It is anticipated that such obligations will be satisfied, in whole or in part, from (i) a portion of any profits realized by Transre and E&S under the Limited Agency Agreement, (ii) the override commission paid to TCO Holdings in connection with the Quota Share Arrangement, and (iii) Exstar Common Stock owned by TCO. Mr. O'Shaughnessy may have contingent liability with respect to certain of these TCO obligations, and, consequently, may benefit from their satisfaction. Other assets and cash flows of TCO will be used to repay debts owed by TCO to the Company. Such assets and cash flows may include furniture, fixtures and systems of TCO (independently appraised at approximately $2.4 million), profits of Transre and E&S under the Limited Agency Agreement (see "-- Relationship with UCIC"), amounts paid to the Company by Claims Control (see "-- Expense Reductions/Reallocations and Staffing Changes"), and potential recoveries by TCO from third parties.
Because the Company and TCO are affiliated through common controlling ownership by Mr. O'Shaughnessy, the transactions and relationships between the Company and TCO and the Company and
Mr. O'Shaughnessy present certain conflicts of interest. Notwithstanding these potential conflicts of interest, management believes that the actions and inactions of the Company, while they have in some cases benefitted TCO and Mr. O'Shaughnessy, have been, when taken as a whole, in the best interests of the Company.
Expense Reductions/Reallocations and Staffing Changes. Prior to January 1995, the Company had no compensated employees; employees of TCO performed all underwriting, claims and other services for the Company pursuant to management agreements between the Company and TCO. See "-- Current and Future Operations and Organizational Structure -- Relationship with TCO." Effective January 1, 1995, certain officers of TCO and Alpine, and certain individuals providing administrative and support services to such officers, became fully or partially compensated employees of Exstar. The salary, benefit costs and other expenses borne by the Company in connection with this arrangement were approximately $2.1 million in 1995. Following the downgrading of the Company's Best ratings in 1996, the Company and TCO significantly reduced their staff and expenses, and most of the remaining employees of TCO (other than Claims Control employees) became employees of Alpine. Consequently, the Company
became directly responsible for the payment of all salaries and benefits related to such employees. The claims handling staff, however, became employees of Claims Control, a TCO Holdings subsidiary, on January 1, 1996. Claims Control is reimbursed by Alpine for the salary and benefit costs related to such employees, and Claims Control's general and administrative expenses, in consideration of Claims Control's continued handling of claims under policies previously issued by the Company. In addition, Claims Control currently pays over to Alpine amounts paid to Claims Control by UCIC for handling UCIC claims. See "-- Current and Future Operations and Organizational Structure -- Relationship with UCIC."
At January 1, 1996, the Company and TCO, together, had 134 employees and total annualized payroll of approximately $7 million. At August 1, 1996, 85 employees remained (almost all of whom, other than the Claims Control employees, had become employees of the Company). The pay levels of many of the remaining employees (principally members of senior and middle management) were reduced. As a result, total annualized payroll at August 1, 1996 (before reimbursement from Transre and E&S) was approximately $4.5 million. Other general and administrative expenses also were reduced substantially from prior levels. General and administrative expenses following the reductions totaled approximately $5 million annualized. Because of cost reductions and other circumstances, individuals no longer employed by the Company include Exstar's former Chief Financial Officer and its Chief Accounting Officer, four senior underwriters, the three most senior members of the Company's management information services department, the former head of the Company's claims department and the former President of Alpine. As a result of these departures, the Company's overall level of management experience has significantly decreased. Depending on the Company's financial condition and prospects, management expects the Company will need to hire additional personnel during 1997, assuming the Quota Share Arrangement remains in place, to support the Company's operations.
During 1996, to assist the Company in retaining sufficient staffing and to offset, in part, salary reductions instituted in 1996, Alpine sought approval from the Illinois DOI to pay bonuses to its employees. The Illinois DOI tentatively approved payment of the bonuses, up to a maximum aggregate amount of $400,000 payable by Alpine, but conditioned payment upon satisfaction of certain preconditions, including the implementation of the Quota Share Arrangement (provided that it remained in effect for a period of time satisfactory to the Illinois DOI). The Company expects ultimately to pay some or all of the bonus amount during 1997, but management has not determined what amounts to pay or at what time payments will be made, and any such determination remains subject to final approval of the Illinois DOI.
The Company has historically operated in a single industry segment, property and casualty insurance, and within this segment it concentrated on a limited number of lines of business. During 1996 and 1995, most of the Company's premium volume was derived from the direct writing of specialized liability coverages, consisting principally of products liability coverages and general liability coverages for contractors, ocean marine coverages, and architects and engineers coverages. A small additional source of premium volume was reinsurance assumed through a reinsurance underwriting manager which is a subsidiary of TCO Holdings. The following table sets forth the sources of the Company's premium for the years presented:
Most of the Company's specialized liability insurance was written on a direct basis on an occurrence form (approximately 94% and 92% of all specialized liability premium in 1996 and 1995, respectively) or a claims-made form (approximately 6% and 8% of all specialized liability premium in 1996 and 1995, respectively). The Company's specialized liability policies excluded liability for pollution and punitive damages, had aggregate limits and paid expenses in addition to policy limits.
Ocean Marine. Ocean marine business accounted for $764,000 or 5.3%, and $7.4 million or 11.5%, of the Company's gross written premium in 1996 and 1995, respectively. Typical insureds included tugs, barges, crew boats, builder risks and yachts. Both hull and protection and indemnity coverages were provided, as was cargo coverage in some instances. The average policy had a premium of approximately $33,000 and an average deductible of $10,000.
Architects and Engineers Professional Liability. The Company's architects and engineers professional liability business accounted for approximately $307,000 or 2.1%, and $2.4 million or 3.8%, of the Company's gross written premium in 1996 and 1995, respectively. The Company's principal classifications of insureds were architects, civil engineers, HVAC/mechanical engineers, electrical engineers, interior designers and land surveyors.
Other. The Company has also written other coverages from time to time, including premises liability and other classifications.
The Company's investments generally consist of those investments permitted by the Illinois Insurance Code. Pursuant to an agreement entered into by the Company in May 1996, Asset Allocation & Management Company, L.L.C. has been granted investment advisory responsibility over most of the Company's liquid invested assets.
The table below shows the classifications of the Company's investments at December 31, 1996:
Certain assets shown in the table above are held in trust as security for the payment of claims of policyholders and other obligations of the Syndicate. See "-- Regulation -- Combination of the Syndicate with Alpine."
Real Estate Owned. The Company had real estate investments totaling $11.1 million at December 31, 1996. These values were net of a reserve for losses of $1.7 million. The reserve against
losses for real estate owned is calculated as the difference between the book value of the real estate owned and the fair value of the real estate owned. The properties have combined fair values ("fair value" generally is the appraised value, less expected costs of sale) of approximately $13.1 million as of December 31, 1996 based on appraisals conducted during the fourth quarter of 1996. The Company is attempting to liquidate, in an orderly fashion, its owned real estate portfolio and has no intention of acquiring or holding real estate, other than possibly the office buildings described below, in the future.
The Company owns three commercial medical condominium units located in Solvang, California. As of December 31, 1996, the book value of these units was $783,000, compared to a $765,000 fair value as of that date.
The Company's remaining owned real estate consists of two properties acquired in liquidation of secured real estate loans and held for sale; two purchased residential properties (one of which was acquired from Peter O'Shaughnessy) located in the Santa Ynez Valley, California, held for sale; and one 23 acre parcel and one 25 acre parcel which were acquired from Mr. O'Shaughnessy, held for sale. These properties had a combined book value at December 31, 1996 of $4.2 million and a combined fair value of $4.4 million as of that date. See "Certain Relationships and Related Transactions" -- Item 13.
preferred stock was convertible by the holder into secured debt of JBW upon the occurrence of specified events.
In August 1995, the Company exercised its right to convert the JBW & Co. preferred stock to a promissory note. As a result, the Company currently holds a collateralized loan receivable in the principal amount of $12.3 million due from JBW & Co. ("JBW & Co. Loan"). The principal amount under the JBW & Co. Loan bears interest at a simple annual rate of 7% per year. The principal and interest are due in quarterly installments commencing March 31, 1997, and ending December 31, 2004. Management believes, based on discussions with representatives of JBW & Co., that JBW & Co. is insolvent and incapable of meeting its obligations, including payments on the JBW & Co. Loan.
The JBW & Co. Loan is collateralized by a pledge by Concord of 81% of the outstanding capital stock of Classic Fire and Marine Insurance Company ("Classic"), an Indiana insurance company affiliated with JBW & Co. and Concord. Classic is currently under supervision by the Indiana Department of Insurance. Although Classic reported policyholders' surplus of $12.2 million at December 31, 1996, management believes that Classic's value is highly uncertain, given that its most recent financial statements have not been audited and include assets and liabilities the values of which are not readily determinable, including among other things the preferred stock of TCO Holdings, discussed below.
In accordance with the equity accounting treatment retroactively adopted by the Company in early 1995, TCO-IL's repayment obligations to the Company are generally not carried as assets of the Company in its GAAP consolidated financial statements. TCO's payment of the $2.2 million debt to Exstar through the transfer of assets would have no impact on the Company's GAAP net income or stockholders' equity. Neither the note receivable nor any other amount owed by TCO to Alpine is
- ------------------ * Ratings are assigned primarily by Standard & Poor's with remaining ratings assigned by Moody's and converted to the equivalent Standard & Poor's ratings.
Investment Results. Investment results of the Company for each year in the three years ended December 31, 1996, are shown in the following table.
- ------------------ (1) Total invested assets on an annual average basis. (2) Calculated on an annualized basis.
In July 1995, the Internal Revenue Service ("IRS") commenced an audit of the Company's 1992 Federal corporate income tax return. In connection with this audit, the IRS reviewed a number of documents concerning the Company, including certain information relating to the restructuring of the Company's predecessor holding company system in 1992, which was reported as a tax-free reorganization of such holding company system. The audit has been completed and the Company believes no material liability will be asserted against the Company. In addition, the IRS has commenced an audit of Peter O'Shaughnessy's 1992 Federal income tax return. The results of this audit may have material adverse consequences on Mr. O'Shaughnessy's financial condition and, among other things, could result in his selling a significant portion of his Exstar Common Stock or his pledging of a significant portion of such stock to secure a loan or loans.
The Company ceased issuing direct insurance in August 1996, and is not currently issuing any insurance policies directly to insureds. Its business activities currently consist of: acting as a reinsurer (effective as of April 1, 1997) with respect to insurance policies issued by UCIC; handling claims under
The Quota Share Arrangement became effective as of April 1, 1997, and applies to all premiums unearned as of such date on policies produced by Transre and E&S for UCIC, and all policies produced by Transre and E&S and placed with UCIC after such date. The continuation of the Quota Share Arrangement is subject to regulatory approval. Management believes that the Quota Share Arrangement will give the Company the opportunity to generate profits from business placed with UCIC and ceded to Alpine.
Although the Company does not write material amounts of business in the property insurance lines, which are lines that tend to be most susceptible to catastrophes, the Company does periodically consider the possibility of its exposure to unusually large or catastrophic events. Management believes the likelihood to be remote that such an event would occur and the Company's reinsurers would fail to meet their obligations with respect to such an event in any material way. With respect to the overall exposure of the Company's reinsurers to catastrophic risk, management monitors the financial condition of such reinsurers generally while relying on rating agencies, including Best, to assess its reinsurers' vulnerabilities to such risk.
Company for losses incurred in excess of $1.0 million per insured, per loss up to a maximum of $2.0 million per insured, per loss, plus pro rata loss adjustment expenses. The second provides coverage for 1993, and the third provides coverage from January through September 1994, for losses incurred in excess of $1.0 million per insured, per loss up to a maximum of $2.0 million per insured, per loss, plus pro rata loss adjustment expenses, by Signet Star Reinsurance Company and Security Reinsurance Company. The fourth provides coverage from October 1, 1994, through December 31, 1995, for losses incurred in excess of $500,000 per insured, per loss up to a maximum of $2.0 million per insured, per loss, plus pro rata loss adjustment expenses by Signet Star Reinsurance Company and Security Reinsurance Company. The fifth cedes 50% of the first $500,000 of losses incurred per insured per loss, plus loss adjustment expenses, for losses occurring under (i) policies issued on or after April 1, 1995 and (ii) policies issued prior to April 1, 1995, for the unexpired portion thereof, by Signet Star Reinsurance Company and Reliance Insurance Company. The sixth provides coverage from January through December, 1996, for losses incurred in excess of $500,000 per insured, per loss up to a maximum of $2.0 million per insured, per loss, plus pro rata loss adjustment expenses, by Underwriters Reinsurance Company.
Included in the Company's statements of operations as part of policy acquisition costs amortized were ceded commission income of $6,670,000, $11,424,000 and $5,315,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
The ceding of liability to a reinsurer does not legally discharge the ceding insurer from its primary liability for the full amount of the policies on which it obtains reinsurance, and the ceding insurer will be required to pay the entire loss if the assuming reinsurer fails to meet its obligations under the reinsurance agreement. The Company has never had a significant reinsurance recovery problem, and expects that it will be able to collect the reinsurance receivables due from its reinsurers.
The following ratios, which are frequently used in evaluating operating performance in the insurance industry, are presented on a statutory and GAAP basis.
expense) while a statutory combined ratio in excess of 100% generally indicates a statutory underwriting loss.
- ------------------ (1) Source: Best's Aggregates & Averages, Property Casualty (1996 edition). (2) Industry combined ratios include policyholder dividends and, therefore, exceed the sum of the loss and loss adjustment expense ratio and the expense ratio. (3) Represents commercial lines of casualty insurance (excluding medical malpractice).
The ratios reflected above with respect to 1996 differ from those that would be calculated on the basis of information in the 1996 annual statement (statutory financial statement) of Alpine filed with state insurance regulatory officials, in that the operating results of the Syndicate were not combined with those of Alpine in Alpine's 1996 annual statement, even though the Syndicate's operations were combined with those of Alpine effective December 31, 1996. See "-- Current and Future Operations and Organizational Structure - -- Combination of the Syndicate with Alpine."
The following table reflects, on a GAAP basis, the consolidated loss and loss adjustment expense ratios, expense ratios and combined ratios of the Syndicate and Alpine for the years ended December 31, 1996, 1995, and 1994.
The loss and loss adjustment expense ratio is calculated by dividing incurred losses and loss adjustment expenses (determined on a statutory or GAAP basis, as the case may be) by earned premium (determined on a statutory or GAAP basis). The statutory expense ratio is calculated by dividing net incurred other underwriting expenses by net written premium. The GAAP expense ratio is calculated by
dividing policy acquisition costs amortized by earned premium. The combined ratio is the sum of the loss and loss adjustment expense ratio plus the expense ratio on both statutory and GAAP bases.
During 1996, the Company reduced its reserves for losses and loss adjustment expenses as of December 31, 1995. See "-- Financial Reporting; Delisting of Common Stock" and "-- Losses and Loss Adjustment Expenses." The reduction in the reserves (approximately $14.9 million) took effect in 1995 and reduced the Company's 1995 loss and loss adjustment expense ratio. The Company's 1995 statutory expense ratio was increased by profit sharing expense related to the foregoing reduction in reserves. The cessation of the Company's writing of direct business in 1996 (without a corresponding immediate reduction in expenses) adversely affected the Company's 1996 statutory expense ratio and combined ratio.
Exstar's insurance company subsidiary, Alpine, is subject to a substantial degree of regulation, which generally is designed to protect the interests of Alpine's policyholders. As an Illinois property and casualty insurance company, Alpine is subject to the primary regulatory oversight of the Illinois DOI.
Illinois Order. Alpine is currently subject to the Illinois Order which limits its and the Company's activities. In May 1996, management approached the Illinois DOI to discuss Alpine's loss reserves, its financial condition, its relationship with TCO and TCO's inability to fully pay Alpine amounts owed. See "-- Current and Future Operations and Organizational Structure -- Relationship with TCO." Based on that discussion and issues concerning Alpine's statutory financial statements and its determination of loss reserves (see "-- Losses and Loss Adjustment Expenses"), the Illinois DOI commenced an actuarial and financial review of Alpine. In connection with this review, on July 5, 1996, the Illinois DOI issued an order directing: (i) that Alpine, including the owners, officers, directors, and employees of Alpine, shall make no disbursements of any kind, except for properly authorized insurance claim payments, whether by direct cash transaction, loan offset, forgiveness of debts, purchase, payment of compensation, dividends of any kind, or by transfer of securities or assets of any kind, unless prior to such disbursement Alpine has obtained the written approval of the Illinois DOI; (ii) that Alpine shall not enter into or agree to enter into any agreement which commits Alpine to any type of disbursement subject to the foregoing clause (i) without the prior written approval of the Illinois DOI; (iii) that Alpine is prohibited from entering into any transactions with any affiliate as defined under the Illinois Insurance Code without the prior written approval of the Illinois DOI; and (iv) that Alpine shall demand immediate payment to Alpine of all Alpine premiums held by any affiliate. The impact of the Illinois Order has been to subject virtually all of Alpine's and the Company's transactions, organizational relationships and business methods to close scrutiny by, and approval of, the Illinois DOI.
Combination of the Syndicate with Alpine. Effective December 31, 1996, the Syndicate withdrew as a syndicate member of the IIE, and concurrently transferred all of its assets (other than the stock of Alpine) and liabilities to Alpine. Pursuant to an agreement with the IIE, certain of the Syndicate's assets transferred to Alpine were placed in trust as security for the payment of claims of policyholders and other Syndicate obligations, and thus are not readily available for the satisfaction of other Alpine obligations. Alpine is subject to certain ongoing reporting and compliance obligations to the IIE with respect to business formerly conducted by the Syndicate. In addition, $1.0 million of assets of the Syndicate are now held, and will continue to be held for a period of at least three years, by the IIE Guaranty Fund,
Inc., an entity which is intended to provide certain financial protection to policyholders of insolvent IIE syndicates. Such $1.0 million is included as an asset of the Company in its GAAP financial statements, and as an asset of Alpine in its statutory financial statements. Because of syndicate insolvencies which have occurred and may occur in the future, the Company's ability to recover in full such $1.0 million may be uncertain.
Holding Company System Regulation. Because of its indirect ownership of Alpine, Exstar is subject to certain provisions of the Illinois Insurance Holding Company Systems Act, which governs any direct or indirect changes in control of Alpine and certain affiliated-party transactions involving Alpine or its assets. No person may acquire, directly or indirectly, 10% or more of the outstanding voting securities or otherwise acquire control of Alpine, Alpine Holdings or Exstar, unless the Illinois DOI has approved such acquisition. The determination of whether to approve any such acquisition is based on a variety of factors, including an evaluation of the acquirer's financial stability, the competence of its management and whether competition in Illinois would be reduced. In addition, certain material transactions involving Alpine and any affiliate must be disclosed to the Illinois DOI not less than 30 days prior to the effective date of the transaction (a transaction can be disapproved by the Illinois DOI within such 30-day period if it does not meet certain standards). Transactions requiring such approval include, but are not limited to, sales, purchases or exchanges of assets, loans and extensions of credit, and investments. Alpine is also required to file periodic and updated statements reflecting the current status of its holding company system, the existence of any related- party transactions and certain financial information relating to any person who directly or indirectly controls (presumed at 10% voting control) Alpine. In addition to the foregoing, the Illinois Order requires approval of the Illinois DOI for most transactions and commitments involving Alpine and its affiliates.
Insurance Guaranty Funds. As an Illinois property and casualty insurance company, Alpine is subject to the provisions of the Illinois Insurance Guaranty Fund Act, which provides for the assessment of member insurance companies based on the amount of direct written premium in Illinois. The amount and timing of such assessments are beyond the control of the Company. Although Alpine is no longer writing direct business, it may be subject to assessments with respect to direct business written in prior years.
In reporting in accordance with the NAIC annual statement form, insurers must comply with statutory accounting practices typically described as those practices "prescribed" or "permitted" by the insurance company's domiciliary insurance regulator. With respect to Alpine, "prescribed" statutory accounting practices are those described under Illinois laws and regulations of the Illinois DOI. "Permitted" statutory accounting practices encompass all statutory accounting practices not so prescribed and must be approved by the appropriate regulatory authority. All practices used by the Company are "prescribed."
Insurance Regulatory Information System Tests. The NAIC also has developed IRIS ratios which are designed to provide regulators indications of potential problems of insurance companies. Alpine failed eight of eleven IRIS ratio tests for 1995 based on the initial 1995 statutory financial statements it filed with regulatory authorities (based on which a number of such regulatory authorities took action restricting Alpine's authority to do business - - see "-- Background Concerning Changes in Operations -- Regulatory Restrictions" and "-- Losses and Loss Adjustment Expenses"). Alpine amended its 1995 statutory financial statements to reflect the overstatement in its loss reserves of approximately $14.9 million, and, based on the amended statements, it failed four IRIS ratio tests for 1995. Alpine failed only
two IRIS ratio tests for 1996 (as a general rule, an insurer may fail up to three IRIS ratio tests without triggering a higher level of NAIC or regulatory scrutiny).
The following table sets forth the NAIC's expected normal values for the IRIS ratios and Alpine's IRIS ratios for 1996 and 1995 (based on its amended statutory statement).
Risk Based Capital. The NAIC has adopted a risk based capital formula for property and casualty insurance companies. This formula calculates a minimum level of capital and surplus which should be maintained by each insurer, based on underwriting, credit, investment and other business risks inherent in an individual company's operations. Various states, including Illinois, have adopted the NAIC's risk based capital model act applicable to property/casualty insurers. The model act authorizes certain regulatory actions based on the ratio of a company's "adjusted capital" (generally the insurer's actual policyholders' surplus) to its "authorized control level" risk based capital.
The following table sets forth the different levels of risk based capital that may trigger regulatory involvement and the actions that may be triggered.
largest market and, in 1995, California accounted for approximately 65% of Alpine's direct written premiums. In addition, Alpine lost its authorization to conduct direct business in Idaho, Michigan, New York, Ohio, Pennsylvania, Texas and Virginia and had its authority restricted in Florida. As a general rule, Alpine's inability to issue direct coverage in a state does not render it unable to provide reinsurance with respect to risks located in the state. Insurers assuming risk only from other insurers rather than issuing direct insurance (reinsurers) are subject to a lesser degree of regulatory scrutiny and compliance obligations outside their states of domicile than insurers issuing direct insurance. Through regulation of the reserves required to be maintained in a ceding insurer's statutory financial statements and the circumstances in which such reserves may be reduced through the cession of liabilities to a reinsurer, however, states can indirectly influence the activities of reinsurers. Due, in part, to such reserve requirements, the Quota Share Arrangement has been structured on a "funds held" basis. See "-- Current and Future Operations and Organizational Structure -- Relationship with UCIC." In addition, Alpine's prior and existing regulatory issues could lead regulators to place restrictions on Alpine's ability to act as a reinsurer of UCIC under the Quota Share Arrangement or of any other insurer.
An insurer's eligibility to write direct insurance on a surplus lines basis in most jurisdictions is dependent on its compliance with certain financial standards, including the maintenance of a requisite level of capital and surplus and the establishment of certain statutory deposits. In recent years, many jurisdictions, including those in which Alpine has conducted most of its insurance business, have increased the minimum financial standards applicable to surplus lines eligibility including adoption of the NAIC's model surplus lines act which, among other things, establishes a minimum policyholders' surplus requirement of $15.0 million. This minimum requirement would preclude the Company from acting as a surplus lines insurer in these jurisdictions but not preclude it from acting as a reinsurer.
In certain states, insurers such as Alpine which are not authorized to conduct insurance business in such states, may not be permitted to file certain pleadings in court until such insurers have posted a bond with the court. Alpine has been faced with this requirement in two states, but has suffered no material adverse impact. If the requirement were to be enforced against Alpine, it could significantly increase Alpine's costs with respect to coverage lawsuits and other litigation matters, and, thus, adversely affect the Company.
When a claim involving a probable loss is reported, the Company establishes a case reserve for the estimated amount of the Company's ultimate loss and loss adjustment expense payments. The estimate reflects an informed judgment based on established reserving practices and the experience and knowledge of claims personnel 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. Management also establishes reserves on an aggregate basis to provide for losses incurred but not reported ("IBNR reserves"), as well as future development on losses reported to the Company. The amount of an insurer's incurred losses in a given period is determined by adding
Estimates for ultimate loss reserves are inherently difficult to determine because they are attempts to quantify future results based on current trends. The effort to predict the Company's ultimate losses and loss adjustment expense has been made more difficult because the Company's recent business includes a substantial amount of insurance written for subcontractors and general contractors, most of which are located in California. California law relating to contractors has changed significantly over the last several years as a consequence of California legal decisions and newly enacted legislation. The Company, additionally, significantly modified its policy forms and underwriting standards relating to its contractor business in each of 1996, 1995 and 1994. Because of the foregoing, the assumptions made and the trends used by the Company in estimating its reserves for losses and loss adjustment expenses have been relatively untested by time and actual development of reserves.
In February 1996, the Company's independent actuaries arrived at a determination that the Syndicate and Alpine had experienced substantial adverse loss development during 1995. This adverse loss development was in addition to adverse loss development experienced by Alpine during 1994 and the Syndicate during 1993. In order to evaluate the loss data on which the actuarial determinations were based, the Company hired an independent claims specialist in February 1996 to conduct a review of its "case" loss reserves (reserves relating to specific claims). Based on the claims specialist's review of the Company's claim files, the Company determined that its case loss reserves were substantially overstated, stemming principally from three inappropriate reserving practices: (i) claims examiners' establishing initial case reserves at levels higher than justified by the information received by the Company with respect to claims, (ii) claims examiners' establishing case reserves without taking into account deductibles (e.g., a claim may have a likely ultimate loss amount of $15,000, but the claim may relate to a policy with a $5,000 deductible payable by the insured, in which case the appropriate reserve generally would be $10,000, assuming the deductible is collectible) and (iii) claims examiners' not timely reducing case reserves following receipt of favorable information with respect to claims. Alpine and the Syndicate were unable to provide data concerning the reserve overstatements in final form to the actuaries in time for such data to be considered in the actuaries' certification of Alpine's and the Syndicate's 1995 loss reserves for their unaudited 1995 statutory financial statements. Consequently, the statutory financial statements which incorporated the overstated loss reserves were provided to Best and state regulatory authorities. The overstatement of loss reserves contributed to the adverse financial results reported by Alpine and the Syndicate, the Best ratings downgrades and the actions taken against the Company by state regulatory authorities (see "-- Background Concerning Changes in Operations").
The Company ceased issuing direct insurance in August 1996, and is not currently issuing any insurance policies directly to insureds. Its current business activities consist of: acting as a reinsurer (effective as of April 1, 1997) with respect to insurance policies issued by UCIC; handling claims under policies and reinsurance contracts previously issued by the Company and implementing mid-term adjustments to and cancellations of such policies; and related management, investment, reporting and accounting functions. In lieu of issuing direct insurance business, effective as of April 1, 1997, Alpine entered into the Quota Share Arrangement with UCIC.
Management believes that competition is increasing in the markets in which the Company historically has operated, which may hinder the Company's re-entry into such markets should the Company recommence direct underwriting operations and may interfere with the Company's ability to generate profits through the Quota Share Arrangement. Many of the Company's and UCIC's existing or potential competitors are larger, have higher Best ratings, have considerably greater financial and other resources and offer a broader line of insurance products than the Company or UCIC. Should the Company recommence underwriting operations, it will face competition from other surplus line insurers, new forms of insurance organizations such as risk retention groups and, potentially, licensed insurers issuing coverages previously written by the Company in the surplus lines market. See also "-- Background Concerning Changes in Operations -- Best Ratings Downgrades."
Prior to January 1995, the Company had no compensated employees; employees of TCO performed all underwriting, claims and other services for the Company pursuant to management agreements between the Company and TCO. See "-- Current and Future Operations and Organizational Structure -- Relationship with TCO." Effective January 1, 1995, certain officers of TCO and Alpine, and certain individuals providing administrative and support services to such officers, became fully or partially compensated employees of Exstar. The salary, benefit costs and other expenses borne by the Company in connection with this arrangement were approximately $2.1 million in 1995. Following the downgrading of the Company's Best ratings in 1996, the Company and TCO significantly reduced their staff and expenses, and most of the remaining employees of TCO (other than Claims Control employees) became employees of Alpine. Consequently, the Company became directly responsible for the payment of all salaries and benefits related to such employees. The claims handling staff, however, became employees of Claims Control, a TCO Holdings subsidiary, on January 1, 1996. Claims Control is reimbursed by Alpine for the salary and benefit costs related to such employees, and Claims Control's general and administrative expenses, in consideration of Claims Control's continued handling of claims under policies previously issued by the Company. Claims Control currently pays over to Alpine amounts paid to Claims Control by UCIC for handling UCIC claims. See "-- Current and Future Operations and Organizational Structure -- Relationship with UCIC."
In addition to performing services directly for the Company, the majority of the Company's employees are performing services for Transre and E&S in connection with the Limited Agency Agreement. In this regard, and in accordance with a plan filed by Alpine with and approved by the Illinois DOI in connection with its review of Alpine (see "-- Regulation -- Illinois Order"), the salaries and benefit costs associated with these employees, as well as general and administrative costs (including rent, utilities, insurance costs and licensing fees), are currently being allocated among Alpine, Transre and E&S. The total amount reimbursed by Transre and E&S to the Company during 1996 (covering the period from the beginning of the allocation on August 1, 1996, through December 31, 1996) was approximately $1.2 million. The amount payable by Claims Control to the Company for 1996 with respect to revenues received from UCIC was approximately $4,000. The allocations are based on management's estimates of the relative amounts of employee time and Company resources devoted to the operations. For example, the majority of the Company's salary expense relating to its underwriting department has been allocated to Transre and E&S, because the underwriting department's principal activities involve producing new business for UCIC, while the underwriting department's activities with respect to the Company's prior business are limited. Conversely, salaries for management, accounting, administration and other departments are allocated as much as 80% to Alpine. The plan approved by the Illinois DOI anticipates that the allocations to Alpine will gradually decrease, and the allocations to Transre and E&S will gradually increase, over time, but no assurances can be given that such allocations will occur at any particular time, if at all. As circumstances change, revised allocations are expected to be implemented, subject to approval by the Illinois DOI.
The Company generally owns real property only for investment or sale. The Company's principal real estate investments consist of two office buildings with a combined book value of approximately $4.3 million. These office buildings serve as the Company's headquarters, and are located at 2028 Village Lane (25,000 square feet) and 2029 Village Lane (13,000 square feet), Solvang, California. The Company currently leases 6,000 square feet of space in one of these buildings to the YMCA at an annual rent of approximately $54,000 (subject to adjustment) under a two-year lease, with three one-year renewal options. The Company from time to time solicits offers to purchase the office
buildings and would be willing to sell the properties to a buyer with whom the Company would enter into a sale-leaseback arrangement if appropriate terms could be agreed upon. At the present time, the Company has not identified such a purchaser.
TCO leases office space in Chicago, Illinois. Exstar may be deemed to be a guarantor of TCO's obligations or otherwise may be deemed to be obligated under the lease. TCO is currently in default under the lease, and the lessor has made a demand for payment. Management contemplates that Alpine may assume the lease with respect to a portion of the property currently leased (approximately 7,000 square feet of the approximately 16,400 square feet currently leased), at a reduced rent (approximately $20 per square foot per year versus the current rate of approximately $38 per square foot per year). Discussions are currently ongoing with the lessor as to a settlement with respect to the lease. Assuming that Alpine leases a portion of the premises on the foregoing terms, the maximum total amount of the remaining obligations under the lease are estimated to be approximately $1.7 million. It is contemplated that a settlement may be reached with the lessor under which the lease obligations are satisfied through the transfer of Exstar Common Stock to the lessor. Some of the Common Stock would be contributed by TCO, from the 536,000 shares of Common Stock currently owned by it with the remainder, if any, being contributed by Exstar from its authorized but unissued stock. Some of the Common Stock owned by TCO is currently pledged to guarantee TCO's obligations pursuant to the Loan Agreement. See "Business -- Investments -- Loan to TCO"--Item 1. The Company has not yet resolved issues concerning the use of Exstar Common Stock owned by TCO in connection with the satisfaction of TCO's obligations. There is also a possibility the Company will be able to sublet this space to an unaffiliated party or that no settlement will be reached and the Company will have to locate alternative office space or become subject to legal proceedings brought by the lessor.
The selected consolidated financial data presented below under the captions "Operating data" and "Balance sheet data" for the years ended December 31, 1996, 1995, 1994 and 1993 have been derived from the audited consolidated financial statements of the Company and its subsidiaries. The selected consolidated financial data as of, and for the year ended, December 31, 1992, have been derived from restated, unaudited financial statements of the Company and its subsidiaries. The statutory operating data
are based on statutory accounting practices and were derived from statutory financial data of the Syndicate and Alpine. The statutory operating data for the year ended December 31, 1996, differ from data which would be derived from the 1996 annual statement of Alpine filed with state insurance regulatory officials in that the operating results of the Syndicate were not combined with those of Alpine in its 1996 annual statement, even though the Syndicate's operations were combined with those of Alpine effective December 31, 1996. These data should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere in this 1996 Form 10-K.
The Company's net income historically derived from the difference between these net revenues and net expenses, after adjustment for taxes and minority interests. In addition, due to the Company's adoption of a form of equity accounting in 1995 (applied retroactively), the Company's net income also has included its equity in gains and losses of its affiliates. See "Business -- Current and Future Operations and Organizational Structure -- Relationship with TCO" -- Item 1 and Note 11 of Notes to Consolidated Financial Statements.
Because of the numerous uncertainties facing the Company and the Company's likelihood of experiencing substantial further changes in its operations and business during 1997 (see "Business -- Current and Future Operations and Organizational Structure" -- Item 1), management has made no effort to anticipate the Company's results in the following discussion beyond the end of 1997. Management's current expectations, additionally are heavily dependent on continuation of the Quota Share Arrangement, on UCIC's maintaining its Best rating and surplus lines authorities, on no material increase in competition, on the Illinois DOI's continuing to allow Alpine to operate generally as it currently is operating and on a number of other less material assumptions and conditions ("Base Conditions").
Gross written premiums were $14.4 million for 1996, a decrease of 77.6% from $64.3 million in 1995. This decrease was due to the Best ratings downgrades of the Company's insurance company subsidiaries in January and April 1996, and the losses of their authorizations to conduct surplus lines business in key states, including California, beginning early in the year (see "Business - -- Regulation" -- Item 1). These developments progressively constricted the Company's ability to write direct insurance policies during the first half of 1996, and led the Company to cease writing direct insurance policies in August 1996. Effective April 1, 1997, however, Alpine entered into the Quota Share Arrangement with UCIC, which management expects will enable the Company to receive premium on business produced for UCIC by Transre and E&S (see "Business - -- Current and Future Operations and Organizational Structure -- Relationship with UCIC" -- Item 1). Assuming the Base Conditions, management expects the Company's gross written premium volume for 1997 to be roughly equal to its gross written premium volume for 1996.
Net premiums earned were $21.0 million in 1996, a 46.3% decrease from $39.1 million in 1995. The decrease directly resulted from the decrease in gross written premiums, though the percentage decrease in net premiums earned between the periods was lower because premiums continued to be earned on previously written insurance after the Company ceased issuing direct insurance in August 1996. Because of a similar delay in earning previously written premiums during 1997, management anticipates, assuming the Base Conditions, net premiums earned in 1997 will continue to decline, perhaps to approximately half of their 1996 amounts, notwithstanding that gross written premiums for 1997 are expected to be roughly equal to gross written premiums for 1996.
Net loss and loss adjustment expense incurred during 1996 totaled $12.7 million, down 19.0% from $15.7 million in 1995. Net loss and loss adjustment expense as a portion of net premiums earned was 60.4% in 1996 compared to 40.0% in 1995. The decrease in net loss and loss adjustment expense incurred between the periods resulted principally from the decrease in net premiums earned. The decrease was relatively smaller than the decrease in net premiums earned between the periods, however, because of the approximately $14.9 million reduction in loss and loss adjustment expense reserves at the end of 1995, which included reductions relating to net premiums earned in prior years. Management anticipates the Company's 1996 year-end reserves for net loss and loss adjustment expense may include additional redundancies which have not yet become actuarially determinable because of changes in reserving practices implemented by the Company in 1996 and difficulties in determining the precise impact on the Company's loss and loss adjustment expense reserves of certain recent California court decisions affecting construction defect claims. See "Business -- Losses and Loss Adjustment Expenses" -- Item 1. Management also expects, assuming the Base Conditions, that the Company's loss ratio on insurance assumed by Alpine pursuant to the Quota Share Arrangement will be substantially lower than the Company's historical loss ratios as a consequence of higher pricing and more restrictive policy forms used in underwriting the insurance assumed by Alpine from UCIC.
The Company's other underwriting expenses for 1996 were $6.4 million, a decrease of 62.1% from $16.9 million in 1995. The ratio of the Company's other underwriting expenses to net premiums earned was 30.5% in 1996 compared to 43.2% in 1995. The decrease in other underwriting expenses between the periods was principally attributable to reduced net expenses resulting from termination of the management agreements with TCO, the Company's earning in 1996 additional commission income under certain reinsurance agreements because of favorable loss development and the Company's payment in 1995 of profit sharing of approximately $3.7 million relating to the approximately $14.9 million reduction in loss and loss adjustment expense reserves at the end of 1995. Management anticipates, assuming the Base Conditions, that the ratio of other underwriting expenses to net premiums earned for 1997 will be about the same as or somewhat in excess of the 1996 ratio, because of the approximately 33-34% aggregate commissions payable by Alpine in connection with the Quota Share Arrangement reduced somewhat by anticipated additional reinsurance commission from potential continuing favorable loss development.
Net investment income for 1996 was $4.0 million, a decrease of $900,000, or 18.0%, from $4.9 million in 1995. The decrease between the periods was caused principally by a 15.8% decrease in average investable assets from $90.8 million in 1995 to $76.4 million in 1996 and a decline in the average yield on investable assets to 5.3% in 1996 from 5.4% in 1995. Management anticipates, assuming the Base Conditions, a continued reduction in investment income in 1997 as a consequence of loss payments and expenses reducing the Company's investable assets more quickly than investable assets increase under the Quota Share Arrangement, though the impact may be partially offset by rising interest rates and yields on invested assets during the year.
Net realized investment (losses) gains for 1996 were a loss of $400,000 versus a gain of $400,000 in 1995. The net loss in 1996 was the result of losses on the sale of an equity security and certain real estate investments, as well as net increases in real estate valuation reserves. The Company realized net investment gains of over $700,000 in 1995 on its fixed maturities portfolio as it benefitted from declining interest rates while liquidating certain assets. Management expects a possible continuation of realized investment losses in 1997 as the Company's payments of losses and expenses require the Company to liquidate investments during a period of possibly rising interest rates. Management anticipates little, if any, adverse impact from the Company's continuing liquidation of real estate investments because of expected stable or somewhat improving conditions in the central California real estate market.
Other expenses, consisting of professional fees, personnel costs and other costs of Exstar, the Syndicate and Alpine, were $7.3 million in 1996 compared to $6.3 million in 1995. This increase was principally due to (i) Exstar's incurring additional legal expenses for the lawsuit against the Company's former auditors (see "Legal Proceedings" -- Item 3), (ii) increases in legal, audit, actuarial and other fees (including approximately $500,000 of IIE withdrawal fees) in connection with the Illinois DOI's review of Alpine, withdrawal of the Syndicate from the IIE and reorganization of the Company's business and operations during 1996, and (iii) Alpine's assuming a portion of the personnel, general and administrative costs previously borne by TCO. Management anticipates a decrease in other expenses for 1997 by approximately $1 million or more as a consequence of (i) the settlement of the C&L suit, a decrease in regulatory and operational issues and the gradual shifting of personnel, general and administrative costs to Transre and E&S in accordance with the plan submitted by Alpine to the Illinois DOI, offset by (ii) an increase in overall personnel and general and administrative costs (a) to pay bonuses for personnel to compensate, in part, for compensation reductions during 1996, and otherwise to provide incentives to personnel to continue with the Company and (b) to improve the Company's overall level of management experience and otherwise replace certain employees and restore certain operating capabilities lost during 1996. See "Business -- Current and Future Operations and Organizational Structure -- Expense Reduction/Reallocations and Staffing Changes" -- Item 1.
Income tax benefit was $1.7 million in 1996 compared to an expense of $5.1 million in 1995, principally because of the Company's substantially higher 1995 taxable net income resulting from the $14.9 million reduction in loss reserves in 1995. The Company had a net pre-tax loss (before minority interest and equity in gains of affiliates) of $1.8 million in 1996 compared to $5.8 million of pre-tax net income (before minority interest and equity in gains of affiliates) in 1995. The difference also resulted from application of a $6.6 million valuation reserve against the Company's deferred tax asset in 1995, compared to a $1.3 million reduction in the reserve in 1996. Assuming the Base Conditions, management anticipates the Company will incur income tax expense in 1997, but management also believes that because of loss carryforwards from prior years, the Company's taxable net income in 1997 will be taxed at a lower rate than otherwise would be applicable, and that the Company may be able to recognize a substantial additional reduction in the valuation reserve applied to the deferred tax asset.
Equity in income (losses) of affiliates generally reflects TCO Holdings' net income or loss for the year after certain adjustments (see Note 11 of Notes to Consolidated Financial Statements). Equity in income of affiliates was $1.6 million in 1996 compared to $3.8 million in 1995. The smaller amount in 1996 reflects a reduction in TCO's revenues for 1996 following the Best rating downgrades and regulatory restrictions affecting the Company's insurance company subsidiaries, and the terminations of the management agreements between the Syndicate and TCO and Alpine and TCO. It also reflects reduced profit sharing of $1.3 million paid to TCO-IL in 1996 compared to the $5.2 million paid to TCO-IL in 1995. The difference between the $1.3 million payment to TCO-IL in 1996 and the $5.2 million payment in 1995 is principally attributable to reductions in net loss and loss adjustment expenses incurred, due, in significant part, to the $14.9 million reduction in the Company's loss reserves at December 31, 1995. Notwithstanding TCO's current financial condition, management anticipates that equity in income of affiliates could be significant in 1997 principally as a consequence of TCO's substantially reduced expenses and its possible settlements of liabilities (other than liabilities to the Company) at less than their book values.
Net income per common share was $0.27 in 1996 compared to $0.86 in 1995. This reflects, overall, the decline in the Company's revenues following the Best rating downgrades and the regulatory restrictions affecting the Company's insurance company subsidiaries beginning in early 1996, compared to the substantial revenues realized from ongoing operations and the income resulting from the $14.9 million reduction in loss reserves in 1995. The impact of these items would have been greater if it had not been offset by an overall swing of $7.7 million in deferred tax expense.
Other underwriting expenses were $16.9 million in 1995, a decrease of 1.6% from $17.2 million in 1994. The ratio of the Company's other underwriting expenses to net premiums earned was 43.2% in 1995 compared to 32.7% in 1994. The increase in the ratio generally resulted from increased profit sharing of $3.7 million paid by the Company in 1995 relating to the $14.9 million reduction in loss and loss adjustment expense reserves due to prior year overstatements.
Net realized investment (losses) gains for 1995 were a gain of $400,000 versus a $40,000 loss in 1994. The Company realized net investment gains of over $700,000 in 1995 on its fixed maturities as it took the opportunity to sell certain instruments at favorable prices caused principally by declining interest rates. These gains were partially offset by losses in equity securities and the Company's real estate holdings. The net losses in 1995 in the real estate portfolio were primarily the result of increases in valuation reserves.
Other income declined in 1995 to $400,000 from $1.3 million in 1994. The 1995 decline was due to TCO's placing less business with the unaffiliated insurance company. Additionally, the amount of funds on deposit with the unaffiliated insurer was significantly reduced in 1995 compared to 1994.
Interest expense increased in 1995 to $200,000 from $150,000 in 1994, due to additional interest payable related to real estate acquired in 1995.
Other expenses, consisting of personnel and other costs of Exstar, the Syndicate and Alpine, were $6.3 million in 1995 compared to $3.2 million in 1994. This increase was principally due to Exstar's incurring approximately $2.1 million of expenses related to certain executive officers and support staff who were shifted from TCO to become employees of Exstar effective January 1, 1995, a one-time charge of $200,000 representing costs incurred related to the potential acquisition of a specialty line insurance company which was terminated during the first quarter of 1995, legal expenses for the lawsuit against C&L and an increase in legal fees for general corporate matters.
At December 31, 1996, cash and investments totaled $64.1 million, compared to $88.8 million at December 31, 1995. At December 31, 1996, the Company had $33.3 million in cash and investments pledged as collateral for letters of credit related to reinsurance, on deposit with the various states in which it has done business, on deposit in the IIE Guaranty Fund, Inc. and held in trust for the benefit of the Syndicate's policyholders and otherwise to satisfy the Syndicate's obligations. This $33.3 million amount represents 51.9% of the Company's total cash and investments at December 31, 1996. Funds held in trust for the benefit of the Syndicate's policyholders may be used by the Company to satisfy claims of the policyholders and other obligations of the Syndicate.
The foregoing $33.3 million includes the following at December 31, 1996: $13.3 million of fixed maturities; $500,000 of cash and cash equivalents; and $3.4 million of short term investments which were required to be maintained as collateral for letters of credit and to satisfy insurance regulatory requirements. Also included in the $33.3 million is $15.9 million comprised of cash and various types of investments held in trust for the benefit of the Syndicate's policyholders. See "Business -- Regulation -- Combination of the Syndicate with Alpine" -- Item 1 and Note 4 of Notes to Consolidated Financial Statements.
The decrease in cash and invested assets at December 31, 1996, compared to December 31, 1995, resulted from cash applied to operations. Cash applied to operations during 1996 was $24.2 million compared to $14.3 million for 1995, and cash provided by operations of $17.1 million for 1994. The increase in cash applied to operations in 1996 resulted principally from a substantial increase in payments of loss and loss adjustment expenses, while premium revenues decreased as a consequence of the Best rating downgrades, regulatory issues affecting the Syndicate and Alpine and the Company's decision to cease writing direct insurance in August 1996, and the Company's increased expenses for personnel and general administrative costs assumed by Alpine effective August 1, 1996. See "Business -- Background Concerning Changes in Operations" -- Item 1. The increased cash applied to operations in 1995 compared to 1994 resulted principally from an increase in payments of loss and loss adjustment expenses in 1995, and payments of premiums to reinsurers during 1995 for reinsurance covering policies written in 1995 and 1994.
In order to fund the cash applied to operations during 1996 and 1995, the Company liquidated investments at more accelerated rates than historically had been necessary. Net cash inflow from investing activities was $21.0 million in 1996 compared to cash applied to investing activities of $6.2 million in 1995 and $14.9 million in 1994.
The total debt obligation of the Company as of December 31, 1996 was $1.6 million. Of this amount, $500,000 is due during 1997.
Exstar, as a parent company, has relied on advances and tax agreement payments from its subsidiaries to fund its cash requirements. Exstar's cash was depleted during 1996 to pay for the suit against C&L. As a consequence of Exstar's settling the suit in January 1997, Exstar received net cash, after expenses not paid during 1996, of approximately $3 million. See "Legal Proceedings" -- Item 3.
The Company currently does not anticipate that it will issue direct insurance in 1997. Additionally, under the Quota Share Arrangement, most of the premiums ultimately due to Alpine will be withheld by UCIC for some time (perhaps several years), and the investment income payable to Alpine initially will be relatively insignificant. The Company's cash available to fund operations, consequently, will be very limited.
Management anticipates the Company's financial condition and lack of revenues will have a relatively minor impact on the Company's currently planned business operations and regulatory status during 1997. (They will, however, prevent the Company from pursuing other opportunities, including writing direct insurance, that it could have pursued if its financial condition were better.) Under the Quota Share Arrangement, Alpine's participation, and consequently the amount of premium assumed by Alpine, may be restricted by UCIC to a multiple of Alpine's policyholders' surplus, but management expects Alpine's policyholders' surplus to be sufficient so that the limit will not be material during 1997. See "Business -- Current and Future Operations and Organizational Structure" -- Item 1. Alpine's IRIS ratios and its risk based capital computation may be adversely impacted by the Company's lack of revenues, but management anticipates the impact will not be material because Alpine's principal insurance activity during 1997 is expected to be acting as a reinsurer of UCIC under the Quota Share Arrangement in accordance with the plan of operation agreed to between Alpine and the Illinois DOI during 1996. See "Business--Regulation" -- Item 1.
To satisfy the Company's cash need beyond 1997, the Company is considering a number of alternatives. Such alternatives currently include (i) issuing shares of its Common Stock in a private placement or a public offering; (ii) seeking funding from or engaging in other transactions with UCIC; and (iii) merging with one or more other insurance operations. Management has not yet determined which of these or other courses of actions to pursue and has not made any commitment with respect to any of the foregoing. See "Market for Registrant's Common Equity and Related Stockholder Matters" -- Item 5.
As of December 31, 1996, the Company had no off-balance sheet obligations or capital commitments that were not reflected in the Company's financial statements. The Company during 1997 may enter into a settlement agreement relating to the JBW & Co. Loan. Pursuant to such a settlement, the amounts paid to TCO Holdings by Alpine in connection with the Quota Share Arrangement may be used to fund a $2.5 million promissory note payable by TCO Holdings in satisfaction of TCO's potential obligations relating to the preferred stock issued by TCO Holdings. See "Business -- Investments -- JBW & Co. Loan" -- Item 1.
The Company believes the premium levels established by UCIC take into account inflationary pressures. The Company believes UCIC, for competitive reasons, is limited in the extent to which it can increase premiums to account for anticipated inflation, and actual inflation may be greater than anticipated. In either event, the Company believes UCIC, rather than its insureds, may have to absorb inflation costs.