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Zenith National Insurance 10-Q 2009

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2009

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to                

 

Commission file number 1-9627

 

ZENITH NATIONAL INSURANCE CORP.

 

Incorporated in Delaware

 

I.R.S. Employer Identification No.

21255 Califa Street, Woodland Hills, California

 

95-2702776

91367-5021

 

 

(818) 713-1000

 

 

 

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  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes  o

No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).

 

Large accelerated filer

x

Accelerated filer

o

 

 

 

 

Non-accelerated filer (do not check

 

 

 

if a smaller reporting company)

o

Smaller reporting company

o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o

No  x

 

At October 15, 2009, there were 37,367,000 shares of Zenith National Insurance Corp. common stock outstanding.

 

 

 



 

Zenith National Insurance Corp. and Subsidiaries

Form 10-Q

For the Quarter Ended September 30, 2009

Table of Contents

 

 

 

Page

 

 

 

Part I – Financial Information

 

 

 

 

Item 1.

Financial Statements (unaudited):

 

 

 

 

 

Consolidated Balance Sheets – September 30, 2009 and December 31, 2008

3

 

 

 

 

Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2009 and 2008

4

 

 

 

 

Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2009 and 2008

5

 

 

 

 

Consolidated Statements of Stockholders’ Equity and Comprehensive Income - Nine Months Ended September 30, 2009 and 2008

7

 

 

 

 

Notes to Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations

24

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

44

 

 

 

Item 4.

Controls and Procedures

45

 

 

 

Part II – Other Information

 

 

 

 

Item 6.

Exhibits

46

 

 

 

Signatures

47

 

2



 

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements

 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

 

September 30,

 

December 31,

 

(Dollars and shares in thousands)

 

2009

 

2008

 

Assets:

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

At fair value (amortized cost $1,427,505 in 2009 and $1,479,295 in 2008)

 

$

1,478,914

 

$

1,406,891

 

At amortized cost (fair value $211,128 in 2008)

 

 

 

203,349

 

Equity securities, at fair value (cost $28,450 in 2009 and $52,888 in 2008)

 

32,639

 

47,742

 

Short-term investments, at fair value (amortized cost $479,333 in 2009 and $241,452 in 2008)

 

479,352

 

241,715

 

Other investments

 

62,063

 

58,297

 

Total investments

 

2,052,968

 

1,957,994

 

Cash

 

15,981

 

10,478

 

Accrued investment income

 

21,346

 

23,147

 

Premiums receivable

 

10,619

 

14,815

 

Reinsurance recoverables

 

259,316

 

285,269

 

Deferred policy acquisition costs

 

7,285

 

7,274

 

Deferred tax asset

 

17,180

 

70,469

 

Income tax receivable

 

9,905

 

33,448

 

Goodwill

 

20,985

 

20,985

 

Other assets

 

93,194

 

102,143

 

Total assets

 

$

2,508,779

 

$

2,526,022

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Unpaid losses and loss adjustment expenses

 

$

1,214,571

 

$

1,274,586

 

Unearned premiums

 

46,112

 

45,226

 

Policyholders’ dividends accrued

 

25,644

 

37,253

 

Redeemable securities payable

 

58,362

 

58,357

 

Other liabilities

 

82,883

 

87,163

 

Total liabilities

 

1,427,572

 

1,502,585

 

 

 

 

 

 

 

Commitments and contingencies (see Note 11)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $1 par value, 1,000 shares authorized; none issued or outstanding in 2009 and 2008

 

 

 

 

 

Common stock, $1 par value, 100,000 shares authorized; issued 37,367 in 2009 and 45,019 in 2008; outstanding 37,367 in 2009 and 37,324 in 2008

 

37,367

 

45,019

 

Additional paid-in capital

 

359,861

 

472,312

 

Retained earnings

 

647,827

 

722,996

 

Accumulated other comprehensive income (loss)

 

36,152

 

(50,238

)

Treasury stock, at cost (7,695 shares in 2008) (see Note 7)

 

 

 

(166,652

)

Total stockholders’ equity

 

1,081,207

 

1,023,437

 

Total liabilities and stockholders’ equity

 

$

2,508,779

 

$

2,526,022

 

 

The accompanying notes are an integral part of these financial statements.

 

3



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

(Dollars in thousands, except per share data)

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

115,702

 

$

152,962

 

$

350,308

 

$

466,362

 

Net investment income

 

20,541

 

22,873

 

68,108

 

68,405

 

Net realized gains (losses) on investments

 

20,645

 

(8,883

)

26,162

 

(6,695

)

Total revenues

 

156,888

 

166,952

 

444,578

 

528,072

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses incurred

 

80,310

 

75,297

 

249,791

 

195,618

 

Underwriting and other operating expenses:

 

 

 

 

 

 

 

 

 

Policy acquisition costs

 

22,151

 

27,543

 

67,426

 

83,296

 

Underwriting and other costs

 

28,832

 

31,146

 

89,323

 

93,422

 

Policyholders’ dividends

 

(5,328

)

5,604

 

(1,514

)

17,641

 

Interest expense

 

1,284

 

1,284

 

3,852

 

3,870

 

Total expenses

 

127,249

 

140,874

 

408,878

 

393,847

 

Income before tax

 

29,639

 

26,078

 

35,700

 

134,225

 

Income tax expense

 

10,439

 

9,478

 

12,100

 

47,325

 

Net income

 

$

19,200

 

$

16,600

 

$

23,600

 

$

86,900

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.51

 

$

0.45

 

$

0.62

 

$

2.34

 

Diluted

 

0.51

 

0.44

 

0.62

 

2.32

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.50

 

$

0.50

 

$

1.50

 

$

1.50

 

 

 

 

 

 

 

 

 

 

 

Net realized gains (losses) on investments, before tax

 

 

 

 

 

 

 

 

 

Other-than-temporary impairment losses:

 

 

 

 

 

 

 

 

 

Total impairment losses on fixed maturity securities

 

 

 

 

 

$

(19,424

)

 

 

Non-credit portion of impairment losses on fixed maturity securities recognized in other comprehensive income

 

 

 

 

 

8,762

 

 

 

Other-than-temporary impairment losses on fixed maturity securities

 

 

 

$

(10,352

)

(10,662

)

$

(13,224

)

Other-than-temporary impairment losses on equity securities

 

 

 

(4,939

)

(8,418

)

(10,606

)

Other net realized gains

 

$

20,645

 

6,408

 

45,242

 

17,135

 

Net realized gains (losses) on investments, before tax

 

$

20,645

 

$

(8,883

)

$

26,162

 

$

(6,695

)

 

The accompanying notes are an integral part of these financial statements.

 

4



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Premiums collected

 

$

368,148

 

$

483,579

 

Investment income received

 

70,228

 

64,191

 

Losses and loss adjustment expenses paid

 

(285,586

)

(297,046

)

Underwriting and other operating expenses paid

 

(162,581

)

(188,040

)

Interest paid

 

(5,069

)

(5,107

)

Income taxes refunded (paid)

 

18,200

 

(56,694

)

Net cash provided by operating activities

 

3,340

 

883

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of investments:

 

 

 

 

 

Fixed maturity securities available-for-sale

 

(794,566

)

(696,311

)

Equity securities available-for-sale

 

(27,613

)

(104,354

)

Other investments

 

(5,434

)

(37,190

)

Proceeds from maturities and redemptions of investments:

 

 

 

 

 

Fixed maturity securities held-to-maturity

 

 

 

20,997

 

Fixed maturity securities available-for-sale

 

73,121

 

70,508

 

Other investments

 

2,790

 

1,528

 

Proceeds from sales of investments:

 

 

 

 

 

Fixed maturity securities available-for-sale

 

950,850

 

719,552

 

Equity securities available-for-sale

 

44,449

 

105,131

 

Net increase in short-term investments

 

(180,326

)

(20,408

)

Capital expenditures and other

 

(4,424

)

(5,299

)

Net cash provided by investing activities

 

58,847

 

54,154

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Cash dividends paid to common stockholders

 

(56,695

)

(56,420

)

Excess tax benefit on stock-based compensation

 

11

 

340

 

Net cash used in financing activities

 

(56,684

)

(56,080

)

 

 

 

 

 

 

Net increase (decrease) in cash

 

5,503

 

(1,043

)

Cash at beginning of period

 

10,478

 

6,933

 

Cash at end of period

 

$

15,981

 

$

5,890

 

 

The accompanying notes are an integral part of these financial statements.

 

5



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

 

 

 

 

 

 

Reconciliation of net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

23,600

 

$

86,900

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation expense

 

6,108

 

6,369

 

Net amortization (accretion)

 

244

 

(5,037

)

Net realized (gains) losses on investments

 

(26,162

)

6,695

 

Decrease (increase) in:

 

 

 

 

 

Accrued investment income

 

1,751

 

1,425

 

Premiums receivable

 

4,114

 

4,830

 

Reinsurance recoverables

 

25,938

 

46,524

 

Net income tax

 

30,300

 

(10,569

)

(Decrease) increase in:

 

 

 

 

 

Unpaid losses and loss adjustment expenses

 

(60,015

)

(147,574

)

Unearned premiums

 

886

 

(1,838

)

Policyholders’ dividends accrued

 

(11,609

)

8,139

 

Other

 

8,185

 

5,019

 

Net cash provided by operating activities

 

$

3,340

 

$

883

 

 

The accompanying notes are an integral part of these financial statements.

 

6



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(UNAUDITED)

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands, except per share data)

 

2009

 

2008

 

 

 

 

 

 

 

Preferred stock, $1 par value

 

None

 

None

 

 

 

 

 

 

 

Common stock, $1 par value:

 

 

 

 

 

Beginning of period

 

$

45,019

 

$

44,802

 

Treasury stock retirement (see Note 7)

 

(7,695

)

 

 

Restricted stock vested

 

43

 

78

 

Conversion of Convertible Senior Notes Payable

 

 

 

69

 

End of period

 

37,367

 

44,949

 

 

 

 

 

 

 

Additional paid-in capital:

 

 

 

 

 

Beginning of period

 

472,312

 

464,932

 

Treasury stock retirement (see Note 7)

 

(116,890

)

 

 

Recognition of stock-based compensation expense

 

4,446

 

4,504

 

Conversion of Convertible Senior Notes Payable

 

 

 

1,223

 

Excess tax (short-fall) benefit on stock-based compensation

 

(7

)

283

 

End of period

 

359,861

 

470,942

 

 

 

 

 

 

 

Retained earnings:

 

 

 

 

 

Beginning of period

 

722,996

 

718,175

 

Treasury stock retirement (see Note 7)

 

(42,067

)

 

 

Net income

 

23,600

 

86,900

 

Cash dividends declared to common stockholders

 

(56,702

)

(56,465

)

End of period

 

647,827

 

748,610

 

 

 

 

 

 

 

Accumulated other comprehensive (loss) income:

 

 

 

 

 

Beginning of period

 

(50,238

)

12,100

 

Net change in unrealized gains (losses) on available-for-sale investments, net of tax and reclassification adjustment

 

85,721

 

(65,394

)

Net change in other-than-temporary impairments for which the credit related portion was recognized in net realized gains, net of tax

 

669

 

 

 

End of period

 

36,152

 

(53,294

)

 

 

 

 

 

 

Treasury stock:

 

 

 

 

 

Beginning of period

 

(166,652

)

(166,652

)

Treasury stock retirement (see Note 7)

 

166,652

 

 

 

End of period

 

 

 

(166,652

)

 

 

 

 

 

 

Total stockholders’ equity

 

$

1,081,207

 

$

1,044,555

 

 

 

 

 

 

 

Stockholders’ equity per outstanding common share

 

$

28.93

 

$

28.04

 

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

Comprehensive income:

 

 

 

 

 

Net income

 

$

23,600

 

$

86,900

 

Net change in unrealized gains (losses) on available-for-sale investments, net of tax and reclassification adjustment

 

85,721

 

(65,394

)

Net change in other-than-temporary impairments for which the credit related portion was recognized in net realized gains, net of tax

 

669

 

 

 

Comprehensive income

 

$

109,990

 

$

21,506

 

 

The accompanying notes are an integral part of these financial statements.

 

7



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1.  Basis of Presentation

 

Zenith National Insurance Corp. (“Zenith National”) is a holding company engaged, through its wholly-owned subsidiaries (primarily Zenith Insurance Company (“Zenith Insurance”)), in the workers’ compensation insurance business, nationally.  Unless otherwise indicated, all references to “Zenith,” “we,” “us,” “our,” the “Company” or similar terms refer to Zenith National together with its subsidiaries.  The accompanying unaudited Consolidated Financial Statements of Zenith National and subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information; with the instructions to Form 10-Q; and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (including normal, recurring adjustments) necessary for a fair statement of our financial position and results of operations for the periods presented have been included.  The results of operations for an interim period are not necessarily indicative of the results for an entire year.  For further information, refer to the audited Financial Statements and Notes thereto included in the Zenith National Insurance Corp. Annual Report on Form 10-K for the year ended December 31, 2008.

 

We evaluated subsequent events through the date and time the Consolidated Financial Statements were issued on October 20, 2009.

 

Reclassifications.  Certain prior year amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the current year presentation.

 

Note 2.  Net Income and Dividends per Share

 

The following table sets forth the computation of basic and diluted net income per common share and cash dividends declared per common share:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars and shares in thousands, except per share data)

 

2009

 

2008

 

2009

 

2008

 

Net income as reported

 

$

19,200

 

$

16,600

 

$

23,600

 

$

86,900

 

Net income allocated to unvested restricted stock shares (see below)

 

233

 

 

 

292

 

 

 

(A)

Net income allocated to common shares

 

$

18,967

 

$

16,600

 

$

23,308

 

$

86,900

 

(B)

Interest expense on the Convertible Senior Notes Payable, net of tax

 

 

 

 

 

 

 

$

11

 

(C)

Weighted average shares outstanding – basic

 

37,353

 

37,248

 

37,342

 

37,190

 

 

Weighted average shares issued under the Restricted Stock Plan (see below)

 

 

 

176

 

 

 

174

 

 

Weighted average shares issued in 2008 upon conversion of the Convertible Senior Notes Payable

 

 

 

 

 

 

 

23

 

(D) 

Weighted average shares outstanding – diluted

 

37,353

 

37,424

 

37,342

 

37,387

 

Net income per common share:

 

 

 

 

 

 

 

 

 

(A)/(C)  

Basic

 

$

0.51

 

$

0.45

 

$

0.62

 

$

2.34

 

((A)+(B))/(D)

Diluted

 

0.51

 

0.44

 

0.62

 

2.32

 

Cash dividends declared per common share

 

$

0.50

 

$

0.50

 

$

1.50

 

$

1.50

 

 

8



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

On January 1, 2009, we adopted the accounting guidance on “Participating Securities and the Two-Class Method,” which required that unvested restricted stock with a right to receive nonforfeitable dividends be included in the two-class method of computing earnings per share.  The weighted average shares outstanding and net income per common share for the three and nine months ended September 30, 2009 are presented in accordance with this guidance.  Prior period amounts were not restated due to immateriality.

 

Note 3.  Investments

 

At September 30, 2009, all of our investments in fixed maturity and equity securities and short-term investments were classified as available-for-sale and reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of tax.

 

At December 31, 2008, in addition to our available-for-sale securities, our investments portfolio also included certain fixed maturity securities classified as held-to-maturity and reported at amortized cost.  We reclassified our entire held-to-maturity investment portfolio with an amortized cost of approximately $200 million at the date of transfer to available-for-sale during the first quarter 2009 because the unprecedented events in the financial markets resulted in market and economic risks that were not present at the time we elected to hold these securities to maturity.  We determined that we no longer had the positive intent to hold these securities to maturity because of these unusual events and substantial economic changes.  In March 2009, we sold all of our mortgage-backed securities issued by the Government National Mortgage Association, most of which were originally classified as held-to-maturity, resulting in a realized gain of $8.8 million before tax.

 

9



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The cost or amortized cost, fair value and carrying value of available-for-sale investments at September 30, 2009 and held-to-maturity and available-for-sale investments at December 31, 2008 were as follows:

 

 

 

Cost or
Amortized

 

Gross
Unrealized

 

Fair

 

Carrying

 

(Dollars in thousands)

 

Cost

 

Gains

 

(Losses)

 

Value

 

Value

 

September 30, 2009

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

Corporate debt

 

$

1,215,754

 

$

53,633

 

$

(8,712

)

$

1,260,675

 

$

1,260,675

 

State and local government debt

 

118,188

 

6,389

 

(1

)

124,576

 

124,576

 

Mortgage-backed securities

 

9,732

 

368

 

 

 

10,100

 

10,100

 

Foreign government debt

 

2,670

 

27

 

 

 

2,697

 

2,697

 

Redeemable preferred stocks

 

26,875

 

241

 

(595

)

26,521

 

26,521

 

U.S. Government debt

 

54,286

 

59

 

 

 

54,345

 

54,345

 

Total fixed maturity securities available-for-sale

 

1,427,505

 

60,717

 

(9,308

)

1,478,914

 

1,478,914

 

Equity securities

 

28,450

 

4,233

 

(44

)

32,639

 

32,639

 

Short-term investments

 

479,333

 

247

 

(228

)

479,352

 

479,352

 

Total available-for-sale investments

 

$

1,935,288

 

$

65,197

 

$

(9,580

)

$

1,990,905

 

$

1,990,905

 

 

December 31, 2008

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

175,737

 

$

7,285

 

 

 

$

183,022

 

$

175,737

 

State and local government debt

 

22,612

 

521

 

$

(43

)

23,090

 

22,612

 

Foreign government debt

 

5,000

 

16

 

 

 

5,016

 

5,000

 

Total fixed maturity securities held-to-maturity

 

$

203,349

 

$

7,822

 

$

(43

)

$

211,128

 

$

203,349

 

Fixed maturity securities available-for sale:

 

 

 

 

 

 

 

 

 

 

 

Corporate debt

 

$

1,280,354

 

$

18,058

 

$

(90,480

)

$

1,207,932

 

$

1,207,932

 

State and local government debt

 

175,516

 

3,450

 

(3,214

)

175,752

 

175,752

 

Mortgage-backed securities

 

14,866

 

638

 

 

 

15,504

 

15,504

 

Redeemable preferred stocks

 

4,505

 

 

 

(892

)

3,613

 

3,613

 

U.S. Government debt

 

4,054

 

36

 

 

 

4,090

 

4,090

 

Total fixed maturity securities available-for-sale

 

1,479,295

 

22,182

 

(94,586

)

1,406,891

 

1,406,891

 

Equity securities

 

52,888

 

1,680

 

(6,826

)

47,742

 

47,742

 

Short-term investments

 

241,452

 

273

 

(10

)

241,715

 

241,715

 

Total available-for-sale investments

 

$

1,773,635

 

$

24,135

 

$

(101,422

)

$

1,696,348

 

$

1,696,348

 

 

Fixed maturity securities, including short-term investments, by contractual maturity were as follows at September 30, 2009:

 

(Dollars in thousands)

 

Amortized
Cost

 

Fair
Value

 

Due in 1 year or less

 

$

606,242

 

$

608,072

 

Due after 1 year through 5 years

 

1,035,185

 

1,078,373

 

Due after 5 years through 10 years

 

233,008

 

239,357

 

Due after 10 years

 

32,403

 

32,464

 

Total

 

$

1,906,838

 

$

1,958,266

 

 

Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary.  We continually assess the prospects for individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair values.  Our other-than-temporary assessment includes reviewing the

 

10



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

extent and duration of declines in fair values of investments below the amortized cost basis, the seniority and duration of the securities, historical and projected company financial performance, company-specific news and other developments, the outlook for industry sectors, credit ratings and macro-economic changes, including government policy initiatives.  For over seventeen years, we have consistently applied the presumption that an unrealized loss of 20% or more continuously for six months or more is other-than-temporary, in addition to issuer specific events.  The accounting guidance on “Recognition and Presentation of Other-Than-Temporary Impairments” that we adopted effective January 1, 2009 amended the determination of other-than-temporary impairments for debt securities, but not for equity securities.  For debt securities, the amount of an other-than-temporary impairment related to a credit loss or an impairment on a security that, at the balance sheet date, we intend to sell before recovery is recognized in earnings and reflected as a reduction in the cost basis of the security.  The amount of an other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of stockholders’ equity in other comprehensive income or loss with no change to the cost basis of the security.  For equity securities, the amount of an other-than-temporary impairment due to the extent and duration that fair value is below cost, in addition to issuer specific events, is recognized in earnings and reflected as a reduction in the cost basis of the security.

 

In determining whether a credit loss existed on debt securities as of each balance sheet date, we estimated the present value of cash flows expected to be collected from the fixed maturity securities.  Considerable judgment is required in determining estimated cash flows for any individual security and we use market observable data as well as management judgment.  The cash flow estimates incorporate our assumption regarding the probability of default, and the timing and amount of recoveries associated with a default.  We develop our estimates using information based on market observable data such as industry analysts’ reports and forecasts, analysis of investment yield spreads to comparable peer company securities where there are no indications of credit related impairments, analysis of credit default swap spreads and other data relevant to the collectability of a security.

 

11



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

There were no other-than-temporary impairments recorded during the three months ended September 30, 2009.  The following table presents other-than-temporary impairments for the nine months ended September 30, 2009 and shows the amounts recognized in earnings and the amounts recorded as a component of stockholders’ equity as of the date of impairment.  For the three and nine months ended September 30, 2008, we recognized other-than-temporary impairments in earnings before tax of $15.3 million and $23.8 million, respectively.

 

 

 

Nine Months Ended
September 30, 2009

 

(Dollars in thousands)

 

Realized Losses
Recognized

in Earnings

 

Unrealized Losses
Recognized

as a Component
of

Stockholders’
Equity

 

Fixed maturity securities:

 

 

 

 

 

With credit related losses

 

$

9,700

 

$

8,762

 

With intent to sell

 

962

 

 

 

Equity securities

 

8,418

 

 

 

 

 

 

 

 

 

Total other-than-temporary impairments, before tax

 

$

19,080

 

$

8,762

 

 

 

 

 

 

 

Total other-than-temporary impairments, after tax

 

$

12,402

 

$

5,695

 

 

We recognized in earnings the credit related impairments of $9.7 million before tax for two corporate debt securities based on estimated cash flows as of March 31, 2009.  We estimated the cash flows at 60% of par value for one of the debt securities and 90% of par value for the other debt security, and discounted the cash flows using the effective interest rate of 6.6% and 5.49% implicit in the two debt securities at the date of acquisition.

 

The $5.7 million unrealized loss after tax was not credit related and was recognized as a component of stockholders’ equity at March 31, 2009, the date of impairment. As of September 30, 2009, this non-credit related loss has fully recovered to a $0.7 million unrealized gain due to the appreciation in fair values and partial sales of the related securities.

 

The following table presents the change in other-than-temporary credit related impairments before tax recognized in earnings:

 

(Dollars in thousands)

 

 

 

Beginning balance for securities owned as of December 31, 2008

 

$

0

 

Not previously recognized

 

9,700

 

Reduction for securities sold subsequent to impairment

 

(5,952

)

Ending balance for securities owned as of September 30, 2009

 

$

3,748

 

 

 

 

 

Beginning balance for securities owned as of June 30, 2009

 

7,096

 

Reduction for securities sold subsequent to impairment

 

(3,348

)

Ending balance for securities owned as of September 30, 2009

 

$

3,748

 

 

12


 


 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following table presents the fair value of securities classified as available-for-sale with unrealized losses, aggregated by investment category and length of time the securities have been in a continuous unrealized loss position at September 30, 2009 and December 31, 2008:

 

(Dollars in thousands)

 

Fair
Value

 

Unrealized
Losses

 

Number of
Issues

 

September 30, 2009

 

 

 

 

 

 

 

Less than 12 months:

 

 

 

 

 

 

 

Corporate debt

 

$

75,565

 

$

(1,254

)

14

 

Short-term investments

 

20,088

 

(228

)

2

 

State and local government debt

 

1,052

 

(1

)

1

 

Total less than 12 months

 

$

96,705

 

$

(1,483

)

17

 

Greater than 12 months:

 

 

 

 

 

 

 

Corporate debt

 

$

115,260

 

$

(7,458

)

16

 

Redeemable preferred stocks

 

3,910

 

(595

)

2

 

Equity securities

 

302

 

(44

)

1

 

Total greater than 12 months

 

$

119,472

 

$

(8,097

)

19

 

Total available-for-sale:

 

 

 

 

 

 

 

Corporate debt

 

$

190,825

 

$

(8,712

)

30

 

Redeemable preferred stocks

 

3,910

 

(595

)

2

 

Short-term investments

 

20,088

 

(228

)

2

 

State and local government debt

 

1,052

 

(1

)

1

 

Equity securities

 

302

 

(44

)

1

 

Total available-for-sale investments

 

$

216,177

 

$

(9,580

)

36

 

 

December 31, 2008

 

 

 

 

 

 

 

Less than 12 months:

 

 

 

 

 

 

 

Corporate debt

 

$

640,894

 

$

(57,606

)

120

 

Equity securities

 

16,163

 

(6,826

)

9

 

State and local government debt

 

67,330

 

(3,214

)

18

 

Redeemable preferred stocks

 

2,956

 

(644

)

1

 

Short-term investments

 

112,435

 

(10

)

1

 

Total less than 12 months

 

$

839,778

 

$

(68,300

)

149

 

Greater than 12 months:

 

 

 

 

 

 

 

Corporate debt

 

$

107,060

 

$

(32,874

)

13

 

Redeemable preferred stocks

 

657

 

(248

)

1

 

Total greater than 12 months

 

$

107,717

 

$

(33,122

)

14

 

Total available-for-sale:

 

 

 

 

 

 

 

Corporate debt

 

$

747,954

 

$

(90,480

)

133

 

Equity securities

 

16,163

 

(6,826

)

9

 

State and local government debt

 

67,330

 

(3,214

)

18

 

Redeemable preferred stocks

 

3,613

 

(892

)

2

 

Short-term investments

 

112,435

 

(10

)

1

 

Total available-for-sale investments

 

$

947,495

 

$

(101,422

)

163

 

 

13



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The unprecedented events in the capital and credit markets have resulted in extreme volatility and disruption to the financial markets over the past twelve months.  The fair value of our available-for-sale investment portfolio improved from an unrealized loss before tax of $77.3 million at December 31, 2008 to an unrealized gain before tax of $55.6 million at September 30, 2009, an increase of $132.9 million.  The unrealized gain on our available-for-sale investment portfolio as of September 30, 2009 is net of unrealized losses on individual fixed maturity and equity securities.

 

The change in unrealized gains (losses) on our available-for-sale investment portfolio were as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Change in unrealized gains (losses) on available-for-sale investments:

 

 

 

 

 

 

 

 

 

Fixed maturity securities, including short-term investments

 

$

45,341

 

$

(61,253

)

$

123,569

 

$

(86,036

)

Equity securities

 

111

 

(4,962

)

9,335

 

(14,571

)

Total change in unrealized gains (losses):

 

 

 

 

 

 

 

 

 

Before tax

 

$

45,452

 

$

(66,215

)

$

132,904

 

$

(100,607

)

After tax

 

29,546

 

(43,038

)

86,390

 

(65,394

)

 

We believe that our unrealized losses on individual fixed maturity and equity securities at September 30, 2009 are not material and are not indicative of impaired values.  We base this conclusion on our current understanding of the issuers of these securities. As of September 30, 2009, we have not made a decision to sell any of these securities with unrealized losses and we have adequate liquidity and will not be required to sell these securities before recovery of their cost basis.  It is possible that we could recognize future impairments on some securities we owned at September 30, 2009 if future events, information and the passage of time cause us to determine that a decline in value is other-than-temporary.

 

Net realized gains (losses) on all of our investments were as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Fixed maturity securities, including short-term investments

 

$

19,031

 

$

2,493

 

$

41,215

 

$

5,462

 

Equity securities

 

648

 

3,620

 

815

 

10,971

 

Partnerships and limited liability companies

 

966

 

278

 

2,710

 

679

 

WorldCom settlement and other

 

 

 

17

 

502

 

23

 

Other-than-temporary impairment losses on fixed maturity securities

 

 

 

(10,352

)

(10,662

)

(13,224

)

Other-than-temporary impairment losses on equity securities

 

 

 

(4,939

)

(8,418

)

(10,606

)

Net realized gains (losses) on investments

 

$

20,645

 

$

(8,883

)

$

26,162

 

$

(6,695

)

 

For the three and nine months ended September 30, 2009 and 2008, the gross realized gains and the gross realized losses on sales of investments classified as available-for-sale were as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Gross realized gains

 

$

21,916

 

$

7,170

 

$

46,717

 

$

25,130

 

Gross realized losses

 

(2,237

)

(1,057

)

(4,687

)

(8,697

)

 

14



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Net investment income before tax was as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Fixed maturity securities

 

$

20,367

 

$

21,445

 

$

68,356

 

$

62,550

 

Short-term investments

 

723

 

1,411

 

1,635

 

6,884

 

Equity securities

 

212

 

470

 

1,029

 

1,671

 

Other

 

1,189

 

1,075

 

2,015

 

2,046

 

Subtotal

 

22,491

 

24,401

 

73,035

 

73,151

 

Investment expenses

 

1,950

 

1,528

 

4,927

 

4,746

 

Net investment income

 

$

20,541

 

$

22,873

 

$

68,108

 

$

68,405

 

 

Note 4. Fair Value Measurements

 

Our available-for-sale investment portfolio consists of fixed maturity and equity securities and short-term investments and is recorded at fair value in the accompanying Consolidated Balance Sheets.

 

Fair value is the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets (“market approach”).  We also consider the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity to identify transactions that are not orderly.

 

Fair value measurements are determined under a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value, distinguishing between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”).  The hierarchy level assigned to each security in our available-for-sale investment portfolio is based on our assessment of the transparency and reliability of the inputs used in the valuation of each instrument at the measurement date.  The highest priority is given to unadjusted quoted prices in active markets for identical assets (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  Securities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.  The three hierarchy levels are as follows:

 

·                  Level 1—Valuations based on unadjusted quoted market prices in active markets for identical securities.  The fair values of fixed maturity and equity securities and short-term investments included in the Level 1 category were based on quoted prices that are readily and regularly available in an active market.  Our Level 1 category includes publicly traded equity securities, highly liquid U.S. Government notes and treasury bills, highly liquid cash management funds, and short-term certificates of deposit.

 

·                  Level 2—Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.  The fair values of fixed maturity securities and short-term investments included in the Level 2 category were based on market values obtained from independent pricing services that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other

 

15



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

market information and price quotes from well-established independent broker-dealers.  The independent pricing services monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants.  Our Level 2 category includes corporate bonds, municipal bonds, short-term commercial paper and redeemable preferred stocks.

 

·                  Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement and involve management judgment.  The fair values of certain privately held or thinly traded securities are determined using internal analytical methods based on the best information available.  The estimated fair values of our Level 3 securities consist primarily of the following: 1) An equity security of a company based in the United Kingdom with fair value approximating its net asset value because a significant portion of the net asset value, excluding cash balances, is comprised principally of real estate holdings supported by independent appraisals.  The estimated fair value for this investment also includes foreign currency fluctuations and considers the value of an unrecognized tax loss carry forward. 2) A fixed maturity security representing our participation in a commercial senior secured term loan. The fair value of this fixed maturity security was based on discounted expected cash flows.

 

The following table presents our available-for-sale investments measured at fair value on a recurring basis as of September 30, 2009 and December 31, 2008 classified by the valuation hierarchy discussed above:

 

 

 

Fair Value Measurements

 

(Dollars in thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

September 30, 2009

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

54,345

 

$

1,415,052

 

$

9,517

 

$

1,478,914

 

Equity securities

 

1,660

 

 

 

30,979

 

32,639

 

Short-term investments

 

429,377

 

49,975

 

 

 

479,352

 

Total

 

$

485,382

 

$

1,465,027

 

$

40,496

 

$

1,990,905

 

 

 

 

 

 

 

 

 

 

 

December 31, 2008

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

19,594

 

$

1,377,866

 

$

9,431

 

$

1,406,891

 

Equity securities

 

19,394

 

 

 

28,348

 

47,742

 

Short-term investments

 

145,883

 

95,832

 

 

 

241,715

 

Total

 

$

184,871

 

$

1,473,698

 

$

37,779

 

$

1,696,348

 

 

16



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following table presents changes in our Level 3 fixed maturity and equity securities measured at fair value on a recurring basis for the three and nine months ended September 30, 2009 and 2008:

 

(Dollars in thousands)

 

Fixed Maturity
Securities

 

Equity
Securities

 

Balance at June 30, 2009

 

$

14,494

 

$

31,855

 

Realized and unrealized gains included in:

 

 

 

 

 

Other comprehensive income (1)

 

(34

)

(876

)

Net income

 

57

 

 

 

Maturities

 

(5,000

)

 

 

Balance at September 30, 2009

 

$

9,517

 

$

30,979

 

 

Balance at December 31, 2008

 

$

9,431

 

$

28,348

 

Realized and unrealized gains included in:

 

 

 

 

 

Other comprehensive income (1)

 

 

 

2,631

 

Net income

 

86

 

 

 

Maturities

 

(5,000

)

 

 

Reclassification from held-to-maturity (see Note 3)

 

5,000

 

 

 

Balance at September 30, 2009

 

$

9,517

 

$

30,979

 

 

Balance at June 30, 2008

 

$

 

 

$

38,472

 

Change in unrealized gains included in other comprehensive income (1)

 

 

 

(4,089

)

Purchases

 

9,404

 

 

 

Balance at September 30, 2008

 

$

9,404

 

$

34,383

 

 

Balance at December 31, 2007

 

$

 

 

$

38,350

 

Change in unrealized gains included in other comprehensive income (1)

 

 

 

(3,967

)

Purchases

 

9,404

 

 

 

Balance at September 30, 2008

 

$

9,404

 

$

34,383

 

 


(1) Changes in unrealized gains for equity securities represent foreign currency fluctuation.

 

Note 5. Goodwill

 

We test goodwill for impairment annually as of December 31 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  A reporting unit is an operating segment or a unit one level below the operating segment.  The impairment tests include a comparison of the carrying amount of goodwill to the present value of future cash flows of both our workers’ compensation segment and our Florida workers’ compensation business operation, a reporting unit.

 

We did not evaluate goodwill for impairment as of September 30, 2009, as no events occurred or circumstances changed that would have more likely than not reduced the fair value of a reporting unit below its carrying amount since December 31, 2008.  The carrying value of goodwill was $21.0 million as of September 30, 2009 and December 31, 2008.

 

17



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Note 6.  Policyholders’ Dividends

 

Most of our workers’ compensation policies are non-participating; however, we issue certain policies in which the policyholder may participate in favorable claims experience through a dividend.  In addition, Florida statutes require payment of additional dividends to policyholders pursuant to a formula based on underwriting results.  An estimated provision for workers’ compensation policyholders’ dividends is accrued as the related premiums are earned.  At December 31, 2008, we accrued approximately $20 million for Florida dividends payable for prior accident years.  In the third quarter 2009 we reduced our estimated Florida policyholders’ dividends for prior accident years by $11.1 million based on our actual filing with the Florida Department of Insurance, which was partially offset by an increase of $3.7 million in our current estimated California policyholders’ dividends.

 

Note 7. Treasury Stock

 

On September 30, 2009, we cancelled and retired 7,695,000 shares of treasury stock which had been repurchased by the Company over the years for an aggregate repurchase price of $166.7 million.  Upon cancellation and retirement, these shares were returned to the status of authorized and unissued.  The excess of the repurchase price of the treasury stock over the par value was allocated between additional paid-in capital and retained earnings.  There was no impact on our consolidated stockholders’ equity as a result of the cancellation and retirement.

 

Note 8.  Segment Information

 

Our business is comprised of the following segments: workers’ compensation, reinsurance and investments.  Segments are designated based on the types of products and services provided.  Workers’ compensation represents insurance coverage for the statutorily prescribed benefits that employers are required to provide to their employees who may be injured in the course of employment.  Reinsurance principally consists of assumed reinsurance of property losses from worldwide catastrophes and large property risks.  In September 2005, we exited the assumed reinsurance business and ceased writing and renewing assumed reinsurance contracts with all contracts fully expired at the end of 2006; however, we will be paying assumed reinsurance claims for several years.  The results of the reinsurance segment will continue to be included in the results of continuing operations.  Income from the workers’ compensation and reinsurance segments is determined by deducting net losses and loss adjustment expenses incurred and underwriting and other operating expenses incurred from net premiums earned (this result is also known as underwriting income or loss).  Income from operations of the investments segment includes net investment income and net realized gains or losses on investments.  We do not allocate investment income to the results of other segments.  The losses from the parent include interest expense and the general operating expenses of Zenith National, a holding company, which owns, directly or indirectly, all of the capital stock of its insurance subsidiaries and other investment securities.

 

The combined ratio, expressed as a percentage, is a key measurement of profitability traditionally used in the property-casualty insurance business.  The combined ratio, also referred to as the “calendar year combined ratio,” is the sum of the losses and loss adjustment expense ratio and the underwriting and other operating expense ratio.  The losses and loss adjustment expense ratio is the percentage of net losses and loss adjustment expenses incurred to net premiums earned.  The underwriting and other operating expense ratio is the percentage of underwriting and other operating expenses to net premiums earned.

 

18



 

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Segment information is set forth below, with a reconciliation to the accompanying Consolidated Statements of Operations shown in the total column:

 

(Dollars in thousands)

 

Workers’
Compensation

 

Reinsurance

 

Investments

 

Parent

 

Total

 

Three Months Ended September 30, 2009

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

115,666

 

$

36

 

 

 

 

 

$

115,702

 

Net investment income

 

 

 

 

 

$

20,541

 

 

 

20,541

 

Net realized gains on investments

 

 

 

 

 

20,645

 

 

 

20,645

 

Total revenues

 

115,666

 

36

 

41,186

 

 

 

156,888

 

Interest expense

 

 

 

 

 

 

 

$

(1,284

)

(1,284

)

(Loss) income before tax

 

(8,526

)

87

 

41,186

 

(3,108

)

29,639

 

Income tax (benefit) expense

 

(2,636

)

29

 

14,134

 

(1,088

)

10,439

 

Net (loss) income

 

$

(5,890

)

$

58

 

$

27,052

 

$

(2,020

)

$

19,200

 

Combined ratio

 

107.4

%

NM