SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended June 30, 2009

Commission File No. 001-12257

 

 

MERCURY GENERAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

California   95-2211612

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

4484 Wilshire Boulevard, Los Angeles, California   90010
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (323) 937-1060

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate 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   ¨     No   ¨

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 definition 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   ¨

Non-accelerated filer

  ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in the Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

At July 31, 2009, the Registrant had issued and outstanding an aggregate of 54,769,713 shares of its Common Stock.

 

 

 


PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

     June 30,
2009
    December 31,
2008
 
ASSETS     

Investments:

    

Fixed maturities trading, at fair value (amortized cost $2,724,175; $2,728,471)

   $ 2,624,812      $ 2,481,673   

Equity securities trading, at fair value (cost $348,285; $403,773)

     258,813        247,391   

Short-term investments, at fair value (cost $94,574; $208,278)

     94,557        204,756   
                

Total investments

     2,978,182        2,933,820   

Cash

     194,710        35,396   

Receivables:

    

Premiums receivable

     256,004        268,227   

Premium notes

     27,410        25,699   

Accrued investment income

     36,634        36,540   

Other

     8,343        9,526   
                

Total receivables

     328,391        339,992   

Deferred policy acquisition costs

     181,132        200,005   

Fixed assets, net

     201,987        191,777   

Current income taxes

     —          43,378   

Deferred income taxes

     119,988        171,025   

Goodwill

     42,850        5,206   

Other intangible assets

     70,229        —     

Other assets

     24,402        29,596   
                

Total assets

   $ 4,141,871      $ 3,950,195   
                
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Losses and loss adjustment expenses

   $ 1,070,003      $ 1,133,508   

Unearned premiums

     862,706        879,651   

Notes payable

     273,426        158,625   

Accounts payable and accrued expenses

     118,766        93,864   

Current income taxes

     9,576        —     

Other liabilities

     164,848        190,496   
                

Total liabilities

     2,499,325        2,456,144   
                

Commitments and contingencies

    

Shareholders’ equity:

    

Common stock without par value or stated value:

    

Authorized 70,000,000 shares; issued and outstanding 54,769,713 in 2009 and 54,763,713 shares in 2008

     72,030        71,428   

Accumulated other comprehensive loss

     (550     (876

Retained earnings

     1,571,066        1,423,499   
                

Total shareholders’ equity

     1,642,546        1,494,051   
                

Total liabilities and shareholders’ equity

   $ 4,141,871      $ 3,950,195   
                

See accompanying Notes to Consolidated Financial Statements.

 

2


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(unaudited)

 

     Three Months Ended June 30,
             2009                    2008        

Revenues:

     

Net premiums earned

   $ 659,211    $ 711,204

Net investment income

     36,212      38,995

Net realized investment gains

     99,862      36,496

Other

     694      1,202
             

Total revenues

     795,979      787,897
             

Expenses:

     

Losses and loss adjustment expenses

     445,463      489,545

Policy acquisition costs

     136,359      157,441

Other operating expenses

     51,364      43,169

Interest

     1,879      1,486
             

Total expenses

     635,065      691,641
             

Income before income taxes

     160,914      96,256

Income tax expense

     46,467      25,530
             

Net income

   $ 114,447    $ 70,726
             

Basic earnings per share (weighted average shares outstanding 54,769,713 in 2009 and 54,733,880 in 2008)

   $ 2.09    $ 1.29
             

Diluted earnings per share (weighted average shares 55,319,836 as adjusted by 550,123 for the dilutive effect of options in 2009 and 54,997,272 as adjusted by 263,392 for the dilutive effect of options in 2008)

   $ 2.07    $ 1.29
             

Dividends declared per share

   $ 0.58    $ 0.58
             

See accompanying Notes to Consolidated Financial Statements.

 

3


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(unaudited)

 

     Six Months Ended June 30,  
             2009                    2008          

Revenues:

     

Net premiums earned

   $ 1,325,274    $ 1,432,120   

Net investment income

     74,126      78,294   

Net realized investment gains (losses)

     181,176      (55,641

Other

     2,361      2,496   
               

Total revenues

     1,582,937      1,457,269   
               

Expenses:

     

Losses and loss adjustment expenses

     889,755      973,018   

Policy acquisition costs

     283,890      317,582   

Other operating expenses

     104,850      87,484   

Interest

     3,425      1,996   
               

Total expenses

     1,281,920      1,380,080   
               

Income before income taxes

     301,017      77,189   

Income tax expense

     89,917      10,424   
               

Net income

   $ 211,100    $ 66,765   
               

Basic earnings per share (weighted average shares outstanding 54,768,520 in 2009 and 54,731,897 in 2008)

   $ 3.85    $ 1.22   
               

Diluted earnings per share (weighted average shares 55,166,115 as adjusted by 397,595 for the dilutive effect of options in 2009 and 54,894,590 as adjusted by 162,693 for the dilutive effect of options in 2008)

   $ 3.83    $ 1.22   
               

Dividends declared per share

   $ 1.16    $ 1.16   
               

See accompanying Notes to Consolidated Financial Statements.

 

4


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)

 

     Three Months Ended June 30,
             2009                    2008        

Net income

   $ 114,447    $ 70,726

Other comprehensive income, before tax:

     

Gains on hedging instrument

     490      713
             

Other comprehensive income, before tax

     490      713

Income tax expense related to gains on hedging instrument

     172      249
             

Comprehensive income, net of tax

   $ 114,765    $ 71,190
             

See accompanying Notes to Consolidated Financial Statements.

 

5


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)

 

     Six Months Ended June 30,
             2009                    2008        

Net income

   $ 211,100    $ 66,765

Other comprehensive income, before tax:

     

Gains on hedging instrument

     502      269
             

Other comprehensive income, before tax

     502      269

Income tax expense related to gains on hedging instrument

     176      94
             

Comprehensive income, net of tax

   $ 211,426    $ 66,940
             

See accompanying Notes to Consolidated Financial Statements.

 

6


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended June 30,  
             2009                     2008          

Cash flows from operating activities:

    

Net income

   $ 211,100      $ 66,765   

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

    

Depreciation and amortization

     17,418        13,075   

Net realized investment (gains) losses

     (181,176     55,641   

Bond amortization, net

     2,218        3,643   

Excess tax benefit from exercise of stock options

     (3     (59

Decease in premiums receivable

     12,223        15,185   

Increase in premiums notes receivable

     (1,711     (2,088

Decrease in deferred policy acquisition costs

     18,873        3,851   

Decrease in unpaid losses and loss adjustment expenses

     (63,505     (82,983

Decrease in unearned premiums

     (16,945     (18,748

Decrease (increase) in income taxes

     103,818        (26,832

Increase (decrease) in accounts payable and accrued expenses

     19,119        (6,353

Decrease in trading securities in nature, net of realized gains and losses

     3,209        1,792   

Share-based compensation

     367        327   

Decrease in other payables

     (12,840     (9,265

Other, net

     (5,802     (1,018
                

Net cash provided by operating activities

     106,363        12,933   

Cash flows from investing activities:

    

Fixed maturities available for sale in nature:

    

Purchases

     (232,116     (412,022

Sales

     123,275        329,915   

Calls or maturities

     111,710        124,949   

Equity securities available for sale in nature:

    

Purchases

     (143,665     (238,349

Sales

     155,652        176,757   

Net increase in payable for securities

     4,127        14,335   

Net decrease in short-term investments

     110,268        53,481   

Purchase of fixed assets

     (20,656     (29,757

Sale of fixed assets

     357        776   

Business acquisition, net of cash acquired

     (115,488     —     

Other, net

     2,784        6,913   
                

Net cash (used in) provided by investing activities

     (3,752     26,998   

Cash flows from financing activities:

    

Dividends paid to shareholders

     (63,533     (63,491

Excess tax benefit from exercise of stock options

     3        59   

Proceeds from stock options exercised

     233        495   

Proceeds from bank loan

     120,000        18,000   
                

Net cash provided by (used in) financing activities

     56,703        (44,937
                

Net increase (decrease) in cash

     159,314        (5,006

Cash:

    

Beginning of the period

     35,396        48,245   
                

End of the period

   $ 194,710      $ 43,239   
                

Supplemental disclosures of cash flow information:

    

Interest paid during the period

   $ 3,689      $ 2,769   

Income taxes (received) paid during the period

   $ (13,903   $ 37,061   

Net realized (losses) gains from sale of investments

   $ (42,877   $ 15,007   

See accompanying Notes to Consolidated Financial Statements.

 

7


MERCURY GENERAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation

The consolidated financial statements include the accounts of Mercury General Corporation (“Mercury General”) and its directly and indirectly wholly owned insurance and non-insurance subsidiaries (collectively, the “Company”). The insurance subsidiaries are: Mercury Casualty Company, Mercury Insurance Company, California Automobile Insurance Company, California General Underwriters Insurance Company, Mercury Insurance Company of Illinois, Mercury Insurance Company of Georgia, Mercury Indemnity Company of Georgia, Mercury National Insurance Company, American Mercury Insurance Company, American Mercury Lloyds Insurance Company (“AML”), Mercury County Mutual Insurance Company (“MCM”), Mercury Insurance Company of Florida and Mercury Indemnity Company of America. The non-insurance subsidiaries are: Mercury Select Management Company, Inc. (“MSMC”), American Mercury MGA, Inc., Concord Insurance Services, Inc., Mercury Insurance Services, LLC, Mercury Group, Inc., AIS Management LLC, Auto Insurance Specialists, LLC (“AIS”) and PoliSeek AIS Insurance Solutions, Inc. (“PoliSeek”). AML is not owned by the Company, but is controlled by the Company through its attorney-in-fact, MSMC. MCM is not owned by the Company, but is controlled through a management contract and therefore its results are included in the consolidated financial statements. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”), which differ in some respects from those filed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates and assumptions in the preparation of these consolidated financial statements relate to losses and loss adjustment expenses and evaluation of the recoverability of deferred tax assets. Actual results could differ materially from those estimates (See Note 1 “Significant Accounting Policies” of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008).

The financial data of the Company included herein has been prepared without audit. In the opinion of management, all material adjustments of a normal recurring nature necessary to present fairly the Company’s financial position at June 30, 2009 and the results of operations, comprehensive income and cash flows for the periods presented have been made. Operating results and cash flows for the six-month period ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

Certain reclassifications have been made to the prior-period balances to conform to the current-period presentation.

2. Recently Adopted Accounting Standards

Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). While SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141, “Business Combinations” (“SFAS No. 141”), that the acquisition method (referred to as the purchase method in SFAS No. 141) be used for all business combinations and for an acquirer to be identified for each business combination, SFAS No. 141(R) significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, and acquisition costs. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This replaces the cost-allocation process, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. Additionally, SFAS No. 141(R) requires costs incurred to effect the acquisition to be recognized separately from the acquisition rather than included in the cost allocated to the assets acquired and liabilities assumed. SFAS No. 141(R) requires the acquirer to recognize goodwill as of the acquisition date, measured as a residual, which in most types of business combinations will result in measuring goodwill as the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. In addition, under SFAS No. 141(R), changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period impact income tax expense. Effective January 1, 2009, MCC acquired all of the membership interests of AIS Management LLC, a California limited liability company, which is the parent company of AIS and PoliSeek. The acquisition was accounted for in accordance with SFAS No. 141(R). The adoption of SFAS No. 141(R) did not have a material impact on the Company’s consolidated financial statements.

In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) by requiring expanded disclosures about

 

8


an entity’s derivative instruments and hedging activities, but does not change the scope of accounting of SFAS No. 133. SFAS No. 161 requires increased qualitative disclosures such as how and why an entity is using a derivative instrument; how the entity is accounting for its derivative instrument and hedged item under SFAS No. 133 and its related interpretations; and how the instrument affects the entity’s financial position, financial performance, and cash flows. Quantitative disclosures should include information about the fair value of the derivative instrument, including gains and losses, and should contain more detailed information about the location of the derivative instrument in the entity’s financial statements. Credit-risk disclosures should include information about the existence and nature of credit-risk-related contingent features included in derivative instruments. Credit-risk-related contingent features can be defined as those that require entities, upon the occurrence of a credit event such as a credit rating downgrade, to settle derivative instruments or post collateral. The Company adopted SFAS No. 161 on January 1, 2009. The adoption of SFAS No. 161 did not have a material impact on the Company’s consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position Financial Accounting Standard 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No.142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company adopted FSP FAS 142-3 on January 1, 2009. The adoption of FSP FAS 142-3 did not have a material impact on the Company’s consolidated financial statements.

On April 1, 2009, the FASB issued FASB Staff Position Financial Accounting Standard 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP FAS 141(R)-1”). Under FSP FAS 141(R)-1, an acquirer is required to recognize at fair value an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period. The Company adopted FSP FAS 141(R)-1 on January 1, 2009. The adoption of FSP FAS 141(R)-1 did not have a material impact on the Company’s consolidated financial statements.

Effective for the interim reporting period ending June 30, 2009, the Company adopted FASB Staff Position Financial Accounting Standard 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 clarifies that when there has been a significant decrease in the volume and level of activity for an asset or liability, some transactions may not be orderly. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for an asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). The adoption of FSP FAS 157-4 did not have a material impact on the Company’s consolidated financial statements.

Effective for the interim reporting period ending June 30, 2009, the Company adopted FASB Staff Position Financial Accounting Standard 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” to require related disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for the interim reporting period ending June 30, 2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material impact on the Company’s consolidated financial statements.

Effective for the interim reporting period ended June 30, 2009, the Company adopted SFAS No. 165, “Subsequent Events” (“SFAS No. 165”). SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The adoption of SFAS No. 165 did not have a material impact on the Company’s consolidated financial statements.

 

9


3. Financial Instruments

The financial instruments recorded in the consolidated balance sheet include investments, receivables, interest rate swap agreements, accounts payable, equity contracts, and secured and unsecured notes payable. Due to their short-term maturity, the carrying amounts of receivables and accounts payable approximate their fair market values. The following table sets forth the carrying amounts and estimated fair values of other financial instruments at June 30, 2009 and December 31, 2008.

 

     June 30, 2009    December 31, 2008
     Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
     (Amounts in thousands)

Assets

           

Investments

   $ 2,978,182    $ 2,978,182    $ 2,933,820    $ 2,933,820

Interest rate swap agreements

   $ 10,523    $ 10,523    $ 14,394    $ 14,394

Liabilities

           

Interest rate swap agreements

   $ 1,509    $ 1,509    $ 1,348    $ 1,348

Equity contracts

   $ 1,779    $ 1,779    $ 2,803    $ 2,803

Secured notes

   $ 138,000    $ 138,000    $ —      $ —  

Unsecured note

   $ 135,426    $ 130,620    $ 158,625    $ 146,758

Methods and assumptions used in estimating fair values are as follows:

Investments

Effective January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”) and elected to apply the fair value option to all investments (available for sale fixed maturity and equity securities, and short-term investments) existing at the time of adoption and similar securities acquired subsequently. Therefore, these securities are carried at fair value. For additional disclosures regarding methods and assumptions used in estimating fair values of these securities, see Note 5 of Notes to Consolidated Financial Statements.

Interest rate swap agreements and equity contracts

The fair value of interest rate swap agreements reflects the estimated amounts that the Company would pay or receive at June 30, 2009 and December 31, 2008 in order to terminate the contracts based on models using inputs, such as interest rate yield curves, observable for substantially the full term of the contract. For additional disclosures regarding methods and assumptions used in estimating fair values of interest rate swap agreements, see Note 5 of Notes to Consolidated Financial Statements.

Equity contracts

The fair value of equity contracts is based on quoted prices for identical instruments in active markets. For additional disclosures regarding methods and assumptions used in estimating fair values of equity contracts, see Note 5 of Notes to Consolidated Financial Statements.

Secured notes

The fair value of the Company’s $120 million and $18 million secured notes is estimated based on assumptions and inputs, such as reset rates, for similar termed notes. The carrying amounts of the Company’s secured notes approximate their fair market value.

Unsecured note

The fair value of the Company’s publicly traded $125 million unsecured notes is based on the unadjusted quoted price for identical notes in active markets.

4. Fair Value of Financial Instruments

Gains and losses due to changes in fair value for items measured at fair value pursuant to election of the fair value option are included in net realized investment gains (losses) in the Company’s consolidated statements of operations, while interest and dividend income on the investment holdings are recognized on an accrual basis on each measurement date and are included in net investment income in the Company’s consolidated statements of operations. The primary reasons for electing the fair value option were simplification and cost-benefit considerations as well as expansion of use of fair value measurement consistent with the long-term measurement objectives of the FASB for accounting for financial instruments. The following table reflects gains (losses) due to changes in fair value for items measured at fair value pursuant to election of the fair value option under SFAS No. 159:

 

     Three Months ended June 30,     Six Months ended June 30,  
             2009                    2008                     2009                     2008          
     (Amounts in thousands)  

Fixed maturity securities

   $ 46,419    $ 51      $ 147,434      $ (313

Equity securities

     77,198      (13,554     66,919        (69,857

Short-term investments

     —        36,077        (3     (543
                               

Total

   $ 123,617    $ 22,574      $ 214,350      $ (70,713
                               

 

10


In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). SFAS No. 155 permits hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation to irrevocably be accounted for at fair value, with changes in fair value recognized in the statement of operations. The Company adopted SFAS No. 155 on January 1, 2007. As SFAS No. 159 incorporates accounting and disclosure requirements that are similar to those of SFAS No. 155; effective January 1, 2008, SFAS No. 159 rather than SFAS No. 155 is applied to the Company’s fair value elections for hybrid financial instruments.

5. Fair Value Measurement

SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Accordingly, when market observable data is not readily available, the Company’s own assumptions are set to reflect those that market participants would be presumed to use in pricing the asset or liability at the measurement date. Financial assets and financial liabilities recorded on the consolidated balance sheets at fair value are categorized based on the reliability of inputs to the valuation techniques as follows:

Level 1  Financial assets and financial liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in active markets that the Company can access.

Level 2  Financial assets and financial liabilities whose values are based on the following:

a) Quoted prices for similar assets or liabilities in active markets;

b) Quoted prices for identical or similar assets or liabilities in non-active markets; or

c) Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.

Level 3  Financial assets and financial liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the financial assets and financial liabilities.

The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment. The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3.

Summary of Significant Valuation Techniques for Financial Assets and Financial Liabilities

The Company obtained unadjusted fair values on approximately 99% of its portfolio from an independent pricing service. For less than 1% of its portfolio, the Company obtained specific unadjusted broker quotes generally from one knowledgeable outside security broker to determine the fair value of each security. For 0.1% of its portfolio, where the Company was not able to obtain fair values from the independent pricing service or outside security brokers, management performed discounted cash flow price modeling.

 

11


Level 1 Measurements - Fair values of financial assets and financial liabilities are obtained from an independent pricing service, and are based on unadjusted quoted prices for identical assets or liabilities in active markets. Additional pricing services and closing exchange values are used as a comparison to ensure realistic fair values are used in pricing the investment portfolio.

U.S. government bonds and agencies : U.S. treasuries and agencies are priced using unadjusted quoted market prices for identical assets in active markets.

Common stock; Other : Comprised of actively traded, exchange listed U.S. and international equity securities and valued based on unadjusted quoted prices for identical assets in active markets.

Short-term bonds/Money market accounts : Valued based on unadjusted quoted prices for identical assets.

Equity contracts : Comprised of free-standing exchange listed derivatives that are actively traded and valued based on quoted prices for identical instruments in active markets.

Level 2 Measurements - Fair values of financial assets and financial liabilities are obtained from an independent pricing service or outside brokers, and are based on prices for similar assets or liabilities in active markets or valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability. Additional pricing services are used as a comparison to ensure realistic fair values are used in pricing the investment portfolio.

Municipal securities : Valued based on models or matrices using inputs including quoted prices for identical or similar assets in active markets.

Mortgage-backed securities : Comprised of securities that are collateralized by residential mortgage loans. Valued based on models or matrices using multiple observable inputs, such as benchmark yields, reported trades and broker/dealer quotes, for identical or similar assets in active markets. At June 30, 2009 and December 31, 2008, the Company had no holdings in commercial mortgage-backed securities.

Corporate securities : Valued based on a multi-dimensional model using multiple observable inputs, such as benchmark yields, reported trades, broker/dealer quotes and issue spreads, for identical or similar assets in active markets.

Collateralized debt obligations : Valued based on observable inputs, such as underlying debt instruments and their appropriate benchmark spread, for identical or similar assets in active markets.

Redeemable and Non-redeemable preferred stock : Valued based on observable inputs, such as underlying and common stock of same issuer and appropriate spread over a comparable U.S. Treasury security, for identical or similar assets in active markets.

Interest rate swap agreements : Valued based on models using inputs, such as interest rate yield curves, observable for substantially the full term of the contract.

Level 3 Measurements - Fair values of financial assets are based on discounted cash flow price modeling performed by management with inputs that are both unobservable and significant to the overall fair value measurement, including any items in which the evaluated prices obtained elsewhere were deemed to be of a distressed trading level.

Municipal securities : Comprised of certain distressed municipal securities for which valuation is based on models that are widely accepted in the financial services industry and require projections of future cash flows that are not market observable. Included in this category are $2.9 million of auction rate securities (“ARS”). ARS are valued based on a discounted cash flow model with certain inputs that are significant to the valuation, but are not market observable.

The Company’s total financial instruments at fair value are reflected in the consolidated balance sheets on a trade-date basis. Related unrealized gains or losses are recognized in net realized investment gains and losses in the consolidated statements of operations. Fair value measurements are not adjusted for transaction costs.

 

12


Assets Measured at Fair Value

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2009, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

 

     June 30, 2009
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
   Balance as of
June 30, 2009
     (Amounts in thousands)

Assets

           

Fixed maturity securities:

           

U.S. government bonds and agencies

   $ 10,099    $ —      $ —      $ 10,099

Municipal securities

     —        2,343,571      2,856      2,346,427

Mortgage-backed securities

     —        148,167      —        148,167

Corporate securities

     —        86,281      —        86,281

Redeemable preferred stock

     —        444         444

Collateralized debt obligations

     —        33,394         33,394

Equity securities:

           

Common stock:

           

Public utilities

     35,726      —        —        35,726

Banks, trusts and insurance companies

     13,291      —        —        13,291

Industrial and other

     197,922      —        —        197,922

Non-redeemable preferred stock

     —        11,874      —        11,874

Short-term bonds/Money market accounts

     94,535      —        —        94,535

Equity contracts

     22      —        —        22

Interest rate swap agreements

     —        10,523      —        10,523
                           

Total assets at fair value

   $ 351,595    $ 2,634,254    $ 2,856    $ 2,988,705
                           

Liabilities

           

Equity contracts

   $ 1,779    $ —      $ —      $ 1,779

Interest rate swap agreements

     —        1,509      —        1,509
                           

Total liabilities at fair value

   $ 1,779    $ 1,509    $ —      $ 3,288
                           

 

13


The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

 

     December 31, 2008
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
   Balance as of
December 31, 2008
     (Amounts in thousands)

Assets

           

Fixed maturity securities:

           

U.S. government bonds and agencies

   $ 9,898    $ —      $ —      $ 9,898

Municipal securities

     —        2,184,684      2,984      2,187,668

Mortgage-backed securities

     —        202,326      —        202,326

Corporate securities

     —        65,727      —        65,727

Collateralized debt obligations

        13,120         13,120

Redeemable preferred stock

     —        2,934      —        2,934

Equity securities:

           

Common stock:

           

Public utilities

     39,148      —        —        39,148

Banks, trusts and insurance companies

     11,328      —        —        11,328

Industrial and other

     186,294      —        —        186,294

Non-redeemable preferred stock

     —        10,621      —        10,621

Short-term bonds/Money market accounts

     204,678      —        —        204,678

Equity contracts

     78      —        —        78

Interest rate swap agreements

     —        14,394      —        14,394
                           

Total assets at fair value

   $ 451,424    $ 2,493,806    $ 2,984    $ 2,948,214
                           

Liabilities

           

Equity contracts

   $ 2,803    $ —      $ —      $ 2,803

Interest rate swap agreements

     —        1,348      —        1,348

Other

     2,492      —        —        2,492
                           

Total liabilities at fair value

   $ 5,295    $ 1,348    $ —      $ 6,643
                           

As required by SFAS No. 157, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3).

 

14


The following table provides a summary of changes in fair value of Level 3 financial assets and financial liabilities held at fair value at June 30, 2009. There were no Level 3 financial assets and financial liabilities held at June 30, 2008.

 

     Three Months Ended
June 30, 2009
 
     Fixed Maturities  
     (Amounts in thousands)  

Fair value at March 31, 2009

   $ 3,264   

Realized losses included in net realized investment gains

     (408
        

Fair value at June 30, 2009

   $ 2,856   
        

The amount of total losses for the period included in earnings attributable to assets held at June 30, 2009

   $ (408
        
     Six Months Ended
June 30, 2009
 
     Fixed Maturities  
     (Amounts in thousands)  

Fair value at December 31, 2008

   $ 2,984   

Realized losses included in net realized investment gains

     (128
        

Fair value at June 30, 2009

   $ 2,856   
        

The amount of total losses for the period included in earnings attributable to assets held at June 30, 2009

   $ (128
        

On January 1, 2009, the Company adopted SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities measured on a nonrecurring basis. At June 30, 2009, the Company had no applicable nonrecurring measurements of nonfinancial assets and nonfinancial liabilities.

6. Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are equity price risk and interest rate risk. Equity contracts on various equity securities are entered into to manage the price risk associated with forecasted purchases or sales of such securities. Interest rate swaps are entered into to manage interest rate risk associated with the Company’s loans with fixed or floating rates.

Fair value hedge

Effective January 2, 2002, the Company entered into an interest rate swap of a 7.25% fixed rate obligation on a $125 million senior note for a floating rate of LIBOR plus 107 basis points. The swap is designated as a fair value hedge and qualifies for the shortcut method under SFAS No. 133. In accordance with SFAS No. 133, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings. The Company includes the gain or loss on the hedged item in the same line item—interest expense—as the offsetting loss or gain on the related interest rate swaps as follows:

 

     Three Months Ended
June 30, 2009
   Six Months Ended
June 30, 2009

Income Statement Classification

   Gains/(Losses)
on Swap
    Gains/(Losses)
on Loan
   Gains/(Losses)
on Swap
    Gains/(Losses)
on Loan
     (Amounts in thousands)

Other revenue

   $ (2,472   $ 2,472    $ (3,871   $ 3,871

As of June 30, 2009, the total fair market value of the Company’s interest rate swap designated as a fair value hedge was $10.5 million.

 

15


Cash flow hedge

On March 3, 2008, the Company entered into an interest rate swap of a floating LIBOR rate on an $18 million bank loan for a fixed rate of 3.75%. The swap is designated as a cash flow hedge and qualifies for the shortcut method under SFAS No. 133. In accordance with SFAS No. 133, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.

As of June 30, 2009, the total fair market value of the Company’s interest rate swap designated as a cash flow hedge was $(0.8) million.

Fair value amounts, and gains and losses on derivative instruments

The following tables provide the location and amounts of derivative fair values in the consolidated balance sheets and derivative gains and losses in the consolidated statements of operations:

Fair Values of Derivative Instruments

 

     Asset Derivatives    Liability Derivatives
     June 30, 2009    December 31, 2008    June 30, 2009    December 31, 2008
     (Amounts in thousands)
     Balance Sheet
Location
   Fair
Values
   Balance Sheet
Location
   Fair
Values
   Balance Sheet
Location
   Fair
Values
   Balance Sheet
Location
   Fair
Values

Derivatives designated as hedging instruments under SFAS No. 133

                       

Interest rate contracts

   Other assets    $ 10,523    Other assets    $ 14,394    Other liabilities    $ 846    Other liabilities    $ 1,348
                                       

Total derivatives designated as hedging instruments under SFAS No. 133

      $ 10,523       $ 14,394       $ 846       $ 1,348
                                       

Derivatives not designated as hedging instruments under SFAS No. 133

                       

Interest rate contract

               Other liabilities    $ 663      

Equity contracts

   Investments    $ 22    Investments    $ 78    Other liabilities      1,779    Other liabilities    $ 2,803
                                       

Total derivatives not designated as hedging instruments under SFAS No. 133

      $ 22       $ 78       $ 2,442       $ 2,803
                                       

Total derivatives

      $ 10,545       $ 14,472       $ 3,288       $ 4,151
                                       

The Effect of Derivative Instruments on the Statements of Operations

for Three Months and Six Months Ended June 30, 2009 and 2008

 

Derivatives in SFAS No. 133 Fair Value
Hedging Relationships

   Location of Gain or (Loss)
Recognized in Income on
Derivatives
   Amount of Gain or (Loss) Recognized in Income on Derivatives
      Three Months Ended June 30,    Six Months Ended June 30,
              2009                    2008                    2009                    2008        
          (Amounts in thousands)

Interest rate contracts

   Interest expense    $ 1,629    $ 1,024    $ 3,348    $ 2,890

 

Derivatives in SFAS No. 133
Cash Flow Hedging
Relationships

   Amount of Gain or (Loss)
Recognized in OCI on Derivatives
   Location of Gain or (Loss)
Reclassified from Accumulated
OCI
into Income
   Amount of Gain or (Loss)
Reclassified from Accumulated OCI
into Income
   Three Months
Ended June 30,
   Six Months
Ended June 30,
      Three Months
Ended June 30,
   Six Months
Ended June 30,
   2009    2008    2009    2008       2009    2008    2009    2008
     (Amounts in thousands)         (Amounts in thousands)

Interest rate contracts

   $ 490    $ 713    $ 502    $ 269    Other revenue    $ —      $ —      $ —      $ —  

 

16


Derivatives Not Designated as
Hedging Instruments under
SFAS No. 133

   Location of Gain or (Loss)
Recognized in Income on Derivatives
   Amount of Gain or (Loss)
Recognized in Income on
Derivatives
      Three Months
Ended June 30,
   Six Months
Ended June 30,
      2009    2008    2009     2008
          (Amounts in thousands)

Interest rate contract

   Other revenue    $ 1,469    $ —      $ (663   $ —  

Equity contracts

   Net realized investment gains      2,971      4,247      6,409        8,176
                               

Total

      $ 4,440    $ 4,247    $ 5,746      $ 8,176
                               

The interest rate contract not designated as hedging instrument under SFAS No. 133 is an interest rate swap that the Company entered into on February 6, 2009. The purpose of the swap is to offset the variability of cash flows resulting from the variable interest rate of a $120 million credit facility which was used for the acquisition of AIS.

Most equity contracts consist of covered calls. The Company writes covered calls on underlying equity positions held as an enhanced income strategy. This is permitted for the Company’s insurance subsidiaries under statutory regulations. The Company manages the risk associated with covered calls through strict capital limitations and asset allocation throughout various industries.

For additional disclosures regarding equity contracts, see Note 5 of Notes to Consolidated Financial Statements.

7. Acquisition

Effective January 1, 2009, the Company acquired all of the membership interests of AIS Management LLC, a California limited liability company, which is the parent company of AIS and PoliSeek. AIS is a major producer of automobile insurance in the state of California and was the Company’s largest independent broker. This preexisting relationship did not require measurement at the date of acquisition as there was no settlement of executory contracts between the Company and AIS as part of the acquisition.

Goodwill of $38 million arising from the acquisition consists largely of the efficiencies and economies of scale expected from combining the operations of the Company and AIS, and is expected to be fully deductible for income tax purposes in 2009 and future years.

The total cost of the acquisition has been allocated to the assets acquired and the liabilities assumed based upon estimates of their fair values at the acquisition date. The following table summarizes the consideration paid for AIS and the allocation of the purchase price.

 

     January 1, 2009  
     (Amounts in thousands)  

Consideration

  

Cash

   $ 120,000   
        

Fair value of total consideration transferred

   $ 120,000   
        

Acquisition-related costs

   $ 2,000   
        

Recognized amounts of identifiable assets acquired and liabilities assumed

  

Financial assets

   $ 12,875   

Property, plant, and equipment

     2,915   

Favorable leases

     1,725   

Trade names

     15,400   

Customer relationships

     51,200   

Software & technology

     4,850   

Liabilities assumed

     (6,608
        

Total identifiable net assets

     82,357   

Goodwill

     37,643   
        

Total

   $ 120,000   
        

 

17


The weighted-average amortization periods for intangible assets with definite lives, by asset class, are: 24 years for trade names, 11 years for customer relationships, 10 years for technology, 2 years for software and 3 years for lease agreements.

A contingent consideration arrangement requires the Company to pay the former owner of AIS up to an undiscounted maximum amount of $34.7 million. The potential undiscounted amount of all future payments that the Company could be required to make under the contingent consideration arrangement is between $0 and $34.7 million. Based on the projected performance of the AIS business over the next two years, the Company does not expect to pay the contingent consideration. That estimate is based on significant inputs that are not observable in the market, including management’s projections of future cash flows, which SFAS No. 157 refers as Level 3 inputs. Key assumptions in determining the estimated contingent consideration include (a) a discount rate of 10.7% and (b) a decline in revenues ranging from 4% to 5%. As of August 4, 2009, the estimates for the contingent consideration arrangement, the range of outcomes, and the assumptions used to develop the estimates have not changed.

The fair value of the financial assets acquired includes cash, prepaid expenses and receivables from customers. The acquired receivables of $6.6 million at fair value were fully collected during the three-month period ended March 31, 2009. The fair value of the liabilities assumed includes accounts payable and other accrued liabilities.

The following table reflects the amount of revenue and net income of AIS, which are included in the Company’s consolidated statement of operations for the three-month and six-month periods ended June 30, 2009, and the revenue of the combined entity for the three-month and six-month periods ended June 30, 2008, had the acquisition date been January 1, 2008.

 

     Three Months ended June 30,
2008 (pro forma)
   Six Months ended June 30,
2008 (pro forma)
     (Amounts in thousands)

Combined entity

     

Revenues (2)

   $ 791,004    $ 1,463,009

Net income (1)

     N/A      N/A
     Three Months ended June 30,
2009
   Six Months ended June 30,
2009
     (Amounts in thousands)

AIS

     

Revenues (3)

   $ 3,201    $ 5,956

Net income (3)

   $ 530    $ 673
 
  (1) 2008 pro forma net income for the combined entity is not available, as AIS was previously consolidated into its parent company and separate financial statements were not available.

 

  (2) Includes net premiums earned, net investment income, net realized investment gains/losses and commission revenues.

 

  (3) Excludes intercompany transactions with the Company’s insurance subsidiaries.

8. Intangible Assets

The following table reflects the components of intangible assets:

 

     June 30, 2009    December 31, 2008
     Gross Carrying
Amount
   Accumulated
Amortization
    Net Carrying
Amount
   Gross Carrying
Amount
   Accumulated
Amortization
   Net Carrying
Amount
     (Amounts in thousands)    (Amounts in thousands)

Customer relationships

   $ 51,640    $ (2,426   $ 49,214    $ —      $ —      $ —  

Trade names

     15,400      (321     15,079      —        —        —  

Software and technology

     4,850      (353     4,497      —        —        —  

Favorable leases

     1,725      (286     1,439      —        —        —  
                                          
   $ 73,615    $ (3,386   $ 70,229    $ —      $ —      $ —  
                                          

 

18


Intangible assets are amortized on a straight-line basis over their weighted average lives. Intangible assets amortization expense was $1.7 million for the three-month period ended June 30, 2009 and $3.4 million for the six-month period ended June 30, 2009. The following table outlines the estimated future amortization expense related to intangible assets as of June 30, 2009:

 

Year Ended December 31,

   (Amounts in thousands)

2009

   $ 3,406

2010

     6,812

2011

     6,358

2012

     6,144

2013

     5,969

Thereafter

     41,540

9. Goodwill

There are no changes in the carrying amount of goodwill for the three-month period ended June 30, 2009. The changes in the carrying amount of goodwill for the six-month period ended June 30, 2009 are as follows:

 

     Six Months ended June 30, 2009
     Balance as of
January 1, 2009
   Acquisitions    Purchase
price
adjustments
   Balance as of
June 30, 2009
     (Amounts in thousands)

Goodwill

   $ 41,557    $ —      $ 1,293    $ 42,850

The purchase price adjustments are the result of additional information obtained in conjunction with the finalization of the purchase price allocation as of March 31, 2009. Goodwill is reviewed for impairment on an annual basis and between annual tests if indicators of potential impairment exist. No indications of impairment were identified during any of the periods presented.

10. Share-Based Compensation

The Company accounts for share-based compensation in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective transition method. Under this transition method, share-based compensation expense includes compensation expense for all share-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Share-based compensation expense for all share-based payment awards granted or modified on or after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is the option vesting term of four or five years, for only those shares expected to vest. The fair value of stock option awards is estimated using the Black-Scholes option pricing model.

11. Income Taxes

The Company accounts for uncertainty in income taxes in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 provides guidance on financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return related to uncertainties in income taxes. FIN No. 48 prescribes a “more-likely-than-not” recognition threshold that must be met before a tax benefit can be recognized in the financial statements. For a tax position that meets the recognition threshold, the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement is recognized in the financial statements.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Tax years that remain subject to examination by major taxing jurisdictions are 2005 through 2008 for federal taxes and 2001 through 2008 for California state taxes.

There were no material changes to the total amount of unrecognized tax benefits related to tax uncertainties during the six months ended June 30, 2009. The Company does not expect any changes in such unrecognized tax benefits to have any significant impact on its consolidated financial statements within the next 12 months. The Company recognizes interest and assessed penalties related to unrecognized tax benefits as part of income taxes.

 

19


The Company is under examination by the California Franchise Tax Board for tax years 2001 through 2005. The taxing authority has proposed significant adjustments to the Company’s California tax liabilities. Management does not believe that the ultimate outcome of this examination will have a material impact on the Company’s financial position. However, an unfavorable outcome may have a material impact on the Company’s results of operations in the period of such resolution.

The Company accounts for current and deferred income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are recorded with respect to temporary differences in the accounting treatment of items for financial reporting purposes and for income tax purposes. Where, in management’s judgment and based on the weight of all available evidence, it is more likely than not that some amount of recorded deferred tax assets will not be realized, a valuation allowance is established for the portion that is not realizable.

At June 30, 2009, the Company’s deferred income taxes were in a net asset position primarily as a result of the fair value declines in the investment portfolio during 2008, which resulted from extreme volatility in the capital markets and a widening of credit spreads beyond historic norms. Realization of deferred tax assets is dependent on generating sufficient taxable income of an appropriate nature to offset tax losses. The Company believes that through the use of prudent tax planning strategies and the generation of capital gains, sufficient income will be realized in order to avoid losing the full benefits of its deferred tax assets. As a result of significant increases in the value of the Company’s securities portfolio during the three months ended June 30, 2009, the Company reversed a valuation allowance of $2.2 million recognized at March 31, 2009. Although realization is not assured, management believes it is more likely than not that the Company’s deferred tax assets will be realized.

12. Contingencies

The Company is, from time to time, named as a defendant in various lawsuits incidental to its insurance business. In most of these actions, plaintiffs assert claims for punitive damages, which are not insurable under judicial decisions. The Company has established reserves for lawsuits in which the Company is able to estimate its potential exposure and the likelihood that the court will rule against the Company is probable. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. An unfavorable ruling against the Company in the actions currently pending may have a material impact on the Company’s quarterly results of operations; however, none is expected to be material to the Company’s financial position. For a discussion of the Company’s pending material litigation, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

13. Recently Issued Accounting Standards

In April 2009, the FASB issued Staff Position Financial Accounting Standard 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”). FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. As the Company adopted SFAS No. 159 and elected to apply the fair value option to all available for sale investments, FSP FAS 115-2 and FAS 124-2 is not applicable to the Company.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 168”). SFAS No. 168 establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. SFAS No. 168 is effective for the interim reporting period ending September 30, 2009. The Company is assessing the impact of adopting SFAS No. 168 on the Company’s consolidated financial statements.

14. Subsequent Events

The Company evaluated subsequent events through August 4, 2009, the date the financial statements were issued, and noted no significant matters to be disclosed.

 

20


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

I. Overview

A. General

The operating results of property and casualty insurance companies are subject to significant quarter-to-quarter and year-to-year fluctuations due to the effect of competition on pricing, the frequency and severity of losses, natural disasters, general economic conditions, the general regulatory environment in those states in which an insurer operates, state regulation of premium rates, and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical, with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. These cycles can have a large impact on the ability of the Company to grow and retain business. Additionally, with the adoption of SFAS No. 159, changes in the fair value of the investment portfolio are reflected in the consolidated statements of operations, which may result in volatility of earnings, particularly in times of high volatility in the capital markets.

The Company utilizes standard industry measures to report operating results that may not be presented in accordance with GAAP. Included within Management’s Discussion and Analysis of Financial Condition and Results of Operations is a non-GAAP financial measure, net premiums written, which represents the premiums charged on policies issued during a fiscal period less any reinsurance. The measure is not intended to replace, and should be read in conjunction with, the Company’s GAAP financial results and is reconciled to the most directly comparable GAAP measure, net premiums earned, below in Results of Operations.

B. Operations

The Company generates its revenues through the issuance of insurance policies, primarily covering personal automobiles and dwellings through 13 insurance subsidiaries (“Insurance Companies”). The Company also offers mechanical breakdown insurance, commercial and dwelling fire insurance, umbrella insurance, commercial automobile insurance and commercial property insurance. These policies are mostly sold through independent agents and brokers who receive a commission averaging 17% of net premiums written for selling policies. The Company believes that it has a thorough underwriting process that gives the Company an advantage over its competitors. The Company views its agent relationships and underwriting process as one of its primary competitive advantages because it allows the Company to charge lower prices yet realize better margins than many competitors. The Company operates primarily in California, the only state in which it operated prior to 1990. The Company has since expanded its operations into the following states: Georgia and Illinois (1990), Oklahoma and Texas (1996), Florida (1998), Virginia and New York (2001), New Jersey (2003), and Arizona, Pennsylvania, Michigan and Nevada (2004). Direct premiums written during the six-month period ended June 30, 2009 by state and line of business were:

 

     Six Months ended June 30, 2009  
     Private Passenger
Auto
    Commercial
Auto
    Homeowners     Other
Lines
    Total        
     (Amounts in thousands)  

California

   $ 863,279      $ 36,481      $ 101,201      $ 26,549      $ 1,027,510      78.5

Florida

     70,169        7,535        6,986        3,208        87,898      6.7

Texas

     35,977        3,716        791        8,376        48,860      3.7

New Jersey

     40,467        —          —          48        40,515      3.1

Other states

     81,000        3,764        8,171        12,161        105,096      8.0
                                              

Total

   $ 1,090,892      $ 51,496      $ 117,149      $ 50,342      $ 1,309,879      100
                                              
     83.3     3.9     9.0     3.8     100  

The Company also generates income from its investment portfolio. Approximately $74.1 million in pre-tax investment income was generated during the six-month period ended June 30, 2009 on average investments of approximately $3.2 billion, at cost, for the six-month period ended June 30, 2009, compared to $78.3 million pre-tax investment income during the corresponding period in 2008 on average investments of approximately $3.5 billion, at cost, for the six-month period ended June 30, 2008. The portfolio is managed by Company personnel with a view towards maximizing after-tax yields and limiting interest rate and credit risk.

The Company’s operating results have allowed it to consistently generate positive cash flow from operations, which was approximately $106.4 million and $12.9 million for the six-month periods ended June 30, 2009 and 2008, respectively. Cash flow from operations has historically been used to pay shareholder dividends and to help support growth.

 

21


II. Results of Operations

Three Months Ended June 30, 2009 compared to Three Months Ended June 30, 2008

A. Revenue

Net premiums earned and net premiums written for the three-month period ended June 30, 2009 decreased approximately 7.3% and 6.8%, respectively, from the corresponding period in 2008. The decrease in net premiums written is primarily due to a decrease in the number of policies written and slightly lower average premiums per policy reflecting the continuing soft market conditions.

Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. Net premiums earned, the most directly comparable GAAP measure, represents the portion of net premiums written that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the term of the policies. The following is a reconciliation of total Company net premiums written to net premiums earned:

 

     Three Months Ended June 30,
     2009    2008
     (in thousands)

Net premiums written

   $ 637,405    $ 684,177

Decrease in net unearned premiums

     21,806      27,027
             

Net premiums earned

   $ 659,211    $ 711,204
             

B. Profitability

Loss and expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. The following table reflects the Insurance Companies’ loss ratio, expense ratio and combined ratio determined in accordance with GAAP:

 

    Three Months ended June 30,  
    2009     2008  

Loss ratio

  67.6   68.8

Expense ratio

  28.5   28.2
           

Combined ratio

  96.1   97.0
           

The loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned. The loss ratio was affected by positive development of approximately $31 million and adverse development of approximately $9 million on prior periods’ loss reserves for the three-month periods ended June 30, 2009 and 2008, respectively. Excluding the effect of prior accident years’ loss development, the loss ratio was 72.3% and 67.6% for the three-month periods ended June 30, 2009 and 2008, respectively. The increase in the loss ratio excluding the effect of prior accident years’ loss development is primarily due to increased loss severity and lower average premiums earned per policy, partially offset by lower loss frequency.

The expense ratio is determined by matching expenses to the period over which net premiums were earned, rather than to the period that net premiums were written. The expense ratio slightly increased primarily due to the impact of the amortization of AIS deferred commissions, which is described below.

The combined ratio of losses and expenses is the key measure of underwriting performance traditionally used in the property and casualty insurance industry. A combined ratio under 100% generally reflects profitable underwriting results; and a combined ratio over 100% generally reflects unprofitable underwriting results. The Company’s underwriting performance contributed approximately $26 million of income (approximately $5 million of loss when excluding prior accident periods reserve development) and approximately $21 million of income (approximately $30 million of income when excluding prior accident periods reserve development) to the Company’s results of operations before income tax expense for the three-month periods ended June 30, 2009 and 2008, respectively.

Prior to the acquisition of AIS, the Company deferred the recognition of commissions paid to AIS to match the earnings of the related premiums. As AIS is now a wholly-owned subsidiary, commissions paid are no longer deferrable. During the three-month period ended June 30, 2009, the amortization of deferred commissions offset by deferrable direct sales cost impacted the statement of operations by $3 million. The Company expects no material impact after June 30, 2009.

 

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C. Investments

The following table summarizes the investment results of the Company:

 

     Three Months ended June 30,  
     2009     2008  
     (Amounts in thousands)  

Average invested assets at cost (1)

   $ 3,195,308      $ 3,455,387   

Net investment income:

    

Before income taxes

   $ 36,212      $ 38,995   

After income taxes

   $ 32,557      $ 34,441   

Average annual yield on investments:

    

Before income taxes

     4.5     4.5

After income taxes

     4.1     4.0

Net realized investment gains

   $ 99,862      $ 36,496   
 
  (1) Fixed maturities at amortized cost, and equities and short-term investments at cost.

Included in net income are net realized investment gains of $99.9 million for the three-month period ended June 30, 2009 compared with net realized investment gains of $36.5 million for the three-month period ended June 30, 2008. Net realized investment gains include gains of $123.6 million for the three-month period ended June 30, 2009 due to changes in the fair value of total investments measured at fair value pursuant to SFAS No. 159 compared with $22.6 million for the three-month period ended June 30, 2008. The gains during the three-month period ended June 30, 2009 arise from the market value improvements on the Company’s fixed maturity and equity securities. During the three-month period ended June 30, 2009, the Company recorded approximately $46.4 million and $77.2 million in gains due to changes in the fair value of its fixed maturity portfolio and equity portfolio, respectively. The primary cause of the significant gains in fair value of equity securities was the overall improvement in the equity markets, which saw a growth of approximately 15.2% in the S&P 500 Index during the three-month period ended June 30, 2009.

The income tax expenses for the three-month periods ended June 30, 2009 and 2008 were $46.5 million and $25.5 million, respectively. The increase resulted primarily from changes in the fair value of the investment portfolio.

Six Months Ended June 30, 2009 compared to Six Months Ended June 30, 2008

A. Revenue

Net premiums earned and net premiums written in the six-month period ended June 30, 2009 decreased approximately 7.5% and 7.4%, respectively, from the corresponding period in 2008. The decrease in net premiums written is primarily due to a decrease in the number of policies written and slightly lower average premiums per policy reflecting the continuing soft market conditions.

Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. Net premiums earned, the most directly comparable GAAP measure, represents the portion of net premiums written that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the term of the policies. The following is a reconciliation of total Company net premiums written to net premiums earned:

 

     Six Months Ended June 30,
     2009    2008
     (in thousands)

Net premiums written

   $ 1,308,297    $ 1,413,443

Decrease in net unearned premiums

     16,977      18,677
             

Net premiums earned

   $ 1,325,274    $ 1,432,120
             

 

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B. Profitability

Loss and expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. The following table reflects the Insurance Companies’ loss ratio, expense ratio and combined ratio determined in accordance with GAAP:

 

     Six Months ended June 30,  
             2009                     2008          

Loss ratio

   67.2   67.9

Expense ratio

   29.3   28.3
            

Combined ratio

   96.5   96.2
            

The loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned. The loss ratio was affected by positive development of approximately $38 million and adverse development of approximately $17 million on prior periods’ loss reserves for the six-month periods ended June 30, 2009 and 2008, respectively. Excluding the effect of prior accident years’ loss development, the loss ratio was 70.0% and 66.8% for the six-month periods ended June 30, 2009 and 2008, respectively. The increase in the loss ratio excluding the effect of prior accident years’ loss development is primarily due to increased loss severity and lower average premiums earned per policy, partially offset by lower loss frequency.

The expense ratio is determined by matching expenses to the period over which net premiums were earned, rather than to the period that net premiums were written. The expense ratio increased primarily due to an accrual for a reduction in workforce during the three-month period ended March 31, 2009 and the impact of the amortization of AIS deferred commissions, both of which are described below.

The combined ratio of losses and expenses is the key measure of underwriting performance traditionally used in the property and casualty insurance industry. A combined ratio under 100% generally reflects profitable underwriting results; and a combined ratio over 100% generally reflects unprofitable underwriting results. The Company’s underwriting performance contributed approximately $47 million of income (approximately $9 million of income when excluding prior accident periods reserve development) and approximately $54 million of income (approximately $71 million of income when excluding prior accident periods reserve development) to the Company’s results of operations before income tax expense for the six-month periods ended June 30, 2009 and 2008, respectively.

To improve profitability, during the three-month period ended March 31, 2009, the Company implemented several cost reduction programs, including a salary freeze, a suspension of the employee 401(k) matching program, and a workforce reduction of approximately 360 employees (7% of workforce) primarily located in California. As a result of the workforce reduction, an $8 million expense was recorded ($5 million to losses and loss adjustment expenses, $3 million to other operating expenses) during the three-month period ended March 31, 2009. The annualized cost savings from these cost reduction programs are expected to be over $20 million, which began to be realized in the three-month period ended June 30, 2009.

Prior to the acquisition of AIS, the Company deferred the recognition of commissions paid to AIS to match the earnings of the related premiums. As AIS is now a wholly-owned subsidiary, commissions paid are no longer deferrable. During the six-month period ended June 30, 2009, the amortization of deferred commissions offset by deferrable direct sales cost impacted the statement of operations by $15 million. The Company expects no material impact after June 30, 2009.

C. Investments

The following table summarizes the investment results of the Company:

 

     Six Months ended June 30,  
     2009     2008  
     (Amounts in thousands)  

Average invested assets at cost (1)

   $ 3,229,138      $ 3,480,177   

Net investment income:

    

Before income taxes

   $ 74,126      $ 78,294   

After income taxes

   $ 65,970      $ 68,805   

Average annual yield on investments:

    

Before income taxes

     4.6     4.5

After income taxes

     4.1     4.0

Net realized investment gains (losses)

   $ 181,176      $ (55,641
 
  (1) Fixed maturities at amortized cost, and equities and short-term investments at cost.

 

24


Included in net income are net realized investment gains of $181.2 million for the six-month period ended June 30, 2009 compared with net realized investment losses of $55.6 million for the six-month period ended June 30, 2008. Net realized investment gains include gains of $214.4 million for the six-month period ended June 30, 2009 due to changes in the fair value of total investments measured at fair value pursuant to SFAS No. 159 compared with losses of $70.7 million for the six-month period ended June 30, 2008. The gains during the six-month period ended June 30, 2009 arise from the market value improvements on the Company’s fixed maturity and equity securities. During the six-month period ended June 30, 2009, the Company recorded approximately $147.4 million and $66.9 million in gains due to changes in the fair value of its fixed maturity portfolio and equity portfolio, respectively. The primary cause of the significant gains in the Company’s equity portfolio was due to the large allocation to energy related stocks. Energy related stocks experienced a significant growth in value more than that of the overall stock market, which saw a slight growth of approximately 1.8% in the S&P 500 Index.

The income tax expenses for the six-month periods ended June 30, 2009 and 2008 were $89.9 million and $10.4 million, respectively. The increase resulted primarily from changes in the fair value of the investment portfolio.

III. Liquidity and Capital Resources

A. Cash Flows

The principal sources of funds for the Insurance Companies are premiums, sales and maturities of invested assets and dividend and interest income from invested assets. The principal uses of funds for the Insurance Companies are the payment of claims and related expenses, operating expenses, dividends to Mercury General and the purchase of investments.

The Company has generated positive cash flow from operations for over twenty consecutive years. Because of the Company’s long track record of positive operating cash flows, it does not attempt to match the duration and timing of asset maturities with those of liabilities. Rather, the Company manages its portfolio with a view towards maximizing total return with an emphasis on after-tax income. With combined cash and short-term investments of $289.3 million at June 30, 2009, the Company believes its cash flow from operations is adequate to satisfy its liquidity requirements without the forced sale of investments. However, the Company operates in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that the Company’s sources of funds will be sufficient to meet its liquidity needs or that the Company will not be required to raise additional funds to meet those needs, including future business expansion, through the sale of equity or debt securities or from credit facilities with lending institutions.

Net cash provided from operating activities in the six-month period ended June 30, 2009 was $106.4 million, an increase of $93.4 million over the corresponding period in 2008. This increase was primarily due to additional operating cash flows from AIS and a decrease in losses and loss adjustment expenses paid during the six-month period ended June 30, 2009 compared with the corresponding period in 2008. The Company has utilized the cash provided from operating activities primarily for the development of information technology such as the NextGen and Mercury First computer systems and the payment of dividends to its shareholders. Funds derived from the sale, redemption or maturity of fixed maturity investments of $235.0 million, were primarily reinvested by the Company in high grade fixed maturity securities.

The following table shows the estimated fair value of fixed maturity securities at June 30, 2009 by contractual maturity in the next five years:

 

     Fixed maturities
     (Amounts in thousands)

Due in one year or less

   $ 24,177

Due after one year through two years

     22,692

Due after two years through three years

     31,258

Due after three years through four years

     86,783

Due after four years through five years

     139,509
      
   $ 304,419
      

Effective January 1, 2009, the Company acquired AIS for $120 million. The acquisition was financed by a $120 million credit facility that is secured by municipal bonds held as collateral. The credit facility calls for the collateral requirement to be greater than the loan amount. The collateral requirement is calculated as the fair market value of the municipal bonds held as collateral multiplied by the advance rates, which vary based on the credit quality and duration of the assets held and range between 75% and 100% of the fair value of each bond. The loan matures on January 1, 2012 with interest payable at a floating rate of LIBOR rate plus 125 basis points. In addition, the Company may be required to pay up to $34.7 million over the next two years as additional consideration for the AIS acquisition. The Company plans to fund that portion of the purchase price, if necessary, from cash on hand and cash flow from operations. On February 6, 2009, the Company entered into an interest rate swap of its floating LIBOR rate on the loan for a fixed rate of 1.93%, resulting in a total fixed rate of 3.18%. The purpose of the swap is to offset the variability of cash flows resulting from the variable interest rate. The swap is not designated as a hedge. Changes in the fair value are adjusted through the consolidated statement of operations in the period of change.

 

25


B. Invested Assets

Portfolio Composition

An important component of the Company’s financial results is the return on its investment portfolio. The Company’s investment strategy emphasizes safety of principal and consistent income generation, within a total return framework. The investment strategy has historically focused on maximizing after-tax yield with a primary emphasis on maintaining a well diversified, investment grade, fixed income portfolio to support the underlying liabilities and achieve return on capital and profitable growth. The Company believes that investment yield is maximized by selecting assets that perform favorably on a long-term basis and by disposing of certain assets to enhance after-tax yield and minimize the potential effect of downgrades and defaults. The Company believes that this strategy maintains the optimal investment performance necessary to sustain investment income over time. The Company’s portfolio management approach utilizes a recognized market risk and asset allocation strategy as the primary basis for the allocation of interest sensitive, liquid and credit assets as well as for determining overall below investment grade exposure and diversification requirements. Within the ranges set by the asset allocation strategy, tactical investment decisions are made in consideration of prevailing market conditions.

The following table sets forth the composition of the total investment portfolio of the Company at June 30, 2009 and December 31, 2008:

 

     June 30, 2009    December 31, 2008
     Cost (1)    Fair Value    Cost (1)    Fair Value
     (Amounts in thousands)

Fixed maturity securities:

           

U.S. government bonds and agencies

   $ 9,922    $ 10,099    $ 9,633    $ 9,898

States, municipalities and political subdivisions

     2,409,548      2,346,427      2,370,879      2,187,668

Mortgage-backed securities

     162,166      148,167      216,483      202,326

Corporate securities

     93,251      86,281      77,097      65,727

Redeemable preferred stock

     49,288      33,838      54,379      16,054
                           
     2,724,175      2,624,812      2,728,471      2,481,673
                           

Equity securities:

           

Common stock:

           

Public utilities

     30,223      35,726      32,293      39,148

Banks, trusts and insurance companies

     19,316      13,291      20,451      11,328

Industrial and other

     277,747      197,922      330,030      186,294

Non-redeemable preferred stock

     20,999      11,874      20,999      10,621
                           
     348,285      258,813      403,773      247,391
                           

Short-term investments

     94,574      94,557      208,278      204,756
                           

Total investments

   $ 3,167,034    $ 2,978,182      3,340,522      2,933,820
                           
 
  (1) Fixed maturities at amortized cost, and equities and short-term investments at cost.

At June 30, 2009, approximately 78.6% of the Company’s total investment portfolio at fair value and 89.1% of its total fixed maturity investments at fair value were invested in tax-exempt state and municipal bonds. Shorter duration redeemable preferred stocks and collateralized mortgage obligations together represented 6.1% of the Company’s total investment portfolio at fair value. Equity holdings consist of perpetual preferred stocks and dividend-bearing common stocks on which dividend income is partially tax-sheltered by the 70% corporate dividend exclusion. At June 30, 2009, short-term investments consisted of highly rated short-duration securities redeemable on a daily or weekly basis. The Company does not have any material direct equity investment in subprime lenders.

During the six-month period ended June 30, 2009, the Company recognized approximately $181.2 million in net realized investment gains, which include approximately $148.2 million and $26.6 million related to fixed maturity securities and equity securities, respectively. Included in the gains were $147.4 million and $66.9 million in gains due to changes in the fair value of the Company’s fixed maturity portfolio and equity security portfolio, respectively, measured at fair value pursuant to SFAS No. 159. Partially offsetting the gain due to changes in the fair value of the Company’s equity security portfolio was approximately $40.6 million in loss from the sale of equity securities.

 

26


Fixed maturity securities

Fixed maturity securities include debt securities and redeemable preferred stocks, which may have fixed or variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of the Company’s asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs, tax planning considerations or other economic factors. A primary exposure for the fixed maturity securities is interest rate risk. The longer the duration, the more sensitive the asset is to market interest rate fluctuations. As assets with longer maturity dates tend to produce higher current yields, the Company’s historical investment philosophy resulted in a portfolio with a moderate duration. The nominal average maturity of the overall bond portfolio, including short-term investments, was 12.9 years at June 30, 2009, which reflects a portfolio heavily weighted in investment grade tax-exempt municipal bonds. Fixed maturity investments purchased by the Company typically have call options attached, which further reduce the duration of the asset as interest rates decline. The call-adjusted average maturity of the overall bond portfolio, including short-term investments, was approximately 8.8 years, related to holdings which are heavily weighted with high coupon issues that are expected to be called prior to maturity. The modified duration of the overall bond portfolio reflecting anticipated early calls was 6.1 years at June 30, 2009, including collateralized mortgage obligations with modified durations of approximately 1.6 years and short-term investments that carry no duration. Modified duration measures the length of time it takes, on average, to receive the present value of all the cash flows produced by a bond, including reinvestment of interest. As it measures four factors (maturity, coupon rate, yield and call terms), which determine sensitivity to changes in interest rates; modified duration is considered a better indicator of price volatility than simple maturity alone.

Another exposure related to the fixed maturity securities is credit risk, which is managed by maintaining a weighted-average portfolio credit quality rating of AA-. To calculate the weighted-average credit quality ratings as disclosed throughout this Form 10-Q, individual securities were weighted based on fair value and a credit quality numeric score that was assigned to each rating grade. Bond holdings are broadly diversified geographically, within the tax-exempt sector. Holdings in the taxable sector consist principally of investment grade issues. At June 30, 2009, bond holdings rated below investment grade and non rated bonds totaled $107.3 million and $39.7 million, respectively, at fair value, and represented approximately 4.1% and 1.5%, respectively, of total fixed maturity securities. At December 31, 2008, bond holdings of lower than investment grade and non rated bonds totaled $55.4 million and $49.5 million, respectively, and represented approximately 2.2% and 2.0%, respectively, of total fixed maturity securities.

The following table presents the credit quality rating of the Company’s fixed maturity portfolio by types of security at June 30, 2009 at fair value. Credit quality ratings are based on the average of ratings assigned by nationally recognized securities rating organizations. Credit ratings for the Company’s fixed maturity portfolio were stable during the six-month period ended June 30, 2009, with 72.0% of fixed maturity securities at fair value experiencing no change in their overall rating. Approximately 26.0% experienced downgrades during the period, offset by approximately 2.0% in credit upgrades. The majority of the downgrades were due to continued downgrading of the monoline insurance carried on much of the municipal holdings. The majority of the downgrades was slight and still within the investment grade portfolio and only approximately $14.7 million at fair value was downgraded to below investment grade during the quarter, allowing the Company to maintain a high overall credit rating on its fixed maturity securities.

 

27


     June 30, 2009        
     AAA     AA     A     BBB     Non Rated/Other     Total  
     (Amounts in thousands)        

U.S. government bonds and agencies:

            

Treasuries

   $ 6,826      $ —        $ —        $ —        $ —        $ 6,826   

Government agency

     3,273        —          —          —          —          3,273   
                                                

Total

     10,099        —          —          —          —          10,099   
                                                
     100.0             100.0

Municipal securities:

            

Insured (1)

     2,220        541,213        652,359        98,643        27,485        1,321,920   

Uninsured

     291,199        326,431        196,599        154,516        55,762        1,024,507   
                                                

Total

     293,419        867,644        848,958        253,159        83,247        2,346,427   
                                                
     12.5     37.0     36.2     10.8     3.5     100.0

Mortgage-backed securities:

            

Agencies

     113,843        —          —          —          —          113,843   

Non-agencies:

            

Prime

     10,495        714        611        3,055        4,326        19,201   

Alt-A

     2,998        5,834        1,545        2,293        2,453        15,123   
                                                

Total

     127,336        6,548        2,156        5,348        6,779        148,167   
                                                
     85.9     4.4     1.5     3.6     4.6     100.0

Corporate securities:

            

Financial

     4,401        11,022        16,720        11,902        12,176        56,221   

Energy

     —          —          —          5,660        8,874        14,534   

Communications

     —          —          —          6,268        —          6,268   

Utilities

     —          —          —          3,490        2,089        5,579   

Basic materials

     —          —          —          3,624        —          3,624   

Consumer - cyclical

     —          —          —          —          55        55   
                                                

Total

     4,401        11,022        16,720        30,944        23,194        86,281   
                                                
     5.1     12.7     19.4     35.9     26.9     100.0

Redeemable preferred stock:

            

Corporate - Hybrid (CDO)

     —          —          —          —          33,394        33,394   

Redeemable preferred stock

     —          —          —          —          444        444   
                                                

Total

     —          —          —          —          33,838        33,838   
                                                
             100.0     100.0

Total

   $ 435,255      $ 885,214      $ 867,834      $ 289,451      $ 147,058      $ 2,624,812   
                                                
     16.6     33.7     33.1     11.0     5.6     100.0

 

(1) Insured municipal bonds based on underlying ratings: AAA: $11,111, AA: $368,288, A: $650,861, BBB: $104,136, Non rated/Other: $187,524

 

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1. Municipal securities

The Company had approximately $2.3 billion at fair value ($2.4 billion at amortized cost) in municipal bonds at June 30, 2009, with an unrealized loss of $63.1 million which represents 63.5% of the unrealized losses in the entire fixed maturity portfolio. Approximately half of the municipal bond positions are insured by bond insurers. For insured municipal bonds that have underlying ratings, the weighted-average rating was AA- at June 30, 2009.

The following table shows the Company’s insured municipal bond portfolio by bond insurer at June 30, 2009 and at December 31, 2008.

 

     June 30, 2009    December 31, 2008

Municipal bond insurer

   Rating (1)    Fair value    Rating (1)    Fair value
     (Amounts in thousands)

MBIA

   BBB    $ 677,963    BBB    $ 606,301

AMBAC (2)

   BB      215,380    BBB      193,701

FSA

   AA      213,062    AA      205,249

ASSURED GTY

   AA      40,927    AA      16,664

XLCA

   CC      40,621    CCC      38,393

CIFG

   CCC      16,441    B      16,278

ACA

   NR      14,365    NR      13,899

RADIAN

   BB      14,265    BBB      15,155

FGIC

   NR      5,098    CCC      9,048

Other

   N/A      83,798    N/A      81,283
                   
      $ 1,321,920       $ 1,195,971
                   
 
  (1) Management’s estimate of average of ratings issued by Standard & Poor’s, Moody’s and Fitch.

 

  (2) Downgraded to CC subsequent to June 30, 2009.

The Company considers the strength of the underlying credit as a buffer against potential market value declines which may result from future rating downgrades of the bond insurers. In addition, the Company has a long-term time horizon for its municipal bond holdings which generally allows it to recover the full principal amounts upon maturity, avoiding forced sales prior to maturity, of bonds that have declined in market value due to the bond insurers’ rating downgrades. Based on the uncertainty surrounding the financial condition of these insurers, it is possible that there will be additional downgrades to below investment grade ratings by the rating agencies in the future, and such downgrades could impact the estimated fair value of municipal bonds.

At June 30, 2009, municipal securities included auction rate securities. The Company owned $2.9 million and $3.0 million at fair value of auction rate securities at June 30, 2009 and December 31, 2008, respectively. Auction rate securities were valued based on a discounted cash flow model with certain inputs that were not observable in the market, to which SFAS No. 157 refers as Level 3 inputs.

2. Mortgage-backed securities

The mortgage-backed securities portfolio is categorized as loans to “prime” borrowers except for approximately $15.1 million and $16.3 million ($19.7 million and $20.0 million amortized cost) of Alt-A mortgages at June 30, 2009 and December 31, 2008, respectively. Alt-A mortgage backed securities are at fixed or variable rates and include certain securities that are collateralized by residential mortgage loans issued to borrowers with stronger credit profiles than sub-prime borrowers, but do not qualify for prime financing terms due to high loan-to-value ratios or limited supporting documentation. At June 30, 2009, the Company had no holdings in commercial mortgage-backed securities.

The weighted-average rating of the Company’s Alt-A mortgages is A and the weighted-average rating of the entire mortgage backed securities portfolio is AA+.

3. Corporate securities

Included in the fixed maturity securities are $86.3 million of fixed rated corporate securities which have a duration of 4.8 years and a weighted-average rating of BBB+.

 

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4. Redeemable preferred stock

Included in fixed maturities securities are redeemable preferred stocks, which represent approximately 1% of the total investment portfolio at June 30, 2009, and had a weighted-average rating of less than investment grade.

Equity securities

Equity holdings consist of non-redeemable preferred stocks and common stocks on which dividend income is partially tax-sheltered by the 70% corporate dividend exclusion. The net gain due to changes in fair value of the Company’s equity portfolio during the six-month period ended June 30, 2009 was $66.9 million. The primary cause of the significant gains in the Company’s equity portfolio was due to the large allocation to energy related stocks. During the six-month period ended June 30, 2009, energy related stocks experienced a significant growth in value more than that of the overall stock market, which saw a slight growth of approximately 1.8% in the S&P 500 Index.

The Company’s common stock allocation is intended to enhance the return of and provide diversification for the total portfolio. At June 30, 2009, 8.7% of the total investment portfolio at fair value was held in equity securities, compared to 8.4% at December 31, 2008.

Short-term investments

At June 30, 2009, short-term investments include money market accounts, options, and short-term bonds which are highly rated short duration securities redeemable on a daily or weekly basis.

C. Regulatory Capital Requirement

Industry and regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to statutory policyholders’ surplus should not exceed 3.0 to 1. Based on the combined surplus of all the Insurance Companies of $1.4 billion at June 30, 2009, and net premiums written for the twelve months ended on that date of $2.6 billion, the ratio of premium writings to surplus was 1.9 to 1.

IV. Regulatory and Litigation Matters

The Department of Insurance (“DOI”) in each state in which the Company operates conducts periodic financial and market conduct examinations of the Company’s insurance subsidiaries domiciled within the respective state. The following table provides a summary of current financial and market conduct examinations:

 

  State  

  

Exam Type

  

Period Under Review

  

Status

CA    Rating & Underwriting    2004 to 2007    Field work has been completed. Awaiting final report.
NJ    Market Conduct    Sept 2007 to Aug 2008    Field work has been completed. Awaiting final report.
OK    Financial    2005 to 2007    Report was issued in May 2009
FL    Market Conduct    Sept 2005 to Dec 2006    Report was issued in June 2009
TX    Financial    2005 to 2008    Data submitted and field work is pending.

No material findings have been noted in the examinations above.

In March 2006, the California DOI issued an Amended Notice of Non-Compliance (“NNC”) to the NNC originally issued in February 2004 alleging that the Company charged rates in violation of the California Insurance Code, willfully permitted its agents to charge broker fees in violation of California law, and willfully misrepresented the actual price insurance consumers could expect to pay for insurance by the amount of a fee charged by the consumer’s insurance broker. Through this action, the California DOI seeks to impose a fine for each policy in which the Company allegedly permitted an agent to charge a broker fee, which the California DOI contends is the use of an unapproved rate, rating plan or rating system. Further, the California DOI seeks to impose a penalty for each and every date on which the Company allegedly used a misleading advertisement alleged in the NNC. Finally, based upon the conduct alleged, the California DOI also contends that the Company acted fraudulently in violation of Section 704(a) of the California Insurance Code, which permits the California Commissioner of Insurance to suspend certificates of authority for a period of one year. The Company filed a Notice of Defense in response to the NNC. The Company does not believe that it has done anything to warrant a monetary penalty from the California DOI. The San Francisco Superior Court, in Robert Krumme, On Behalf Of The General Public v. Mercury Insurance Company, Mercury Casualty Company, and California Automobile Insurance Company, denied plaintiff’s requests for restitution or any other form of retrospective monetary relief based on the same facts and legal theory. A hearing before the administrative law judge has been set to start on September 14, 2009.

The Company is, from time to time, named as a defendant in various lawsuits incidental to its insurance business. In most of these actions, plaintiffs assert claims for punitive damages which are not insurable under judicial decisions. The Company has established reserves for lawsuits in which the Company is able to estimate its potential exposure and the likelihood that the court will

 

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rule against the Company is probable. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. An unfavorable ruling against the Company in the actions currently pending may, but is not likely to, have a material impact on the Company’s quarterly results of operations; however, it is not expected to be material to the Company’s financial position. For a further discussion of the Company’s pending material regulatory matters and litigation, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

V. Critical Accounting Policies and Estimates

A. Reserves

The preparation of the Company’s consolidated financial statements requires judgment and estimates. The most significant is the estimate of loss reserves as required by SFAS No. 60, “Accounting and Reporting by Insurance Enterprises” (“SFAS No. 60”), and SFAS No. 5, “Accounting for Contingencies” (“SFAS No. 5”). Estimating loss reserves is a difficult process as many factors can ultimately affect the final settlement of a claim and, therefore, the reserve that is required. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates, among other factors, can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of a claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims.

The Company also engages independent actuarial consultants to review the Company’s reserves and to provide the annual actuarial opinions required under state statutory accounting requirements. The Company does not rely on actuarial consultants for GAAP reporting or periodic report disclosure purposes. The Company analyzes loss reserves quarterly primarily using the incurred loss development, average severity and claim count development methods described below. The Company also uses the paid loss development method to analyze loss adjustment expense reserves and industry claims data as part of its reserve analysis. When deciding which method to use in estimating its reserves, the Company evaluates the credibility of each method based on the maturity of the data available and the claims settlement practices for each particular line of business or coverage within a line of business. When establishing the reserve, the Company will generally analyze the results from all of the methods used rather than relying on one method. While these methods are designed to determine the ultimate losses on claims under the Company’s policies, there is inherent uncertainty in all actuarial models since they use historical data to project outcomes. The Company believes that the techniques it uses provide a reasonable basis in estimating loss reserves.

The incurred loss development method analyzes historical incurred case loss (case reserves plus paid losses) development to estimate ultimate losses. The Company applies development factors against current case incurred losses by accident period to calculate ultimate expected losses. The Company believes that the incurred loss development method provides a reasonable basis for evaluating ultimate losses, particularly in the Company’s larger, more established lines of business which have a long operating history. The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim can be estimated. The claim count development method analyzes historical claim count development to estimate future incurred claim count development for current claims. The Company applies these development factors against current claim counts by accident period to calculate ultimate expected claim counts. The average severity method coupled with the claim count development method provide meaningful information regarding inflation and frequency trends that the Company believes is useful in establishing reserves. The paid loss development method analyzes historical payment patterns to estimate the amount of losses yet to be paid. The Company primarily uses this method for loss adjustment expenses because specific case reserves are generally not established for loss adjustment expenses.

In states with little operating history where there are insufficient claims data to prepare a reserve analysis relying solely on Company historical data, the Company generally projects ultimate losses using industry average loss data or expected loss ratios. As the Company develops an operating history in these states, the Company will rely increasingly on the incurred loss development and average severity and claim count development methods. The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average expected loss per claim based on reserves established by adjusters and average losses on previous similar catastrophes.

At June 30, 2009, the Company recorded its point estimate of approximately $1,070.0 million in losses and loss adjustment expenses liability which includes approximately $373.6 million of incurred but not reported (“IBNR”) loss reserves. IBNR includes estimates, based upon past experience, of ultimate developed costs which may differ from case estimates, unreported claims which occurred on or prior to June 30, 2009 and estimated future payments for reopened claims. Management believes that the liability for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss adjustment expenses incurred to date; however, since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provision.

 

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The Company evaluates its reserves quarterly. When management determines that the estimated ultimate claim cost requires reduction for previously reported accident years, positive development occurs and a reduction in losses and loss adjustment expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously reported accident years, negative development occurs and an increase in losses and loss adjustment expenses is reported in the current period. For the six-month period ended June 30, 2009, the Company reported positive development of approximately $38 million on the 2008 and prior accident years’ loss and loss adjustment expense reserves which at December 31, 2008 totaled approximately $1.1 billion. The positive loss development was almost entirely from the California operations and resulted primarily from decreases in the personal automobile loss severity estimates for the 2008 and 2007 accident years and fewer late reported claims than originally anticipated for the 2008 accident year.

For a further discussion of the Company’s reserving methods, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

B. Premiums

The Company complies with SFAS No. 60 in recognizing revenue on insurance policies written. The Company’s insurance premiums are recognized as income ratably over the term of the policies, that is, in proportion to the amount of insurance protection provided. Unearned premiums are carried as a liability on the balance sheet and are computed on a monthly pro-rata basis. The Company evaluates its unearned premiums periodically for premium deficiencies by comparing the sum of expected claim costs, unamortized acquisition costs and maintenance costs to related unearned premiums, net of investment income. To the extent that any of the Company’s lines of business become substantially unprofitable, a premium deficiency reserve may be required. The Company does not expect this to occur on any of its significant lines of business.

C. Investments

Beginning January 1, 2008, all of the Company’s fixed maturity and equity investments are classified as “trading” and carried at fair value as required by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”), as amended, and SFAS No. 159. Prior to January 1, 2008, the Company’s fixed maturity and equity investment portfolios were classified either as “available for sale” or “trading” and carried at fair value under SFAS No. 115, as amended. The Company adopted SFAS No. 157 and SFAS No. 159 as of January 1, 2008. Equity holdings, including non-sinking fund preferred stocks, are, with minor exceptions, actively traded on national exchanges or trading markets, and were valued at the last transaction price on the balance sheet date. Changes in fair value of the investments are reflected in net realized investment gains or losses in the consolidated statements of operations as required under SFAS No. 115, as amended, and SFAS No. 159.

D. Fair Value of Financial Instruments

Certain financial assets and financial liabilities are recorded at fair value. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair values of the Company’s financial instruments are generally based on, or derived from, executable bid prices. In the case of financial instruments transacted on recognized exchanges, the observable prices represent quotations for completed transactions from the exchange on which the financial instrument is principally traded.

The Company’s financial instruments include securities issued by the U.S. government and its agencies, securities issued by states and municipalities, certain corporate and other debt securities, corporate equity securities, and exchange traded funds. Over 99% of the fair value of the financial instruments held at June 30, 2009 is based on observable market prices, observable market parameters, or is derived from such prices or parameters. The availability of observable market prices and pricing parameters can vary across different financial instruments. Observable market prices and pricing parameters in a financial instrument, or a related financial instrument, are used to derive a price without requiring significant judgment.

Certain financial instruments that the Company holds or may acquire may lack observable market prices or market parameters currently or in future periods because they are less actively traded. The fair value of such instruments is determined using techniques appropriate for each particular financial instrument. These techniques may involve some degree of judgment. The price transparency of the particular financial instrument will determine the degree of judgment involved in determining the fair value of the Company’s financial instruments. Price transparency is affected by a wide variety of factors, including, for example, the type of financial instrument, whether it is a new financial instrument and not yet established in the marketplace, and the characteristics particular to the transaction. Financial instruments for which actively quoted prices or pricing parameters are available or for which fair value is derived from actively quoted prices or pricing parameters will generally have a higher degree of price transparency. By contrast, financial instruments that are thinly traded or not quoted will generally have diminished price transparency. Even in normally active markets, the price transparency for actively quoted instruments may be reduced for periods of time during periods of market dislocation. Alternatively, in thinly quoted markets, the participation of market makers willing to purchase and sell a financial instrument provides a source of transparency for products that otherwise is not actively quoted.

 

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E. Income Taxes

At June 30, 2009, the Company’s deferred income taxes were in a net asset position primarily as a result of the fair value declines in the investment portfolio in recent months, which resulted from extreme volatility in the capital markets and a widening of credit spreads beyond historic norms. The Company assesses the likelihood that its deferred tax assets will be realized and, to the extent management does not believe these assets are more likely than not to be realized, a valuation allowance is established.

Management’s recoverability assessment is based on estimates of anticipated capital gains, available capital gains realized in prior years that could be utilized through carryback, and tax-planning strategies available to generate future taxable capital gains, all of which would contribute to the realization of deferred tax benefits. The Company expects to hold certain quantities of debt securities, which are currently in loss positions, to recovery or maturity. Management believes unrealized losses related to these debt securities, which represent a significant portion of the unrealized loss positions at year-end, are not due to default risk. Thus, the principal amounts are believed to be fully realizable at maturity. The Company has a long-term horizon for holding these securities, which management believes will allow avoidance of forced sales prior to maturity. The Company has prior years’ realized capital gains available to offset realized capital losses, via the filing of carryback refund claims. The Company also has unrealized gains in its investment portfolio which could be realized through asset dispositions, at management’s discretion. Further, the Company has the capability to generate additional realized capital gains by entering into a sale-leaseback transaction using one or more properties of its appreciated real estate holdings. Finally, the Company has an established history of generating capital gain premiums earned through its common stock call option program. Based on the continued existence of the options market, the substantial amount of capital committed to supporting the call option program, and the Company’s favorable track record in generating net capital gains from this program in both upward and downward markets, management believes it will be able to generate sufficient amounts of option premium capital gains (more than sufficient to offset any losses on the underlying stocks employed in the program) on a consistent, long term basis.

The Company has the capability to implement these strategies as it has a steady history of generating positive cash flow from operations, as well as the reasonable expectation that its cash flow needs can be met in future periods without the forced sale of its investments. This capability will enable management to use its discretion in controlling the timing and amount of realized losses it generates during future periods. By prudent utilization of some or all of these actions, management believes that it has the ability and intent to generate capital gains, and minimize tax losses, in a manner sufficient to avoid losing the full benefits of its deferred tax assets. Thus, as a result of the Company’s strategies and an improvement in the fair values of our investments, a $2.2 million valuation allowance recognized at March 31, 2009 was reversed at June 30, 2009. Management will continue to assess the need for a valuation allowance on a quarterly basis. Although realization is not assured, management believes it is more likely than not that the Company’s deferred tax assets will be realized.

F. Goodwill

Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets acquired. The Company annually evaluates goodwill for impairment using widely accepted valuation techniques to estimate the fair value of its reporting units. The Company also reviews its goodwill for impairment whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill may exceed its implied fair value.

G. Contingent Liabilities

The Company has known, and may have unknown, potential liabilities that are evaluated using the criteria established by SFAS No. 5. These include claims, assessments or lawsuits relating to the Company’s business. The Company continually evaluates these potential liabilities and accrues for them or discloses them in the notes to the consolidated financial statements if they meet the requirements stated in SFAS No. 5. While it is not possible to know with certainty the ultimate outcome of contingent liabilities, an unfavorable result may have a material impact on the Company’s quarterly results of operations; however, it is not expected to be material to the Company’s financial position.

VI. Forward-Looking Statements

Certain statements in this report on Form 10-Q that are not historical facts constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may address, among other things, the Company’s strategy for growth, business development, regulatory approvals, market position, expenditures, financial results and reserves. Forward-looking statements are not guarantees of performance and are subject to important factors and events that could cause the Company’s actual business, prospects and results of operations to differ materially from the historical information contained in this Form 10-Q and from those that may be expressed or implied by the forward-looking statements.

 

33


Factors that could cause or contribute to such differences include, among others: the competition currently existing in the automobile insurance markets in states where the Company does business; the cyclical and general competitive nature of the property and casualty insurance industry and general uncertainties regarding loss reserve or other estimates; the accuracy and adequacy of the Company’s pricing methodologies; a successful integration of the operations of AIS and the achievement of the synergies and revenue growth from the acquisition of AIS; the Company’s success in managing its business in states outside of California; the impact of potential third party “bad-faith” legislation, changes in laws or regulations, tax position challenges by the California Franchise Tax Board, and decisions of courts, regulators and governmental bodies, particularly in California; the Company’s ability to obtain and the timing of premium rate changes for the Company’s private passenger automobile policies; the performance of and general market risk associated with the Company’s investment portfolio, including the impact of current economic conditions on the Company’s market and investment portfolio; uncertainties related to assumptions and projections generally, inflation and changes in economic conditions; changes in driving patterns and loss trends; court decisions and trends in litigation and health care and auto repair costs; adverse weather conditions or natural disasters in the markets served by the Company; the stability of the Company’s information technology systems and the ability of the Company to execute on its information technology initiatives; the Company’s ability to realize current deferred tax assets or to hold certain securities with current loss positions to recovery or maturity; acts of war and terrorist activities; and other uncertainties, all of which are difficult to predict and many of which are beyond the Company’s control. GAAP prescribes when a Company may reserve for particular risks including litigation exposures. Accordingly, results for a given reporting period could be significantly affected if and when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain periods.

The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information or future events or otherwise. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Form 10-Q or, in the case of any document the Company incorporates by reference, the date of that document. Investors also should understand that it is not possible to predict or identify all factors and should not consider the risks set forth above to be a complete statement of all potential risks and uncertainties. If the expectations or assumptions underlying the Company’s forward-looking statements prove inaccurate or if risks or uncertainties arise, actual results could differ materially from those predicted in any forward-looking statements. The factors identified above are believed to be some, but not all, of the important factors that could cause actual events and results to be significantly different from those that may be expressed or implied in any forward-looking statements. Any forward-looking statements should also be considered in light of the information provided in “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 and in Item 1A. Risk Factors in Part II - Other Information of this Quarterly Report on Form 10-Q.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to various market risk exposures. Primary market risk exposures are changes in interest rates, equity prices and credit risk. Adverse changes to these rates and prices may occur due to changes in the liquidity of a market, or to changes in market perceptions of credit worthiness and risk tolerance. The following disclosure reflects estimates of future performance and economic conditions. Actual results may differ.

Overview

The Company’s investment policies define the overall framework for managing market and investment risks, including accountability and controls over risk management activities, and specify the investment limits and strategies that are appropriate given the liquidity, surplus, product profile and regulatory requirements of the subsidiary. Executive oversight of investment activities is conducted primarily through the Company’s investment committee. The investment committee focuses on strategies to enhance yields, mitigate market risks and optimize capital to improve profitability and returns.

The Company manages exposures to market risk through the use of asset allocation, duration and credit ratings. Asset allocation limits place restrictions on the total funds that may be invested within an asset class. Duration limits on the fixed maturities portfolio place restrictions on the amount of interest rate risk that may be taken. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by investment policies.

Credit risk

Credit risk is risk due to uncertainty in a counterparty’s ability to meet its obligations. Credit risk is managed by maintaining a weighted-average fixed maturities portfolio credit quality rating of AA-. Historically, the ten-year default rate per Moody’s for AA rated municipal bonds has been less than 1%. The Company’s municipal bond holdings, which represent 89.4% of its fixed maturity portfolio at June 30, 2009 at fair value, are broadly diversified geographically and of those approximately 99.7% are in the tax-exempt sector. The largest holdings are in populous states such as Texas (16.3%) and California (12.1%); however, such holdings are further diversified primarily between cities, counties, schools, public works, hospitals and state general obligations. In California, the Company owns approximately $7.6 million at fair value of general obligations of the state at June 30, 2009. Credit risk is addressed

 

34


by limiting exposure to any particular issuer to ensure diversification. Taxable fixed maturity securities represent 10.9% of the Company’s fixed maturity portfolio. Approximately 43.5% of the Company’s taxable fixed maturity securities were comprised of U.S. government bonds and agencies, which were rated AAA at June 30, 2009. Approximately 18.6% of the Company’s taxable fixed maturity securities were rated below investment grade. Below investment grade issues are considered “watch list” items by the Company, and their status is evaluated within the context of the Company’s overall portfolio and its investment policy on an aggregate risk management basis, as well as its ability to recover its investment on an individual issue basis.

Credit ratings for the Company’s fixed maturity portfolio were stable during the six-month period ended June 30, 2009, with 72.0% of the fixed maturity portfolio at fair value experiencing no change in their overall rating. Approximately 26.0% experienced downgrades during the period, offset by approximately 2.0% in credit upgrades. The majority of the downgrades were due to continued downgrading of the monoline insurance carried on much of the municipal holdings. The majority of the downgrades was slight and still within the investment grade portfolio and only approximately $14.7 million at fair value was downgraded to below investment grade during the quarter, allowing the Company to maintain a high overall credit rating on its fixed maturity securities.

Equity price risk

Equity price risk is the risk that the Company will incur losses due to adverse changes in the general levels of the equity markets.

At June 30, 2009, the Company’s primary objective for common equity investments is current income. The fair value of the equity investment consists of $246.9 million in common stocks and $11.9 million in non-redeemable preferred stocks. The common stock equity assets are typically valued for future economic prospects as perceived by the market. The current market expectation is cautiously optimistic following government programs designed to sustain the economy. The Company has also allocated more to the energy sector relative to the S&P 500 Index to hedge against potential inflationary pressures on the equity markets possible in a sudden economic recovery.

The common equity portfolio represents approximately 8.3% of total investments at fair value. Beta is a measure of a security’s systematic (non-diversifiable) risk, which is the percentage change in an individual security’s return for a 1% change in the return of the market. The weighted-average Beta for the Company’s common stock holdings was 1.15 at June 30, 2009. Based on a hypothetical 25% or 50% reduction in the overall value of the stock market, the fair value of the common stock portfolio would decrease by approximately $71.0 million or $142.0 million, respectively.

Interest rate risk

Interest rate risk is the risk that the Company will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of interest bearing assets and liabilities. This risk arises from many of its primary activities, as the Company invests substantial funds in interest sensitive assets and issues interest sensitive liabilities. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key benchmarks as well as changes in interest rates resulting from the widening credit spreads and credit exposure to collateralized securities.

The value of the fixed maturity portfolio, which represents 88.1% of total investments at fair value, is subject to interest rate risk. As market interest rates decrease, the value of the portfolio increases and vice versa. A common measure of the interest sensitivity of fixed maturity assets is modified duration, a calculation that utilizes maturity, coupon rate, yield and call terms to calculate an average age of the expected cash flows. The longer the duration, the more sensitive the asset is to market interest rate fluctuations.

The Company has historically invested in fixed maturity investments with a goal towards maximizing after-tax yields and holding assets to the maturity or call date. Since assets with longer maturity dates tend to produce higher current yields, the Company’s historical investment philosophy resulted in a portfolio with a moderate duration. Bond investments made by the Company typically have call options attached, which further reduce the duration of the asset as interest rates decline. The increase in municipal bond credit spreads in 2008 caused overall interest rates to increase, which resulted in the increase in the duration of the Company’s portfolio. Consequently, the modified duration of the bond portfolio, including short-term investments, is 6.1 years at June 30, 2009. Given a hypothetical parallel increase of 100 basis or 200 basis points in interest rates, the fair value of the bond portfolio at June 30, 2009 would decrease by approximately $160.4 million or $320.8 million, respectively.

Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on its $125 million fixed 7.25% rate senior notes for a floating rate. The interest rate swap has the effect of hedging the fair value of the senior notes.

 

35


Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect the Company’s internal control over financial reporting. The Company’s process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.

 

36


PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

The Company is, from time to time, named as a defendant in various lawsuits incidental to its insurance business. In most of these actions, plaintiffs assert claims for punitive damages which are not insurable under judicial decisions. The Company has established reserves for lawsuits in which the Company is able to estimate its potential exposure and the likelihood that the court will rule against the Company is probable. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. An unfavorable ruling against the Company in the actions currently pending may have a material impact on the Company’s quarterly results of operations; however, none is expected to be material to the Company’s financial position. For a detailed description of the pending material lawsuits, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

 

Item 1A. Risk Factors

The Company’s business, operations, and financial position are subject to various risks. These risks are described elsewhere in this report and in its other filings with the United States Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The risk factors identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 have not changed in any material respect.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3. Defaults Upon Senior Securities

None

 

Item 4. Submission of Matters to a Vote of Security Holders

The Company held its Annual Meeting of Shareholders on May 13, 2009. The matters voted upon at the meeting included the election of all nine directors. The votes cast with respect to this matter were as follows:

Election of Directors:

 

Nominee

   Number of
Shares Voted
For
   Number of
Shares
Withheld

Nathan Bessin

   40,227,756    2,916,884

Bruce A. Bunner

   42,201,328    943,312

Michael D. Curtius

   42,202,553    942,087

Richard E. Grayson

   42,074,469    1,070,171

George Joseph

   42,256,963    887,677

Martha E. Marcon

   41,946,331    1,198,309

Donald. P. Newell

   41,946,309    1,198,331

Donald R. Spuehler

   41,957,933    1,186,706

Gabriel Tirador

   42,209,069    935,571

 

Item 5. Other Information

None

 

Item 6. Exhibits

 

10.34    Credit Agreement, dated as of January 2, 2009, among Mercury Casualty Company, Mercury General Corporation, Bank of America, N.A., and the lenders party thereto
15.1      Report of Independent Registered Public Accounting Firm
15.2      Awareness Letter of Independent Registered Public Accounting Firm
31.1      Certification of Registrant’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2      Certification of Registrant’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1      Certification of Registrant’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. This certification is being furnished solely to accompany this Quarterly Report on Form 10-Q and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company.
32.2      Certification of Registrant’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. This certification is being furnished solely to accompany this Quarterly Report on Form 10-Q and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company.

 

37


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  MERCURY GENERAL CORPORATION
Date: August 4, 2009     By:    /s/    Gabriel Tirador
      Gabriel Tirador
      President and Chief Executive Officer
Date: August 4, 2009     By:   /s/    Theodore Stalick
      Theodore Stalick
      Vice President and Chief Financial Officer

 

38

Exhibit 10.34

EXECUTION VERSION

CREDIT AGREEMENT

Dated as of January 2, 2009

Among

MERCURY CASUALTY COMPANY,

as the Borrower,

MERCURY GENERAL CORPORATION,

as the Guarantor,

BANK OF AMERICA, N.A.,

as Administrative Agent

And

The Other Lenders Party Hereto

BANC OF AMERICA SECURITIES LLC,

as Sole Lead Arranger and Sole Book Manager


TABLE OF CONTENTS

 

ARTICLE I.    DEFINITIONS AND ACCOUNTING TERMS

   1

1.01

  

Defined Terms

   1

1.02

  

Other Interpretive Provisions

   17

1.03

  

Accounting Terms

   18

1.04

  

Rounding

   19

1.05

  

Times of Day

   19

ARTICLE II.    THE LOANS

   19

2.01

  

Loans

   19

2.02

  

Initial Borrowing, Conversions and Continuations of Loans

   19

2.03

  

Prepayments

   20

2.04

  

Repayment of Loans

   21

2.05

  

Interest

   21

2.06

  

Fees

   22

2.07

  

Computation of Interest and Fees

   22

2.08

  

Evidence of Debt

   22

2.09

  

Payments Generally; Administrative Agent’s Clawback

   23

2.10

  

Sharing of Payments by Lenders

   24

ARTICLE III.    TAXES, YIELD PROTECTION AND ILLEGALITY

   24

3.01

  

Taxes

   24

3.02

  

Illegality

   28

3.03

  

Inability to Determine Rates

   28

3.04

  

Increased Costs; Reserves on Eurodollar Rate Loans

   28

3.05

  

Compensation for Losses

   30

3.06

  

Mitigation Obligations; Replacement of Lenders

   30

3.07

  

Survival

   31

ARTICLE IV.    CONDITIONS PRECEDENT TO LOANS

   31

4.01

  

Conditions of Effective Date

   31

4.02

  

Conditions to all Loans

   32

ARTICLE V.    REPRESENTATIONS AND WARRANTIES

   34

5.01

  

Existence, Qualification and Power

   34

5.02

  

Authorization; No Contravention

   34


5.03

  

Governmental Authorization; Other Consents

   34

5.04

  

Binding Effect

   34

5.05

  

Financial Statements; No Material Adverse Effect

   35

5.06

  

Litigation

   35

5.07

  

No Default

   36

5.08

  

Ownership of Property; Liens

   36

5.09

  

Environmental Compliance

   36

5.10

  

Insurance

   36

5.11

  

Taxes

   36

5.12

  

ERISA Compliance

   36

5.13

  

Subsidiaries; Equity Interests

   37

5.14

  

Margin Regulations; Investment Company Act

   37

5.15

  

Disclosure

   37

5.16

  

Compliance with Laws

   38

5.17

  

Taxpayer Identification Number

   38

5.18

  

First Priority Security Interest

   38

ARTICLE VI.    AFFIRMATIVE COVENANTS

   38

6.01

  

Financial Statements

   38

6.02

  

Certificates; Other Information

   39

6.03

  

Notices

   42

6.04

  

Payment of Obligations

   43

6.05

  

Preservation of Existence, Etc.

   43

6.06

  

Maintenance of Properties

   43

6.07

  

Maintenance of Insurance

   43

6.08

  

Compliance with Laws

   43

6.09

  

Books and Records

   44

6.10

  

Inspection Rights

   44

6.11

  

Use of Proceeds

   44

6.12

  

Bank as Principal Depository

   44

6.13

  

Further Assurances

   44

6.14

  

Collateral Value

   44

ARTICLE VII.    NEGATIVE COVENANTS

   45

7.01

  

Liens

   45

 

ii


7.02

  

Investments

   46

7.03

  

Indebtedness

   46

7.04

  

Fundamental Changes

   47

7.05

  

Dispositions

   48

7.06

  

Restricted Payments

   49

7.07

  

Change in Nature of Business

   49

7.08

  

Transactions with Affiliates

   49

7.09

  

Burdensome Agreements

   49

7.10

  

Use of Proceeds

   50

7.11

  

Financial Covenants

   50

ARTICLE VIII.    EVENTS OF DEFAULT AND REMEDIES

   50

8.01

  

Events of Default

   50

8.02

  

Remedies Upon Event of Default

   53

8.03

  

Application of Funds

   53

ARTICLE IX.    ADMINISTRATIVE AGENT

   54

9.01

  

Appointment and Authority

   54

9.02

  

Rights as a Lender

   54

9.03

  

Exculpatory Provisions

   54

9.04

  

Reliance by Administrative Agent

   55

9.05

  

Delegation of Duties

   55

9.06

  

Resignation of Administrative Agent

   55

9.07

  

Non-Reliance on Administrative Agent and Other Lenders

   56

9.08

  

No Other Duties, Etc.

   56

9.09

  

Administrative Agent May File Proofs of Claim

   56

9.10

  

Collateral Matters

   57

ARTICLE X.    PARENT GUARANTEE

   57

10.01

  

Unconditional Guarantee

   57

10.02

  

Guarantee Absolute

   58

10.03

  

Waivers

   58

10.04

  

Subrogation

   59

10.05

  

Survival

   59

10.06

  

Severability

   59

 

iii


ARTICLE XI.    MISCELLANEOUS

   60

11.01

  

Amendments, Etc

   60

11.02

  

Notices; Effectiveness; Electronic Communication

   61

11.03

  

No Waiver; Cumulative Remedies; Enforcement

   63

11.04

  

Expenses; Indemnity; Damage Waiver

   63

11.05

  

Payments Set Aside

   65

11.06

  

Successors and Assigns

   66

11.07

  

Treatment of Certain Information; Confidentiality

   69

11.08

  

Right of Setoff

   70

11.09

  

Interest Rate Limitation

   70

11.10

  

Counterparts; Integration; Effectiveness

   70

11.11

  

Survival of Representations and Warranties

   70

11.12

  

Severability

   71

11.13

  

Replacement of Lenders

   71

11.14

  

Governing Law; Jurisdiction; Etc

   72

11.15

  

Waiver of Jury Trial

   72

11.16

  

California Proceedings

   73

11.17

  

No Advisory or Fiduciary Responsibility

   73

11.18

  

Electronic Execution of Assignments and Certain Other Documents

   74

11.19

  

USA PATRIOT Act

   74

11.20

  

Time of the Essence

   74

11.21

  

Entire Agreement

   74

 

iv


SCHEDULES

 

1.01   

Collateral Advance Rates

2.01   

Commitments and Applicable Percentages

5.13   

Subsidiaries; Other Equity Investments

11.02   

Administrative Agent’s Office; Certain Addresses for Notices

EXHIBITS

Form of

 

A   

Loan Notice

B   

Note

C-1   

Compliance Certificate

C-2   

Collateral Value Certificate

D-1   

Assignment and Assumption

D-2   

Administrative Questionnaire

E-1   

Security Agreement

E-2   

Control Agreement

F   

Opinion Matters

 

v


CREDIT AGREEMENT

This CREDIT AGREEMENT (“ Agreement ”) is entered into as of January 2, 2009, among MERCURY CASUALTY COMPANY, a California corporation (the “ Borrower ”), MERCURY GENERAL CORPORATION, a California corporation (the “ Parent ”), each lender from time to time party hereto (collectively, the “ Lenders ” and individually, a “ Lender ”), and BANK OF AMERICA, N.A., as Administrative Agent.

The Borrower has requested that the Lenders provide a term loan facility, and the Lenders are willing to do so on the terms and conditions set forth herein.

In consideration of the mutual covenants and agreements herein contained, the parties hereto covenant and agree as follows:

ARTICLE I.

DEFINITIONS AND ACCOUNTING TERMS

1.01 Defined Terms.

As used in this Agreement, the following terms shall have the meanings set forth below:

Account Bank ” means any “bank” within the meaning of Section 9-102(a)(8) of the UCC at which any deposit account constituting a Collateral Account is held, which shall be (a) located in the United States and (b) reasonably acceptable to the Administrative Agent.

Act ” has the meaning specified in Section 11.17 .

Acquisition ” means the acquisition of all outstanding capital stock of AIS Management, LLC, a California limited liability company (“ AIS ”) which is the parent company of Auto Insurance Specialists, LLC, a California limited liability company, and Poliseek AIS Insurance Solutions, Inc.

Acquisition Agreement ” means the Stock Purchase Agreement by and among Aon Corporation, Aon Services Group, Inc. and the Borrower dated as of October 10, 2008 entered into in connection with the Acquisition.

Acquisition Documents ” means the Acquisition Agreement and the related documents delivered pursuant thereto.

Adjusted Fair Market Value ” means with respect to any Eligible Collateral, an amount equal to the product of the Fair Market Value of such Eligible Collateral and the applicable percentage with respect to such Eligible Collateral as set forth on Schedule 1.01 .

Administrative Agent ” means Bank of America in its capacity as administrative agent under any of the Loan Documents, or any successor administrative agent.


Administrative Agent’s Office ” means the Administrative Agent’s address and, as appropriate, account as set forth on Schedule 11.02 , or such other address or account as the Administrative Agent may from time to time notify to the Borrower and the Lenders.

Administrative Questionnaire ” means an Administrative Questionnaire in substantially the form of Exhibit D-2 or any other form approved by the Administrative Agent.

Affiliate ” means, with respect to any Person, another Person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by or is under common Control with the Person specified.

Aggregate Commitments ” means the Commitments of all the Lenders.

Agreement ” means this Credit Agreement.

Annual Statement ” means with respect to any Insurance Subsidiary, the annual financial statement of such Insurance Subsidiary as required to be filed with the Applicable Insurance Regulatory Authority, together with all exhibits or schedules filed therewith, prepared in conformity with SAP.

Applicable Percentage ” means with respect to any Lender at any time, the percentage (carried out to the ninth decimal place) of such Lender’s Loans divided by the Outstanding Amount. The initial Applicable Percentage of each Lender is set forth opposite the name of such Lender on Schedule 2.01 or in the Assignment and Assumption pursuant to which such Lender becomes a party hereto, as applicable.

Applicable Insurance Regulatory Authority ” means, with respect to any Material Insurance Subsidiary, the California Department of Insurance or similar Governmental Authority located in (x) the jurisdiction in which such Person is domiciled or (y) such other jurisdiction which due to the nature of such Person’s activities, has regulatory authority over such Person, and any federal Governmental Authority regulating the insurance industry.

Applicable Rate ” means 1.25%.

Approved Fund ” means any Fund that is administered or managed by (a) a Lender, (b) an Affiliate of a Lender or (c) an entity or an Affiliate of an entity that administers or manages a Lender.

Arranger ” means Banc of America Securities LLC, in its capacity as sole lead arranger and sole book manager.

Assignee Group ” means two or more Eligible Assignees that are Affiliates of one another or two or more Approved Funds managed by the same investment advisor.

Assignment and Assumption ” means an assignment and assumption entered into by a Lender and an assignee (with the consent of any party whose consent is required by Section 11.06(b) ), and accepted by the Administrative Agent, in substantially the form of Exhibit D-1 or any other form approved by the Administrative Agent.

 

2


Attributable Indebtedness ” means, on any date, (a) in respect of any capital lease of any Person, the capitalized amount thereof that would appear on a balance sheet of such Person prepared as of such date in accordance with GAAP, and (b) in respect of any Synthetic Lease Obligation, the capitalized amount of the remaining lease payments under the relevant lease that would appear on a balance sheet of such Person prepared as of such date in accordance with GAAP if such lease were accounted for as a capital lease.

Bank of America ” means Bank of America, N.A. and its successors.

Base Rate ” means for any day a fluctuating rate per annum equal to the highest of (a) the Federal Funds Rate plus 1/2 of 1% and (b) the rate of interest in effect for such day as publicly announced from time to time by Bank of America as its “prime rate” and (c) the Eurodollar Rate for a one-month Interest Period commencing on such day plus 0.50% The “prime rate” is a rate set by Bank of America based upon various factors including Bank of America’s costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans, which may be priced at, above, or below such announced rate. Any change in such rate announced by Bank of America shall take effect at the opening of business on the day specified in the public announcement of such change.

Base Rate Loan ” means a Loan that bears interest at a rate based on the Base Rate.

Borrower ” has the meaning specified in the introductory paragraph hereto.

Borrower Materials ” has the meaning specified in Section 6.02 .

Borrower Statutory Surplus ” means, on any date, the amount (determined in accordance with SAP) of the Borrower’s surplus as at the last day of any fiscal quarter ending on or most recently ended prior to such date.

Business Day ” means any day other than a Saturday, Sunday or other day on which commercial banks are authorized to close under the Laws of, or are in fact closed in, the state where the Administrative Agent’s Office is located or Los Angeles, California and, if such day relates to any Eurodollar Rate Loan, means any such day on which dealings in Dollar deposits are conducted by and between banks in the London interbank eurodollar market.

Cash ” means Dollars held in a Collateral Account.

Cash Equivalents ” means at any time:

(a) time deposits and certificates of deposit, maturing not more than two years after the date of determination, which are issued by the applicable Securities Intermediary; and

(b) investments in money market funds or short-term asset management accounts offered by the Securities Intermediary which are acceptable to the Administrative Agent.

Change in Law ” means the occurrence, after the date of this Agreement, of any of the following: (a) the adoption or taking effect of any law, rule, regulation or treaty, (b) any change in any law, rule, regulation or treaty or in the administration, interpretation or application thereof by any Governmental Authority or (c) the making or issuance of any request, guideline or directive (whether or not having the force of law) by any Governmental Authority.

 

3


Change of Control ” means an event or series of events by which:

(a) any “person” or “group” (as such terms are used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, but excluding any employee benefit plan of such person or its subsidiaries, and any person or entity acting in its capacity as trustee, agent or other fiduciary or administrator of any such plan) becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Securities Exchange Act of 1934, except that a person or group shall be deemed to have “beneficial ownership” of all securities that such person or group has the right to acquire, whether such right is exercisable immediately or only after the passage of time (such right, an “ option right ”)), directly or indirectly, of 50% or more of the equity securities of the Parent entitled to vote for members of the board of directors or equivalent governing body of the Parent on a fully-diluted basis (and taking into account all such securities that such person or group has the right to acquire pursuant to any option right);

(b) during any period of 12 consecutive months, a majority of the members of the board of directors or other equivalent governing body of the Parent cease to be composed of individuals (i) who were members of that board or equivalent governing body on the first day of such period, (ii) whose election or nomination to that board or equivalent governing body was approved by individuals referred to in clause (i) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body or (iii) whose election or nomination to that board or other equivalent governing body was approved by individuals referred to in clauses (i) and (ii) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body (excluding, in the case of both clause (ii) and clause (iii), any individual whose initial nomination for, or assumption of office as, a member of that board or equivalent governing body occurs as a result of an actual or threatened solicitation of proxies or consents for the election or removal of one or more directors by any person or group other than a solicitation for the election of one or more directors by or on behalf of the board of directors); or

(c) the Parent ceases to own, directly or indirectly, 100% of the Equity Interests in the Borrower, free and clear of Liens.

Closing Date ” means the first date all the conditions precedent in Sections 4.01 and 4.02 are satisfied or waived in accordance with Section 11.01 .

Code ” means the Internal Revenue Code of 1986.

Collateral ” means all property and assets that are from time to time subject to the Security Agreement.

Collateral Account ” means (a) account no. 244398 at The Bank of New York Mellon Trust Company, National Association as to which the Borrower, The Bank of New York Mellon Trust Company, National Association and the Administrative Agent have entered into a Control Agreement, and (b) any other account at The Bank of New York Mellon Trust Company, National Association or another Securities Intermediary or Account Bank as to which such Securities Intermediary or Account Bank, as the case may be, the Borrower and the Administrative Agent have entered into a Control Agreement.

 

4


Collateral Value ” means, on any date, an amount equal to the sum of the Adjusted Fair Market Value of all Eligible Collateral.

Collateral Value Certificate ” means a certificate substantially in the form of Exhibit C-2 with such changes therein as the Administrative Agent and the Borrower may reasonably agree from time to time.

Compliance Certificate ” means a certificate substantially in the form of Exhibit C-1 .

Consolidated Parent Debt ” means, as of any date of determination, the balance sheet amount of the consolidated Indebtedness of the Parent and its Subsidiaries on that date.

Consolidated Parent Net Worth ” means, as of any date of determination, for the Parent and its Subsidiaries on a consolidated basis, Shareholders’ Equity of the Parent and its Subsidiaries on that date.

Consolidated Statutory Net Income ” means, for any period, for the Borrower, the net statutory income of the Borrower for that period excluding (a) extraordinary gains and extraordinary losses and (b) dividends and other distributions from its Subsidiaries and other Affiliates for such period, calculated in accordance with SAP.

Contractual Obligation ” means, as to any Person, any provision of any security issued by such Person or of any agreement, instrument or other undertaking to which such Person is a party or by which it or any of its property is bound.

Control ” means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ability to exercise voting power, by contract or otherwise. “ Controlling ” and “ Controlled ” have meanings correlative thereto.

Control Agreement ” means an agreement between the Borrower, the applicable Securities Intermediary or Account Bank, as the case may be, and the Administrative Agent with respect to any Collateral Account substantially in the form of Exhibit E-2 or such other form as may be reasonably acceptable to the Administrative Agent.

Corporate Securities ” means publicly traded debt securities (other than preferred stock) denominated in Dollars issued by a corporation, limited liability company, limited partnership or similar entity organized in the United States.

Debtor Relief Laws ” means the Bankruptcy Code of the United States, and all other liquidation, conservatorship, bankruptcy, assignment for the benefit of creditors, moratorium, rearrangement, receivership, insolvency, reorganization, or similar debtor relief Laws of the United States or other applicable jurisdictions from time to time in effect and affecting the rights of creditors generally.

 

5


Default ” means any event or condition that constitutes an Event of Default or that, with the giving of any notice, the passage of time, or both, would be an Event of Default.

Default Rate ” means an interest rate equal to (i) the Base Rate plus (ii) the Applicable Rate, if any, applicable to Base Rate Loans plus (iii) 2% per annum; provided , however , that with respect to a Eurodollar Rate Loan, the Default Rate shall be an interest rate equal to the interest rate (including any Applicable Rate) otherwise applicable to such Loan plus 2% per annum.

Disposition ” or “ Dispose ” means the sale, transfer, license, lease or other disposition (including any sale and leaseback transaction) of any property by any Person, including any sale, assignment, transfer or other disposal, with or without recourse, of any notes or accounts receivable or any rights and claims associated therewith.

Dollar ” and “ $ ” mean lawful money of the United States.

Eligible Assignee ” means any Person that meets the requirements to be an assignee under Section 11.06(b)(iii) , (v)  and (vi)  (subject to such consents, if any, as may be required under Section 11.06(b)(iii) ).

Eligible Collateral ” means Cash, Cash Equivalents, Corporate Securities, Federal Agency Debt, Government Debt and Municipal Securities which (a) are denominated in Dollars, (b) if applicable, have the required rating and/or maximum tenor as set forth on Schedule 1.01 , (c) are capable of being marked to market on a daily basis and capable of being cleared by the Depository Trust Company and (d) are held in a Collateral Account.

Environmental Laws ” means any and all Federal, state, local, and foreign statutes, laws, regulations, ordinances, rules, judgments, orders, decrees, permits, concessions, grants, franchises, licenses, agreements or governmental restrictions relating to pollution and the protection of the environment or the release of any materials into the environment, including those related to hazardous substances or wastes, air emissions and discharges to waste or public systems.

Environmental Liability ” means any liability, contingent or otherwise (including any liability for damages, costs of environmental remediation, fines, penalties or indemnities), of the Parent or any of its Subsidiaries directly or indirectly resulting from or based upon (a) violation of any Environmental Law, (b) the generation, use, handling, transportation, storage, treatment or disposal of any Hazardous Materials, (c) exposure to any Hazardous Materials, (d) the release or threatened release of any Hazardous Materials into the environment or (e) any contract, agreement or other consensual arrangement pursuant to which liability is assumed or imposed with respect to any of the foregoing.

Equity Interests ” means, with respect to any Person, all of the shares of capital stock of (or other ownership or profit interests in) such Person, all of the warrants, options or other rights for the purchase or acquisition from such Person of shares of capital stock of (or other ownership or profit interests in) such Person, all of the securities convertible into or exchangeable for shares of capital stock of (or other ownership or profit interests in) such Person or warrants, rights or options for the purchase or acquisition from such Person of such shares (or such other interests),

 

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and all of the other ownership or profit interests in such Person (including partnership, member or trust interests therein), whether voting or nonvoting, and whether or not such shares, warrants, options, rights or other interests are outstanding on any date of determination.

ERISA ” means the Employee Retirement Income Security Act of 1974.

ERISA Affiliate ” means any trade or business (whether or not incorporated) under common control with the Parent within the meaning of Section 414(b) or (c) of the Code (and Sections 414(m) and (o) of the Code for purposes of provisions relating to Section 412 of the Code).

ERISA Event ” means (a) a Reportable Event with respect to a Pension Plan; (b) a withdrawal by the Parent or any ERISA Affiliate from a Pension Plan subject to Section 4063 of ERISA during a plan year in which it was a “substantial employer” (as defined in Section 4001(a)(2) of ERISA) or a cessation of operations that is treated as such a withdrawal under Section 4062(e) of ERISA; (c) a complete or partial withdrawal (within the meanings of Sections 4203 and 4205 of ERISA) by the Parent or any ERISA Affiliate from a Multiemployer Plan or receipt by the Parent or any ERISA Affiliate of notice from any Multiemployer Plan that it is in “reorganization” (within the meaning of Section 4241 of ERISA); (d) the filing of a notice of intent by the plan administrator to terminate, the treatment of a Plan amendment as a termination under Section 4041 or 4041A of ERISA, or the commencement of proceedings by the PBGC to terminate a Pension Plan or Multiemployer Plan; or (e) an event or condition which constitutes grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Pension Plan or Multiemployer Plan.

Eurodollar Rate ” means, for any Interest Period with respect to a Eurodollar Rate Loan, the rate per annum equal to the British Bankers Association LIBOR Rate (“ BBA LIBOR ”), as published by Reuters (or other commercially available source providing quotations of BBA LIBOR as designated by the Administrative Agent from time to time) at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period, for Dollar deposits (for delivery on the first day of such Interest Period) with a term equivalent to such Interest Period. If such rate is not available at such time for any reason, then the “Eurodollar Rate” for such Interest Period shall be the rate per annum determined by the Administrative Agent to be the rate at which deposits in Dollars for delivery on the first day of such Interest Period in same day funds in the approximate amount of the Eurodollar Rate Loan being made, continued or converted by Bank of America and with a term equivalent to such Interest Period would be offered by Bank of America’s London Branch to major banks in the London interbank eurodollar market at their request at approximately 11:00 a.m. (London time) two Business Days prior to the commencement of such Interest Period.

Eurodollar Rate Loan ” means a Loan that bears interest at a rate based on the Eurodollar Rate.

Event of Default ” has the meaning specified in Section 8.01 .

 

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Excluded Taxes ” means, with respect to the Administrative Agent, any Lender or any other recipient of any payment to be made by or on account of any obligation of a Loan Party hereunder, (a) Taxes imposed on or measured by its overall net income or gross receipts (however denominated), and franchise Taxes imposed on it (in lieu of net income taxes), by the jurisdiction (or any political subdivision thereof) under the Laws of which such recipient is organized or in which its principal office is located or, in the case of any Lender, in which its applicable Lending Office is located, (b) any branch profits Taxes imposed by the United States or any similar Tax imposed by any other jurisdiction in which such Loan Party is located, (c) any backup withholding Tax that is withheld from amounts payable to a Lender that has failed to comply with clause (A) of Section 3.01(e)(ii) , and (d) in the case of a Foreign Lender (other than an assignee pursuant to a request by the Borrower under Section 11.13 in which the Borrower has agreed to pay the applicable withholding taxes), any United States withholding tax that (i) is imposed on amounts payable to such Foreign Lender pursuant to the Laws in force at the time such Foreign Lender becomes a party hereto (or designates a new Lending Office) or (ii) is attributable to such Foreign Lender’s failure or inability (other than as a result of a Change in Law) to comply with clause (B) of Section 3.01(e)(ii) , except to the extent that such Foreign Lender (or its assignor, if any) was entitled, at the time of designation of a new Lending Office (or assignment), to receive additional amounts from such Loan Party with respect to such withholding tax pursuant to Section 3.01(a)(ii) or (iii) .

Existing Term Loan Agreement ” means that certain Amended and Restated Loan Agreement dated as of January 2, 2009 between the Borrower and Bank of America.

Fair Market Value ” means (a) with respect to any Government Debt, Federal Agency Debt, or other publicly-traded security (other than those set forth in clause (b)) the closing price for such security on Bloomberg, Inc. or, if Bloomberg, Inc. is not available, another quotation service reasonably acceptable to the Administrative Agent, (b) with respect to Cash and Cash Equivalents, the amounts thereof, and (c) with respect to any Eligible Collateral (other than those set forth in clauses (a), and (b)), the price for such Eligible Collateral on the date of calculation obtained from a generally recognized source reasonably approved by the Administrative Agent or the most recent bid quotation from such approved source (or, if no generally recognized source exists as to such Eligible Collateral, any other source specified by the Borrower to which the Administrative Agent does not reasonably object).

Federal Agency ” means any of the following agencies of the federal government of the United States: (a) Government National Mortgage Association; (b) the Export-Import Bank of the United States; (c) the Farmers Home Administration, an agency of the United States Department of Agriculture; (d) the United States General Services Administration; (e) the United States Maritime Administration; (f) the United States Small Business Administration; (g) the Commodity Credit Corporation; (h) the Rural Electrification Administration; (i) the Rural Telephone Bank; (j) Washington Metropolitan Area Transit Authority; (k) the Federal Home Loan Mortgage Corporation; (l) the Federal National Mortgage Association; (m) the Federal Housing Finance Board; (n) the Federal Home Loan Bank; and (o) such other federal agencies as are reasonably acceptable to the Administrative Agent.

Federal Agency Debt ” means evidence of Freely Transferable Indebtedness that constitutes obligations of a Federal Agency.

 

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Federal Funds Rate ” means, for any day, the rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Business Day next succeeding such day; provided that (a) if such day is not a Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Business Day as so published on the next succeeding Business Day, and (b) if no such rate is so published on such next succeeding Business Day, the Federal Funds Rate for such day shall be the average rate (rounded upward, if necessary, to a whole multiple of 1/100 of 1%) charged to Bank of America on such day on such transactions as determined by the Administrative Agent.

Fee Letter ” means the letter agreement, dated December 15, 2008, among the Loan Parties, the Administrative Agent and Bank of America and the Arranger.

Foreign Lender ” means any Lender that is organized under the Laws of a jurisdiction other than that in which the Borrower is resident for tax purposes. For purposes of this definition, the United States, each State thereof and the District of Columbia shall be deemed to constitute a single jurisdiction.

Freely Transferable ” means securities which are freely transferable and traded in established and recognized markets and as to which there are readily available price quotations.

FRB ” means the Board of Governors of the Federal Reserve System of the United States.

Fund ” means any Person (other than a natural person) that is (or will be) engaged in making, purchasing, holding or otherwise investing in commercial loans and similar extensions of credit in the ordinary course of its activities.

GAAP ” means generally accepted accounting principles in the United States set forth in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or such other principles as may be approved by a significant segment of the accounting profession in the United States, that are applicable to the circumstances as of the date of determination, consistently applied.

Governmental Authority ” means the government of the United States or any other nation, or of any political subdivision thereof, whether state or local, and any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative powers or functions of or pertaining to government (including any supra-national bodies such as the European Union or the European Central Bank).

Government Debt ” means Freely Transferable Indebtedness issued by the U.S. Treasury Department or backed by the full faith and credit of the United States.

 

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Guarantee ” means, as to any Person, any (a) any obligation, contingent or otherwise, of such Person guaranteeing or having the economic effect of guaranteeing any Indebtedness or other obligation payable or performable by another Person (the “primary obligor”) in any manner, whether directly or indirectly, and including any obligation of such Person, direct or indirect, (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation, (ii) to purchase or lease property, securities or services for the purpose of assuring the obligee in respect of such Indebtedness or other obligation of the payment or performance of such Indebtedness or other obligation, (iii) to maintain working capital, equity capital or any other financial statement condition or liquidity or level of income or cash flow of the primary obligor so as to enable the primary obligor to pay such Indebtedness or other obligation, or (iv) entered into for the purpose of assuring in any other manner the obligee in respect of such Indebtedness or other obligation of the payment or performance thereof or to protect such obligee against loss in respect thereof (in whole or in part), or (b) any Lien on any assets of such Person securing any Indebtedness or other obligation of any other Person, whether or not such Indebtedness or other obligation is assumed by such Person (or any right, contingent or otherwise, of any holder of such Indebtedness to obtain any such Lien). The amount of any Guarantee shall be deemed to be an amount equal to the stated or determinable amount of the related primary obligation, or portion thereof, in respect of which such Guarantee is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by the guaranteeing Person in good faith. The term “Guarantee” as a verb has a corresponding meaning.

Hazardous Materials ” means all explosive or radioactive substances or wastes and all hazardous or toxic substances, wastes or other pollutants, including petroleum or petroleum distillates, asbestos or asbestos-containing materials, polychlorinated biphenyls, radon gas, infectious or medical wastes and all other substances or wastes of any nature regulated pursuant to any Environmental Law.

Indebtedness ” means, as to any Person at a particular time, without duplication, all of the following, whether or not included as indebtedness or liabilities in accordance with GAAP:

(a) all obligations of such Person for borrowed money and all obligations of such Person evidenced by bonds, debentures, notes, loan agreements or other similar instruments;

(b) all direct or contingent obligations of such Person arising under letters of credit (including standby and commercial), bankers’ acceptances, bank guaranties, surety bonds and similar instruments;

(c) net obligations of such Person under any Swap Contract;

(d) all obligations of such Person to pay the deferred purchase price of property or services (other than trade accounts payable in the ordinary course of business);

(e) indebtedness (excluding prepaid interest thereon) secured by a Lien on property owned or being purchased by such Person (including indebtedness arising under conditional sales or other title retention agreements), whether or not such indebtedness shall have been assumed by such Person or is limited in recourse;

(f) capital leases and Synthetic Lease Obligations;

 

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(g) all obligations of such Person to purchase, redeem, retire, defease or otherwise make any payment in respect of any Equity Interest in such Person or any other Person, valued, in the case of a redeemable preferred interest, at the greater of its voluntary or involuntary liquidation preference plus accrued and unpaid dividends; and

(h) all Guarantees of such Person in respect of any of the foregoing.

For all purposes hereof, the Indebtedness of any Person shall include the Indebtedness of any partnership or joint venture (other than a joint venture that is itself a corporation or limited liability company) in which such Person is a general partner or a joint venturer, unless such Indebtedness is expressly made non-recourse to such Person. The amount of any net obligation under any Swap Contract on any date shall be deemed to be the Swap Termination Value thereof as of such date. The amount of any capital lease or Synthetic Lease Obligation as of any date shall be deemed to be the amount of Attributable Indebtedness in respect thereof as of such date.

Indemnified Taxes ” means Taxes other than Excluded Taxes.

Indemnitees ” has the meaning specified in Section 11.04(b) .

Information ” has the meaning specified in Section 11.07 .

Insurance License ” means any license, certificate of authority, permit or other authorization which is required to be obtained from any Governmental Authority in connection with the operation, ownership or transaction of insurance or reinsurance business.

Insurance Subsidiary ” means each of the Borrower and any other Subsidiary of the Parent which is licensed by any Governmental Authority to engage in the insurance and/or reinsurance business.

Interim Statement ” means with respect to any Insurance Subsidiary, any interim statutory financial statement or financial report (whether quarterly, semiannually or otherwise) of such Insurance Subsidiary as required to be filed with the Applicable Insurance Regulatory Authority, together with all exhibits or schedules filed therewith, prepared in conformity with SAP.

Interest Payment Date ” means, (a) as to any Loan other than a Base Rate Loan, the last day of each Interest Period applicable to such Loan and the Maturity Date; provided , however , that if any Interest Period for a Eurodollar Rate Loan exceeds three months, the respective dates that fall every three months after the beginning of such Interest Period shall also be Interest Payment Dates; and (b) as to any Base Rate Loan, the last Business Day of each March, June, September and December, and the Maturity Date.

Interest Period ” means, as to each Eurodollar Rate Loan, the period commencing on the date such Eurodollar Rate Loan is disbursed or converted to or continued as a Eurodollar Rate Loan and ending on the date one, two, three or six months thereafter, as selected by the Borrower in its Loan Notice or such other period that is twelve months or less requested by the Borrower and consented to by all the Lenders; provided that:

(i) any Interest Period that would otherwise end on a day that is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Business Day;

 

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(ii) any Interest Period that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Business Day of the calendar month at the end of such Interest Period; and

(iii) no Interest Period shall extend beyond the Maturity Date.

Investment ” means, as to any Person, any direct or indirect acquisition or investment by such Person, whether by means of (a) the purchase or other acquisition of capital stock or other securities of another Person or (b) a loan, advance or capital contribution to, Guarantee or assumption of debt of, or purchase or other acquisition of any other debt or equity participation or interest in, another Person, including any partnership or joint venture interest in such other Person and any arrangement pursuant to which the investor Guarantees Indebtedness of such other Person. For purposes of covenant compliance, the amount of any Investment shall be the amount actually invested, without adjustment for subsequent increases or decreases in the value of such Investment.

IRS ” means the United States Internal Revenue Service.

Laws ” means, collectively, all international, foreign, Federal, state and local statutes, treaties, rules, guidelines, regulations, ordinances, codes and administrative or judicial precedents or authorities, including the interpretation or administration thereof by any Governmental Authority charged with the enforcement, interpretation or administration thereof, and all applicable administrative orders, directed duties, requests, licenses, authorizations and permits of, and agreements with, any Governmental Authority, in each case whether or not having the force of law.

Lender ” and “ Lenders ” have the meaning specified in the introductory paragraph hereto.

Lending Office ” means, as to any Lender, the office or offices of such Lender described as such in such Lender’s Administrative Questionnaire, or such other office or offices as a Lender may from time to time notify the Borrower and the Administrative Agent.

Lien ” means any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), charge, or preference, priority or other security interest or preferential arrangement in the nature of a security interest of any kind or nature whatsoever (including any conditional sale or other title retention agreement, any easement, right of way or other encumbrance on title to real property, and any financing lease having substantially the same economic effect as any of the foregoing).

Loan ” has the meaning specified in Section 2.01 .

 

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Loan Documents ” means this Agreement, each Note, the Security Agreement, the Control Agreement and the Fee Letter.

Loan Notice ” means a notice of (a) the initial borrowing hereunder, (b) a conversion of Loans from one Type to the other, or (c) a continuation of Eurodollar Rate Loans, pursuant to Section 2.02(a) , which, if in writing, shall be substantially in the form of Exhibit A .

Loan Parties ” means, collectively, the Borrower and the Parent.

Margin Stock ” has the meaning specified in Regulation U issued by the FRB.

Material Adverse Effect ” means (a) a material adverse change in, or a material adverse effect upon, the operations, business, properties, liabilities (actual or contingent), operations or financial condition of the Borrower and its Subsidiaries taken as a whole or the Parent and its Subsidiaries taken as a whole; (b) a material impairment of the ability of any Loan Party to perform its obligations under any Loan Document to which it is a party; or (c) a material adverse effect upon the legality, validity, binding effect or enforceability against any Loan Party of any Loan Document to which it is a party.

Material Insurance Subsidiary ” means the Borrower and each other Insurance Subsidiary which is Material Party.

Material Party ” means each Loan Party and each Subsidiary of the Parent whose consolidated assets or revenues exceed 10% of the consolidated assets or revenues of the Parent and its Subsidiaries for the most recent fiscal quarter for which financial statements have been delivered pursuant to Section 6.01(a) or (b) .

Maturity Date ” means January 2, 2012 if such date is not a Business Day, the Maturity Date shall be the next succeeding Business Day.

Moody’s ” means Moody’s Investors Service, Inc. and any successor thereto.

Multiemployer Plan ” means any “employee benefit plan” (as such term is defined in Section 3(3) of ERISA) of the type described in Section 4001(a)(3) of ERISA, to which the Parent or any ERISA Affiliate makes or is obligated to make contributions, or during the preceding five plan years, has made or been obligated to make contributions.

Municipal Securities ” means publicly traded debt securities issued by any state or municipality or subdivision or instrumentality thereunder located in the United States.

NAIC ” means the National Association of Insurance Commissioners and any successor thereto.

Note ” means a promissory note made by the Borrower in favor of a Lender evidencing Loans made by such Lender, substantially in the form of Exhibit B .

 

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Obligations ” means all advances to, and debts, liabilities, obligations, covenants and duties of, any Loan Party arising under any Loan Document or otherwise with respect to any Loan, whether direct or indirect (including those acquired by assumption), absolute or contingent, due or to become due, now existing or hereafter arising and including interest and fees that accrue after the commencement by or against any Loan Party or any Affiliate thereof of any proceeding under any Debtor Relief Laws naming such Person as the debtor in such proceeding, regardless of whether such interest and fees are allowed claims in such proceeding.

Organization Documents ” means, (a) with respect to any corporation, the certificate or articles of incorporation and the bylaws (or equivalent or comparable constitutive documents with respect to any non-U.S. jurisdiction); (b) with respect to any limited liability company, the certificate or articles of formation or organization and operating agreement; and (c) with respect to any partnership, joint venture, trust or other form of business entity, the partnership, joint venture or other applicable agreement of formation or organization and any agreement, instrument, filing or notice with respect thereto filed in connection with its formation or organization with the applicable Governmental Authority in the jurisdiction of its formation or organization and, if applicable, any certificate or articles of formation or organization of such entity.

Other Taxes ” means all present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies arising from any payment made hereunder or under any other Loan Document or from the execution, delivery or enforcement of this Agreement or any other Loan Document.

Outstanding Amount ” means the aggregate outstanding principal amount of Loans on any date after giving effect to any prepayments of Loans, occurring on such date.

Parent ” has the meaning specified in the introductory paragraph.

Parent Debt to Capital Ratio ” means the ratio, expressed as a percentage, of (a) Consolidated Parent Debt to (b) Parent Net Worth plus Consolidated Parent Debt.

Parent Net Worth ” means, as of any date of determination, the consolidated shareholders’ equity of the Parent calculated in accordance with GAAP.

Participant ” has the meaning specified in Section 11.06(d) .

PBGC ” means the Pension Benefit Guaranty Corporation.

Pension Plan ” means any “employee pension benefit plan” (as such term is defined in Section 3(2) of ERISA), other than a Multiemployer Plan, that is subject to Title IV of ERISA and is sponsored or maintained by the Parent or any ERISA Affiliate or to which the Parent or any ERISA Affiliate contributes or has an obligation to contribute, or in the case of a multiple employer or other plan described in Section 4064(a) of ERISA, has made contributions at any time during the immediately preceding five plan years.

Person ” means any natural person, corporation, limited liability company, trust, joint venture, association, company, partnership, Governmental Authority or other entity.

 

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Plan ” means any “employee benefit plan” (as such term is defined in Section 3(3) of ERISA) established by the Parent or, with respect to any such plan that is subject to Section 412 of the Code or Title IV of ERISA, any ERISA Affiliate.

Platform ” has the meaning specified in Section 6.02 .

Post-Closing Filings ” has the meaning specified in Section 5.03 .

Public Lender ” has the meaning specified in Section 6.02 .

Register ” has the meaning specified in Section 11.06(c) .

Related Parties ” means, with respect to any Person, such Person’s Affiliates and the partners, directors, officers, employees, agents, trustees and advisors of such Person and of such Person’s Affiliates.

Reportable Event ” means any of the events set forth in Section 4043(c) of ERISA, other than events for which the 30 day notice period has been waived.

Required Lenders ” means, as of any date of determination, Lenders holding in the aggregate more than 50% of the Outstanding Amount. In the event that the Borrower or any of its Affiliates become the owner of Loans in accordance with Section 11.06(b)(v) or a participant in Loans in accordance with Section 11.06(d) , such Person shall not have a vote and such Person’s Loans shall be excluded in calculating the Outstanding Amount for purposes of determining Required Lenders unless 100% of the Lenders approved the assignment of such Loans to such Person.

Responsible Officer ” means the chief executive officer, president, chief financial officer, corporate secretary, treasurer, assistant treasurer or controller of a Loan Party and, solely for purposes of notices given pursuant to Article II, any other officer of the applicable Loan Party so designated by any of the foregoing officers in a notice to the Administrative Agent. Any document delivered hereunder that is signed by a Responsible Officer of a Loan Party shall be conclusively presumed to have been authorized by all necessary corporate, partnership and/or other action on the part of such Loan Party and such Responsible Officer shall be conclusively presumed to have acted on behalf of such Loan Party.

Restricted Payment ” means any dividend or other distribution (whether in cash, securities or other property) with respect to any capital stock or other Equity Interest of the Borrower, or any payment (whether in cash, securities or other property), including any sinking fund or similar deposit, on account of the purchase, redemption, retirement, acquisition, cancellation or termination of any such capital stock or other Equity Interest, or on account of any return of capital to the Borrower’s stockholders, partners or members (or the equivalent Person thereof).

Risk Based Capital Ratio ” means, as to any Material Insurance Subsidiary, the “risk based capital ratio” calculated in accordance with SAP pursuant to the requirements of the Applicable Insurance Regulatory Authority in such Material Insurance Subsidiary’s domicile.

 

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SAP ” means, as to any Material Insurance Subsidiary, the accounting practices prescribed or permitted by NAIC, if then applicable to such Material Insurance Subsidiary, or the Applicable Insurance Regulatory Authority of the jurisdiction of domicile of such Material Insurance Subsidiary for the preparation of Annual Statements, Interim Statements and other financial reports by insurance companies of the same type as such Material Insurance Subsidiary.

S&P ” means Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies, Inc. and any successor thereto.

SEC ” means the Securities and Exchange Commission, or any Governmental Authority succeeding to any of its principal functions.

Securities Intermediary ” means any “securities intermediary” within the meaning of Section 8.102(a)(14) of the UCC at which any securities account constituting a Collateral Account is held, which shall be (a) located in the United States and (b) reasonably acceptable to the Administrative Agent.

Security Agreement ” means a security agreement substantially in the form of Exhibit E-1 entered into on the Closing Date.

Subsidiary ” of a Person means a corporation, partnership, joint venture, limited liability company or other business entity of which a majority of the shares of securities or other interests having ordinary voting power for the election of directors or other governing body (other than securities or interests having such power only by reason of the happening of a contingency) are at the time beneficially owned, or the management of which is otherwise controlled, directly, or indirectly through one or more intermediaries, or both, by such Person. Unless otherwise specified, all references herein to a “Subsidiary” or to “Subsidiaries” shall refer to a Subsidiary or Subsidiaries of the Parent.

Swap Contract ” means (a) any and all rate swap transactions, basis swaps, credit derivative transactions, forward rate transactions, commodity swaps, commodity options, forward commodity contracts, equity or equity index swaps or options, bond or bond price or bond index swaps or options or forward bond or forward bond price or forward bond index transactions, interest rate options, forward foreign exchange transactions, cap transactions, floor transactions, collar transactions, currency swap transactions, cross-currency rate swap transactions, currency options, spot contracts, or any other similar transactions or any combination of any of the foregoing (including any options to enter into any of the foregoing), whether or not any such transaction is governed by or subject to any master agreement, and (b) any and all transactions of any kind, and the related confirmations, which are subject to the terms and conditions of, or governed by, any form of master agreement published by the International Swaps and Derivatives Association, Inc., any International Foreign Exchange Master Agreement, or any other master agreement (any such master agreement, together with any related schedules, a “ Master Agreement ”), including any such obligations or liabilities under any Master Agreement.

 

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Swap Termination Value ” means, in respect of any one or more Swap Contracts, after taking into account the effect of any legally enforceable netting agreement relating to such Swap Contracts, (a) for any date on or after the date such Swap Contracts have been closed out and termination value(s) determined in accordance therewith, such termination value(s), and (b) for any date prior to the date referenced in clause (a), the amount(s) determined as the mark-to-market value(s) for such Swap Contracts, as determined based upon one or more mid-market or other readily available quotations provided by any recognized dealer in such Swap Contracts (which may include a Lender or any Affiliate of a Lender).

Synthetic Lease Obligation ” means the monetary obligation of a Person under (a) a so-called synthetic, off-balance sheet or tax retention lease, or (b) an agreement for the use or possession of property creating obligations that do not appear on the balance sheet of such Person but which, upon the insolvency or bankruptcy of such Person, would be characterized as the indebtedness of such Person (without regard to accounting treatment).

Taxes ” means all present or future taxes, levies, imposts, duties, deductions, withholdings (including backup withholding), assessments, fees or other charges imposed by any Governmental Authority, including any interest, additions to tax or penalties applicable thereto.

Threshold Amount ” means $25,000,000.

Type ” means, with respect to a Loan, its character as a Base Rate Loan or a Eurodollar Rate Loan.

UC C” means the Uniform Commercial Code as in effect from time to time in the State of New York.

Unfunded Pension Liability ” means the excess of a Pension Plan’s benefit liabilities under Section 4001(a)(16) of ERISA, over the current value of that Pension Plan’s assets, determined in accordance with the assumptions used for funding the Pension Plan pursuant to Section 412 of the Code for the applicable plan year.

United States ” and “ U.S. ” mean the United States of America.

Unmatured Surviving Obligations ” means, as of any date, Obligations that by their terms survive the termination of this Agreement or any other Loan Document and are not due and payable as of such date.

1.02 Other Interpretive Provisions.

With reference to this Agreement and each other Loan Document, unless otherwise specified herein or in such other Loan Document:

(a) The definitions of terms herein shall apply equally to the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words “ include ,” “ includes ” and “ including ” shall be deemed to be followed by the phrase “without limitation.” The word “ will ” shall be construed to have the same meaning and effect as the word “ shall .” Unless the context requires otherwise, (i) any definition of or reference to any agreement, instrument or other document (including any Organization Document) shall be construed as referring to such

 

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agreement, instrument or other document as from time to time amended, supplemented or otherwise modified (subject to any restrictions on such amendments, supplements or modifications set forth herein or in any other Loan Document), (ii) any reference herein to any Person shall be construed to include such Person’s successors and assigns, (iii) the words “ herein ,” “ hereof ” and “ hereunder ,” and words of similar import when used in any Loan Document, shall be construed to refer to such Loan Document in its entirety and not to any particular provision thereof, (iv) all references in a Loan Document to Articles, Sections, Exhibits and Schedules shall be construed to refer to Articles and Sections of, and Exhibits and Schedules to, the Loan Document in which such references appear, (v) any reference to any law shall include all statutory and regulatory provisions consolidating, amending, replacing or interpreting such law and any reference to any law or regulation shall, unless otherwise specified, refer to such law or regulation as amended, modified or supplemented from time to time, and (vi) the words “ asset ” and “ property ” shall be construed to have the same meaning and effect and to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights.

(b) In the computation of periods of time from a specified date to a later specified date, the word “ from ” means “ from and including ;” the words “ to ” and “ until ” each mean “ to but excluding ;” and the word “ through ” means “ to and including .”

(c) Section headings herein and in the other Loan Documents are included for convenience of reference only and shall not affect the interpretation of this Agreement or any other Loan Document.

1.03 Accounting Terms.

(a) Generally . All accounting terms not specifically or completely defined herein shall be construed in conformity with, and all financial data (including financial ratios and other financial calculations) required to be submitted pursuant to this Agreement shall be prepared in conformity with GAAP or SAP, as applicable.

(b) Changes in GAAP or SAP . If any change in GAAP or SAP from that used in preparing the financial statements described in Section 5.05 would affect the computation of any financial ratio or requirement set forth in any Loan Document, and either the Borrower or the Required Lenders shall so request, the Administrative Agent, the Lenders and the Borrower shall negotiate in good faith to amend such ratio or requirement to preserve the original intent thereof in light of such change in GAAP or SAP, as applicable (subject to the approval of the Required Lenders); provided that , until so amended, (i) such ratio or requirement shall continue to be computed in accordance with GAAP or SAP, as applicable prior to such change therein and (ii) the Borrower shall provide to the Administrative Agent and the Lenders financial statements and other documents required under this Agreement or as reasonably requested hereunder setting forth a reconciliation between calculations of such ratio or requirement made before and after giving effect to such change in GAAP or SAP, as applicable.

 

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1.04 Rounding.

Any financial ratios required to be maintained by any Loan Party pursuant to this Agreement shall be calculated by dividing the appropriate component by the other component, carrying the result to one place more than the number of places by which such ratio is expressed herein and rounding the result up or down to the nearest number (with a rounding-up if there is no nearest number).

1.05 Times of Day.

Unless otherwise specified, all references herein to times of day shall be references to California time (daylight or standard, as applicable).

ARTICLE II.

THE COMMITMENTS AND LOANS

2.01 Loans.

Subject to the terms and conditions set forth herein, each Lender severally agrees to make loans (each such loan, a “ Loan ”) to the Borrower on the Closing Date not to exceed $120,000,000. Loans may be Base Rate Loans or Eurodollar Rate Loans, as further provided herein.

2.02 Initial Borrowing, Conversions and Continuations of Loans.

(a) The initial borrowing hereunder and each conversion of Loans from one Type to the other, and each continuation of Eurodollar Rate Loans shall be made upon the Borrower’s irrevocable notice to the Administrative Agent, which may be given by telephone. Each such notice must be received by the Administrative Agent not later than 11:00 a.m. (i) three Business Days prior to the requested date of the initial borrowing hereunder of, or the conversion to or continuation of, Eurodollar Rate Loans or (ii) on the Business Day of the requested date of the initial borrowing hereunder of, or conversion to, Base Rate Loans; provided , however , that if the Borrower wishes to request Eurodollar Rate Loans having an Interest Period other than one, two, three or six months in duration as provided in the definition of “Interest Period,” the applicable notice must be received by the Administrative Agent not later than 11:00 a.m. four Business Days prior to the requested date of such conversion or continuation, whereupon the Administrative Agent shall give prompt notice to the Lenders of such request and determine whether the requested Interest Period is acceptable to all of them. Not later than 11:00 a.m., three Business Days before the requested date of such conversion or continuation, the Administrative Agent shall notify the Borrower (which notice may be by telephone) whether or not the requested Interest Period has been consented to by all the Lenders. Each telephonic notice by the Borrower pursuant to this Section 2.02(a) must be confirmed promptly by delivery to the Administrative Agent of a written Loan Notice, appropriately completed and signed by a Responsible Officer of the Borrower. The initial borrowing hereunder of and each conversion to or continuation of Eurodollar Rate Loans shall be in a principal amount of $3,000,000 or a whole multiple of $500,000 in excess thereof. The initial borrowing hereunder of or conversion to Base Rate Loans shall be in a principal amount of $500,000 or a whole multiple of $100,000 in excess thereof. Each Loan Notice (whether telephonic or written) shall specify (i) whether the Borrower is requesting the initial borrowing hereunder of, a conversion of Loans from one Type

 

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to the other, or a continuation of Eurodollar Rate Loans, (ii) the requested date of the initial borrowing hereunder, conversion or continuation, as the case may be (which shall be a Business Day), (iii) the principal amount of Loans to be borrowed, converted or continued, (iv) the Type of Loans to be borrowed or to which existing Loans are to be converted, and (v) if applicable, the duration of the Interest Period with respect thereto. If the Borrower fails to specify a Type of Loan in a Loan Notice or if the Borrower fails to give a timely notice requesting a conversion or continuation, then the applicable Loans shall be made as, or converted to, Eurodollar Rate Loans with a one-month Interest Period. Any such automatic conversion to Base Rate Loans shall be effective as of the last day of the Interest Period then in effect with respect to the applicable Eurodollar Rate Loans. If the Borrower requests a conversion to, or continuation of Eurodollar Rate Loans in any such Loan Notice, but fails to specify an Interest Period, it will be deemed to have specified an Interest Period of one month. Notwithstanding the foregoing, the Borrower may request that Loans made on the Closing Date bear interest at a rate equal to the sum of (x) the “overnight rate” as quoted by the Administrative Agent on the Closing Date plus (y) the Applicable Rate provided the Borrower delivers to the Administrative Agent no later than 10:00 a.m. on the Closing Date (1) a Loan Notice requesting such rate and (2) a Loan Notice requesting conversion of the Loans made on the Closing Date to a Eurodollar Loan(s) on the second Business Day after the Closing Date. Thereafter, all conversions and continuations shall be made in accordance with the provisions of this Section 2.02(a) .

(b) Following receipt of a Loan Notice, the Administrative Agent shall promptly notify each Lender of the contents thereof, and if no timely notice of a conversion or continuation is provided by the Borrower, the Administrative Agent shall notify each Lender of the details of any automatic conversion to Eurodollar Rate Loans with a one-month Interest Period described in the preceding subsection.

(c) Except as otherwise provided herein, a Eurodollar Rate Loan may be continued or converted only on the last day of an Interest Period for such Eurodollar Rate Loan. During the existence of an Event of Default, no Loans may be requested as, converted to or continued as Eurodollar Rate Loans without the consent of the Required Lenders.

(d) The Administrative Agent shall promptly notify the Borrower and the Lenders of the interest rate applicable to any Interest Period for Eurodollar Rate Loans upon determination of such interest rate. At any time that Base Rate Loans are outstanding, the Administrative Agent shall notify the Borrower and the Lenders of any change in Bank of America’s prime rate used in determining the Base Rate promptly following the public announcement of such change.

(e) After giving effect to the outstanding Loans, all conversions of Loans from one Type to the other, and all continuations of Loans as the same Type, there shall not be more than five Interest Periods in effect with respect to Loans.

2.03 Voluntary Prepayments.

The Borrower may, upon notice to the Administrative Agent, at any time or from time to time voluntarily prepay Loans in whole or in part without premium or penalty; provided that (i) such notice must be received by the Administrative Agent not later than 11:00 a.m. (A) three Business Days prior to any date of prepayment of Eurodollar Rate Loans and (B) on the date of

 

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prepayment of Base Rate Loans; (ii) any prepayment of Eurodollar Rate Loans shall be in a principal amount of $3,000,000 or a whole multiple of $500,000 in excess thereof; and (iii) any prepayment of Base Rate Loans shall be in a principal amount of $500,000 or a whole multiple of $100,000 in excess thereof or, in each case, if less, the entire principal amount thereof then outstanding. Each such notice shall specify the date and amount of such prepayment and the Type(s) of Loans to be prepaid and, if Eurodollar Rate Loans are to be prepaid, the Interest Period(s) of such Loans. The Administrative Agent will promptly notify each Lender of its receipt of each such notice, and of the amount of such Lender’s Applicable Percentage of such prepayment. If the Borrower gives notice of voluntary prepayment to the Administrative Agent, the Borrower shall pay all accrued interest, together with any additional amounts required pursuant to Section 3.05 . Each such prepayment shall be applied to the Loans of the Lenders in accordance with their respective Applicable Percentages. If such notice is given by the Borrower and such prepayment is not made on the date stipulated in the notice, the applicable Loans shall be automatically converted to Base Rate Loans on such date, and the Borrower shall pay all accrued interest and any additional amounts required pursuant to Section 3.05 . Amounts repaid may not be reborrowed.

2.04 Repayment of Loans.

The Borrower shall repay to the Lenders on the Maturity Date the aggregate principal amount of Loans outstanding on such date.

2.05 Interest.

(a) Subject to the provisions of subsection (b) below, (i) each Eurodollar Rate Loan shall bear interest on the outstanding principal amount thereof for each Interest Period at a rate per annum equal to the Eurodollar Rate for such Interest Period plus the Applicable Rate; and (ii) each Base Rate Loan shall bear interest on the outstanding principal amount thereof from the applicable borrowing or conversion date at a rate per annum equal to the Base Rate plus the Applicable Rate.

(b) (i) If any amount of principal of any Loan is not paid when due (without regard to any applicable grace periods), whether at stated maturity, by acceleration or otherwise, such amount shall thereafter bear interest at a fluctuating interest rate per annum at all times equal to the Default Rate to the fullest extent permitted by applicable Laws.

(ii) If any amount (other than principal of any Loan) payable by the Borrower under any Loan Document is not paid when due (without regard to any applicable grace periods), whether at stated maturity, by acceleration or otherwise, then upon the request of the Required Lenders, such amount shall thereafter bear interest at a fluctuating interest rate per annum at all times equal to the Default Rate to the fullest extent permitted by applicable Laws.

(iii) Upon the request of the Required Lenders, while any Event of Default exists, the Borrower shall pay interest on the principal amount of all outstanding Obligations hereunder at a fluctuating interest rate per annum at all times equal to the Default Rate to the fullest extent permitted by applicable Laws.

 

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(iv) Accrued and unpaid interest on past due amounts (including interest on past due interest) shall be due and payable upon demand.

(v) The Administrative Agent shall notify the Borrower in writing of the imposition of the Default Rate.

(c) Interest on each Loan shall be due and payable in arrears on each Interest Payment Date applicable thereto and at such other times as may be specified herein. Interest hereunder shall be due and payable in accordance with the terms hereof before and after judgment, and before and after the commencement of any proceeding under any Debtor Relief Law.

2.06 Fees.

The Borrower shall pay to the Arranger and the Administrative Agent for their own respective accounts fees in the amounts and at the times specified in the Fee Letter. Such fees shall be fully earned when paid and shall not be refundable for any reason whatsoever.

2.07 Computation of Interest and Fees.

(a) All computations of interest for Base Rate Loans when the Base Rate is determined by Bank of America’s “prime rate” shall be made on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed. All other computations of fees and interest shall be made on the basis of a 360-day year and actual days elapsed (which results in more fees or interest, as applicable, being paid than if computed on the basis of a 365-day year). Interest shall accrue on each Loan for the day on which the Loan is made, and shall not accrue on a Loan, or any portion thereof, for the day on which the Loan or such portion is paid. Each determination by the Administrative Agent of an interest rate or fee hereunder shall be conclusive and binding for all purposes, absent manifest error.

2.08 Evidence of Debt.

The Loans made by each Lender shall be evidenced by one or more accounts or records maintained by such Lender and by the Administrative Agent in the ordinary course of business. The accounts or records maintained by the Administrative Agent and each Lender shall be conclusive absent manifest error of the amount of the Loans made by the Lenders to the Borrower and the interest and payments thereon. Any failure to so record or any error in doing so shall not, however, limit or otherwise affect the obligation of the Borrower hereunder to pay any amount owing with respect to the Obligations. In the event of any conflict between the accounts and records maintained by any Lender and the accounts and records of the Administrative Agent in respect of such matters, the accounts and records of the Administrative Agent shall control in the absence of manifest error. Upon the request of any Lender made through the Administrative Agent, the Borrower shall execute and deliver to such Lender (through the Administrative Agent) a Note, which shall evidence such Lender’s Loans in addition to such accounts or records. Each Lender may attach schedules to its Note and endorse thereon the date, Type (if applicable), amount and maturity of its Loans and payments with respect thereto.

 

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2.09 Payments Generally; Administrative Agent’s Clawback.

(a) General . All payments to be made by the Borrower shall be made without condition or deduction for any counterclaim, defense, recoupment or setoff. Except as otherwise expressly provided herein, all payments by the Borrower hereunder shall be made to the Administrative Agent, for the account of the respective Lenders to which such payment is owed, at the Administrative Agent’s Office in Dollars and in immediately available funds not later than 2:00 p.m. on the date specified herein. The Administrative Agent will promptly distribute to each Lender its Applicable Percentage (or other applicable share as provided herein) of such payment in like funds as received by wire transfer to such Lender’s Lending Office. All payments received by the Administrative Agent after 2:00 p.m. shall be deemed received on the next succeeding Business Day and any applicable interest or fee shall continue to accrue. If any payment to be made by the Borrower shall come due on a day other than a Business Day, payment shall be made on the next following Business Day, and such extension of time shall be reflected in computing interest or fees, as the case may be.

(b) Payments by Borrower; Presumptions by Administrative Agent . Unless the Administrative Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Administrative Agent for the account of the Lenders hereunder that the Borrower will not make such payment, the Administrative Agent may assume that the Borrower has made such payment on such date in accordance herewith and may, in reliance upon such assumption, distribute to the Lenders the amount due. In such event, if the Borrower has not in fact made such payment, then each of the Lenders severally agrees to repay to the Administrative Agent forthwith on demand the amount so distributed to such Lender, in immediately available funds with interest thereon, for each day from and including the date such amount is distributed to it to but excluding the date of payment to the Administrative Agent, at the greater of the Federal Funds Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation. A notice of the Administrative Agent to the Borrower with respect to any amount owing under this subsection (b) shall be conclusive, absent manifest error.

(c) Obligations of Lenders Several . The obligations of the Lenders hereunder to make Loans and to make payments pursuant to Section 11.04(c) are several and not joint. The failure of any Lender to make any Loan, or to make any payment under Section 11.04(c) on any date required hereunder shall not relieve any other Lender of its corresponding obligation to do so on such date, and no Lender shall be responsible for the failure of any other Lender to so make its Loan, or to make its payment under Section 11.04(c) .

(d) Funding Source . Nothing herein shall be deemed to obligate any Lender to obtain the funds for any Loan in any particular place or manner or to constitute a representation by any Lender that it has obtained or will obtain the funds for any Loan in any particular place or manner.

 

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2.10 Sharing of Payments by Lenders.

If any Lender shall, by exercising any right of setoff or counterclaim or otherwise, obtain payment in respect of any principal of or interest on any of the Loans made by it, resulting in such Lender’s receiving payment of a proportion of the aggregate amount of such Loans and accrued interest thereon greater than its pro rata share thereof as provided herein, then the Lender receiving such greater proportion shall (a) notify the Administrative Agent of such fact, and (b) purchase (for cash at face value) participations in the Loans of the other Lenders, or make such other adjustments as shall be equitable, so that the benefit of all such payments shall be shared by the Lenders ratably in accordance with the aggregate amount of principal of and accrued interest on their respective Loans and other amounts owing them, provided that:

(i) if any such participations are purchased and all or any portion of the payment giving rise thereto is recovered, such participations shall be rescinded and the purchase price restored to the extent of such recovery, without interest; and

(ii) the provisions of this Section shall not be construed to apply to (x) any payment made by the Borrower pursuant to and in accordance with the express terms of this Agreement or (y) any payment obtained by a Lender as consideration for the assignment of or sale of a participation in any of its Loans to any assignee or participant (provided, however, if such assignment or participation was made to the Parent or any of its Affiliates or Subsidiaries other than in accordance with Section 11.06(b)(v) or (c) , as applicable, the provisions of this Section shall apply to such payment).

Each Loan Party consents to the foregoing and agrees, to the extent it may effectively do so under applicable law, that any Lender acquiring a participation pursuant to the foregoing arrangements may exercise against such Loan Party rights of setoff and counterclaim with respect to such participation as fully as if such Lender were a direct creditor of such Loan Party in the amount of such participation.

ARTICLE III.

TAXES, YIELD PROTECTION AND ILLEGALITY

3.01 Taxes.

(a) Payments Free of Taxes; Obligation to Withhold; Payments on Account of Taxes .

(i) Any and all payments by or on account of any obligation of the Borrower hereunder or under any other Loan Document shall to the extent permitted by applicable Laws be made free and clear of and without reduction or withholding for any Taxes. If, however, applicable Laws require the Borrower or the Administrative Agent to withhold or deduct any Tax, such Tax shall be withheld or deducted in accordance with such Laws as determined by the Borrower or the Administrative Agent, as the case may be, upon the basis of the information and documentation to be delivered pursuant to subsection (e) below.

(ii) If the Borrower or the Administrative Agent shall be required by the Code to withhold or deduct any Taxes, including both United States Federal backup withholding and withholding taxes, from any payment, then (A) the Administrative Agent shall withhold or make such deductions as are determined by the Administrative Agent to be required based upon the information and documentation it has received pursuant to subsection (e) below, (B) the Administrative Agent shall timely pay the full

 

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amount withheld or deducted to the relevant Governmental Authority in accordance with the Code, and (C) to the extent that the withholding or deduction is made on account of Indemnified Taxes or Other Taxes, the sum payable by the Borrower shall be increased as necessary so that after any required withholding or the making of all required deductions (including deductions applicable to additional sums payable under this Section) the Administrative Agent or Lender, as the case may be, receives an amount equal to the sum it would have received had no such withholding or deduction been made.

(b) Payment of Other Taxes by the Borrower . Without limiting the provisions of subsection (a) above, the Borrower shall timely pay, without duplication, any Other Taxes to the relevant Governmental Authority in accordance with applicable Laws.

(c) Tax Indemnifications . (i) Without limiting the provisions of subsection (a) or (b) above, the Borrower shall, without duplication, and does hereby, indemnify the Administrative Agent and each Lender, and shall make payment in respect thereof within 10 days after demand therefor, for the full amount of any Indemnified Taxes or Other Taxes (including Indemnified Taxes or Other Taxes imposed or asserted on or attributable to amounts payable under this Section) withheld or deducted by the Borrower or the Administrative Agent or paid by the Administrative Agent or such Lender, as the case may be, and any penalties, interest and reasonable expenses arising therefrom or with respect thereto, whether or not such Indemnified Taxes or Other Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. The Borrower shall also, and does hereby, indemnify the Administrative Agent, and shall make payment in respect thereof within 10 days after demand therefor, for any amount which a Lender for any reason fails to pay indefeasibly to the Administrative Agent as required by clause (ii) of this subsection. A certificate as to the amount of any such payment or liability delivered to the Borrower by a Lender (with a copy to the Administrative Agent), or by the Administrative Agent on its own behalf or on behalf of a Lender, shall be conclusive absent manifest error.

(ii) Without limiting the provisions of subsection (a) or (b) above, each Lender shall, and does hereby, indemnify the Borrower and the Administrative Agent, and shall make payment in respect thereof within 10 days after demand therefor, against any and all Taxes and any and all related losses, claims, liabilities, penalties, interest and expenses (including the fees, charges and disbursements of any counsel for the Borrower or the Administrative Agent) incurred by or asserted against the Borrower or the Administrative Agent by any Governmental Authority as a result of the failure by such Lender to deliver, or as a result of the inaccuracy, inadequacy or deficiency of, any documentation required to be delivered by such Lender to the Borrower or the Administrative Agent pursuant to subsection (e). Each Lender hereby authorizes the Administrative Agent to set off and apply any and all amounts at any time owing to such Lender under this Agreement or any other Loan Document against any amount due to the Administrative Agent under this clause (ii). The agreements in this clause (ii) shall survive the resignation and/or replacement of the Administrative Agent, any assignment of rights by, or the replacement of, a Lender, the termination of the Aggregate Commitments and the repayment, satisfaction or discharge of all other Obligations.

 

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(d) Evidence of Payments . Upon request by the Borrower or the Administrative Agent, as the case may be, after any payment of Taxes by the Borrower or by the Administrative Agent to a Governmental Authority as provided in this Section 3.01 , the Borrower shall deliver to the Administrative Agent or the Administrative Agent shall deliver to the Borrower, as the case may be, the original or a certified copy of a receipt issued by such Governmental Authority evidencing such payment, a copy of any return required by Laws to report such payment or other evidence of such payment reasonably satisfactory to the Borrower or the Administrative Agent, as the case may be.

(e) Status of Lenders; Tax Documentation . (i) Each Lender shall deliver to the Borrower and to the Administrative Agent, at the time or times prescribed by applicable Laws or when reasonably requested by the Borrower or the Administrative Agent, such properly completed and executed documentation prescribed by applicable Laws or by the taxing authorities of any jurisdiction and such other reasonably requested information as will permit the Borrower or the Administrative Agent, as the case may be, to determine (A) whether or not payments made hereunder or under any other Loan Document are subject to Taxes, (B) if applicable, the required rate of withholding or deduction, and (C) such Lender’s entitlement to any available exemption from, or reduction of, applicable Taxes in respect of all payments to be made to such Lender by the Borrower pursuant to this Agreement or otherwise to establish such Lender’s status for withholding tax purposes in the applicable jurisdiction.

(ii) Without limiting the generality of the foregoing, if the Borrower is resident for tax purposes in the United States,

(A) any Lender that is a “United States person” within the meaning of Section 7701(a)(30) of the Code shall deliver to the Borrower and the Administrative Agent executed originals of Internal Revenue Service Form W-9 or such other documentation or information prescribed by applicable Laws or reasonably requested by the Borrower or the Administrative Agent as will enable the Borrower or the Administrative Agent, as the case may be, to determine whether or not such Lender is subject to backup withholding or information reporting requirements; and

(B) each Foreign Lender that is entitled under the Code or any applicable treaty to an exemption from or reduction of withholding tax with respect to payments hereunder or under any other Loan Document shall deliver to the Borrower and the Administrative Agent (in such number of copies as shall be requested by the recipient) on or prior to the date on which such Foreign Lender becomes a Lender under this Agreement (and from time to time thereafter upon the request of the Borrower or the Administrative Agent, but only if such Foreign Lender is legally entitled to do so), whichever of the following is applicable:

(1) executed originals of Internal Revenue Service Form W-8BEN claiming eligibility for benefits of an income tax treaty to which the United States is a party,

 

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(2) executed originals of Internal Revenue Service Form W-8ECI,

(3) executed originals of Internal Revenue Service Form W-8IMY and all required supporting documentation,

(4) in the case of a Foreign Lender claiming the benefits of the exemption for portfolio interest under section 881(c) of the Code, (x) a certificate to the effect that such Foreign Lender is not (A) a “bank” within the meaning of section 881(c)(3)(A) of the Code, (B) a “10 percent shareholder” of the Borrower within the meaning of section 881(c)(3)(B) of the Code, or (C) a “controlled foreign corporation” described in section 881(c)(3)(C) of the Code and (y) executed originals of Internal Revenue Service Form W-8BEN, or

(5) executed originals of any other form prescribed by applicable Laws as a basis for claiming exemption from or a reduction in United States Federal withholding tax together with such supplementary documentation as may be prescribed by applicable Laws to permit the Borrower or the Administrative Agent to determine the withholding or deduction required to be made.

(iii) Each Lender shall promptly (A) notify the Borrower and the Administrative Agent of any change in circumstances which would modify or render invalid any claimed exemption or reduction, and (B) take such steps as shall not be materially disadvantageous to it, in the reasonable judgment of such Lender, and as may be reasonably necessary (including the re-designation of its Lending Office) to avoid any requirement of applicable Laws of any jurisdiction that the Borrower or the Administrative Agent make any withholding or deduction for taxes from amounts payable to such Lender.

(f) Treatment of Certain Refunds . Unless required by applicable Laws, at no time shall the Administrative Agent have any obligation to file for or otherwise pursue on behalf of a Lender, or have any obligation to pay to any Lender, any refund of Taxes withheld or deducted from funds paid for the account of such Lender. If the Administrative Agent or any Lender determines, in its sole discretion, that it has received a refund of any Taxes or Other Taxes as to which it has been indemnified by the Borrower or with respect to which the Borrower has paid additional amounts pursuant to this Section, it shall pay to the Borrower an amount equal to such refund (but only to the extent of indemnity payments made, or additional amounts paid, by the Borrower under this Section with respect to the Taxes or Other Taxes giving rise to such refund), net of all out-of-pocket expenses incurred by the Administrative Agent or such Lender, as the case may be, and without interest (other than any interest paid by the relevant Governmental Authority with respect to such refund), provided that the Borrower, upon the request of the Administrative Agent or such Lender, agrees to repay the amount paid over to the Borrower (plus any penalties, interest or other charges imposed by the relevant Governmental Authority) to the Administrative Agent or such Lender in the event the Administrative Agent or such Lender is required to repay such refund to such Governmental Authority. This subsection shall not be construed to require the Administrative Agent or any Lender to make available its tax returns (or any other information relating to its taxes that it deems confidential) to the Borrower or any other Person.

 

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3.02 Illegality. If any Lender determines that any Law has made it unlawful, or that any Governmental Authority has asserted that it is unlawful, for any Lender or its applicable Lending Office to make, maintain or fund Eurodollar Rate Loans, or to determine or charge interest rates based upon the Eurodollar Rate, or any Governmental Authority has imposed material restrictions on the authority of such Lender to purchase or sell, or to take deposits of, Dollars in the London interbank market, then, on notice thereof by such Lender to the Borrower through the Administrative Agent, any obligation of such Lender to make or continue Eurodollar Rate Loans or to convert Base Rate Loans to Eurodollar Rate Loans shall be suspended until such Lender notifies the Administrative Agent and the Borrower that the circumstances giving rise to such determination no longer exist. Upon receipt of such notice, the Borrower shall, upon demand from such Lender (with a copy to the Administrative Agent), prepay or, if applicable, convert all Eurodollar Rate Loans of such Lender to Base Rate Loans, either on the last day of the Interest Period therefor, if such Lender may lawfully continue to maintain such Eurodollar Rate Loans to such day, or immediately, if such Lender may not lawfully continue to maintain such Eurodollar Rate Loans. Upon any such prepayment or conversion, the Borrower shall also pay accrued interest on the amount so prepaid or converted.

3.03 Inability to Determine Rates. If the Required Lenders determine that for any reason in connection with any request for a conversion to or continuation of a Eurodollar Rate Loan that (a) Dollar deposits are not being offered to banks in the London interbank eurodollar market for the applicable amount and Interest Period of such Eurodollar Rate Loan, (b) adequate and reasonable means do not exist for determining the Eurodollar Rate for any requested Interest Period with respect to a proposed Eurodollar Rate Loan, or (c) the Eurodollar Rate for any requested Interest Period with respect to a proposed Eurodollar Rate Loan does not adequately and fairly reflect the cost to such Lenders of funding such Loan, the Administrative Agent will promptly so notify the Borrower and each Lender. Thereafter, the obligation of the Lenders to convert to or maintain Eurodollar Rate Loans shall be suspended until the Administrative Agent (upon the instruction of the Required Lenders) revokes such notice. Upon receipt of such notice, the Borrower may revoke any pending request for a conversion to or continuation of Eurodollar Rate Loans or, failing that, will be deemed to have converted such request into a request for a conversion to or continuation of Base Rate Loans in the amount specified therein.

3.04 Increased Costs; Reserves on Eurodollar Rate Loans.

(a) Increased Costs Generally . If any Change in Law shall:

(i) impose, modify or deem applicable any reserve, special deposit, compulsory loan, insurance charge or similar requirement against assets of, deposits with or for the account of, or credit extended or participated in by, any Lender (except any reserve requirement contemplated by Section 3.04(e) );

(ii) subject any Lender to any tax of any kind whatsoever with respect to this Agreement or any Eurodollar Rate Loan made by it, or change the basis of taxation of payments to such Lender in respect thereof (except for Indemnified Taxes or Other Taxes covered by Section 3.01 and the imposition of, or any change in the rate of, any Excluded Tax payable by such Lender); or

 

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(iii) impose on any Lender or the London interbank market any other condition, cost or expense affecting this Agreement or Eurodollar Rate Loans made by such Lender;

and the result of any of the foregoing shall be to increase the cost to such Lender of making or maintaining any Eurodollar Rate Loan (or of maintaining its obligation to make any such Loan), or to increase the cost to such Lender, or to reduce the amount of any sum received or receivable by such Lender hereunder (whether of principal, interest or any other amount) then, upon request of such Lender, the Borrower will pay to such Lender, as the case may be, such additional amount or amounts as will compensate such Lender, as the case may be, for such additional costs incurred or reduction suffered.

(b) Capital Requirements . If any Lender determines that any Change in Law affecting such Lender or any Lending Office of such Lender or such Lender’s holding company, if any, regarding capital requirements has or would have the effect of reducing the rate of return on such Lender’s capital or on the capital of such Lender’s holding company, if any, as a consequence of this Agreement, or the Loans made by such Lender to a level below that which such Lender or such Lender’s holding company could have achieved but for such Change in Law (taking into consideration such Lender’s policies and the policies of such Lender’s holding company with respect to capital adequacy), then from time to time the Borrower will pay to such Lender such additional amount or amounts as will compensate such Lender or such Lender’s holding company for any such reduction suffered.

(c) Certificates for Reimbursement . A certificate of a Lender setting forth the amount or amounts necessary to compensate such Lender or its holding company, as the case may be, as specified in subsection (a) or (b) of this Section and delivered to the Borrower shall be conclusive absent manifest error. The Borrower shall pay such Lender the amount shown as due on any such certificate within 10 Business Days after receipt thereof.

(d) Delay in Requests . Failure or delay on the part of any Lender to demand compensation pursuant to the foregoing provisions of this Section shall not constitute a waiver of such Lender’s right to demand such compensation, provided that the Borrower shall not be required to compensate a Lender pursuant to the foregoing provisions of this Section for any increased costs incurred or reductions suffered more than six months prior to the date that such Lender notifies the Borrower of the Change in Law giving rise to such increased costs or reductions and of such Lender’s intention to claim compensation therefor (except that, if the Change in Law giving rise to such increased costs or reductions is retroactive, then the six-month period referred to above shall be extended to include the period of retroactive effect thereof).

(e) Reserves on Eurodollar Rate Loans . The Borrower shall pay to each Lender, as long as such Lender shall be required to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency funds or deposits (currently known as “Eurocurrency liabilities”), additional interest on the unpaid principal amount of each Eurodollar Rate Loan

 

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equal to the actual costs of such reserves allocated to such Loan by such Lender (as determined by such Lender in good faith, which determination shall be conclusive), which shall be due and payable on each date on which interest is payable on such Loan, provided the Borrower shall have received at least 10 Business Days’ prior notice (with a copy to the Administrative Agent) of such additional interest from such Lender. If a Lender fails to give notice 10 Business Days prior to the relevant Interest Payment Date, such additional interest shall be due and payable 10 Business Days from receipt of such notice.

3.05 Compensation for Losses. Upon demand of any Lender (with a copy to the Administrative Agent) from time to time, the Borrower shall promptly compensate such Lender for and hold such Lender harmless from any loss, cost or expense incurred by it as a result of:

(a) any continuation, conversion, payment or prepayment of any Loan other than a Base Rate Loan on a day other than the last day of the Interest Period for such Loan (whether voluntary, mandatory, automatic, by reason of acceleration, or otherwise);

(b) any failure by the Borrower to prepay, borrow, continue or convert any Loan other than a Base Rate Loan on the date or in the amount notified by the Borrower; or

(c) any assignment of a Eurodollar Rate Loan on a day other than the last day of the Interest Period therefor as a result of a request by the Borrower pursuant to Section 11.13 ;

including any loss of anticipated profits and any loss or expense arising from the liquidation or reemployment of funds obtained by it to maintain such Loan or from fees payable to terminate the deposits from which such funds were obtained. The Borrower shall also pay any customary administrative fees charged by such Lender in connection with the foregoing. Notwithstanding the foregoing, the Borrower shall not be liable to pay such amounts in the event that a Eurodollar Loan is not continued or a Base Rate Loan is not converted into a Eurodollar Loan in accordance with the Borrower’s Loan Notice for the same due to a written request of a Lender pursuant to Section 3.02 or a written notice from the Required Lenders pursuant to Section 3.03 .

For purposes of calculating amounts payable by the Borrower to the Lenders under this Section 3.05 , each Lender shall be deemed to have funded each Eurodollar Rate Loan made by it at the Eurodollar Rate for such Loan by a matching deposit or other borrowing in the London interbank eurodollar market for a comparable amount and for a comparable period, whether or not such Eurodollar Rate Loan was in fact so funded.

3.06 Mitigation Obligations; Replacement of Lenders.

(a) Designation of a Different Lending Office . If any Lender requests compensation under Section 3.04 , or the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 3.01 , or if any Lender gives a notice pursuant to Section 3.02 , then such Lender shall use reasonable efforts to designate a different Lending Office for funding or booking its Loans hereunder or to assign its rights and obligations hereunder to another of its offices, branches or affiliates, if, in the judgment of such Lender, such designation or assignment (i) would eliminate or reduce amounts payable pursuant to Section 3.01 or 3.04 , as the case may be, in the future, or eliminate the need for the notice pursuant to Section 3.02 , as applicable, and (ii) in each case, would not subject

 

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such Lender to any unreimbursed cost or expense and would not otherwise be disadvantageous to such Lender. The Borrower hereby agrees to pay all reasonable costs and expenses incurred by any Lender in connection with any such designation or assignment.

(b) Replacement of Lenders . If any Lender requests compensation under Section 3.04 , or if any Lender gives a notice pursuant to Section 3.02, or if the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 3.01 , the Borrower may replace such Lender in accordance with Section 11.13 .

3.07 Survival.

All of the Borrower’s obligations under this Article III shall survive, repayment of all other Obligations hereunder and resignation of the Administrative Agent.

ARTICLE IV.

CONDITIONS PRECEDENT TO LOANS

4.01 Documentary Conditions of Closing Date.

The obligation of each Lender to make the Loans hereunder is subject to the Administrative Agent’s receipt of the following, each of which shall be originals, electronic copies or facsimiles (followed promptly by originals) unless otherwise specified, each properly executed by a Responsible Officer of the signing Loan Party, each dated the Closing Date (or, in the case of certificates of governmental officials, a recent date before the Closing Date) and each in form and substance and number reasonably satisfactory to the Administrative Agent and each of the Lenders:

(a) Executed counterparts of this Agreement and the Security Agreement.

(b) Such certificates of resolutions or other action, incumbency certificates and/or other certificates of Responsible Officers of each Loan Party as the Administrative Agent may reasonably require evidencing the identity, authority and capacity of each Responsible Officer thereof authorized to act as a Responsible Officer in connection with this Agreement and the other Loan Documents to which such Loan Party is a party.

(c) Such documents and certifications as the Administrative Agent may reasonably require to evidence that each Loan Party is duly organized or formed, and that each Loan Party is validly existing, in good standing and qualified to engage in business in each jurisdiction where its ownership, lease or operation of properties or the conduct of its business requires such qualification including, in the case of the Borrower, certificates from the California Department of Insurance and any other Applicable Insurance Regulatory Authority having jurisdiction over the Borrower, except to the extent that failure to be so qualified could not reasonably be expected to have a Material Adverse Effect.

(d) A favorable opinion of legal counsel to the Loan Parties, addressed to the Administrative Agent and each Lender, as to the matters set forth in Exhibit F and such other matters concerning the Loan Parties and the Loan Documents as the Required Lenders may reasonably request.

 

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(e) A certificate of a Responsible Officer of each Loan Party either (A) attaching copies of all consents, licenses and approvals required in connection with the execution, delivery and performance by such Loan Party and the validity against such Loan Party of the Loan Documents to which it is a party, and such consents, licenses and approvals shall be in full force and effect, or (B) stating that no such consents, licenses or approvals are so required.

(f) A certificate of a Responsible Officer of the Borrower certifying (A) a true and correct copy of the Acquisition Documents, (B) that concurrent with making of the Loans, the closing of the Acquisition will occur in accordance with the terms of the Acquisition Documents without waiver of any material condition thereof, and (C) the Acquisition complies in all material respects with applicable legal requirements, and all necessary consents and approvals from any Governmental Authority required for the consummation of the Acquisition were duly obtained, and continue to be in full force and effect, except for such requirements, consents or approvals that would not, in the aggregate, have a Material Adverse Effect.

(g) A certificate signed by a Responsible Officer of the Borrower certifying that after giving effect to the closing of the Acquisition and making of the Loans (A) no Default or Event of Default shall have occurred and be continuing under the Loan Documents or will result from the making of the Loan, (B) all warranties and representations contained in this Agreement are true and correct in all material respects as of the date hereof; and (C) no Material Adverse Effect has occurred since September 30, 2008.

(h) A duly completed Compliance Certificate on a proforma basis after giving effect to the Acquisition as of the last day of the fiscal quarter of the Parent ended on September 30, 2008, signed by a Responsible Officer of the Borrower and the Parent.

(i) A duly completed Collateral Value Certificate calculated as of the most recent Business Day signed by a Responsible Officer of the Borrower.

(j) A Control Agreement with respect to the Collateral Account executed by the parties thereto.

(k) Such other assurances, certificates, documents, consents or opinions as the Administrative Agent or the Lenders reasonably may require.

4.02 Conditions Precedent to Loans .

The obligation of each Lender to make Loans is further subject to the following conditions precedent:

(a) The Administrative Agent shall have received reasonably satisfactory evidence that the Lenders have a valid and perfected first priority lien and security interest in the Collateral.

 

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(b) The absence of any action, suit, investigation or proceeding pending or, to the knowledge of the Borrower, threatened in any court or before any arbitrator or governmental authority that could reasonably be expected to have a Material Adverse Effect or restrain, enjoin or otherwise prohibit the Acquisition.

(c) The Borrower shall have a financial strength rating by A.M. Best Company, Inc. of A- stable or better.

(d) There shall have been no amendment to the Acquisition Agreement that is adverse to the Lenders (and the Lenders shall have received a copy of all amendments) except such amendments as have received the written approval of the Administrative Agent (such approval not to be unreasonably withheld or delayed).

(e) The receipt of any material governmental and other third party approvals required for the intended use of the proceeds of the Senior Credit Facility, the granting of the Collateral and the Acquisition.

(f) All conditions precedent in the Acquisition Documents (other than payment of the purchase price thereunder) have been satisfied or otherwise waived (with the approval of the Administrative Agent (such approval not to be unreasonably withheld or delayed)) and the closing thereunder shall occur on the Closing Date.

(g) The Existing Credit Agreement shall have been (or concurrently with the Closing Date is being) amended in a manner reasonably satisfactory to the Administrative Agent to revise the statutory surplus covenant and provide for collateral for the obligations thereunder on the same terms and conditions as this Agreement.

(h) The Lenders shall have received two year projections for the Loan Parties giving effect to the Acquisition.

(i) Any fees required to be paid on or before the Closing Date shall have been paid.

(j) Unless waived by the Administrative Agent, the Borrower shall have paid all fees, charges and disbursements of counsel to the Administrative Agent (directly to such counsel if requested by the Administrative Agent) to the extent invoiced prior to the Closing Date, plus such additional amounts of such fees, charges and disbursements as shall constitute its reasonable estimate of such fees, charges and disbursements incurred or to be incurred by it through the closing proceedings (provided that such estimate shall not thereafter preclude a final settling of accounts between the Borrower and the Administrative Agent).

 

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ARTICLE V.

REPRESENTATIONS AND WARRANTIES

Each Loan Party represents and warrants to the Administrative Agent and the Lenders on the Closing Date that:

5.01 Existence, Qualification and Power.

The Parent and each Subsidiary (a) is duly organized or formed, validly existing and, as applicable, in good standing under the Laws of the jurisdiction of its incorporation or organization, (b) has all requisite power and authority and all requisite governmental licenses, authorizations, consents and approvals to (i) own or lease its assets and carry on its business and (ii) execute, deliver and perform its obligations under the Loan Documents to which it is a party, and (c) is duly qualified and is licensed and, as applicable, in good standing under the Laws of each jurisdiction where its ownership, lease or operation of properties or the conduct of its business requires such qualification or license; except in each case referred to in clause (b)(i) or (c), to the extent that failure to do so could not reasonably be expected to have a Material Adverse Effect.

5.02 Authorization; No Contravention.

The execution, delivery and performance by each Loan Party of each Loan Document to which such Person is party, have been duly authorized by all necessary corporate or other organizational action, and do not and will not (a) contravene the terms of any of such Person’s Organization Documents; (b) conflict with or result in any breach or contravention of, or the creation of any Lien under, or require any payment to be made under (i) any Contractual Obligation to which such Person is a party or affecting such Person or the properties of such Person or any of its Subsidiaries, which could reasonably be expected to have a Material Adverse Effect, or (ii) any order, injunction, writ or decree of any Governmental Authority or any arbitral award to which such Person or its property is subject; or (c) violate any Law.

5.03 Governmental Authorization; Other Consents.

No approval, consent, exemption, authorization, or other action by, or notice to, or filing with, any Governmental Authority or any other Person is necessary or required in connection with the execution, delivery or performance by, or enforcement against, any Loan Party of this Agreement or any other Loan Document; except (a) for approvals, consents, exemptions, authorizations, actions, notices or filings (i) which have already been obtained or made or (ii) for which the failure to obtain or make could not reasonably be expected to have a Material Adverse Effect and such failure could be cured without unreasonable delay or cost and (b) the Borrower is required to file post-closing reports pursuant to California Insurance Code section 1185 et seq. with the California Department of Insurance and NAIC with respect to the Acquisition and the Borrower’s granting of Collateral pursuant to the Loan Documents (the “ Post-Closing Filings ”).

5.04 Binding Effect.

This Agreement has been, and each other Loan Document, when delivered hereunder, will have been, duly executed and delivered by each Loan Party that is party thereto. This Agreement constitutes, and each other Loan Document when so delivered will constitute, a legal, valid and binding obligation of such Loan Party, enforceable against each Loan Party that is party thereto in accordance with its terms.

 

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5.05 Financial Statements; No Material Adverse Effect.

(a) The unaudited consolidated balance sheet of the Parent and its Subsidiaries dated September 30, 2008, and the related consolidated statements of income or operations, shareholders’ equity and cash flows for the fiscal quarter ended on that date (i) were prepared in accordance with GAAP consistently applied throughout the period covered thereby, except as otherwise expressly noted therein, and (ii) fairly present the financial condition of the Parent and its Subsidiaries as of the date thereof and their results of operations for the period covered thereby, subject, in the case of clauses (i) and (ii), to the absence of footnotes and to normal year-end audit adjustments.

(b) (i) The Annual Statement of the Borrower as of and for the year ending December 31, 2007 (including, without limitation, the provisions made therein for investments and the valuation thereof, reserves, policy and contract claims and statutory liabilities) as filed with the Applicable Insurance Regulatory Authority and the Interim Statement of the Borrower as of and for the calendar quarter ended September 30, 2008 as filed with the Applicable Insurance Regulatory Authority (collectively, the “Statutory Financial Statements”), have been prepared in all material respects in accordance with SAP applied on a consistent basis (except as noted therein). Each such Statutory Financial Statement was in material compliance with applicable Law when filed. The Statutory Financial Statements fairly present the financial position, the results of operations, changes in equity and changes in financial position of the Borrower as of and for the respective dates and periods indicated therein in accordance with SAP applied on a consistent basis, except as set forth in the notes thereto.

(c) The Investments of the Borrower reflected in the Statutory Financial Statements comply in all material respects with all applicable requirements of the California Department of Insurance as well as those of any other Applicable Insurance Regulatory Authority relating to Investments in respect of which the Borrower may invest its funds.

(d) The provisions made by the Borrower in the Statutory Financial Statements for reserves, policy and contract claims and statutory liabilities are in compliance in all material respects with the requirements of the Applicable Insurance Regulatory Authority, and have been computed in accordance with SAP.

(e) Marketable securities and short term investments reflected in the Statutory Financial Statements are valued at cost, amortized cost or market value, as required by applicable Law.

(f) Since September 30, 2008, there has been no event or circumstance, either individually or in the aggregate, that has had or could reasonably be expected to have a Material Adverse Effect.

5.06 Litigation.

There are no actions, suits, proceedings, claims or disputes pending or, to the knowledge of either Loan Party after due and diligent investigation, threatened or contemplated, at law, in equity, in arbitration or before any Governmental Authority, by or against the Parent or any of its Subsidiaries or against any of their properties or revenues that (a) purport to affect the validity or enforceability of this Agreement or any other Loan Document, or the consummation of any of the transactions contemplated hereby, or (b) either individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect.

 

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5.07 No Default. Neither the Parent nor any Subsidiary is in default under or with respect to any Contractual Obligation that could, either individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. No Default has occurred and is continuing or would result from the consummation of the Acquisition or the transactions contemplated by this Agreement or any other Loan Document.

5.08 Ownership of Property; Liens. Each of the Parent and each Subsidiary has good record and marketable title in fee simple to, or valid leasehold interests in, all real property necessary or used in the ordinary conduct of its business, except for such defects in title as could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

5.09 Environmental Compliance. The Parent and its Subsidiaries conduct in the ordinary course of business a review of the effect of existing Environmental Laws and claims alleging potential liability or responsibility for violation of any Environmental Law on their respective businesses, operations and properties, and as a result thereof the Parent has reasonably concluded that such Environmental Laws and claims could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

5.10 Insurance. The properties of the Parent and its Subsidiaries are insured with financially sound and reputable insurance companies not Affiliates of the Parent, in such amounts (after giving effect to any self-insurance compatible with the following standards), with such deductibles and covering such risks as are customarily carried by companies engaged in similar businesses and owning similar properties in localities where the Parent or the applicable Subsidiary operates.

5.11 Taxes. The Parent and its Subsidiaries have filed all material Federal, state and other tax returns and reports required to be filed (taking into account extensions), and have paid all material Federal, state and other taxes, assessments, fees and other governmental charges levied or imposed upon them or their properties, income or assets otherwise due and payable, except those which are being contested in good faith by appropriate proceedings diligently conducted and for which adequate reserves have been provided in accordance with GAAP. To the knowledge of the Borrower, there is no proposed tax assessment against the Parent or any Subsidiary that could reasonably be expected to have a Material Adverse Effect.

5.12 ERISA Compliance.

(a) Except as could not reasonably be expected to have a Material Adverse Effect, (i) each Plan is in compliance with the applicable provisions of ERISA, the Code and other Federal or state Laws; (ii) each Plan that is intended to qualify under Section 401(a) of the Code has received a favorable determination letter from the IRS or an application for such a letter is currently being processed by the IRS with respect thereto and, to the best knowledge of each Loan Party, nothing has occurred which would prevent, or cause the loss of, such qualification; and (iii) the Parent and each ERISA Affiliate have made all required contributions to each Plan subject to Section 412 of the Code, and no application for a funding waiver or an extension of any amortization period pursuant to Section 412 of the Code has been made with respect to any Plan.

 

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(b) There are no pending or, to the best knowledge of either Loan Party, threatened claims, actions or lawsuits, or action by any Governmental Authority, with respect to any Plan that could reasonably be expected to have a Material Adverse Effect. There has been no prohibited transaction or violation of the fiduciary responsibility rules with respect to any Plan that has resulted or could reasonably be expected to result in a Material Adverse Effect.

(c) Except as could not reasonably be expected to have a Material Adverse Effect, (i) no ERISA Event has occurred or is reasonably expected to occur; (ii) no Pension Plan has any Unfunded Pension Liability; (iii) neither the Loan Party nor any ERISA Affiliate has incurred, or reasonably expects to incur, any liability under Title IV of ERISA with respect to any Pension Plan (other than premiums due and not delinquent under Section 4007 of ERISA); (iv) neither the Loan Party nor any ERISA Affiliate has incurred, or reasonably expects to incur, any liability (and no event has occurred which, with the giving of notice under Section 4219 of ERISA, would result in such liability) under Section 4201 or 4243 of ERISA with respect to a Multiemployer Plan; and (v) neither the Loan Party nor any ERISA Affiliate has engaged in a transaction that could be subject to Section 4069 or 4212(c) of ERISA.

5.13 Subsidiaries; Equity Interests. As of the Closing Date, (a) the Parent has no Subsidiaries other than those specifically disclosed in Part (a) of Schedule 5.13 , and all of the outstanding Equity Interests in such Subsidiaries have been validly issued, are fully paid and nonassessable and are owned by the Person and in the amounts specified on Part (a) of Schedule 5.13 free and clear of all consensual Liens and such Schedule correctly indicates, as of the Closing Date, whether such Subsidiary is a Material Party, an Insurance Subsidiary or a Material Insurance Subsidiary, and (b) the Parent and its Subsidiaries do not have any equity investments in any other corporation or entity other than those specifically disclosed in Part(b) of Schedule 5.13 or, in the case of Insurance Subsidiaries, maintained in their investment portfolio in the ordinary course of business.

5.14 Margin Regulations; Investment Company Act.

(a) The Borrower is not engaged, principally or as one of its important activities, in the business of purchasing or carrying margin stock (within the meaning of Regulation U issued by the FRB), or extending credit for the purpose of purchasing or carrying margin stock. Less than 25% of the assets of the Borrower and its Subsidiaries (taken as a whole) consists of Margin Stock.

(b) None of the Parent, any Person Controlling the Parent, or any Subsidiary is or is required to be registered as an “investment company” under the Investment Company Act of 1940.

5.15 Disclosure. The Parent has disclosed to the Administrative Agent and the Lenders all agreements, instruments and corporate or other restrictions to which it or any of its Subsidiaries is subject, and all other matters known to it, that, individually or in the aggregate, could reasonably be expected to result in a Material Adverse Effect. No report, financial statement, certificate or other information furnished (whether in writing or orally) by or on behalf of any Loan Party to the Administrative Agent or any Lender in connection with the transactions contemplated hereby and the negotiation of this Agreement or delivered hereunder

 

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or under any other Loan Document (in each case, as modified or supplemented by other information so furnished) contains any material misstatement of fact or omits to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided that, with respect to projected financial information, the Borrower represents only that such information was prepared in good faith based upon assumptions believed to be reasonable at the time such projected financial information was prepared.

5.16 Compliance with Laws. The Parent and each Subsidiary is in compliance in all material respects with the requirements of all Laws and all orders, writs, injunctions and decrees applicable to it or to its properties, except in such instances in which (a) such requirement of Law or order, writ, injunction or decree is being contested in good faith by appropriate proceedings diligently conducted or (b) the failure to comply therewith, either individually or in the aggregate, could not reasonably be expected to have a Material Adverse Effect.

5.17 Taxpayer Identification Number. Each Loan Party’s true and correct U.S. taxpayer identification number is set forth on Schedule 11.02 .

5.18 First Priority Security Interest. The Administrative Agent, for the benefit of the Lenders, has a first priority perfected security interest in the Collateral pledged by the Borrower pursuant to the Security Agreement.

5.19 Insurance Licenses. Each Insurance Subsidiary has all Insurance Licenses necessary to conduct its business except to the extent the failure to have such Insurance License would not have a Material Adverse Effect. Except as set forth in its SEC filings, to the best of the each Loan Party’s knowledge, (a) no Insurance License of any Insurance Subsidiary is the subject of a proceeding for suspension or revocation or any similar proceedings, (b) there is no sustainable basis for such a suspension or revocation, and (c) no such suspension or revocation is threatened by any Applicable Insurance Regulatory Authority; except, in each case referred to in clauses (a)-(c) , to the extent that such event could not reasonably be expected to have a Material Adverse Effect.

ARTICLE VI.

AFFIRMATIVE COVENANTS

So long as any Loan or other Obligation (other than Unmatured Surviving Obligations) hereunder shall remain unpaid or unsatisfied, the Loan Parties shall, and shall (except in the case of the covenants set forth in Sections 6.01 , 6.02 , 6.03 , and 6.14 ) cause each Subsidiary to:

6.01 Financial Statements. Deliver to the Administrative Agent:

(a) as soon as available, but in any event within ninety (90) days after the end of each fiscal year of the Parent (commencing with the fiscal year ended December 31, 2008), a consolidated balance sheet of the Parent and its Subsidiaries as at the end of such fiscal year, and the related consolidated statements of income or operations, statement of shareholders’ equity, and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail and prepared in accordance with GAAP, such consolidated statements to be audited and accompanied by a report and opinion of KPMG or

 

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another independent certified public accountant of nationally recognized standing reasonably acceptable to the Required Lenders, which report and opinion shall be prepared in accordance with generally accepted auditing standards and shall not be subject to any “going concern” or like qualification or exception or any qualification or exception as to the scope of such audit;

(b) as soon as available, but in any event within fifty-five (55) days after the end of each of the first three fiscal quarters of each fiscal year of the Parent (commencing with the fiscal quarter ended March 31, 2009), a consolidated balance sheet of the Parent and its Subsidiaries as at the end of such fiscal quarter, the related consolidated statements of income or operations for such fiscal quarter and for the portion of the Parent’s fiscal year then ended, and cash flows for the portion of the Parent’s fiscal year then ended, in each case setting forth in comparative form, as applicable, the figures for the corresponding fiscal quarter of the previous fiscal year and the corresponding portion of the previous fiscal year, all in reasonable detail, certified by the chief executive officer, chief financial officer, treasurer or controller of the Parent as fairly presenting the financial condition, results of operations, shareholders’ equity and cash flows of the Parent and its Subsidiaries in accordance with GAAP, subject only to year-end audit adjustments and the absence of footnotes;

(c) within five (5) Business Days after the applicable regulatory filing date, but in any event not later than fifty-five (55) days after the end of each calendar quarter (commencing with the calendar quarter ended March 31, 2009) in respect of which an Interim Statement is required to be filed, a copy of each Interim Statement of the Borrower for such calendar quarter, prepared in accordance with SAP;

(d) within five (5) Business Days after the applicable regulatory filing date for each calendar year (commencing with the filing for calendar year ended December 31, 2008), but in any event within ninety (90) days after the end of each calendar year, a copy of the Annual Statement of the Borrower for such calendar year prepared in accordance with SAP; and

(e) within five (5) Business Days after the applicable regulatory filing date for each calendar year (commencing with the filing for calendar year ended December 31, 2008), but in any event prior to June 10th of the year in which such filing is required, a copy of the annual audit for the Borrower for such calendar year prepared in accordance with the Annual Audited Financial Reports instructions contained in the annual statement instructions prepared by the NAIC from time to time by KPMG or other independent public accountants of recognized national standing.

As to any information contained in materials furnished pursuant to Section 6.02(c) , the Parent shall not be separately required to furnish such information under clause (a) or (b) above, but the foregoing shall not be in derogation of the obligation of the Borrower to furnish the information and materials described in clauses (a) and (b) above at the times specified therein.

6.02 Certificates; Other Information. Deliver to the Administrative Agent:

(a) concurrently with the delivery of the financial statements referred to in Sections 6.01(a) and (b)  (commencing with the delivery of the financial statements for the fiscal year ended December 31, 2008), a duly completed Compliance Certificate signed by the chief executive officer, chief financial officer, treasurer or controller of the Borrower and the Parent;

 

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(b) promptly after any written request by the Administrative Agent or any Lender, copies of any detailed audit reports, management letters or recommendations submitted to the board of directors (or the audit committee of the board of directors) of a Loan Party by independent accountants in connection with the accounts or books of the Parent or any Subsidiary, or any audit of any of them;

(c) promptly after the same are available, copies of each annual report, proxy or financial statement or other report or communication sent to the stockholders of the Parent, and copies of all annual, regular, periodic and special reports and registration statements which the Parent may file or be required to file with the SEC under Section 13 or 15(d) of the Securities Exchange Act of 1934, and not otherwise required to be delivered to the Administrative Agent pursuant hereto;

(d) within fifteen (15) days after being delivered to any Material Insurance Subsidiary, any final Report on Examination issued by the Applicable Insurance Regulatory Authority or the NAIC that results in material adjustments to the financial statements referred to in Sections 6.01(c) , (d)  or (e) ;

(e) promptly, upon written request of the Administrative Agent, a copy of each “Statement of Actuarial Opinion” and “Management Discussion and Analysis” for any Material Insurance Subsidiary which is required to be provided to the Applicable Insurance Regulatory Authority as to the adequacy of loss reserves of such Person;

(f) within five (5) Business Days of receipt, a copy of any financial examination reports by any Applicable Insurance Regulatory Authority with respect to any Material Insurance Subsidiary relating to the insurance business of such Person (when, and if, prepared); provided, such Material Insurance Subsidiary shall only be required to deliver any interim report hereunder at such time as such Material Insurance Subsidiary has knowledge that a final report will not be issued and delivered to the Administrative Agent, within ninety (90) days of any such interim report;

(g) within five (5) Business Days of such notice, notice of actual suspension, termination or revocation of any material Insurance License of any Material Insurance Subsidiary by any Applicable Insurance Regulatory Authority;

(h) promptly upon notice thereof, any change in the A.M. Best Rating financial strength rating of any Material Insurance Subsidiaries;

(i) as soon as available, but in any event within 10 Business Days after the end of each calendar month of each fiscal year, a Collateral Value Certificate executed by a Responsible Officer of the Borrower calculated as of the last Business Day of such calendar month;

(j) promptly, at the request of the Administrative Agent, a Collateral Value Certificate for any given Business Day executed by a Responsible Officer of the Borrower calculated as of the close of business on such Business Day; and

 

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(k) promptly, such additional information regarding the business, financial or corporate affairs of the Parent or any Subsidiary, or compliance with the terms of the Loan Documents, as the Administrative Agent or any Lender may from time to time reasonably request;

(l) promptly after filing, a copy of the Post-Closing Filings.

Documents required to be delivered pursuant to Section 6.01(a) or (b)  or Section 6.02(c) (to the extent any such documents are included in materials otherwise filed with the SEC) may be delivered electronically and if so delivered, shall be deemed to have been delivered on the date on which such documents are posted on the Parent’s behalf on an Internet or intranet website, if any, to which each Lender and the Administrative Agent have access (whether a commercial, third-party website or whether sponsored by the Administrative Agent); provided that: (i) the Borrower shall deliver paper copies of such documents to the Administrative Agent or any Lender that requests in writing the Borrower to deliver such paper copies until a written request to cease delivering paper copies is given by the Administrative Agent or such Lender and (ii) the Borrower shall notify the Administrative Agent and each Lender (by telecopier or electronic mail) of the posting of any such documents and provide to the Administrative Agent by electronic mail electronic versions ( i.e. , soft copies) of such documents. Notwithstanding anything contained herein, in every instance the Borrower shall be required to provide paper copies of the Compliance Certificates required by Section 6.02(b) to the Administrative Agent. Except for such Compliance Certificates, the Administrative Agent shall have no obligation to request the delivery or to maintain copies of the documents referred to above, and in any event shall have no responsibility to monitor compliance by the Borrower with any such request for delivery, and each Lender shall be solely responsible for requesting delivery to it or maintaining its copies of such documents.

The Loan Parties hereby acknowledge that (a) the Administrative Agent and/or the Arranger will make available to the Lenders materials and/or information provided by or on behalf of the Loan Parties hereunder (collectively, “ Borrower Materials ”) by posting the Borrower Materials on IntraLinks or another similar electronic system (the “ Platform ”) and (b) certain of the Lenders (each, a “ Public Lender ”) may have personnel who do not wish to receive material non-public information with respect to the Parent or its Affiliates, or the respective securities of any of the foregoing, and who may be engaged in investment and other market-related activities with respect to such Persons’ securities. Each Loan Party hereby agrees that (w) all Borrower Materials that are to be made available to Public Lenders shall be clearly and conspicuously marked “PUBLIC” which, at a minimum, shall mean that the word “PUBLIC” shall appear prominently on the first page thereof; (x) by marking Borrower Materials “PUBLIC,” the Borrower shall be deemed to have authorized the Administrative Agent, the Arranger and the Lenders to treat such Borrower Materials as not containing any material non-public information with respect to the Borrower or its securities for purposes of United States Federal and state securities laws ( provided , however , that to the extent such Borrower Materials constitute Information, they shall be treated as set forth in Section  11.07 ); (y) all Borrower Materials marked “PUBLIC” are permitted to be made available through a portion of the Platform designated “Public Side Information;” and (z) the Administrative Agent and the Arranger shall be entitled to treat any Borrower Materials that are not marked “PUBLIC” as being suitable only for posting on a portion of the Platform that is not designated “Public Side Information.”

 

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6.03 Notices. Promptly notify the Administrative Agent and each Lender:

(a) of the occurrence of any Default;

(b) of the commencement of, or any material development in, any litigation or proceeding affecting the Borrower or any of its Subsidiaries involving an amount in excess of 10% of Borrower Statutory Surplus as calculated as of the most recently ended fiscal quarter for which statutory statements were delivered or were required to be delivered pursuant to Section 6.01(c) or (d) .

(c) of the commencement of, or any material development in, any litigation or proceeding affecting the Parent or any Subsidiary other than the Borrower and its Subsidiaries that could reasonably be expected to have a Material Adverse Effect;

(d) of receipt of notice from any Governmental Authority notifying the Borrower or any of its Insurance Subsidiaries of a hearing relating to a suspension, termination or revocation of any Insurance License, including any request by a Governmental Authority which commits the Borrower or any of its Subsidiaries to take, or refrain from taking, any action or which otherwise materially and adversely affects the authority of the Borrower or any such Insurance Subsidiary to conduct its business;

(e) (i) any breach or non-performance of, or any default under, a Contractual Obligation of the Parent or any Subsidiary and (ii) of any dispute, litigation, investigation, proceeding or suspension between a Material Insurance Subsidiary and any Governmental Authority, in each case, to the extent the same has resulted or could reasonably be expected to result in a Material Adverse Effect;

(f) of any matter that has resulted or could reasonably be expected to result in a Material Adverse Effect;

(g) of the occurrence of any ERISA Event;

(h) of any material change in accounting policies or financial reporting practices by the Parent or any Material Party;

(i) notice of any actual or, to the Borrower’s knowledge, proposed set-off, claims, withholdings or other defenses to which any material portion of the Collateral or the Administrative Agent’s rights with respect to any material portion of the Collateral are subject;

(j) of any announcement by A.M. Best & Company, Inc. of any change in or change in the outlook for a financial strength rating by A.M Best Company, Inc. of any Material Insurance Subsidiary, and

(k) of any announcement by S&P or Moody’s of any change in the Parent’s non-credit-enhanced, senior unsecured long-term debt.

 

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Each notice pursuant to this Section 6.03 (a), (b), (c) or (d)  shall be accompanied by a statement of a Responsible Officer of the Borrower setting forth details of the occurrence referred to therein and stating what action the Borrower has taken and proposes to take with respect thereto. Each notice pursuant to Section 6.03(a) shall describe with particularity any and all provisions of this Agreement and any other Loan Document that have been breached.

6.04 Payment of Obligations. Pay and discharge as the same shall become due and payable, all its material obligations and liabilities, including (a) all material tax liabilities, assessments and governmental charges or levies upon it or its properties or assets, unless the same are being contested in good faith by appropriate proceedings diligently conducted and adequate reserves in accordance with GAAP are being maintained by the Parent or such Subsidiary; (b) all material lawful claims which, if unpaid, would by law become a Lien upon its property; and (c) all material Indebtedness, as and when due and payable, but subject to any subordination provisions contained in any instrument or agreement evidencing such Indebtedness.

6.05 Preservation of Existence, Etc. (a) Preserve, renew and maintain in full force and effect its legal existence and good standing under the Laws of the jurisdiction of its organization except in a transaction permitted by Section 7.04 or 7.05 ; (b) take all reasonable action to maintain all rights, privileges, permits, licenses and franchises necessary or desirable in the normal conduct of its business, except to the extent that failure to do so could not reasonably be expected to have a Material Adverse Effect; and (c) preserve or renew all of its registered patents, trademarks, trade names and service marks, the non-preservation of which could reasonably be expected to have a Material Adverse Effect.

6.06 Maintenance of Properties. (a) Maintain, preserve and protect all of its material properties and equipment necessary in the operation of its business in good working order and condition, ordinary wear and tear excepted; and (b) make all necessary repairs thereto and renewals and replacements thereof except where the failure to do so could not reasonably be expected to have a Material Adverse Effect.

6.07 Maintenance of Insurance. Maintain with financially sound and reputable insurance companies not Affiliates of the Parent, insurance with respect to its properties and business against loss or damage of the kinds customarily insured against by Persons engaged in the same or similar business, of such types and in such amounts (after giving effect to any self-insurance compatible with the following standards) as are customarily carried under similar circumstances by such other Persons.

6.08 Compliance with Laws. Comply in all material respects with the requirements of all Laws and all orders, writs, injunctions and decrees applicable to it or to its business or property, except in such instances in which (a) such requirement of Law or order, writ, injunction or decree is being contested in good faith by appropriate proceedings diligently conducted; or (b) the failure to comply therewith could not reasonably be expected to have a Material Adverse Effect.

 

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6.09 Books and Records. (a) Maintain proper books of record and account, in which full, true and correct entries in conformity with GAAP or SAP, as applicable consistently applied shall be made of all financial transactions and matters involving the assets and business of the Parent or such Subsidiary, as the case may be; and (b) maintain such books of record and account in material conformity with all applicable requirements of any Governmental Authority having regulatory jurisdiction over the Parent or such Subsidiary, as the case may be.

6.10 Inspection Rights. Permit representatives and independent contractors of the Administrative Agent and each Lender to visit and inspect any of its properties, to examine its corporate, financial and operating records, and make copies thereof or abstracts therefrom, and to discuss its affairs, finances and accounts with its directors, officers, and independent public accountants, all at the expense of the Borrower and at such reasonable times during normal business hours and as often as may be reasonably desired, upon reasonable advance notice to the Borrower; provided , however , that as long as no Event of Default has occurred and is continuing, the Borrower shall not bear the expense of more than one visit per year; provided, further , that when an Event of Default exists the Administrative Agent or any Lender (or any of their respective representatives or independent contractors) may do any of the foregoing at the expense of the Borrower at any time during normal business hours and without advance notice.

6.11 Use of Proceeds. Use the proceeds of the Loans to make the Acquisition and pay fees and expenses in connection therewith and hereunder.

6.12 Bank as Principal Depository. To, and cause each of its Subsidiaries to, maintain Bank of America as its primary depository bank, including for the maintenance of business, cash management, operating and administrative deposit accounts.

6.13 Further Assurances. Promptly upon the request of the Administrative Agent, the Borrower shall execute, acknowledge, deliver and record and do any and all such further acts and deeds as the Administrative Agent may reasonably request from time to time in order to insure that the Obligations are secured by a first priority perfected interest in the assets of the Borrower stated to be pledged pursuant to the Security Agreement and to perfect and maintain the validity, effectiveness and priority of the Security Agreement and the Liens created thereby. Without the prior written consent of the Administrative Agent, the Borrower shall not give directions or entitlement orders to the Securities Intermediary party to any Control Agreement to make a delivery to the Borrower or any other Person of assets or properties from the Collateral Account except in connection with the sale of the Eligible Collateral the proceeds of which will be deposited into the Collateral Account. The Administrative Agent, on behalf of the Lenders, agrees that provided (i) no Default exists and is continuing and (ii) after giving effect to the proposed delivery, the Collateral Value is equal to or in excess of the Outstanding Amount, the Administrative Agent shall consent to and give instructions to the holder of the Collateral Account permitting any such delivery within one Business Day of a request.

6.14 Collateral Value. (a) For purposes of calculating Collateral Value on any date, the Adjusted Fair Market Value of the following shall be excluded: (i) any Collateral which directly includes sub-prime mortgage assets, (ii) the portion of any issue of Eligible Collateral (other than Government Debt) which exceeds 10% of the Adjusted Fair Market Value of all Eligible Collateral, (iii) without duplication of any amount excluded pursuant to clause (ii), the portion of Eligible Collateral of any issuer (other than Government Debt) which exceeds 10% of the Adjusted Fair Market Value of all Eligible Collateral, (iv) the portion of the Eligible Collateral

 

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that is rated A-/A3, BBB+/Baa1 or BBB/Baa2 and exceeds 20% of the Adjusted Fair Market Value of all Eligible Collateral, and (v) without duplication of any amount excluded pursuant to clause (iv), the portion of the Eligible Collateral that is rated BBB+/Baa1 or BBB/Baa2 and exceeds 10% of the Adjusted Fair Market Value of all Eligible Collateral.

(b) If at any time the Outstanding Amount shall exceed (the amount of such excess, the “ Collateral Shortfall ”) the Collateral Value for three consecutive Business Days, an Event of Default shall occur unless within three Business Days of the date the Collateral Shortfall occurred no Collateral Shortfall exists as a result of (i) a change in the Collateral Value due to market fluctuations, (ii) a deposit of additional securities in the Collateral Account and/or (iii) prepayment of the Outstanding Amount. Any prepayment made pursuant to this Section 6.14(b) shall be made without premium or penalty provided any prepayment of a Eurodollar Rate Loan shall be accompanied by all accrued interest on the amount prepaid, together with any additional amounts required pursuant to Section 3.05 . Each such prepayment shall be applied to the Loans of the Lenders in accordance with their respective Applicable Percentages. Amounts so prepaid may not be reborrowed.

ARTICLE VII.

NEGATIVE COVENANTS

The Loan Parties agree that so long as any Loan or other Obligation (other than Unmatured Surviving Obligations) hereunder shall remain unpaid or unsatisfied:

7.01 Liens. The Borrower shall not, and shall not permit its Subsidiaries to, create, incur, assume or suffer to exist any Lien upon any of its property, assets or revenues, whether now owned or hereafter acquired, other than the following:

(a) Liens pursuant to any Loan Document;

(b) Liens securing the Existing Term Loan Agreement provided that the outstanding principal amount thereof does not exceed $18,000,000 or any additional amount permitted pursuant to Section 7.03(b) ;

(c) Liens for taxes not yet due or which are being contested in good faith and by appropriate proceedings diligently conducted, if adequate reserves with respect thereto are maintained on the books of the applicable Person in accordance with GAAP;

(d) carriers’, warehousemen’s, mechanics’, materialmen’s, repairmen’s or other like Liens arising in the ordinary course of business which are not overdue for a period of more than 60 days or which are being contested in good faith and by appropriate proceedings diligently conducted, if adequate reserves with respect thereto are maintained on the books of the applicable Person in accordance with GAAP;

(e) pledges or deposits in the ordinary course of business in connection with workers’ compensation, unemployment insurance and other social security legislation, other than any Lien imposed by ERISA;

 

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(f) deposits to secure the performance of bids, trade contracts and leases (other than Indebtedness), statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business;

(g) easements, rights-of-way, restrictions and other similar encumbrances affecting real property which, in the aggregate, are not substantial in amount, and which do not in any case materially detract from the value of the property subject thereto or materially interfere with the ordinary conduct of the business of the applicable Person;

(h) Liens on assets other than the Collateral or any Equity Interests in any Subsidiary of the Borrower provided the amount of outstanding Indebtedness and other obligations (other than judicial judgments(including surety and appeal bonds)) secured thereby does not exceed $50,000,000 at any time; and

(i) Liens on assets other than the Collateral and any Equity Interest in any Subsidiary of the Borrower securing judicial judgments (including surety and appeal bonds) provided the outstanding amount secured thereby does not exceed $100,000,000 at any time.

7.02 Investments. The Material Insurance Subsidiaries shall not make any Investments, except:

(a) Investments disclosed on Schedule 5.14 ;

(b) Investments maintained in such Material Insurance Subsidiary’s investment portfolio in the ordinary course of business and in compliance with applicable Law;

(c) Investments by such Material Insurance Subsidiary in its Subsidiaries or by a Subsidiary of such Material Insurance Subsidiary in such Material Insurance Subsidiary; and

(d) Trade accounts receivables.

7.03 Indebtedness. The Borrower and its Subsidiaries shall not create, incur, assume or suffer to exist any Indebtedness except:

(a) Indebtedness under the Loan Documents;

(b) Indebtedness under the Existing Term Loan Agreement and refinancings, refundings, renewals or extensions thereof; provided that the amount of such Indebtedness is not increased at the time of such refinancing, refunding, renewal or extension except by an amount equal to a reasonable premium or interest and other reasonable amounts paid, and fees and expenses reasonably incurred, in connection with such refinancing;

(c) obligations (contingent or otherwise) existing or arising under any Swap Contract, provided that (i) such obligations are (or were) entered into by such Person in the ordinary course of business for the purpose of directly mitigating risks associated with fluctuations in interest rates or foreign exchange rates, (ii) such Swap Contract is not (and is not required by GAAP to be) accounted for as speculative in nature, and (iii) such Swap Contract does not contain any provision exonerating the non-defaulting party from its obligation to make payments on outstanding transactions to the defaulting party;

 

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(d) Guarantees of Indebtedness permitted pursuant to this Section 7.03 ;

(e) Indebtedness owed to any Person providing property, casualty or liability insurance to the Borrower or any Subsidiary of the Borrower, so long as the outstanding amount of such Indebtedness does not exceed $5,000,000 at any time, and shall be incurred only to defer the cost of, such insurance for the year in which such Indebtedness is incurred and such Indebtedness shall be outstanding only during such year;

(f) (i) Indebtedness arising from the honoring by a bank or other financial institution of a check, draft or similar instrument drawn against insufficient funds in the ordinary course of business; provided that such Indebtedness is extinguished within five Business Days of its incurrence, (ii) Indebtedness in respect of credit cards provided the outstanding amount of such Indebtedness does not exceed $500,000 at any time and is extinguished within 60 days from the date of invoice, and (iii) Indebtedness in respect of purchase cards provided such Indebtedness is extinguished within 60 days from the date of invoice;

(g) contingent (but not matured) reimbursement, indemnification or similar obligations (including any arising by right of subrogation) of the Borrower or of one or more Subsidiaries in respect of stay or appeal bonds; and

(h) Indebtedness not exceeding an aggregate principal amount of $150,000,000 at any time outstanding.

7.04 Fundamental Changes. The Parent shall not, and shall not permit any of its Subsidiaries to, merge, dissolve, liquidate, consolidate with or into another Person, or acquire (whether in one transaction or in a series of transactions) all or substantially all of its assets of or Equity Interests in, or assets which constitute a business unit of, any Person, or except that:

(a) so long as no Default exists or would result therefrom, the Borrower or any of its Subsidiaries may acquire (in one transaction or a series of transactions) the assets of any Person which constitute a business unit provided that the aggregate purchase price paid for all such acquisitions in any fiscal year does not exceed 10% of the Statutory Surplus of the Borrower as of the most recently ended fiscal year;

(b) so long as no Default exists or would result therefrom, any Subsidiary (other than the Borrower or its Subsidiaries) may merge with (i) the Parent, provided that the Parent shall be the continuing or surviving person, or (ii) any one or more other Subsidiaries (other than the Borrower or any of its subsidiaries);

(c) so long as no Default exists or would result therefrom, any Subsidiary of the Borrower may merge with (i) the Borrower, provided that the Borrower shall be the continuing or surviving Person, or (ii) any one or more other Subsidiaries of the Borrower;

 

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(d) so long as no Default exists or would result therefrom, the Borrower may merge or consolidate with any Person (other than the Parent) provided (i) either the Borrower is the continuing or surviving Person or the continuing or surviving Person is organized in the United States and assumes all obligations under this Agreement and the other Loan Documents to which the Borrower is a party in a manner reasonably satisfactory to the Administrative Agent and (ii) the Borrower has provided the Lenders with advance notice of such merger or consolidation and provided a pro forma Compliance Certificate giving effect to such merger or consolidation;

(e) so long as no Default exists or would result therefrom, the Parent may merge or consolidate with any Person (other than the Borrower) provided that (i) such merger or consolidation does not result in a Change of Control, (ii) either the Parent is the continuing or surviving Person or the continuing or surviving Person is organized in the United States and assumes all obligations under this Agreement and the other Loan Documents to which the Parent is a party in a manner reasonably satisfactory to the Administrative Agent and (iii) the Parent has provided the Lenders with advance notice of such merger or consolidation and provided a pro forma Compliance Certificate giving effect to such merger or consolidation; and

(f) the Parent or any of its Subsidiaries (other than the Borrower and its Subsidiaries) may purchase or otherwise acquire all or substantially all the assets or Equity Interests in, any other Person provided (i) no Default exists or would result thereof and (ii) the Borrower has provided the Lenders with advance notice of such acquisition and provided a pro forma Compliance Certificate giving effect to such acquisition.

7.05 Dispositions. The Parent and its Subsidiaries shall not make any Disposition or enter into any agreement to make any Disposition, except:

(a) Dispositions of obsolete or worn out property or property no longer useful in the business of Parent and its Subsidiaries, whether now owned or hereafter acquired, in the ordinary course of business;

(b) Dispositions of Investments in the ordinary course of business;

(c) Dispositions of equipment or real property to the extent that (i) such property is exchanged for credit against the purchase price of similar replacement property or (ii) the proceeds of such Disposition are reasonably promptly applied to the purchase price of such replacement property;

(d) Dispositions of property by any Subsidiary (other than the Borrower or one of its Subsidiaries) to the Parent or another Subsidiary;

(e) Dispositions of property by the Parent or any Subsidiary (other than the Borrower or one of its Subsidiaries) for fair market value;

(f) Dispositions by the Borrower or any of its Subsidiaries for fair market value in an aggregate amount not exceeding 10% of the Borrower’s Statutory Surplus in any calendar year provided (x) no Default exists or would result therefrom and (y) after giving effect to such transaction the Loan Parties would be in pro forma compliance with Section 7.11 ;

 

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(g) leases, subleases, licenses or sublicenses of property in the ordinary course of business and which do not materially interfere with the business of the Parent and its Subsidiaries;

(h) transfers of property subject to casualty events upon receipt of the insurance payments with respect to such casualty event;

(i) sales or discounts without recourse of accounts receivable arising in the ordinary course of business in connection with the compromise or collection thereof; and

(j) Dispositions by any Subsidiary of the Borrower to the Borrower or another Subsidiary of the Borrower.

7.06 Restricted Payments. The Borrower shall not declare or make, directly or indirectly, any Restricted Payment, or incur any obligation (contingent or otherwise) to do so, (other than dividends paid in capital stock) if a Default exists or would occur as a result of such payment.

7.07 Change in Nature of Business. The Parent shall not, and shall not permit any of its Subsidiaries to , engage in any material line of business substantially different from those lines of business conducted by the Parent and its Subsidiaries on the date hereof or any business substantially related or incidental thereto.

7.08 Transactions with Affiliates. The Parent shall not, and shall not permit any of its Subsidiaries to, enter into any transaction of any kind with any Affiliate of the Parent, whether or not in the ordinary course of business, other than on fair and reasonable terms substantially as favorable to the Parent or such Subsidiary as would be obtainable by the Parent or such Subsidiary at the time in a comparable arm’s length transaction with a Person other than an Affiliate, provided that the foregoing restriction shall not apply to transactions between or among the Parent and any of its Subsidiaries or between and among any Subsidiaries.

7.09 Burdensome Agreements. The Borrower shall not, and shall not permit any of its Subsidiaries to, enter into any Contractual Obligation (other than this Agreement or any other Loan Document or the Existing Term Loan Agreement) that (a) limits the ability (i) of any Subsidiary of the Borrower to make Restricted Payments to the Borrower to otherwise transfer property to the Borrower, (ii) of any Subsidiary of the Borrower to Guarantee the Indebtedness of the Borrower or (iii) of the Borrower or any of its Subsidiaries to create, incur, assume or suffer to exist Liens on property of such Person; provided , however , that this clause (iii) shall not prohibit any negative pledge incurred or provided in favor of any holder of secured Indebtedness permitted under Section 7.01 and Section 7.03) solely to the extent any such negative pledge relates to the property financed by or the subject of such Indebtedness; or (b) requires the grant of a Lien to secure an obligation of such Person if a Lien is granted to secure another obligation of such Person, except in each case for prohibitions or restrictions existing under or by reason of:

(i) customary non-assignment provisions with respect to leases or licensing agreements entered into by the Borrower or any of its Subsidiaries, in each case entered into in the ordinary course of business and consistent with past practices; and

 

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(ii) any restriction or encumbrance with respect to any asset of the Borrower or any of its Subsidiaries imposed pursuant to an agreement which has been entered into for the sale or disposition of such assets or all or substantially all of the capital stock or assets of such Subsidiary, so long as such sale or disposition is permitted under this Agreement.

7.10 Use of Proceeds. Use the proceeds of any Loan, whether directly or indirectly, and whether immediately, incidentally or ultimately, to purchase or carry margin stock (within the meaning of Regulation U of the FRB) or to extend credit to others for the purpose of purchasing or carrying Margin Stock or to refund indebtedness originally incurred for such purpose.

7.11 Financial Covenants.

(a) Borrower Statutory Surplus . The Borrower shall not permit the Borrower Statutory Surplus to be less than an amount equal to the sum of (a) $750,000,000 plus (b) 25% of Borrower Statutory Net Income earned in each calendar year commencing with the calendar year ending December 31, 2008.

(b) Debt to Capital Ratio . The Parent shall not permit the Parent Debt to Capital Ratio to exceed thirty- percent (30%).

(c) Risk Based Capital Ratio . The Loan Parties shall not permit the Risk Based Capital Ratio of the Borrower or any other Material Insurance Subsidiary to be less than 200%.

ARTICLE VIII.

EVENTS OF DEFAULT AND REMEDIES

8.01 Events of Default. Any of the following shall constitute an “Event of Default”:

(a) Non-Payment . The Borrower or any other Loan Party fails to pay (i) when and as required to be paid herein, any amount of principal of any Loan, or (ii) within three days after the same becomes due, any interest on any Loan, or any fee due hereunder, or (iii) within five days after the same becomes due, any other amount payable hereunder or under any other Loan Document; or

(b) Specific Covenants . Any Loan Party fails to perform or observe any term, covenant or agreement contained in any of Section 6.03 , 6.05(a) , 6.10 , 6.11 , 6.13 or 6.14 or Article VII ; or Article X .

(c) Financial Information . Any Loan Party fails to perform or observe any term, covenant or agreement contained in Section 6.01 or 6.02 on its part to be performed or observed and such failure continues for 10 days after the earlier of (i) written notice from the Administrative Agent of such failure or (ii) the date a Responsible Officer becomes aware of such failure;

(d) Other Defaults . Any Loan Party fails to perform or observe any other covenant or agreement (not specified in subsection (a), (b) or (c) above) contained in any Loan Document on its part to be performed or observed and such failure continues for 30 days after the earlier of (i) written notice from the Administrative Agent of such failure or (ii) the date a Responsible Officer becomes aware of such failure; or

 

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(e) Representations and Warranties . Any representation, warranty, certification or statement of fact made or deemed made by or on behalf of the Borrower or any other Loan Party herein, in any other Loan Document, or in any document delivered in connection herewith or therewith shall be incorrect or misleading in any material respect when made or deemed made; or

(f) Cross-Default . (i) The Parent or any Material Subsidiary (A) fails to make any payment when due (whether by scheduled maturity, required prepayment, acceleration, demand, or otherwise) in respect of any Indebtedness (other than Indebtedness hereunder and Indebtedness under Swap Contracts) having an aggregate outstanding principal amount (including amounts owing to all creditors under any combined or syndicated credit arrangement) of more than the Threshold Amount, or (B) fails to observe or perform any other agreement or condition relating to any such Indebtedness or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event occurs, the effect of which default or other event is to cause, or to permit the holder or holders of such Indebtedness (or a trustee or agent on behalf of such holder or holders or beneficiary or beneficiaries) to cause, with the giving of notice if required, such Indebtedness to be demanded or to become due or to be repurchased, prepaid, defeased or redeemed (automatically or otherwise), or an offer to repurchase, prepay, defease or redeem such Indebtedness to be made, prior to its stated maturity; or (ii) there occurs under any Swap Contract an Early Termination Date (as defined in such Swap Contract) resulting from (A) any event of default under such Swap Contract as to which the Parent or any Material Subsidiary is the Defaulting Party (as defined in such Swap Contract) or (B) any Termination Event (as so defined) under such Swap Contract as to which the Parent or any Material Subsidiary is an Affected Party (as so defined) and, in either event, the Swap Termination Value owed by the Parent or such Material Subsidiary as a result thereof is greater than the Threshold Amount; or

(g) Insolvency Proceedings, Etc . Any Loan Party or any of its Subsidiaries that are Material Parties institutes or consents to the institution of any proceeding under any Debtor Relief Law, or makes an assignment for the benefit of creditors; or applies for or consents to the appointment of any receiver, trustee, custodian, conservator, liquidator, rehabilitator or similar officer for it or for all or any material part of its property; or any receiver, trustee, custodian, conservator, liquidator, rehabilitator or similar officer is appointed without the application or consent of such Person and the appointment continues undischarged or unstayed for 60 calendar days; or any proceeding under any Debtor Relief Law relating to any such Person or to all or any material part of its property is instituted without the consent of such Person and continues undismissed or unstayed for 60 calendar days, or an order for relief is entered in any such proceeding; or

(h) Inability to Pay Debts; Attachment . (i) The Parent or any Subsidiary that is a Material Party becomes unable or admits in writing its inability or fails generally to pay its debts as they become due, or (ii) any writ or warrant of attachment or execution or similar process is issued or levied against all or any material part of the property of any such Person and remains unsatisfied, unreleased, unvacated or unfully bonded for a period of 30 consecutive days after its issue or levy; or

 

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(i) Judgments . There is entered against the Parent or any Subsidiary that is a Material Party (i) one or more final judgments or orders for the payment of money in an aggregate amount (as to all such judgments or orders) exceeding the Threshold Amount (to the extent not covered by independent third-party insurance as to which the insurer does not dispute coverage), or (ii) any one or more non-monetary final judgments that have, or could reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect and, in either case, (A) enforcement proceedings are commenced by any creditor upon such judgment or order, or (B) there is a period of 30 consecutive days during which a stay of enforcement of such judgment, by reason of a pending appeal or otherwise, is not in effect and such judgment is not satisfied; or

(j) ERISA . (i) An ERISA Event occurs with respect to a Pension Plan or Multiemployer Plan which has resulted or could reasonably be expected to result in liability of the Borrower under Title IV of ERISA to the Pension Plan, Multiemployer Plan or the PBGC in an aggregate amount in excess of the Threshold Amount, or (ii) the Parent or any ERISA Affiliate fails to pay when due, after the expiration of any applicable grace period, any installment payment with respect to its withdrawal liability under Section 4201 of ERISA under a Multiemployer Plan which has resulted or could reasonably be expected to result in a liability of the Borrower in an aggregate amount in excess of the Threshold Amount; or

(k) Invalidity of Loan Documents . Any Loan Document, at any time after its execution and delivery and for any reason other than as expressly permitted hereunder or thereunder or satisfaction in full of all the Obligations (other than Unmatured Surviving Obligations), ceases to be in full force and effect; or any Borrower or any other Person contests in any manner the validity or enforceability of any Loan Document; or any Borrower denies that it has any or further liability or obligation under any Loan Document, or purports to revoke, terminate or rescind any Loan Document; or the Administrative Agent shall cease to have a first priority perfected Lien on any Collateral;

(l) Government Action . (a) Any Insurance License of the Borrower or any of its Material Insurance Subsidiaries (i) shall be revoked by the Applicable Insurance Regulatory Authority, (ii) shall be suspended by the Applicable Insurance Regulatory Authority for a period in excess of thirty days or (iii) shall not be reissued or renewed by the Applicable Insurance Regulatory Authority upon the expiration thereof following application for such reissuance or renewal of such Person, or (b) any Applicable Insurance Regulatory Authority shall issue any order of conservation or seizure, however denominated, relating to the Borrower or any Material Insurance Subsidiary or shall take any other action to exercise Control (i) over the Borrower or any Material Insurance Subsidiary or (ii) over any assets of the Borrower or any Material Insurance Subsidiary; which, in the case of each of clauses (a) and (b) above, would reasonably be expected to have a Material Adverse Effect.

(m) Change of Control . There occurs any Change of Control.

 

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8.02 Remedies Upon Event of Default. If any Event of Default occurs and is continuing, the Administrative Agent shall, at the request of, or may, with the consent of, the Required Lenders, take any or all of the following actions:

(a) declare the unpaid principal amount of all outstanding Loans, all interest accrued and unpaid thereon, and all other amounts owing or payable hereunder or under any other Loan Document to be immediately due and payable, without presentment, demand, protest or other notice of any kind, all of which are hereby expressly waived by the Borrower; and

(b) exercise on behalf of itself and the Lenders all rights and remedies available to it and the Lenders under the Loan Documents;

provided , however , that upon the occurrence of an actual or deemed entry of an order for relief with respect to the Borrower under the Bankruptcy Code of the United States, the unpaid principal amount of all outstanding Loans and all interest and other amounts as aforesaid shall automatically become due and payable, in each case without further act of the Administrative Agent or any Lender.

8.03 Application of Funds. After the exercise of remedies provided for in Section 8.02, any amounts received on account of the Obligations (including proceeds of Collateral) shall be applied by the Administrative Agent in the following order:

First , to payment of that portion of the Obligations constituting fees, indemnities, expenses and other amounts (including fees, charges and disbursements of counsel to the Administrative Agent and amounts payable under Article III ) payable to the Administrative Agent in its capacity as such;

Second , to payment of that portion of the Obligations constituting fees, indemnities and other amounts (other than principal and interest) payable to the Lenders (including fees, charges and disbursements of counsel to the respective Lenders (including fees and time charges for attorneys who may be employees of any Lender) and amounts payable under Article III ), ratably among them in proportion to the respective amounts described in this clause Second payable to them;

Third , to payment of that portion of the Obligations constituting accrued and unpaid interest on the Loans and other Obligations, ratably among the Lenders in proportion to the respective amounts described in this clause Third payable to them;

Fourth , to payment of that portion of the Obligations constituting unpaid principal of the Loans, ratably among the Lenders in proportion to the respective amounts described in this clause Fourth held by them;

Last , the balance, if any, after all of the Obligations (other than Unmatured Surviving Obligations) have been indefeasibly paid in full, to the Borrower or as otherwise required by Law.

 

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ARTICLE IX.

ADMINISTRATIVE AGENT

9.01 Appointment and Authority. Each of the Lenders hereby irrevocably appoints Bank of America to act on its behalf as the Administrative Agent hereunder and under the other Loan Documents and authorizes the Administrative Agent to take such actions on its behalf and to exercise such powers as are delegated to the Administrative Agent by the terms hereof or thereof, together with such actions and powers as are reasonably incidental thereto. The provisions of this Article (other than the consent right of the Borrower contained in Section 9.06 ) are solely for the benefit of the Administrative Agent and the Lenders and no Loan Party shall have rights as a third party beneficiary of any of such provisions.

9.02 Rights as a Lender. The Person serving as the Administrative Agent hereunder shall have the same rights and powers in its capacity as a Lender as any other Lender and may exercise the same as though it were not the Administrative Agent and the term “Lender” or “Lenders” shall, unless otherwise expressly indicated or unless the context otherwise requires, include the Person serving as the Administrative Agent hereunder in its individual capacity. Such Person and its Affiliates may accept deposits from, lend money to, act as the financial advisor or in any other advisory capacity for and generally engage in any kind of business with the Borrower or any Subsidiary or other Affiliate thereof as if such Person were not the Administrative Agent hereunder and without any duty to account therefor to the Lenders.

9.03 Exculpatory Provisions. The Administrative Agent shall not have any duties or obligations except those expressly set forth herein and in the other Loan Documents. Without limiting the generality of the foregoing, the Administrative Agent:

(a) shall not be subject to any fiduciary or other implied duties, regardless of whether a Default has occurred and is continuing;

(b) shall not have any duty to take any discretionary action or exercise any discretionary powers, except discretionary rights and powers expressly contemplated hereby or by the other Loan Documents that the Administrative Agent is required to exercise as directed in writing by the Required Lenders (or such other number or percentage of the Lenders as shall be expressly provided for herein or in the other Loan Documents), provided that the Administrative Agent shall not be required to take any action that, in its opinion or the opinion of its counsel, may expose the Administrative Agent to liability or that is contrary to any Loan Document or applicable law; and

(c) shall not, except as expressly set forth herein and in the other Loan Documents, have any duty to disclose, and shall not be liable for the failure to disclose, any information relating to the Borrower or any of its Affiliates that is communicated to or obtained by the Person serving as the Administrative Agent or any of its Affiliates in any capacity.

The Administrative Agent shall not be liable for any action taken or not taken by it (i) with the consent or at the request of the Required Lenders (or such other number or percentage of the Lenders as shall be necessary, or as the Administrative Agent shall believe in good faith shall be necessary, under the circumstances as provided in Sections 11.01 and 8.02 ) or (ii) in the absence of its own gross negligence or willful misconduct. The Administrative Agent shall be deemed not to have knowledge of any Default unless and until notice describing such Default is given to the Administrative Agent by the Borrower or a Lender.

 

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The Administrative Agent shall not be responsible for or have any duty to ascertain or inquire into (i) any statement, warranty or representation made in or in connection with this Agreement or any other Loan Document, (ii) the contents of any certificate, report or other document delivered hereunder or thereunder or in connection herewith or therewith, (iii) the performance or observance of any of the covenants, agreements or other terms or conditions set forth herein or therein or the occurrence of any Default, (iv) the validity, enforceability, effectiveness or genuineness of this Agreement, any other Loan Document or any other agreement, instrument or document or (v) the satisfaction of any condition set forth in Article IV or elsewhere herein, other than to confirm receipt of items expressly required to be delivered to the Administrative Agent.

9.04 Reliance by Administrative Agent. The Administrative Agent shall be entitled to rely upon, and shall not incur any liability for relying upon, any notice, request, certificate, consent, statement, instrument, document or other writing (including any electronic message, Internet or intranet website posting or other distribution) believed by it to be genuine and to have been signed, sent or otherwise authenticated by the proper Person. The Administrative Agent also may rely upon any statement made to it orally or by telephone and believed by it to have been made by the proper Person, and shall not incur any liability for relying thereon. In determining compliance with any condition hereunder to the making of a Loan that by its terms must be fulfilled to the satisfaction of a Lender, the Administrative Agent may presume that such condition is satisfactory to such Lender unless the Administrative Agent shall have received notice to the contrary from such Lender prior to the making of such Loan. The Administrative Agent may consult with legal counsel (who may be counsel for the Borrower), independent accountants and other experts selected by it, and shall not be liable for any action taken or not taken by it in accordance with the advice of any such counsel, accountants or exp