periods have been marked by continuing intensified competitive conditions in terms of premium rates and treaty terms and conditions in both the property and casualty segments of the marketplace. These conditions have worsened due to large domestic primary companies retaining more of their business and ceding less premiums to reinsurers. While the Company is initially somewhat disadvantaged compared with many of its competitors, which are larger, have greater resources and longer operating histories than the Company, it believes it has been able to generate attractive opportunities in the marketplace due to its substantial unencumbered capital base, experienced management team and relationship with its equity investment advisor as well as its strategic focus on generating a small number of large reinsurance treaty transactions that may also be integrated with an equity investment in client companies. 10 As of October 30, 1997, the Company had 72 in-force treaties, with approximately $160 million of annualized in-force premiums. Such in-force premiums represent estimated annualized premiums from treaties entered into during 1996 and the 1997 renewal periods that are expected to generate net premiums written during calendar year 1997. All except one of such treaties are subject to renewal. RESULTS OF OPERATIONS For the nine month periods ended September 30, 1997 and 1996, the Company had consolidated net income of approximately $3.8 million, or $0.22 per share, and $2.7 million, or $0.16 per share, respectively. After-tax realized investment gains of $2.4 million, or $0.14 per share, for the first nine months of 1997, compare with a net investment gain of $94,000, or $0.01 per share, for the same prior year period. Net income for the first nine months of 1997 included an after-tax loss of $0.5 million, or $0.02 per share, representing the Company's equity in the net loss of investee companies, which are accounted for under the equity method of accounting. The Company believes that the results of operations for the nine months ended September 30, 1997 are not necessarily indicative of its future financial results due to a number of factors, including (i) the increase in net premiums written indicated by the Company's January 1 and subsequent 1997 renewal season activity, (ii) the Company's emphasis on targeting casualty business that is longer-tail than its current mix of business and (iii) the Company's investment strategy. Increased premium writings, particularly longer-tail casualty business, can generally be expected to generate higher underwriting losses because of the related requirement to establish claims liabilities that are adequate to cover the costs of anticipated future claim payments without taking into account the time value of money. The amount of investment income earned that may offset underwriting losses from quarter to quarter could vary and diminish as the Company continues to employ its strategy of investing a substantial portion of its investment portfolio in publicly traded and privately held equity securities of insurance companies and insurance-related entities. Investments in equity securities yield less current investment income than fixed maturity investments. Variability and declines in the Company's results of operations could be further exacerbated by private equity investments in start-up companies which are accounted for under the equity method. Such start-up companies may be expected to initially generate operating losses. The Company's results may also be impacted by currency gains and losses for business transacted in currencies other than U.S. dollars. Accordingly, the Company's results of operations for the year ending December 31, 1997 may vary from quarter to quarter and from the financial results reported by the Company in 1996, and could also produce operating losses. At September 30, 1997, primary and fully-diluted book value per share were $23.26 and $22.35, respectively, which compare with primary and fully-diluted book value per share of $20.68 at December 31, 1996. For the first nine months of 1997, unrealized appreciation increased by $39.0 million, net of tax, or $2.29 per share. Included in the change in unrealized appreciation for the 1997 nine-month period is an unrealized gain, net of tax, of $2.2 million, or $0.13 per share, relating to the Company's privately held equity investment in Venton Holdings, Ltd. 11 Unrealized appreciation or depreciation of investments to the extent that it occurs for investments carried at fair value is recorded in a separate component of stockholders' equity, net of related deferred income taxes. Such gains or losses are recorded in net income to the extent investments are sold. The timing and recognition of such gains and losses are unpredictable and not indicative of future operating results. NET PREMIUMS WRITTEN Net premiums written for the nine month periods ended September 30, 1997 and 1996 were as follows:
(IN MILLIONS) NINE MONTHS ENDED SEPTEMBER 30, -------------------- 1997 1996 --------- --------- Property....................................... $ 14.1 $ 12.4 Casualty....................................... 50.8 11.3 Multi-line..................................... 24.6 18.7 Specialty...................................... 8.1 11.1 Marine......................................... 1.3 --------- --------- Total.......................................... $ 98.9 $ 53.5 --------- --------- --------- ---------
Approximately 29% of net premiums written in the first nine months of 1997 was from non-U.S. clients, compared with 32% in the first nine months of 1996. Set forth below is the Company's statutory composite ratios for the nine month periods ended September 30, 1997 and 1996:
NINE MONTHS ENDED SEPTEMBER 30, -------------------- 1997 1996 --------- --------- Claims and claims expense ratio............................ 70.1% 67.4% Commissions and brokerage ratio............................ 26.5% 20.4% Operating expense ratio.................................... 10.0% 14.7% --------- --------- Statutory composite ratio.................................. 106.6% 102.5% --------- --------- --------- ---------
Given the low level of premium volume the Company may initially generate and the long-term nature of the casualty business which the Company seeks to write, it is likely that earned premiums will be insufficient to cover claims costs, acquisition costs and operating expenses, thereby resulting in continued underwriting losses in 1997. In pricing its reinsurance treaties, the Company focuses on many factors, including exposure to claims and commissions and brokerage expenses. Commissions and brokerage expenses are acquisition costs that generally vary by the type of treaty and line of business, and are considered by the Company's underwriting and actuarial staff in evaluating the adequacy of premium writings. 12 Other operating expenses increased to $10.8 million for the first nine months of 1997, compared to $8.0 million for the 1996 prior year period. Assuming the successful execution of the Company's business strategy, the Company expects other operating expenses to grow commensurate with growing operations, but expects other operating expenses to decline moderately as a percentage of net premiums written because increases in premium writings are generally expected to exceed the growth in such expenses. Included in 1997 other operating expenses is a pre-tax foreign exchange loss of $654,000. Such loss is principally related to assets and premiums receivable of approximately $5.8 million denominated in European Currency Units ("ECU's"), which is recorded separately from statutory underwriting results and therefore excluded from the statutory composite ratio. Unhedged monetary assets and liabilities are translated at the exchange rate in effect at the balance sheet date, with the resulting foreign exchange gains or losses recognized in income. Such future gains or losses are unpredictable, and could be material. INVESTMENT RESULTS At September 30, 1997, approximately 51% of the Company's invested assets, short-term investments and cash consisted of fixed maturity and short-term investments compared to 63% at the end of 1996. Net investment income for the first nine months of 1997 was approximately $10.8 million, compared to $9.8 million for the prior year period. The amount of investment income from quarter to quarter could vary and diminish as the Company continues to employ its strategy of investing a substantial portion of its investment portfolio in publicly traded and privately held equity securities of insurance companies which generally yield less current investment income than fixed maturity investments. Unrealized appreciation or depreciation of such investments to the extent that it occurs is recorded in a separate component of stockholders' equity, net of related deferred income taxes. Gains or losses are recorded in net income to the extent investments are sold, but the recognition of such gains and losses is unpredictable and not indicative of future operating results. INCOME TAXES The Company's effective tax rates for the first nine months of 1997 and 1996 are less than the 35% statutory rate on pre-tax operating income due to tax exempt income and the dividends received deductions. The gross deferred income tax benefits for the first nine months of 1997 and 1996 of approximately $262,000 and $1.5 million, respectively, which are assets considered recoverable from future taxable income, resulted principally from temporary differences between financial and taxable income. Temporary differences include, among other things, charges for restricted stock grants which are not deductible for income tax purposes until vested (vesting of existing restricted stock grants will occur over a five-year period), as well as charges for a portion of unearned premiums and claims reserves and equity in net loss of investees. 13 INVESTMENTS A principal component of the Company's investment strategy is investing a significant portion of invested assets in publicly traded and privately held equity securities, primarily issued by insurance and reinsurance companies and companies providing services to the insurance industry. Cash and fixed maturity investments and, if necessary, the sale of publicly traded equity securities will be used to support shorter-term liquidity requirements. As a significant portion of the Company's investment portfolio will generally be equity securities issued by insurance and reinsurance companies and companies providing services to the insurance industry, the equity portfolio lacks industry diversification and will be particularly subject to the cyclicallity of the insurance industry. Unlike fixed income securities, equity securities such as common stocks, including the equity securities in which the Company may invest, generally are not and will not be rated by any nationally recognized rating service. The values of equity securities generally are more dependent on the financial condition of the issuer and less dependent on fluctuations in interest rates than are the values of fixed income securities. The market value of equity securities generally is regarded as more volatile than the market value of fixed income securities. The effects of such volatility on the Company's equity portfolio could be exacerbated to the extent that such portfolio is concentrated in the insurance industry and in relatively few issuers. As the Company's investment strategy is to invest a significant portion of its investment portfolio in equity securities, its investment income in any fiscal period may be smaller, as a percentage of investments, and less predictable than that of other insurance companies, and net realized and unrealized gains (losses) on investments may have a greater effect on the Company's results of operations or stockholders' equity at the end of any fiscal period than other insurance and/or reinsurance companies. Because the realization of gains and losses on equity investments is not generally predictable, such gains and losses may differ significantly from period to period. Investments included in the Company's private portfolio include securities issued by privately held companies and securities issued by public companies that are generally restricted as to resale or are otherwise illiquid and do not have readily ascertainable market values. The risk of investing in such securities is generally greater than the risk of investing in securities of widely held, publicly traded companies. Lack of a secondary market and resale restrictions may result in the Company's inability to sell a security at a price that would otherwise be obtainable if such restrictions did not exist and may substantially delay the sale of a security the Company seeks to sell. At September 30, 1997, cash and invested assets totaled approximately $480.0 million, consisting of $115.0 million of cash and short-term investments, $132.9 million of publicly traded fixed maturity investments, $174.3 million of publicly traded equity securities and $57.8 million of privately held securities. 14 During the first nine months of 1997, the Company allocated approximately $5.3 million from its short-term portfolio to publicly traded equity securities, and an additional $22.6 million to fund investments in privately held securities. Funds allocated from the short-term portfolio to publicly traded equity securities are net of proceeds generated from sales in the public portfolio. See Note 4 under the caption "Investment Information" of the accompanying Notes to Consolidated Financial Statements for certain information regarding the Company's privately held securities and their carrying values. During the remainder of 1997 and over the long-term, the Company intends to continue to allocate a substantial portion of its cash and short-term investments into publicly traded and privately held equity securities, subject to market conditions and opportunities in the marketplace. At September 30, 1997, the publicly traded equity portfolio consisted of investments in 11 publicly traded domestic insurers, reinsurers, or companies providing services to the insurance industry. The estimated fair values of such investments ranged individually from $2.8 million to $25.1 million. The fixed maturity and short-term investments were all rated investment grade by Moody's Investors Service, Inc. or Standard & Poor's Corporation and have an average quality rating of AA and an average duration of approximately 2.2 years. The Company's pre-tax and net of tax investment yields in the first nine months of 1997 were 3.7% and 2.7%, respectively, compared to 3.8% and 2.8%, respectively, for the same prior year period. Assuming a stable interest rate environment, the Company anticipates such yields to moderately decline as funds invested in short-term securities are allocated into equity securities. The Company has not invested in derivative financial instruments such as futures, forward contracts, swaps, or options or other financial instruments with similar characteristics such as interest rate caps or floors and fixed-rate loan commitments. Liquidity and Capital Resources RCHI is a holding company and has no significant operations or assets other than its ownership of all of the capital stock of Risk Capital Reinsurance, whose primary and predominant business activity is providing reinsurance, and other forms of capital, to insurance and reinsurance companies and making investments in insurance-related companies. RCHI will rely on cash dividends and distributions from Risk Capital Reinsurance to pay any cash dividends to stockholders of RCHI and to pay any operating expense that RCHI may incur. The payment of dividends by RCHI will be dependent upon the ability of Risk Capital Reinsurance to provide funds to RCHI. The ability of Risk Capital Reinsurance to pay dividends or make distributions to RCHI is dependent upon its ability to achieve satisfactory underwriting and investment results and to meet certain regulatory standards of the State of Nebraska. There are presently no contractual restrictions on the payment of dividends or the making of distributions by Risk Capital Reinsurance to RCHI. 15 Nebraska insurance laws provide that, without prior approval of the Nebraska Director of Insurance (the "Nebraska Director"), Risk Capital Reinsurance cannot pay a dividend or make a distribution (together with other dividends or distributions paid during the preceding 12 months) that exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net income from operations from the preceding calendar year not including realized capital gains. Net income (exclusive of realized capital gains) not previously distributed or paid as dividends from the preceding two calendar years may be carried forward for dividends and distribution purposes. Any proposed dividend or distribution in excess of such amount is called an "extraordinary" dividend or distribution and may not be paid until either it has been approved, or a 30-day waiting period has passed during which it has not been disapproved, by the Nebraska Director. Notwithstanding the foregoing, Nebraska insurance laws provide that any distribution that is a dividend may be paid by Risk Capital Reinsurance only out of earned surplus arising from its business, which is defined as unassigned funds (surplus) as reported in the statutory financial statement filed by Risk Capital Reinsurance with the Nebraska Insurance Department for the most recent year. In addition, Nebraska insurance laws also provide that any distribution that is a dividend and that is in excess of Risk Capital Reinsurance's unassigned funds, exclusive of any surplus arising from unrealized capital gains or revaluation of assets, will be deemed an "extraordinary" dividend subject to the foregoing requirements. RCHI and Risk Capital Reinsurance file consolidated federal income tax returns and have entered into a tax sharing agreement (the "Tax Sharing Agreement"), allocating the consolidated income tax liability on a separate return basis. Pursuant to the Tax Sharing Agreement, Risk Capital Reinsurance makes tax sharing payments to RCHI based on such allocation. Net cash flow from operating activities for the nine months ended September 30, 1997 was $30.7 million, compared with $24.5 million in the prior year period. The primary sources of liquidity for Risk Capital Reinsurance are net cash flow from operating activities, principally premiums received, the receipt of dividends and interest on investments and proceeds from the sale or maturity of investments. The Company's cash flow is also affected by claims payments, some of which could be large. Therefore, the Company's cash flow could fluctuate significantly from period to period. The Company does not currently have any material commitments for any capital expenditures over the next 12 months other than in connection with the further development of the Company's infrastructure. The Company expects that its financing and operational needs for the foreseeable future will be met by the Company's balance of cash and short-term investments, as well as by funds generated from operations. However, no assurance can be given that the Company will be successful in the implementation of its business strategy. At September 30, 1997, the Company's consolidated stockholders' equity totaled $396.2 million, or $23.26 per share. At such date, statutory surplus of Risk Capital Reinsurance was approximately $386.1 million. Based on data available as of June 30, 1997 from the Reinsurance Association of America, Risk Capital Reinsurance is the thirteenth largest domestic broker market oriented reinsurer as measured by statutory surplus. 16 Safeharbor Statement Under the Private Securities Litigation Reform Act of 1995 Except for the historical information contained herein, the matters discussed in this Form 10-Q include forward looking statements that involve risks and uncertainties, including, but not limited to, quarterly fluctuations in results and other risks detailed from time to time in the Company's Securities and Exchange Commission filings. Among the factors that could cause such forward looking statements not to be realized include, without limitation, acceptance in the market of the Company's reinsurance products; the availability of investments on terms that are attractive to the Company; pricing competition; the amount of underwriting capacity from time to time in the market; general economic conditions and conditions specific to the reinsurance and investment markets in which the Company operates; regulatory changes and conditions; rating agency policies and practices; claims development and loss of key executives. Actual results may differ materially from management expectations. The Company assumes no obligation to update any forward looking statement or other information contained in this report. 17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits.
EXHIBIT NO. DESCRIPTION - --------------- ----------------------------------------------------------------------------------------------------- 15 Accountants' Awareness Letter and Limitation of Liability (regarding unaudited interim financial information) 27 Financial Data Schedule
(b) Reports on Form 8-K. There were no reports filed on Form 8-K for the three month period ended September 30, 1997. Omitted from this Part II are items which are inapplicable or to which the answer is negative for the period covered. 18 SIGNATURES Pursuant to the requirements 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. RISK CAPITAL HOLDINGS, INC. ---------------------------------- (Registrant) ---------------------------------- Date: November 13, 1997 MARK D. MOSCA President ---------------------------------- Date: November 13, 1997 PAUL J. MALVASIO Chief Financial Officer 19 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ----------- --------------------------------------------------------------------------------------------------------- 15 Accountants' Awareness Letter and Limitation of Liability (regarding unaudited interim financial information) 27 Financial Data Schedule
20 EX-15 2 EX-15 Exhibit 15 ACCOUNTANTS' AWARENESS LETTER AND LIMITATION OF LIABILITY We are aware of the incorporation by reference in the Registration Statement on Form S-8 (Registration No. 33-99974) of Risk Capital Holdings, Inc. of our report dated October 29, 1997 (issued pursuant to the provisions of Statement on Auditing Standards No. 71) appearing in this Form 10-Q. We are also aware of our responsibilities under the Securities Act of 1933. We are not subject to the liability provisions of section 11 of the Securities Act of 1933 for our report dated October 29, 1997 (issued pursuant to the provisions of Statement on Auditing Standards No. 71) on the unaudited interim consolidated financial information of Risk Capital Holdings, Inc. because our report is not a "report" or a "part" of the Registration Statement on Form S-8 (Registration No. 33-99974) prepared or certified by us within the meaning of sections 7 and 11 of the Securities Act of 1933. PRICE WATERHOUSE LLP New York, New York November 13, 1997 EX-27 3 EXHIBIT 27 FINANCIAL DATA SCHEDULE
7 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 132,945 0 0 232,062 0 0 475,900 4,090 0 15,500 557,188 52,733 71,301 0 0 0 0 0 0 396,200 557,188 65,628 10,774 3,617 0 45,992 17,740 10,842 5,445 1,175 4,270 0 0 (473) 3,797 .22 .22 0 0 0 13,860 0 52,733 0
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