UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

             [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 1998
                                       OR
            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                 For the transition period from ______ to ______

                          Commission file number 1-8993

                    FUND AMERICAN ENTERPRISES HOLDINGS, INC.
             (Exact name of Registrant as specified in its charter)

          DELAWARE                                             94-2708455
(State or other jurisdiction of                             (I.R.S. Employer
incorporation or organization)                             Identification No.)

80 SOUTH MAIN STREET, HANOVER, NEW HAMPSHIRE                    03755-2053
(Address of principal executive offices)                        (Zip Code)

     Registrant's telephone number, including area code: (603) 643-1567

           Securities registered pursuant to Section 12(b) of the Act:

   Title of each class              Name of each exchange on which registered
   -------------------              -----------------------------------------
Common Stock, par value $1.00                  New York Stock Exchange
         per share

           Securities registered pursuant to section 12(g) of the Act:

                                      None

     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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

     The aggregate market value of voting shares (based on the closing price of
those shares listed on the New York Stock Exchange and the consideration
received for those shares not listed on a national or regional exchange) held by
non-affiliates of the Registrant as of March 22, 1999, was $720,239,846.

     As of March 22, 1999, 5,843,731 shares of Common Stock, par value of $1.00
per share, were outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Notice of 1999 Annual Meeting of Shareholders and
Proxy Statement dated March 29, 1999 (Part III)



                                  FUND AMERICAN


                               TABLE OF CONTENTS

                                     PART I

                                                                       
ITEM 1.    Business.......................................................    1

           a.   General...................................................    1

           b.   Insurance Operations......................................    1

           c.   Mortgage Banking Operations...............................   15

           d.   Investment Portfolio Management...........................   19

           e.   Certain Business Conditions...............................   20

           f.   Regulation................................................   20

           g.   Employees.................................................   21

           h.   Forward-Looking Statements................................   21

ITEM 2.    Properties ....................................................   22

ITEM 3.    Legal Proceedings..............................................   22

ITEM 4.    Submission of Matters to a Vote of Security Holders............   22


                                     PART II

ITEM 5.    Market for Registrant's Common Equity and Related 
             Stockholder Matters .........................................   22

ITEM 6.    Selected Financial Data........................................   24

ITEM 7.    Management's Discussion and Analysis of Financial Condition
             and Results of Operations ...................................   26

ITEM 7A.   Quantitative and Qualitative Disclosures About Market Risk.....   52

ITEM 8.    Financial Statements and Supplementary Data....................   52

ITEM 9.    Changes in and Disagreements with Accountants on 
             Accounting and Financial Disclosure .........................   52


                                    PART III

ITEM 10.   Directors and Executive Officers...............................   53

ITEM 11.   Executive Compensation.........................................   54

FUND AMERICAN ITEM 12. Security Ownership of Certain Beneficial Owners and Management .................................................. 54 ITEM 13. Certain Relationships and Related Transactions................. 54 PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................................ 65
PART I ITEM 1. BUSINESS GENERAL Fund American Enterprises Holdings, Inc., (the "Company"), is a Delaware corporation which was organized in 1980. Within this report, the consolidated organization is referred to as "Fund American". Fund American's principal businesses are conducted through White Mountains Holdings, Inc. and its operating subsidiaries ("White Mountains"). White Mountains' consolidated and unconsolidated insurance operations are conducted through its subsidiaries and affiliates in the businesses of property and casualty insurance, property and casualty reinsurance and financial guaranty insurance. White Mountains' mortgage banking operations are conducted through Source One Mortgage Services Corporation and its subsidiaries ("Source One"). The Company's principal office is located at 80 South Main Street, Hanover, New Hampshire, 03755-2053, and its telephone number is (603) 643-1567. INSURANCE OPERATIONS CONSOLIDATED REINSURANCE OPERATIONS FOLKSAMERICA HOLDING COMPANY, INC. ("FOLKSAMERICA"). Folksamerica, through its wholly-owned subsidiary, Folksamerica Reinsurance Company (a New York corporation), is a multi-line broker-market reinsurance company which provides reinsurance to insurers of property and casualty risks in the United States, Canada, Latin America and the Carribean. Folksamerica is rated "A" (Excellent) by A.M. Best Company. During 1998, 1997 and 1996, Folksamerica had net written premiums of $212.6 million, $232.4 million and $171.9 million, respectively. At December 31, 1998 and 1997, Folksamerica had total assets $1.2 billion and $1.2 billion, respectively, and shareholders' equity of $302.0 million and $255.0 million, respectively. In June 1996 White Mountains purchased a 50.0% economic interest in Folksamerica for $79.9 million from a group of European mutual insurance companies (the "European Mutuals") who continued to own the remaining 50.0% interest. White Mountains' initial investment in Folksamerica consisted of 6,920,000 shares of ten-year 6.5% voting preferred stock having a liquidation preference of $79.4 million ("Folksamerica Preferred Stock") and ten-year warrants ("Folksamerica Warrants") to purchase up to 6,920,000 shares of the common stock of Folksamerica ("Folksamerica Common Stock") for $11.47 per share, subject to certain adjustments. In November 1997 White Mountains and the European Mutuals each purchased an additional 1,563,907 shares of Folksamerica Common Stock for $20.8 million which maintained White Mountains 50% economic ownership position. 1 On August 18, 1998, White Mountains acquired all of the remaining outstanding shares of the Folksamerica Common Stock from the European Mutuals for $169.1 million which resulted in Folksamerica becoming a wholly-owned consolidated subsidiary of Fund American as of that date. Following the August 18, 1998 transaction, Folksamerica retired the Folksamerica Preferred Stock and issued White Mountains an equivalent amount of Folksamerica Common Stock. As of December 31, 1998, White Mountains owned all of the outstanding shares of Folksamerica Common Stock. REINSURANCE OVERVIEW Reinsurance is an arrangement in which a reinsurance company (the "reinsurer") agrees to indemnify an insurance company (the "ceding company") for all or a portion of the insurance risks underwritten by the ceding company under one or more insurance policies. Reinsurance can benefit a ceding company in a number of ways, including reducing net liability exposure on individual risks, providing catastrophe protections from large or multiple losses, stabilizing financial results and assisting in maintaining acceptable operating leverage ratios. Reinsurance also provides a ceding company with additional underwriting capacity by permitting it to accept larger risks and underwrite a greater number of risks without a corresponding increase in its capital or surplus. Reinsurers may also purchase reinsurance, known as retrocessional reinsurance, to cover their own risks assumed from primary ceding companies. Reinsurance companies enter into retrocessional agreements for many of the same reasons that ceding companies enter into reinsurance agreements. Folksamerica writes both treaty and facultative reinsurance. Treaty reinsurance is an agreement whereby the ceding company is obligated to cede, and the reinsurer is obligated to assume, a specified portion or category of risk under all qualifying policies issued by the ceding company during the term of a treaty. In the underwriting of treaty reinsurance, the reinsurer does not evaluate each individual risk assumed and generally accepts the original underwriting decisions made by the ceding insurer. Facultative reinsurance is underwritten on a risk-by-risk basis whereby Folksamerica applies its own pricing to an individual exposure. Facultative reinsurance is normally purchased by insurance companies for individual risks not covered under reinsurance treaties or for amounts in excess of limits on risks covered under reinsurance treaties. The majority of Folksamerica's assumed premiums are derived from treaty reinsurance contracts. Folksamerica obtains virtually all of its business through brokers and reinsurance intermediaries which seek its participation on reinsurance being placed for their customers. Reinsurance is provided both on an excess of loss and quota share basis, which in 1998 amounted to 30.2% and 69.8% of its business, respectively. Folksamerica derives its business from a spectrum of ceding insurers including national, regional, specialty and excess and surplus lines writers. Folksamerica selects transactions based solely on 2 anticipated underwriting results of the transaction which are evaluated on a variety of factors including the quality of the reinsured, the attractiveness of the reinsured's insurance rates, policy conditions and the adequacy of the proposed reinsurance terms. A significant period of time normally elapses between the receipt of reinsurance premiums and the disbursement of reinsurance claims ("float"). The claims process generally begins upon the occurrence of an event causing an insured loss followed by: (i) the reporting of the loss to the ceding company; (ii) the reporting of the loss by the ceding company to Folksamerica; (iii) the ceding company's adjustment and payment of the loss; and (iv) the payment to the ceding company by Folksamerica. During this time, Folksamerica earns investment income on the float. Therefore, Folksamerica's combined ratio can generally be higher than that of Fund American's consolidated property and casualty insurance operations and yet may still earn an equivalent or superior return on equity. LINES OF BUSINESS AND GEOGRAPHIC LOCATION The following tables set forth information regarding Folksamerica's net written premiums by lines of business and geographic location:
Year Ended December 31, ------------------------------------------------------- Millions 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------- Liability $122.0 $123.6 $ 79.6 $ 71.9 $ 63.0 Property 87.2 104.9 85.9 87.9 89.9 Marine 3.4 3.9 6.4 - - ------------------------------------------------------- Total $212.6 $232.4 $171.9 $159.8 $152.9 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Year Ended December 31, ------------------------------------------------------- Millions 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------- United States $190.9 $208.6 $155.2 $159.8 $152.9 Canada 13.9 10.1 4.2 - - Latin America 7.8 13.7 12.5 - - ------------------------------------------------------- Total $212.6 $232.4 $171.9 $159.8 $152.9 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
3 UNDERWRITING Folksamerica's primary underwriting objective is to carefully assess reinsurance opportunities to determine the probability of a particular transaction providing an underwriting profit. Those risks that do not provide a reasonable likelihood of delivering an underwriting profit are rejected. Underwriting opportunities presented to Folksamerica are evaluated based on a number of factors including historical analysis of results, estimates of future loss costs, a review of other programs displaying similar exposure characteristics, the primary insurers underwriting and claims experience and the primary insurer's financial condition. Folksamerica regularly conducts underwriting and claims audits of ceding companies to assist it in evaluating the information submitted by the ceding companies. Folksamerica's most senior underwriters and executives are responsible for its underwriting policy and quality standards and informing Folksamerica's board of directors of current and anticipated market conditions and underwriting results. MARKETING Folksamerica generally obtains all its reinsurance business through brokers and reinsurance intermediaries which represent the ceding company in negotiations for the purchase of reinsurance. The process of effecting a brokered reinsurance placement typically begins when a ceding company enlists the aid of a reinsurance broker in structuring a reinsurance program. Often the ceding company and the broker will consult with one or more lead reinsurers as to the pricing and contract terms for the reinsurance protection being sought. Once the ceding company has approved the terms quoted by the lead reinsurer, the broker will offer participations to qualified reinsurers until the program is fully subscribed by reinsurers at terms agreed to by all parties. Folksamerica pays its reinsurance brokers commissions representing negotiated percentages of the premium it writes. These commissions, which generally average 5% of premium, constitute part of Folksamerica's total acquisition costs and are included in its underwriting expenses. During the year ended December 31, 1998, Folksamerica received approximately 67% of its gross reinsurance premiums written from three major reinsurance brokers as follows: (i) E. W. Blanch - 25%; (ii) Guy Carpenter and affiliates - 23%; and (iii) AON Re, Inc. - 19%. During the year ended December 31, 1998, Folksamerica received no more than 10% of its gross reinsurance premiums from any individual ceding company. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES Insurers and reinsurers establish loss and loss adjustment expense reserves representing estimates of future amounts needed to pay claims and related expenses with respect to insured events that have occurred. 4 Loss and loss adjustment expense reserves have two components: case reserves, which are reserves for reported losses, and incurred but not reported ("IBNR") reserves, which are reserves for losses not yet reported. Reserve estimates reflect the judgement of both the ceding company and the reinsurer, based on the experience and knowledge of its claims personnel, regarding the nature and value of the claim. The ceding company may periodically adjust the amount of the case reserves as additional information becomes known or partial payments are made. Upon notification of a loss from a ceding company, Folksamerica establishes case reserves, including loss adjustment expense reserves, based upon Folksamerica's share of the amount of reserves established by the ceding company and Folksamerica's independent evaluation of the loss. Where appropriate, Folksamerica establishes case reserves in excess of its share of the reserves established by the ceding company. Folksamerica uses a combination of actuarial methods to determine its IBNR reserves. These methods fall into two general categories: (1) methods by which ultimate claims are estimated based upon historical patterns of reported claim development experienced by Folksamerica, as supplemented by reported industry data, and (2) methods in which the level of Folksamerica's IBNR claim reserves are established based upon the IBNR claim reserves relative to earned premium applied by accident year, line of business and type of reinsurance written by Folksamerica. Due to the inherent uncertainties of estimating claim reserves, actual losses and loss adjustment expenses may deviate, perhaps substantially, from estimates of Folksamerica's reserves reflected in its consolidated financial statements. 5 During the claims settlement period, which may extend over a long period of time, additional facts regarding claims and trends may become known which may cause Folksamerica to adjust its estimates of the ultimate liability. The revised estimates of ultimate liability may prove to be less than or greater than the actual settlement or award amount for which the claim is finally discharged. REINSURANCE INDUSTRY AND COMPETITION Folksamerica commenced writing business in 1980 as one of a host of newly formed, foreign-owned reinsurers capitalized with minimum surplus. In 1991, recognizing that surplus size and critical mass would become an increasingly important business issue, Folksamerica launched an aggressive strategy to increase its resources and capacity through the acquisition of select broker-market companies. Since 1991, Folksamerica has acquired three such reinsurers which has raised Folksamerica's surplus and contributed a number of important business relationships. In general, competition among primary companies has caused primary insurers to reduce their own premium writings or restructure their reinsurance programs, reducing the amount of reinsurance they purchase. As a result of consolidation within the industry, many ceding companies are now larger and financially stronger, enabling them to retain more risk. In addition, increasingly intense competition in the reinsurance markets has driven reinsurance prices on a number of accounts below pricing levels which Folksamerica will accept. Folksamerica's management believes that the reinsurance industry, including the intermediary market, will continue to undergo further consolidation. Management further believes that, although size and financial strength will continue to be factors in selecting reinsurance partners, product pricing has become the most telling competitive factor. CONSOLIDATED INSURANCE OPERATIONS Since 1995 White Mountains has been acquiring and developing various insurance operating interests. In December 1995 White Mountains acquired Valley Group, Inc. ("VGI") of Albany, Oregon and Charter Group, Inc. ("CGI") of Richardson, Texas for $41.7 million in cash less $3.0 million of purchase price adjustments. In September 1995, White Mountains formed White Mountains Insurance Company ("WMIC") which is a New Hampshire-based midsize commercial property and casualty company. In December 1995 CGI and WMIC were contributed to VGI thereby making them wholly-owned subsidiaries of VGI. VALLEY INSURANCE COMPANIES. Valley Insurance Company ("VIC"), Valley Property & Casualty Insurance Company ("Valley P&C"), Valley National Insurance Company ("Valley National") and certain related non-insurance affiliates, collectively ("Valley"), write personal and commercial lines as further described below: 6 VIC: A Northwest-based property and casualty company which writes personal and commercial lines. In 1998, 1997 and 1996, VIC had $86.7 million, $77.7 million and $75.1 million of net written premiums, respectively, primarily in Oregon, California and Washington. At December 31, 1998 and 1997, VIC had $158.2 million and $146.6 million of total admitted assets, respectively, and $56.5 million and $61.2 million of policyholders' surplus, respectively. VIC was established in 1982 and began writing insurance policies in 1985. VIC is rated "A" or "excellent" by A.M. Best. VALLEY P&C: On December 5, 1996, VGI formed Valley P&C to specifically write property and casualty insurance within Oregon. Valley P&C wrote its first policies in February 1997 and had $6.2 million and $5.2 million in net written premiums during 1998 and 1997, respectively. At December 31, 1998 and 1997, Valley P&C had $13.0 million and $7.7 million of total admitted assets, respectively, and $7.3 million and $3.7 million of policyholders' surplus, respectively. Valley P&C is rated "A" or "excellent" by A.M. Best. VALLEY NATIONAL: On January 19, 1996, Valley purchased an inactive insurance company for $13.2 million, net of cash balances acquired. The newly acquired insurance company, which was renamed Valley National, is licensed to write property and casualty insurance in 48 states. Assets acquired pursuant to the purchase of Valley National included an investment portfolio, consisting principally of fixed maturity investments, totalling $6.7 million. Valley National wrote its first policies in December 1996 and had $10.9 million and $2.7 million in gross written premiums ($1.4 million and $.3 million of net written premiums) during 1998 and 1997, respectively. In the future, Valley National may further expand its operations to certain other states in which it is currently licensed. At December 31, 1998 and 1997, Valley National had $13.2 million and $11.5 million of total admitted assets, respectively, and $11.9 million and $11.1 million of policyholders' surplus, respectively. Valley National is a wholly-owned subsidiary of VIC and shares its A.M. Best's "A" rating through a combination of a reinsurance arrangement with VIC and its ownership structure. Valley markets insurance products principally through independent agents. Valley's primary business focus is to establish strong long-term relationships with its agents and insured customers by focusing on providing quality insurance products to families and family-owned businesses. This approach has resulted in an established track record of growth:
Year Ended December 31, -------------------------------------------- Statutory Basis(a), in Millions 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------- Gross written premiums $ 95.8 $ 89.2 $ 81.9 $ 73.1 $ 64.8 Ending total assets 171.2 154.3 138.2 126.8 80.4 - ----------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------- Ending policyholders' surplus 63.8 64.9 57.8 58.5 23.5 - ----------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------
7 (a) The term "statutory" as contained herein refers to a basis of accounting other than generally accepted accounting principles ("GAAP") that is prescribed by the individual states that an insurance company transacts business in. In 1998, 1997 and 1996 Valley wrote $95.8, $89.2 million and $81.9 million, respectively, of gross premiums within the following states, through approximately 317 independent agents:
Year Ended December 31, 1998 ---------------------------------------- Gross Written Policies Dollars in millions Premiums In Force* Agents* - --------------------------------------------------------------------------- Oregon $ 44.5 30,876 99 California 27.7 12,084 90 Washington 16.6 6,983 62 Arizona, Idaho, Utah and other 7.0 5,372 66 ---------------------------------------- Totals $ 95.8 55,315 317 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
Year Ended December 31, 1997 ---------------------------------------- Gross Written Policies Dollars in millions Premiums In Force* Agents* - --------------------------------------------------------------------------- Oregon $ 43.1 30,789 98 California 26.2 12,333 80 Washington 17.2 6,960 69 Arizona, Idaho, Utah and other 2.7 2,180 38 ---------------------------------------- Totals $ 89.2 52,262 285 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
Year Ended December 31, 1996 ---------------------------------------- Gross Written Policies Dollars in millions Premiums In Force* Agents* - --------------------------------------------------------------------------- Oregon $ 40.9 31,118 99 California 27.5 12,910 74 Washington 13.2 4,554 63 Arizona, Idaho, Utah and other .3 222 9 ---------------------------------------- Totals $ 81.9 48,804 245 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
* Determined at year end. 8 Valley's focus on delivering insurance products to families and family-owned businesses has resulted in a book of business which is balanced between personal lines and commercial lines. Gross written premiums for Valley's primary lines of business are shown below:
Year Ended December 31, ------------------------------------------------ Millions 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------- Personal lines: Automobile $ 33.1 $ 29.3 $ 25.9 $ 23.9 $ 22.5 Homeowners 14.0 13.4 12.0 10.4 8.3 Other 1.0 1.5 1.3 1.1 .8 ------------------------------------------------ Total personal lines 48.1 44.2 39.2 35.4 31.6 ------------------------------------------------ Commercial lines: Multiple peril 45.2 42.2 39.1 34.3 30.2 Other 2.5 2.8 3.6 3.4 3.0 ------------------------------------------------ Total commercial lines 47.7 45.0 42.7 37.7 33.2 ------------------------------------------------ Total gross written premiums $ 95.8 $ 89.2 $ 81.9 $ 73.1 $ 64.8 - --------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------
The long-term relationships cultivated by Valley with its agents and insured customers, along with superior customer service and convenient premium billing and payment systems, have produced a relatively high level of persistency in Valley's "package" book of business. In 1998, 1997 and 1996, package business represented approximately 73.6%, 79.1% and 80.0% of Valley's premium writings, respectively, for both personal and commercial lines:
Year Ended December 31, ------------------------------------------------ Renewal retention ratios 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------------------- Personal automobile/homeowners packages 91.0% 91.4% 89.4% 88.2% 87.8% Commercial multiple peril packages 74.6% 78.9% 75.5% 76.5% 84.5% - -------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------
Renewal persistency can be a significant indicator of an insurance company's long-term prospects for successful underwriting. An insurance company typically incurs more marketing and underwriting costs to write new business (e.g., policies written for new customers) 9 than it does to write "seasoned" business (e.g., policy renewals). Additionally, losses and loss adjustment expenses are typically higher and less predictable for new business than for seasoned business. CHARTER INSURANCE COMPANIES. CGI, through its wholly-owned subsidiary Charter Indemnity Company, its controlled affiliate Charter County Mutual Insurance Company and certain related non-insurance subsidiaries (collectively "Charter"), markets and underwrites nonstandard automobile insurance to individuals primarily in the states of Texas and Oklahoma. For the years ended December 31, 1998, 1997 and 1996, Charter's net written premiums totalled $64.3 million, $62.9 million and $69.9 million, respectively, and its earned premiums totalled $64.2 million, $62.4 million and $37.7 million, respectively. Written premiums (and related expenses and losses) for Charter's policies written prior to January 1, 1996, were entirely ceded to Charter's former parent and are now fully retained, therefore, Charter's 1996 earned premiums are not directly comparable to its 1998 and 1997 earned premiums. Charter writes all its business through independent agents. At December 31, 1998 Charter had approximately 1,600 agents. During 1998 Charter began to write policies in California and Missouri and is expected to expand its operations to other states. Charter is rated "A-" or "excellent" by A.M. Best. The nonstandard automobile insurance market consists of drivers who are unable to obtain coverage from standard carriers due to their prior driving records, other underwriting criteria or market conditions. Management believes that opportunities in the nonstandard automobile insurance market are influenced by many factors including the market conditions for standard automobile insurance, residual market plans, and the extent to which state motor vehicle laws are enforced. The nonstandard automobile insurance market has grown in recent years as the result of tightening of underwriting standards by underwriters of standard and preferred automobile insurance, and increased enforcement of motor vehicle laws including driving while intoxicated and uninsured motorist laws. Charter offers both liability and physical damage coverage in its nonstandard automobile insurance markets, generally with policies having terms of 6 months or 12 months. Most of Charter's policyholders choose basic limits of liability coverage, typically $20,000 per person and $40,000 per accident for bodily injury, and $15,000 for property damage. For the year ended December 31, 1998, Charter's net written premiums totalled $43.1 million for liability coverages and $21.2 million for physical damage coverages. Management pursues a strategy of establishing Charter as a low cost provider of nonstandard automobile insurance while maintaining a commitment to provide "service beyond expectation" to both agents and the insured. Management believes that Charter has become a low cost provider of nonstandard automobile insurance. Increased automation of certain marketing, underwriting, claims and administrative functions has provided Charter with the ability to process more business without a corresponding increase in costs, while maintaining a high level of service to its agents and insured customers. 10 Management believes that most classes of nonstandard automobile insurance can be underwritten profitably if they are priced adequately. Charter seeks to classify risks into narrowly defined segments through the utilization of available underwriting criteria and internal performance statistical data. Charter maintains a proprietary database which contains statistical records with respect to its agents and the insured. Management believes this database enhances Charter's ability to analyze loss experience, and to underwrite and price its products based on a number of variables. Charter utilizes many factors and analyses to determine its rates including: type, age and location of the vehicle; number of vehicles per policyholder; number and type of traffic violations or accidents; limits of liability; deductibles; and age, sex and marital status of the insured. Automobile damage claims are normally settled in a timely manner which limits the amount of investment income that can be generated on the earned and unearned insurance premiums that it has received from its policyholders. Therefore, Charter's combined ratio must generally be lower than that of Fund American's other consolidated property and casualty insurance operations in order to earn an equivalent return on equity. WHITE MOUNTAINS INSURANCE COMPANY. WMIC is currently licensed to write insurance in Maine, New Hampshire, Vermont, Massachusetts, New York, Rhode Island and Texas and is expected to expand its operations to other states as additional regulatory approvals are obtained. WMIC markets its products principally through independent agents and had gross written premiums during 1998, 1997 and 1996 of $7.5 million, $5.2 million and $2.4 million ($6.3 million, $4.7 million and $2.0 million of net written premiums), respectively. At December 31, 1998 and 1997, WMIC had $33.3 million and $31.4 million of total admitted assets, respectively, and $30.3 million and $29.1 million of policyholders' surplus, respectively. WMIC is a wholly-owned subsidiary of VIC and shares its A.M. Best's "A" rating through a combination of a reinsurance arrangement with VIC and its ownership structure. UNDERWRITING Valley, Charter and WMIC's primary underwriting objective is to carefully assess insurance risks to determine the likelihood of a particular risk providing an underwriting profit. Those risks that do not provide a reasonable likelihood of delivering an underwriting profit are rejected. Valley, Charter and WMIC's Underwriting Committee, composed of its most senior underwriters and executives, is responsible for its underwriting policy, quality standards and for informing their boards of directors of current and anticipated market conditions and its actual underwriting results. MARKETING In the United States, property and casualty insurance can be obtained through national and regional companies that use an agency distribution system, direct writers, brokers or through self-insurance including the use by corporations of subsidiary captive insurers. Valley, Charter and WMIC market their products principally through independent agents. 11 Valley, Charter and WMIC pay their independent agents commissions representing negotiated percentages of the premium they write. These commissions, which currently range from 10.0% to 17.5% of premium, depending on the line of business, constitute part of total acquisition costs and are included in underwriting expenses. COMPETITION The principal competitive factors that affect Valley, Charter and WMIC are: (i) pricing; (ii) underwriting; (iii) quality of claims and policyholder services; (iv) appointing and retaining high quality independent agents; (v) operating efficiencies; and (vi) product differentiation and availability. No single company or group of affiliated companies dominates the insurance industry. The highly competitive environment in the property and casualty insurance market during the past several years has intensified due to increased capacity resulting from growing capital supporting the industry and robust investment returns achieved in recent years. Valley, Charter and WMIC strive to be low cost operators within their sectors of the insurance industry while maintaining superior levels of customer service. Valley, Charter and WMIC each maintain a disciplined approach to pricing and underwriting of insurance risks. Application of this disciplined approach in a highly competitive environment results in a lower volume of insurance premiums than would result from a less disciplined approach, but should produce better overall financial returns from the business over long periods of time. Perception of financial strength, as reflected in the ratings assigned to an insurance company, especially by A.M. Best, is also a factor in determining an insurance company's competitive position. Valley, Charter and WMIC have consistently maintained adequate capitalization and claims payment ratings to effectively conduct its business and management believes that such strength will continue to be maintained in the future. INVESTMENTS IN UNCONSOLIDATED INSURANCE AFFILIATES White Mountains' investments in unconsolidated insurance affiliates represent strategic operating investments in other insurers in which White Mountains has a significant voting and economic interest but does not own greater than 50% of the entity. Since 1994, Fund American has been active in accumulating its investments in unconsolidated affiliates which are further described below: FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. ("FSA"). FSA, through its wholly-owned subsidiary, Financial Security Assurance Inc., guarantees scheduled payments of principal and interest on municipal bonds and asset-backed securities, including residential mortgage-backed securities. FSA's guaranty on investment-grade securities helps issuers lower their funding costs and provides bondholders with the highest-quality investments. FSA's claims-paying ability is rated Triple-A by Fitch IBCA, Inc., Moody's Investors Service, Inc., Standard & Poor's Rating Services and Nippon Investors Service Inc. For 1998, 1997 and 1996 FSA's gross premiums written totalled $319.3 million, $236.4 million and $177.0 million, respectively, and its net income was $117.0 million, $100.5 million and $80.8 million, respectively. As of December 31, 1998 and 1997, FSA's total assets were $2.4 billion and 12 $1.9 billion, respectively, and its shareholders' equity was $1,073.4 million and $882.4 million, respectively. In May 1994 Fund American purchased 2,000,000 shares of the common stock of FSA ("FSA Common Stock") from MediaOne Capital Corp. ("MediaOne", formerly U S WEST Capital Corp.), a wholly-owned subsidiary of MediaOne Group, Inc. (formerly U S WEST, Inc.). The purchase was part of an initial public offering of 8,082,385 shares of FSA Common Stock at the offering price of $20.00 per share. In September 1994 Fund American acquired various fixed price options and shares of convertible preferred stock ("FSA Options and Preferred Stock") which, in total, give Fund American the right to acquire up to 4,560,607 additional shares of FSA Common Stock for aggregate consideration of $125.7 million. In 1995 and 1996, respectively, Fund American purchased an additional 460,200 shares of FSA Common Stock on the open market for $8.8 million and an additional 1,000,000 shares of FSA Common Stock in a private transaction for $26.5 million. All shares of and rights to FSA Common Stock owned or acquired by Fund American as described above (other than those acquired on the open market) are subject to certain restrictions on transfer, voting provisions and other limitations and requirements set forth in a Registration Rights Agreement and a Voting Trust Agreement. As of December 31, 1998, 1997 and 1996 Fund American's economic interest in FSA was approximately 25.1%, 26.2% and 25.1%, respectively, and Fund American's voting interest in FSA was approximately 23.1%, 24.0% and 23.0%, respectively. During 1997 Fund American transferred all of its interests in FSA to Source One. Mr. John J. ("Jack") Byrne (Chairman of the Company) is Vice Chairman of FSA and Mr. K. Thomas Kemp (President and CEO of the Company) and Mr. James H. Ozanne (President of Fund American Enterprises, Inc. ("FAE"), a wholly-owned subsidiary of White Mountains) are directors of FSA. In addition to being FSA directors, Mr. Kemp is Chairman of FSA's Human Resources Committee and Mr. Ozanne is Chairman of FSA's Underwriting Committee. Fund American's investment in FSA Common Stock is accounted for using the equity method. FSA Common Stock is publicly traded on the New York Stock Exchange ("NYSE"). The market value of the FSA Common Stock as of December 31, 1998 and 1997, as quoted on the NYSE, exceeded Fund American's carrying value of the FSA Common Stock under the equity method. Fund American's investments in FSA Options and Preferred Stock are accounted for under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115 whereby the investments are reported at fair value as of the balance sheet date, with related unrealized investment gains and losses, after tax, reported as a net amount in a separate component of shareholders' equity and reported on the income statement as a component of comprehensive net income. MAIN STREET AMERICA HOLDINGS, INC. ("MSA"). MSA is a subsidiary of National Grange Mutual Insurance Company of Keene, New Hampshire ("NGM"). NGM insures property and casualty risks located primarily in New York, Massachusetts, Connecticut, Pennsylvania, New Hampshire, Virginia and Florida. NGM's principal lines of business and approximate percentage of total written premiums are personal 13 automobile (45%), homeowners (15%), commercial multi-peril (15%), commercial automobile (10%) and all other (15%). MSA participates in NGM's property and casualty business through a reinsurance agreement. MSA's net written premiums totalled $258.5 million, $156.6 million and $147.2 million in 1998, 1997 and 1996, respectively, and its net income was $13.4 million, $11.9 million and $9.7 million, respectively. MSA's total assets as of December 31, 1998 and 1997 were $588.6 million and $337.2 million, respectively, and its shareholders' equity was $232.5 million and $120.6 million, respectively. In December 1994 the Company (who subsequently transferred the MSA investment to White Mountains) acquired 90,606 shares of the common stock of MSA ("MSA Common Stock") for $25.0 million in cash plus $1.2 million in subsequent purchase price adjustments. White Mountains initial investment in MSA represented approximately 33.1% of the MSA Common Stock outstanding at that time. From 1994 to 1997 MSA participated in 40% NGM's property and casualty business through a reinsurance agreement. In March 1998 White Mountains acquired an additional 131,487 shares of MSA Common Stock for $70.3 million (subject to certain purchase price adjustments which are not expected to exceed $3.5 million) which raised White Mountains ownership of MSA to 50.0%. As a result of White Mountains' additional investment in MSA during 1998, MSA's reinsurance pooling agreement was increased from 40% to 60% and NGM contributed certain of its insurance, reinsurance and financial services subsidiaries to MSA. Fund American's investment in MSA Common Stock is accounted for using the equity method. Messrs. Raymond Barrette (Executive Vice President and Chief Financial Officer of the Company), Terry L. Baxter (President of White Mountains), Morgan W. Davis (Executive Vice President of White Mountains) and Kemp are directors of MSA. AMLIN PLC ("AMLIN") FORMERLY ML (BERMUDA) LIMITED ("MURRAY LAWRENCE"). Amlin is a managing agency group in the Lloyd's insurance market. On December 8, 1997, White Mountains purchased approximately 15.8% of the common stock of Murray Lawrence for $23.6 million. At December 31, 1997 White Mountains carried this investment as an "investment in unconsolidated insurance affiliate" and valued it at its original cost of $23.6 million which approximated its fair value at that date. During 1998 Murray Lawrence merged with Angerstein Underwriting and the combined entity was named Amlin. Amlin is publicly traded on the London Stock Exchange. White Mountains owns 13,980,861 shares of the common stock of Amlin, which represents an approximate 6.5% ownership stake as of December 31, 1998. As a result of White Mountains' decreased ownership percentage of this investment resulting from the merger, White Mountains recharacterized its investment in Amlin as an "other investment" and carried the investment at its fair value of $25.1 million at December 31, 1998. Mr. Kemp is a director of Amlin. 14 MORTGAGE BANKING OPERATIONS Source One was incorporated in 1972 and is the successor to Citizens Mortgage Corporation which was organized in 1946. As a mortgage banker, Source One engages primarily in the business of producing and selling residential mortgage loans and servicing and subservicing residential mortgage loans for third parties. Through subsidiaries, Source One also markets credit-related insurance products (such as life, disability, health, accidental death and property and casualty insurance). Source One's principal office is located in Farmington Hills, Michigan. Source One is a wholly-owned subsidiary of Fund American whereby the Company currently owns 3% of the outstanding common stock of Source One and White Mountains owns the remaining 97% of the outstanding common stock of Source One. MORTGAGE BANKING OVERVIEW Mortgage banking is the business of serving as a financial intermediary in the origination and purchase of mortgage loans, the holding of such loans while aggregating sufficient loans to form appropriate mortgage-backed security pools, selling such loans through pools or directly to investors and servicing or subservicing such loans during the repayment period. The origination process involves providing competitive mortgage loan rates, soliciting loan applications, reviewing title and credit matters, and funding loans at closing. Mortgage loans can also be purchased from other originating mortgage bankers. Marketing or selling mortgage loans requires matching the needs of the production market (homebuyers and homeowners seeking new mortgages) with the needs of the secondary market for mortgage loans (securities broker-dealers, depository institutions, insurance companies, pension funds and other investors). Conventional mortgage loans (e.g., those not guaranteed or insured by agencies of the Federal government) which are secured by residential properties, and which comply with applicable requirements, are packaged for direct sale or conversion to a mortgage-backed security. Such mortgage-backed securities are guaranteed by the Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). Mortgage loans insured by the Federal Housing Administration ("FHA") and the Veterans Administration ("VA") are packaged in the form of modified pass-through mortgage-backed securities guaranteed by the Government National Mortgage Association ("GNMA") for sale primarily to securities broker-dealers. In addition, private entities may pool mortgage loans in various forms and offer the resulting mortgage-backed securities to the public through securities broker-dealers. Servicing involves collecting principal, interest and funds to be escrowed for tax and insurance payments from mortgage loan borrowers, remitting principal and interest collections to mortgage loan investors, paying property taxes and insurance premiums on mortgaged property and performing all related accounting and reporting 15 activities. Servicing may also involve advancing uncollected payments to mortgage loan investors, administering delinquent loans and supervising foreclosures in the event of unremedied defaults. Servicing generates cash income in the form of fees, which represent a percentage of the declining outstanding principal amount of the loans serviced and are collected from each mortgage loan payment received plus any late charges. Subservicing involves the administrative servicing of loans owned by others for a fee. MORTGAGE LOAN PRODUCTION Source One produces residential mortgage loans through: (i) a correspondent network of more than 200 banks, thrift institutions and other mortgage lenders; (ii) 163 retail branch offices in 31 states and Puerto Rico; (iii) approximately 425 mortgage brokers; and (iv) a specialized marketing and affinity program. Source One primarily produces fixed rate mortgage loans. Generally speaking, fixed rate mortgages tend to capture a large share of origination volumes in a declining interest rate environment. Additionally, fixed rate mortgage loans are inherently less susceptible to prepayment risk than adjustable rate mortgages. During periods of increasing interest rates, the likely adverse effects of lower fixed rate mortgage loan originations are mitigated by a reduction in the prepayment risk on the fixed rate mortgage loans Source One services. During 1998 and 1997, fixed rate mortgage loan production accounted for approximately 98% and 88%, respectively, of Source One's total mortgage loan production. The following table sets forth selected information regarding Source One's mortgage loan production:
Year Ended December 31, ----------------------------------------------------------- Millions 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Loan production by type of loan: FHA insured and VA guaranteed $ 3,009 $ 2,985 $ 2,035 $ 1,565 $ 2,065 Conventional 7,857 1,418 1,796 1,287 2,521 ----------------------------------------------------------- Total $10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586 ----------------------------------------------------------- ----------------------------------------------------------- Loan production by origination source: Correspondent network acquisitions $ 6,880 $ 2,552 $ 1,640 $ 1,157 $ 1,081 Retail branch office originations 2,692 1,339 1,590 1,347 2,005 Mortgage broker originations 872 390 369 196 696 Specialized marketing program originations 290 122 232 152 804 Subprime and other 132 -- -- -- -- ----------------------------------------------------------- Total $10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586 ----------------------------------------------------------- ----------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------
16 During 1997 Source One broadened its product line by offering higher profit margin products such as FHA home improvement ("203(k)") loans, manufactured housing loans, subprime loans and 125% loan to value second mortgage ("125% LTV") loans. The 203(k) loans and manufactured housing loans produced by Source One are sold to third parties with servicing retained whereby the subprime loans and 125% LTV loans produced by Source One are sold to third parties on a servicing released basis. Source One is currently expanding its capability to service and subservice subprime loans and to subservice 125% LTV loans. These new products did not account for a significant portion of Source One's total mortgage loan production during 1998 or 1997. SALES OF LOANS Source One sells mortgage loans either through mortgage-backed securities issued pursuant to programs of GNMA, FNMA and FHLMC, or to institutional investors. Most mortgage loans are aggregated in pools of $1.0 million or more, which are purchased by institutional investors after having been guaranteed by GNMA, FNMA or FHLMC. During 1998 approximately 71.1%, 20.6% and 5.3% of the principal amount of Source One's loans were sold in pools through GNMA, FNMA and FHLMC, respectively. During 1997 approximately 65.5%, 23.3% and 6.7% of the principal amount of Source One's loans were sold in pools through GNMA, FNMA and FHLMC, respectively. During 1996 approximately 42.8%, 35.3% and 11.6% of the principal amount of Source One's loans were sold in pools through GNMA, FNMA and FHLMC, respectively. Since 1993, substantially all GNMA securities have been sold without recourse to Source One for loss of principal in the event of a subsequent default by the mortgage borrower. Servicing agreements relating to mortgage-backed securities issued pursuant to the programs of GNMA, FNMA or FHLMC require Source One to advance funds to make the required payments to investors in the event of a delinquency by the borrower. Source One expects that it would recover most funds advanced upon cure of default by the borrower or at foreclosure. However, in connection with VA partially guaranteed loans and certain conventional loans (which may be partially insured by private mortgage insurers), funds advanced may not cover losses due to potential declines in collateral value. To minimize interest rate risk associated with mortgage loans whose interest rate is "locked" but has not yet been sold, Source One obtains mandatory forward commitments of up to 120 days to sell mortgage-backed securities with respect to all loans which have been funded and a substantial portion of loans in process (the "Pipeline") which it believes will close. Source One's risk management function closely monitors the Pipeline to determine appropriate forward commitment coverage on a daily basis. 17 LOAN SERVICING Source One generally retains the rights to service the mortgage loans it produces. In addition, Source One may purchase servicing rights from banks, thrift institutions and other mortgage lenders. There were no significant purchases of mortgage servicing rights by Source One during 1998 and 1997. Source One also sells servicing rights when management deems it economically advantageous. During 1998 Source One sold the rights to service $10.6 billion of nonrecourse mortgage loans and continues to subservice a large portion of these loans pursuant to a subservicing agreement. During 1997 Source One sold the rights to service a $17.0 billion portfolio of nonrecourse mortgage loans and continues to subservice a portion of these loans pursuant to a subservicing agreement. The following table summarizes the changes in Source One's mortgage loan servicing portfolio, excluding loans sold but not transferred:
Year Ended December 31, --------------------------------------------------- Billions 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------- Servicing portfolio owned at beginning of year $ 11.6 $ 26.4 $ 27.8 $ 35.3 $ 38.4 --------------------------------------------------- Mortgage loan production 10.9 4.4 3.8 2.9 4.6 Servicing acquisitions and other -- -- 2.8 4.7 3.7 Total servicing in 10.9 4.4 6.6 7.6 8.3 Regular payoffs 1.6 1.2 3.0 2.3 4.7 Sales of servicing 10.6 17.0 3.3 11.0 3.9 Principal amortization, foreclosures and other 1.1 1.0 1.7 1.8 2.8 Total servicing out 13.3 19.2 8.0 15.1 11.4 Servicing portfolio owned 9.2 11.6 26.4 27.8 35.3 Subservicing portfolio 15.9 14.9 2.8 4.0 4.3 Balance at end of year $ 25.1 $ 26.5 $ 29.2 $ 31.8 $ 39.6 - ------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------
COMPETITION 18 Source One competes nationally and locally for loan production with other mortgage banks, state and national banks, thrift institutions and insurance companies. National banks and thrift institutions have substantially more flexibility in their loan origination programs than Source One, which generally originates loans meeting the standards of the secondary market. Mortgage lenders compete primarily with respect to price and service. Competition may also occur on mortgage terms and closing costs. Source One competes, in part, by using its commissioned sales force to maintain close relationships with real estate brokers, builders and developers and members of its correspondent and broker network. It is the opinion of the management of Source One that no single mortgage lender dominates the industry. INVESTMENT PORTFOLIO MANAGEMENT Fund American's philosophy is to invest all assets to maximize their after tax total return over extended periods of time. Under this approach, each dollar of after tax investment income, realized capital gains and unrealized appreciation is valued equally. Management further believes that insurance company float generated should be invested in a "balanced portfolio" consisting of a mixture of fixed income investments, equity securities and occasionally other investments in order to maximize returns over extended periods of time. This investment philosophy of Fund American is established and administered by the Fund American and White Mountains Finance Committees. The Finance Committees also regularly monitor the overall investment results of Fund American, review the results of each of Fund American's various investment managers, review compliance with established investment guidelines, approve all purchases and sales of investment securities and ultimately report the overall investment results to the Company's Board of Directors (the "Board"). The fixed income portfolios of Valley, Charter and WMIC are actively managed by an affiliate of MSA pursuant to discretionary management agreements. The fixed income and equity investment portfolio and other investments of Folksamerica are managed internally by employees of Folksamerica. The equity investment portfolios and other investments of the Company, White Mountains, Valley, Charter and WMIC are managed by a small group of employees located in Hanover, New Hampshire and various internal and external portfolio managers pursuant to discretionary management agreements. FAE's investment portfolio is primarily managed by a small group of employees located in White River Junction, Vermont. As previously stated, the investment portfolios of Fund American's insurance operations consist, in part, of common equity securities and related investments as follows: (i) $143.0 million at Folksamerica or approximately 15% of Folksamerica's total investment portfolio at December 31, 1998; (ii) $48.5 million at Valley and Charter or approximately 28% of Valley and Charter's total investment portfolio at 19 December 31, 1998; and (iii) $26.7 million at WMIC or approximately 83% of WMIC's total investment portfolio at December 31, 1998. Management believes that modest investments of equity securities within the investment portfolios of its insurance operations will enhance their after tax returns without significantly increasing the risk profile of the portfolio when considered over long periods of time. CERTAIN BUSINESS CONDITIONS Inflation and changes in market interest rates can have significant effects on White Mountains' insurance operations. Inflation increases the costs of settling insurance claims over time. Increases in market interest rates, which often occur during periods of high inflation, reduce the market value of the insurance operations' fixed-income investments. Conversely, reductions in market interest rates increase the market value of White Mountains' fixed-income investments. Changes in the economy or prevailing interest rates can also have significant effects, including material adverse effects, on the mortgage banking industry including Source One. Inflation and changes in interest rates can have differing effects on various aspects of Source One's business, particularly with respect to marketing gains and losses from the sale of mortgage loans, mortgage loan production, the value of Source One's servicing portfolio and net interest revenue. Historically, Source One's loan originations and loan production income have increased in response to falling interest rates and have decreased during periods of rising interest rates. Periods of low inflation and falling interest rates tend to reduce loan servicing income and the value of Source One's mortgage loan servicing portfolio because prepayments of mortgages increase and the average life of mortgage servicing rights is shortened. Conversely, periods of increasing inflation and rising interest rates tend to increase loan servicing income and the value of Source One's mortgage servicing rights because prepayments of mortgages decline and the average life of loan servicing rights is lengthened. In an attempt to mitigate Source One's exposure to changes in market interest rates, Source One utilizes various derivative financial instruments. See "Management's Discussion and Analysis". REGULATION Folksamerica, Valley, Charter and WMIC are subject to regulation and supervision of their operations in each of the jurisdictions where they conduct business. Regulations vary between jurisdictions but, generally, they provide regulatory authorities with broad supervisory, regulatory and administrative powers over such matters as licenses, standards of solvency, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial 20 statements, reserves for unpaid losses and loss adjustment expenses, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, periodic examinations and annual and other report filings. Over the last several years most states have, and continue to implement, laws which establish standards for current, as well as continued, state accreditation. In addition, the National Association of Insurance Commissioners has adopted risk-based capital ("RBC") standards for property and casualty companies. The RBC ratios for Folksamerica, Valley, Charter and WMIC, as of December 31, 1998 and 1997, were above the levels which would require regulatory action. Source One is subject to the rules and regulations of, and examinations by, investors and insurers including FNMA, FHLMC, GNMA, FHA and VA with respect to the origination and selling and servicing of mortgage loans. Lenders are required to submit audited financial statements annually and to maintain specified net worth levels which vary depending on the amount of loans serviced and annual production. Mortgage loan origination activities are also subject to fair housing laws, the Equal Credit Opportunity Act, the Federal Truth-in-Lending Act, the Real Estate Settlement Procedures Act, the Fair Credit Reporting Act, licensing laws, usury laws, the Home Mortgage Disclosure Act, and other regulations which, among other things, prohibit discrimination in residential lending and require disclosure of certain information to borrowers. There are various other state laws and regulations affecting Source One's mortgage banking operations. Source One's internal audit function (which is managed by Source One but is outsourced to a third party) and quality control departments monitor compliance with all these laws and regulations. Fund American is not aware of any current recommendations by regulatory authorities that would be expected to have a material effect on its results of operations or liquidity or any other matters that would require disclosure herein. EMPLOYEES As of December 31, 1998, the Company employed 11 persons and White Mountains employed 2,825 persons (including 261 persons at Valley, 186 persons at Charter, 34 persons at WMIC, 2,212 persons at Source One, 125 persons at Folksamerica and 3 persons at FAE). None of Fund American's employees are covered by a collective bargaining agreement. Management believes that Fund American's employee relations are good. FORWARD-LOOKING STATEMENTS From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial 21 performance, business prospects, new products and similar matters. This information is often subject to various risks and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that numerous factors could cause actual results and experience to differ materially from anticipated results or other expectations expressed in its forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business include those discussed elsewhere herein (such as those involving competition, regulation and certain business conditions). ITEM 2. PROPERTIES The Company leases 8,600 square feet of space at 80 South Main Street, Hanover, New Hampshire, under a lease expiring in 2006, which serves as its corporate office. Folksamerica leases 40,000 square feet of office space in New York, New York, under a lease expiring 2004, which serves as its principal office. Charter leases 56,000 square feet of office space in Richardson, Texas under a lease expiring in 2007, which serves as its principal office. Valley and Source One own their principal offices in Albany, Oregon and Farmington Hills, Michigan, respectively. Fund American leases several other office facilities and operating equipment under cancelable and noncancelable agreements. Most leases contain renewal clauses. ITEM 3. LEGAL PROCEEDINGS Various claims have been made against Fund American in the normal course of its business. In management's opinion, the outcome of such claims will not, in the aggregate, have a material effect on Fund American's financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of Fund American's shareholders during the fourth quarter of 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS As of March 22, 1999, there were 470 registered holders of shares of the Company's Common Stock, par value $1.00 per share ("Shares"). During 1998 and 1997 the Company declared and paid quarterly cash dividends of $.40 per Share and $.20 per Share, respectively. The Board currently intends to reconsider from time to time the declaration of regular periodic dividends on Shares with due consideration given to the financial characteristics of Fund American's remaining invested 22 assets and operations and the amount and regularity of its cash flows at the time. The Company's Common Stock (symbol FFC) is listed on the NYSE. The quarterly trading range for Shares during 1998 and 1997 is presented below:
1998 1997 ----------------------- ----------------------- High Low High Low - --------------------------------------------------------------------- Quarter ended: December 31 $144 3/8 $117 $124 $105 1/4 September 30 153 1/4 119 108 99 1/2 June 30 150 1/4 135 9/16 110 1/2 98 March 31 137 5/16 120 1/8 109 3/4 94 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
23 ITEM 6. SELECTED FINANCIAL DATA Selected consolidated income statement data and ending balance sheet data for each of the five years ended December 31, 1998, follows:
Year Ended December 31, -------------------------------------------------------------------------- Millions, except per share amounts 1998(a) 1997 1996 1995 1994 -------------------------------------------------------------------------- INCOME STATEMENT DATA: Revenues $ 578 $ 310 $ 325 $ 222 $ 228 Expenses 519 329 336 234 219 Pretax operating earnings (loss) 59 (19) (11) 4 9 Net realized investment gains 71 97 39 39 39 Pretax earnings 130 78 28 43 48 Income tax provision 48 29 19 17 21 After tax earnings 82 49 9 26 27 Loss on early extinguishment of debt, after tax -- (6) -- -- -- Gain from sale of discontinued operations, after tax -- -- -- 66(b) -- Cumulative effect of accounting change - purchased mortgage servicing, after tax -- -- -- -- (44)(c) Net income (loss) 82 43 9 92 (17) Other comprehensive income (loss), after tax (9) 42(d) 54 18 (55) Comprehensive net income (loss) $ 73 $ 85 $ 63 $ 110 $ (72) Basic earnings per share: After tax earnings $ 13.38 $ 6.89 $ .66 $ 1.88 $ 1.27 Net income (loss) 13.38 5.98 .66 10.30 (3.72) Comprehensive net income (loss) 11.87 12.33(d) 8.01 12.64 (9.89) Diluted earnings per share: After tax earnings 11.94 6.22 .60 1.71 1.20 Net income (loss) 11.94 5.40 .60 9.36 (3.51) Comprehensive net income (loss) 10.58 11.15(d) 7.33 11.48 (9.34) Cash dividends paid per share of common stock 1.60 .80 .80 .20 -- ENDING BALANCE SHEET DATA: Total assets $ 3,281 $ 2,010(d) $ 1,981 $ 1,872 $ 1,807 Short-term debt 749 571 408 445 254 Long-term debt 360 304 424 407 547 Minority interest - preferred stock of subsidiary 44 44 44 44 100 Shareholders' equity 703 659(d) 687(e) 700(e) 661(e) Book value per common and equivalent share (f) 109.68(g) 100.08(d) 90.81 83.28 68.95
24 (a) Includes the ending balance sheet and the interim period results of operations of Folksamerica which was acquired by Fund American on August 18, 1998. (b) Reflects the settlement of certain tax liabilities relating to the sale of Fireman's Fund Insurance Company ("Fireman's Fund") for less than the previously accrued amount. (c) Reflects the prior years' cumulative effect of a change in Source One's methodology used to measure impairment of its purchased mortgage servicing rights asset. (d) Restated as a result of Fund American's acquisition of Folksamerica during 1998. See Note 2. (e) Reflects significant redemptions of the Company's Voting Preferred Stock Series D, par value $1.00 per share and repurchases of Shares. (f) Book value per common share as adjusted for the after tax dilutive effects of outstanding options and warrants to acquire Shares. (g) Excludes a $37.1 million unamortized deferred credit associated with Fund American's purchase of Folksamerica which will serve to increase the Company's future book value per common and equivalent share by $5.43 over an approximate five year period. See Note 2. 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 CONSOLIDATED RESULTS Fund American reported comprehensive net income of $73.3 million for the year ended December 31, 1998, which compares to comprehensive net income of $84.7 million and $63.2 million for 1997 and 1996, respectively. Comprehensive net income for 1998 includes after tax unrealized investment holding gains of $37.2 million versus $104.6 million and $79.6 million for 1997 and 1996, respectively. Net income, which does not include comprehensive income items (primarily unrealized investment holding gains and losses), for 1998 was $82.2 million versus $43.0 million and $8.6 million for 1997 and 1996, respectively. Net income for 1998 includes after tax realized investment gains of $46.1 million versus $62.9 million and $25.0 million for 1997 and 1996, respectively. Net income applicable to common stock (which is net of preferred stock dividends) for 1998, 1997 and 1996 was $78.5 million, $39.3 million and $4.9 million, respectively. Book value per common and common equivalent share was $109.68 at December 31, 1998 ($115.11 including the after tax unamortized deferred credit associated with Fund American's purchase of Folksamerica in August 1998), which compares to $100.08 at December 31, 1997. Strong operating results at the Company's reinsurance and mortgage banking subsidiaries and favorable investment portfolio results produced most of the increase in book value per share from 1997 to 1998. INSURANCE OPERATIONS REINSURANCE OPERATIONS Folksamerica contributed $10.0 million to net income during 1998, which includes $4.5 million of net income from January 1, 1998 to August 18, 1998 during which Folksamerica was an unconsolidated affiliate and $5.5 million of net income during which Folksamerica was consolidated. Folksamerica contributed $5.2 million and $2.4 million to net income as an unconsolidated insurance affiliate during 1997 and 1996, respectively. Folksamerica's results for the three years ended December 31, 1998, 1997 and 1996 included $238.1 million, $238.0 million and $181.4 million of earned reinsurance premiums, respectively, and $170.3 million, $165.6 million and $138.6 million of losses and loss adjustment expenses, respectively. For 1998 Folksamerica's combined ratio was 108.0% versus a combined ratio of 102.9% and 108.9% for the comparable 1997 and 1996 periods. 26 A summary of Folksamerica's 1998, 1997 and 1996 underwriting results follows:
Year Ended December 31, -------------------------------------- Dollars in millions 1998 1997 1996 - ---------------------------------------------------------------------------- Net written premiums $ 212.6 $ 232.4 $ 171.9 -------------------------------------- Earned premiums 238.1 238.0 181.4 Losses and loss adjustment expenses 170.3 165.6 138.6 Underwriting expenses 92.6 81.6 54.8 Underwriting loss $ (24.8) $ (9.2) $ (12.0) Combined ratios: Loss and loss adjustment expense 71.5% 69.6% 76.4% Underwriting expense 36.5 33.3 32.5 -------------------------------------- Combined 108.0% 102.9% 108.9% - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
27 During 1998, Folksamerica's written premium volume decreased approximately 9% versus 1997 premium levels reflecting an increase in non-renewed business due to deteriorating terms and conditions. Folksamerica's combined ratio for 1998 was higher than that of 1997 due primarily to two property events experienced during the year (Canadian ice storms and Hurricane Georges) and higher asbestos and environmental losses. During 1997, Folksamerica's premium volume increased approximately 35% versus 1996 premium levels reflecting its acquisition of Christiania General Insurance Corporation in June 1996. As previously mentioned, Folksamerica underwrites each reinsurance contract anticipating an element of underwriting profit. The anticipated degree of underwriting profit varies by contract and is based on a variety of factors which can include some degree of float. Despite this expectation on an individual contract basis, Folksamerica's reported results for the years ended December 31, 1998, 1997 and 1996 included overall underwriting losses due to the following: (i) actual results on some accounts or classes have produced higher than anticipated loss costs. Considering the highly competitive market conditions, there has been insufficient margin in profitable accounts to absorb higher loss costs produced by other accounts; (ii) higher than anticipated property catastrophe losses, particularly during 1998; and (iii) continued strengthening of reserve portfolios relating to acquired companies, particularly for claims related to mass torts. In this regard, Folksamerica has built ample protections into its prior acquisition structures which partially mitigate the underwriting losses. The financial benefits of those protections are generally not reflected in the underwriting results, rather, such benefit is included in "other insurance operations revenue" in the income statement. Since Folksamerica's claims settlement period generally extends over a long period of time, Folksamerica earns significant amounts of investment income on the float generated by its reinsurance operations. When considering investment income and certain other items at the Folksamerica holding company level (primarily interest expense and income taxes), Folksamerica reported net income of $27.3 million, $35.9 million and $17.1 million for the three years ended December 31, 1998, 1997 and 1996, respectively, and reported comprehensive net income of $53.3 million, $50.9 million and $18.4 million during those periods, respectively. This resulted in Folksamerica attaining an after tax return on its beginning equity of 20.9%, 29.9% and 16.0% for 1998, 1997 and 1996, respectively. The following table presents the subsequent development of the year-end reinsurance losses for the ten year period from 1988 to 1998. Section I of the table shows the estimated liabilities that were recorded at the end of each of the indicated years for all current and prior year unpaid losses and loss adjustment expenses ("lae"). Section II shows the re-estimate of the liabilities made in each succeeding year. Section III shows the cumulative liabilities paid of such previously recorded liabilities. Section IV shows the cumulative deficiency representing the aggregate change in the liability from the original balance sheet dates: 28
Reinsurance Losses and Loss Adjustment Expenses (a) Year Ended December 31, ---------------------------------------------------------------------------------------------------- Dollars in Millions 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 - --------------------------------------------------------------------------------------------------------------------------------- I. Liability for unpaid losses and lae $267.7 $312.7 $355.2 $425.2 $647.1 $670.6 $709.7 $760.8 $740.8 $739.1 $723.2 II. Liability re-estimated as of: 1 year later 276.7 321.5 388.8 456.3 695.4 701.1 768.7 786.4 765.2 755.8 - 2 years later 279.0 353.1 413.3 462.2 717.0 757.3 797.8 810.4 785.4 3 years later 301.4 376.1 415.4 476.9 759.2 779.2 818.6 833.0 4 years later 326.5 378.0 424.9 496.6 770.4 800.1 837.5 5 years later 328.7 391.0 438.2 499.2 795.0 817.1 6 years later 344.2 400.5 441.7 509.6 808.9 7 years later 351.4 403.7 450.4 516.0 8 years later 354.5 410.4 456.8 9 years later 364.6 415.7 10 years later 370.3 III. Cumulative amount of liability paid through: 1 year later 66.0 84.5 93.8 119.4 220.8 201.5 203.1 214.1 183.1 175.0 - 2 years later 103.5 135.4 154.7 179.1 338.1 324.9 341.4 339.5 305.6 3 years later 131.7 171.5 191.7 233.9 416.5 422.6 432.4 424.5 4 years later 156.1 195.5 226.8 278.3 487.2 487.7 494.5 5 years later 172.1 221.6 258.3 312.4 534.0 529.4 6 years later 193.5 243.7 285.0 339.1 563.1 7 years later 211.4 265.5 304.7 353.0 8 years later 229.2 278.6 314.4 9 years later 242.8 286.4 10 years later 250.2 IV. Cumulative deficiency $102.6 $103.0 $101.6 $ 90.8 $161.8 $146.4 $127.9 $72.2 $44.6 $16.8 - Percent deficient 38% 33% 29% 21% 25% 22% 18% 9% 6% 2% - - ---------------------------------------------------------------------------------------------------------------------------------
(1) For the years 1988 through 1991 liabilities are shown net of reinsurance recoverable. For the years 1992 through 1998 liabilities are shown without regard to reinsurance recoverable in accordance with SFAS No. 113. The table excludes 29 the insurance operations of VGI whose liability for unpaid losses and lae totalled $88.5 million, $71.9 million and $65.4 million as of December 31, 1998, 1997 and 1996, respectively. Historic data for VGI is not considered to be meaningful due to Charter reinsuring all of its business to its former owner for periods prior to 1996. During 1998 and 1996, VGI's losses and loss adjustment expenses relating to prior years developed unfavorably by $6.7 million and $3.5 million, respectively. During 1997, VGI's losses and loss adjustment expenses relating to prior years developed favorably by $2.5 million pretax. The table above has been prepared in accordance with prescribed instructions, however, management believes that this information is not indicative of Folksamerica's actual loss development history for the following reasons: (i) with respect to 1992 through 1998, the information is presented prior to considering the benefit of significant amounts of ceded reinsurance recovered (and recoverable) from Folksamerica's reinsurers; (ii) the information includes the complete loss development history for companies acquired by Folksamerica for all periods presented, including periods prior to Folksamerica's acquisition of such companies; and (iii) the structure of each of Folksamerica's acquisitions has provided effective economic protections to offset potential post-acquisition loss development. The form of these protections has included deferred and adjustable purchase consideration and favorable purchase prices. In consideration of such factors, the table presented below is management's attempt to adjust the deficiencies presented above for the most recent five years:
Year Ended December 31, --------------------------------------- Percent of deficit to carried 1994 1995 1996 1997 1998 reserves: - ---------------------------------------------------------------------- Deficiency as reported 18% 9% 6% 2% -% Deficiency as adjusted for the effects described above 3% 2% 1% -% -% - ---------------------------------------------------------------------- - ----------------------------------------------------------------------
INSURANCE OPERATIONS Valley, Charter and WMIC represent Fund American's consolidated insurance subsidiaries. Valley, Charter and WMIC's results for the years ended December 31, 1998, 1997 and 1996, included $160.6 million, $145.3 million and $109.7 million of property and casualty insurance premiums earned, respectively, and $115.1, $97.1 million and $85.9 million of losses and loss adjustment expenses, respectively. A summary of 1998, 1997 and 1996 underwriting results for Valley, Charter and WMIC follows:
Year Ended December 31, 1998 ------------------------------------- Dollars in millions Valley Charter WMIC - --------------------------------------------------------------------------- Net written premiums $ 94.3 $ 64.3 $ 6.3 ------------------------------------- Earned premiums 91.1 64.2 5.3 Losses and loss adjustment expenses 67.8 43.7 3.6 Underwriting expenses 31.3 15.5 3.5 Underwriting profit (loss) $ (7.9) $ 5.0 $ (1.8) Combined ratios: Loss and loss adjustment expense 74.4% 68.0% 67.3% Underwriting expense 33.5 23.8 61.1 ------------------------------------- Combined 107.9% 91.8% 128.4% - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
30
Year Ended December 31, 1997 ------------------------------------- Dollars in millions Valley Charter WMIC - --------------------------------------------------------------------------- Net written premiums $ 83.2 $ 62.9 $ 4.7 ------------------------------------- Earned premiums 79.6 62.4 3.3 Losses and loss adjustment expenses 51.8 41.8 3.5 Underwriting expenses 28.3 17.1 2.0 Underwriting profit (loss) $ (.5) $ 3.5 $ (2.2) Combined ratios: Loss and loss adjustment expense 65.0% 66.9% 107.8% Underwriting expense 34.8 27.3 53.1 ------------------------------------- Combined 99.8% 94.2% 160.9% - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
Year Ended December 31, 1996 ------------------------------------- Dollars in millions Valley Charter WMIC - --------------------------------------------------------------------------- Net written premiums $ 75.1 $ 69.9 $ 2.0 ------------------------------------- Earned premiums 70.7 37.7 1.3 Losses and loss adjustment expenses 54.4 30.3 1.2 Underwriting expenses 24.8 8.0 .9 Underwriting loss $ (8.5) $ (.6) $ (.8) Combined ratios: Loss and loss adjustment expense 76.8% 80.4% 95.8% Underwriting expense 34.9 18.9 50.4 ------------------------------------- Combined 111.7% 99.3% 146.2% - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
31 Valley's 1998 underwriting results suffered from losses in certain of its commercial lines business (primarily within Washington) which resulted in an underwriting ratio of 107.9% for the year and an underwriting loss of $7.9 million. Charter's 1998 underwriting results produced a satisfactory 91.8% combined ratio and a $5.0 million underwriting profit. For 1998, Charter's policy counts increased strongly but total premiums were down due to price reductions, a shift towards liability-only policies and a shift towards six-month policies. WMIC's loss and loss adjustment expense ratio for 1998 of 67.3% shows significant improvement over prior year results but its expense ratio for 1998 of 61.1% will not be meaningful for some time. WMIC's premium volumes must grow significantly from current levels to provide sufficient expense ratio economies of scale. Valley and Charter's 1997 underwriting results produced satisfactory combined ratios and an overall underwriting profit. However, premium growth at both Valley and Charter suffered during 1997 as a result of increased competition in the marketplace which illustrates Fund American's underwriting discipline in a highly competitive market. WMIC's 1997 results were adversely impacted by several large workers' compensation claims although underwriting results on this small and growing book of business are not yet considered to be meaningful. Valley's 1996 underwriting results were adversely impacted by severe fourth quarter storm-related losses and by $3.5 million in reserve strengthening for losses and loss adjustment expenses incurred in prior years. Charter's earned premiums trailed net written premiums during 1996 because Charter began to retain virtually all its written premiums. Charter's policies written prior to 1996 were fully ceded to a former affiliate of Charter. Valley, Charter and WMIC's claims are normally settled in a more timely manner than those of Folksamerica which limits the amount of investment income that can be generated on the earned and unearned insurance premiums that it has received from its policyholders. When considering investment income and certain other items of VGI (primarily interest expense, income taxes and goodwill amortization), VGI reported net income (loss) of $5.0 million, $7.2 million and $(2.6) million for the three years ended December 31, 1998, 1997 and 1996, respectively, and reported comprehensive net income (loss) of $11.4 million, $13.6 million and $(1.8) million during those periods, respectively. This resulted in VGI attaining an after tax return (loss) on equity of 11.0%, 14.8% and (1.9)% for 1998, 1997 and 1996, respectively. INVESTMENTS IN UNCONSOLIDATED INSURANCE AFFILIATES FSA and MSA represented Fund American's investments in unconsolidated insurance affiliates at December 31, 1998. Fund American's investment in FSA increased $42.0 million during 1998 which consisted of $13.8 million of pretax earnings from FSA Common Stock, $26.6 million of pretax unrealized investment gains from FSA Options and Preferred Stock, $3.1 million of pretax unrealized investment gains 32 from FSA's investment portfolio, less $1.5 million of dividends received from FSA Common Stock. White Mountains' investment in MSA increased $9.0 million during 1998 (excluding White Mountains' additional purchase of MSA Common Stock for $70.3 million in February 1998) which consisted of $4.9 million of pretax earnings from MSA Common Stock and $4.1 million of pretax unrealized investment gains from MSA's investment portfolio. FSA, MSA, Folksamerica and Murray Lawrence represented Fund American's investments in unconsolidated insurance affiliates as of December 31, 1997. Fund American's investment in FSA increased $80.0 million during 1997 which consisted of $11.4 million of pretax earnings from FSA Common Stock, $68.0 million of pretax unrealized investment gains from FSA Options and Preferred Stock, $2.1 million of pretax unrealized investment gains from FSA's investment portfolio, less $1.5 million of dividends received from FSA Common Stock. White Mountains' investment in MSA increased $6.2 million during 1997 which consisted of $3.8 million of pretax earnings from MSA Common Stock and $2.4 million of pretax unrealized investment gains from MSA's investment portfolio. White Mountains' investment in Folksamerica increased $2.7 million during 1997 (excluding White Mountains' purchase of Folksamerica Common Stock for $20.8 million during December 1997) which consisted of $.9 million of pretax earnings from Folksamerica Common Stock and $1.8 million of pretax unrealized investment gains from Folksamerica's investment portfolio. White Mountains investment in Murray Lawrence, which was acquired on December 8, 1997, remained at its cost of $23.6 million during 1997. FSA, MSA and Folksamerica represented Fund American's investments in unconsolidated insurance affiliates as of December 31, 1996. Fund American's investment in FSA increased $23.1 million during 1996 (excluding Fund American's purchase of 1,000,000 additional shares of FSA Common Stock for $26.5 million during 1996) which consisted of $7.8 million of pretax earnings from FSA Common Stock, $17.3 million of pretax unrealized investment gains from FSA Options and Preferred Stock, less $1.0 million of pretax unrealized investment losses from FSA's investment portfolio, less $1.0 million of dividends received from FSA Common Stock. White Mountains' investment in MSA increased $1.0 million during 1996 which consisted of $1.5 million of pretax earnings from MSA Common Stock offset by $.5 million of pretax unrealized investment losses from MSA's investment portfolio. White Mountains' investment in Folksamerica increased $.2 million from June 1996 to December 31, 1996. MORTGAGE BANKING OPERATIONS For the year ended December 31, 1998, Source One's mortgage banking operations contributed $33.2 million of net income to Fund American versus net losses of $22.1 million and $8.0 million for during 1997 and 1996, respectively. Source One's 1998 results include a $15.2 million 33 pretax, $9.9 million after tax, gain on sales of mortgage servicing rights. Source One's 1997 results included the following charges: (i) a $6.0 million after tax extraordinary loss on early extinguishment of debt, (ii) restructuring and compensation charges of $3.1 million pretax, $2.0 after tax, associated with Source One's plan to reduce its operating costs and improve its financial performance, (iii) an $8.0 million pretax, $5.2 million after tax, loss on sales of mortgage servicing rights and assumption of subservicing and (iv) a $17.7 million pretax, $11.5 million after tax, charge to Source One's valuation allowance for impairment of their capitalized mortgage loan servicing portfolio. Source One's 1996 results include a $29.1 million pretax ($25.9 after tax) write-off of goodwill and certain other intangible assets which was partially offset by a $10.1 million pretax, $6.6 million after tax, gain on sales of mortgage servicing rights. Gross mortgage servicing revenue was $78.1 million for the year ended December 31, 1998 which compares to $94.9 million in 1997 and $139.6 million in 1996. The decrease in gross mortgage servicing revenue from 1996 to 1998 is primarily the result of sales of mortgage servicing rights with respect to $10.6 billion and $17.0 billion of mortgage loans during 1998 and 1997, respectively. Source One's net mortgage servicing revenue was $43.3 million for the year ended December 31, 1998 which compares to $38.2 million in 1997 and $70.3 million in 1996. Net mortgage servicing revenue for the year ended December 31, 1998 was enhanced by $20.4 million of pretax net gains on financial instruments versus gains of $11.3 million for 1997 and $9.9 million for 1996. Source One utilizes interest rate floor contracts, interest rate swap agreements and principal only swap agreements to mitigate the effect on earnings of higher amortization and impairment of the capitalized servicing asset caused by changes in market interest rates. These financial instruments are carried at fair value on the balance sheet with unrealized and realized gains reported as net gains on financial instruments on the income statement. Source One's management believes that these financial instruments have proven to be an effective means to substantially offset fluctuations in the value of Source One's mortgage servicing asset caused by changes in market interest rates. Net gains on sales of mortgages were $86.8 million for the year ended December 31, 1998, versus $21.5 million in 1997 and $38.3 million in 1996. The increase in gains from 1997 to 1998 reflects significant increases in Source One's correspondent production and related mortgage sales volumes during the period. The decrease in gains from 1996 to 1997 are due primarily to a change in Source One's loan production mix which included a proportionately higher volume of correspondent production during 1997 versus 1996 (which generates lower originated mortgage servicing rights income). During 1998 Source One sold the rights to service $10.6 billion of nonrecourse mortgage loans for cash proceeds of $227.9 million, resulting in a pretax gain of $15.2 million. During 1997 Source One 34 sold the rights to service $17.0 billion of nonrecourse mortgage loans for cash proceeds of $266.9 million, resulting in a pretax loss of $8.0 million. As part of the 1998 and 1997 servicing sales, Source One retained the right to subservice $4.1 billion and $17.0 billion of these loans, respectively, for a contracted fee through 2001. During 1996 Source One sold the rights to service $3.3 billion of mortgage loans for net proceeds of $55.9 million, resulting in a pretax gain of $10.1 million. Total mortgage loan production for the years ended December 31, 1998, 1997 and 1996, was $10.9 billion, $4.4 billion and $3.8 billion, respectively. The increase in production from 1996 to 1998 is reflective of overall lower market interest rates and a corresponding increase in refinancing activities during the period. Production related to refinancing activities made up 61%, 40% and 33% of total production during 1998, 1997 and 1996, respectively. INVESTMENT OPERATIONS The total return from Fund American's investment activities (excluding net unrealized investment holding gains and losses from Fund American's investments in unconsolidated insurance affiliates) is shown below:
Year Ended December 31, ---------------------------------- Millions 1998 1997 1996 - ---------------------------------------------------------------------------- Net investment income: Mortgage banking operations $ 81.6 $ 43.5 $ 40.8 Insurance operations, reinsurance operations and other 36.8 21.6 16.5 ---------------------------------- Total net investment income 118.4 65.1 57.3 Net unrealized investment holding gains arising during the period 26.8 86.6 106.5 ---------------------------------- Total net investment return, before tax $ 145.2 $ 151.7 $ 163.8 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
Fund American's investment income is comprised primarily of interest income earned on mortgage loans originated by Source One, interest income associated with the fixed maturity investments of its consolidated insurance and reinsurance operations and dividend income from its equity investments. The increase in net investment income from mortgage banking operations from 1996 to 1998 is mainly attributable to an increase in interest income from mortgage loans held for sale due to higher mortgage loan production experienced during 35 those periods, particularly during 1998. The increase in net investment income from insurance, reinsurance and other from 1997 to 1998 is primarily the result of the addition of Folksamerica's sizable fixed income portfolio in August 1998. The increase in net investment income from insurance, reinsurance and other from 1996 to 1997 is a result of increases in investment income from White Mountains' growing portfolio of fixed maturity investments. Net realized investment gains of $71.0 million recorded during 1998 resulted principally from the sale of all Fund American's holdings (1,014,250 common shares) of White River Corporation for net proceeds of $92.1 million. The total cash received by Fund American included the sales proceeds associated with shares which were being held for delivery upon the exercise of existing employee stock options (295,432 common shares or $17.8 million) and is payable to the recipient at a future date pursuant to the Company's nonqualified retirement plan. Net realized investment gains of $96.7 million recorded during 1997 included $37.2 million of pretax gains from the sale of 1,980,982 shares of the common stock of Travelers Property Casualty Corp. for net proceeds of $69.2 million, $24.3 million of pretax gains from the sale of 5,000,000 units of beneficial interest of San Juan Basin Royalty Trust for net proceeds of $45.7 million, $10.3 million of pretax gains from the sale of 388,140 shares of the common stock of Mid Ocean Limited ("Mid Ocean") for net proceeds of $22.6 million and $15.5 million of pretax gains from the sale of 834,895 shares of the common stock of Veritas DGC Inc. for net proceeds of $20.9 million. Net realized investment gains of $38.5 million recorded during 1996, before tax, included $27.2 million of pretax gains from the sale of 2,928,100 shares of the common stock of The Louisiana Land & Exploration Company common stock for net proceeds of $125.1 million, $1.4 million of pretax gains from the sale of 2,042,572 shares of the common stock of Zurich Reinsurance Centre Holdings, Inc. for net proceeds of $61.8 million and $9.3 million of pretax gains from the sale of 600,000 of the shares of common stock of Mid Ocean for net proceeds of $28.2 million. EXPENSES Insurance losses and loss adjustment expenses totalled $174.8 million for 1998 versus $97.1 million for 1997 and $85.9 million for 1996. Insurance and reinsurance acquisition expenses totalled $54.8 million for 1998 versus $23.2 million for 1997 and $15.2 million for 1996. The increase in these insurance expenses from 1997 to 1998 is primarily attributable to the inclusion of Folksamerica in the Company's consolidated results during the 1998 third quarter. The 36 increase in these insurance expenses from 1996 to 1997 is due to an increase in insurance premium volumes at Valley, Charter and WMIC. During 1998 and 1996, losses and loss adjustment expenses relating to prior years developed unfavorably by $6.7 million and $3.5 million, respectively. During 1997, losses and loss adjustment expenses relating to prior years developed favorably by $2.5 million pretax. Compensation and benefits expenses totalled $130.2 million for 1998 versus $101.8 million for 1997 and $91.3 million for 1996. The increase in compensation and benefits expense from 1997 to 1998 is due to an increase in production-related compensation at Source One and the inclusion of $7.1 million of Folksamerica's compensation and benefits expenses for 1998. The increase in compensation and benefits expense from 1996 to 1997 is primarily due to an increase in stock-based compensation accruals associated with certain of the Company's long-term compensation plans and its qualified and nonqualified retirement plans. During 1997 the market value of the Company's common stock rose 26%. Interest expense of $83.9 million for 1998 compares to $46.0 million for 1997 and $46.3 million for 1996. The increase in interest expense from 1997 to 1998 reflects: (i) an increase in average indebtedness outstanding during 1998 at Source One as a result of significantly higher mortgage loan production volumes; (ii) the inclusion of $1.4 million of Folksamerica's interest expense for 1998; and (iii) an increase in average indebtedness under White Mountains' $50.0 million revolving credit facility associated with its 1998 acquisition of Folksamerica and its 1998 increase in its investment in MSA. General expenses of $75.4 million for 1998 compares to $60.5 million for 1997 and $64.9 million for 1996. The increase in compensation and benefits expense from 1997 to 1998 is due to an increase in production-related general expenses at Source One and the inclusion of $1.3 million of Folksamerica's general expenses for 1998. Source One's provision for mortgage loan losses, included in general expenses, was $3.8 million in 1998 which compares to $4.7 million for 1997 and $3.0 million for 1996. The decrease in provision for loan losses from 1996 to 1998 primarily reflects significant reductions in the size of Source One's owned mortgage servicing portfolio during the period. Source One has established an allowance for mortgage loan losses which totalled $11.5 million and $12.8 million as of December 31, 1998 and 1997, respectively. In addition, Source One has established a $5.2 million and $8.2 million pretax reserve for estimated losses on its principal recourse portfolio as of December 31, 1998 and 1997, respectively. Source One believes that its total allowances are adequate to provide for estimated uninsured losses on the mortgage servicing portfolio. INCOME TAXES 37 The income tax provision related to pretax earnings for 1998, 1997 and 1996 represents an effective tax rate of 36.8%, 37.5% and 68.7%, respectively. The primary reason for the high effective tax rate experienced in 1996 was the write-off of goodwill and certain other intangible assets related to Source One. The total pretax write-off of these assets was $32.6 million and the related tax benefit was $3.2 million. Fund American recorded a net deferred Federal income tax asset of $7.8 million as of December 31, 1998. The 1998 net deferred tax asset includes $142.9 million of deferred tax assets (relating primarily to various operating items) partially offset by $135.1 million of deferred tax liabilities (relating primarily to net unrealized investment holding gains). Fund American recorded a net deferred Federal income tax liability of $19.6 million as of December 31, 1997. The 1997 net deferred tax liability includes $108.0 million of deferred tax liabilities (relating primarily to net unrealized investment holding gains) partially offset by $88.4 million in net deferred tax assets (relating primarily to various operating items). 38 On January 2, 1991, the Company sold Fireman's Fund to Allianz of America, Inc. The $1.3 billion gain from the sale as reported in 1991 included a $75.0 million tax benefit related to the Company's estimated tax loss from the sale. Since 1991 the Company has carried an estimated reserve related to tax matters affecting the amount of the deductible tax loss from the sale and other tax matters. The amount of tax benefit from the sale of Fireman's Fund ultimately realized by the Company may be significantly more or less than the Company's current estimate due to possible changes in or new interpretations of tax rules, possible amendments to Fund American's 1991 or prior years' Federal income tax returns, the results of further IRS audits and other matters affecting the amount of the deductible tax loss from the sale. LIQUIDITY AND CAPITAL RESOURCES PARENT COMPANY The primary sources of cash inflows for the Company are investment income, sales of investment securities and dividends received from its operating subsidiaries. In August 1998 the Company entered into a $35.0 million revolving credit agreement with a syndicate of banks which served to replace an expiring arrangement in the same amount. Under the agreement, through August 12, 1999, the Company may borrow up to $35.0 million at short-term market interest rates. The credit agreement contains certain customary covenants and conditions. At December 31, 1998 the Company was in compliance with all covenants under the facility and had no borrowings outstanding under the agreement. At December 31, 1997 the Company had no outstanding borrowings under the former facility. During 1993 the Company issued $150.0 million in principal amount of medium-term notes for net cash proceeds of $148.0 million after related costs. During 1995 and 1994 the Company repurchased $8.8 million and $24.9 million, respectively, in principal amount of the notes due in February 2003. At December 31, 1998 the $116.3 million of remaining outstanding notes had an average maturity of 4.4 years and a yield to maturity of 7.82%. During 1998 and 1997 the Company repurchased 151,916 Shares for $19.8 million and 924,739 Shares for $103.5 million, respectively. All Shares repurchased during 1998 and 1997 have been retired. During 1998 and 1997 the Company declared and paid quarterly cash dividends of $.40 per Share and $.20 per share, respectively. The Company's repurchases of Shares and dividends paid during 1998 and 1997 represent returns of excess capital to its shareholders. In connection with Source One's 1997 sale of approximately $17.0 billion of mortgage servicing rights to a third party, the Company has made a collection, payment and performance guaranty to the buyer for a 39 period of no more than ten years. The aggregate amount of the Company's guaranty is initially limited to $20.0 million and amortizes down to $15.0 million as mortgage loans serviced under agreement are repaid. During 1998, the Company permitted the third party to include an additional $2.9 billion of mortgage servicing rights that it purchased from Source One during 1998 to be included in the guaranty, however, the inclusion of the 1998 servicing rights sold did not serve to change the maximum amount of the guaranty or the original term of the agreement. The Company estimates that its aggregate guaranty under this arrangement is currently approximately $15.0 million. WHITE MOUNTAINS, FOLKSAMERICA, VALLEY AND CHARTER In November 1996 White Mountains and Valley entered into a five year credit facility under which they may borrow up to $50.0 million and $15.0 million, respectively, at market interest rates. The facility contains certain customary covenants and conditions but does limit White Mountains' ability to pay dividends to its shareholders. As of December 31, 1998 and 1997, White Mountains and Valley were in compliance with all covenants under the facility. At December 31, 1998 White Mountains had $50.0 million of borrowings outstanding under the facility which were used to partially fund White Mountains additional investment in MSA and its acquisition of Folksamerica during 1998. White Mountains 1998 borrowings had a weighted average interest rate of 6.20%. White Mountains had no borrowings outstanding at December 31, 1997 under the facility. During 1998 and 1997 Valley had $15.0 million of borrowings outstanding under the facility with a weighted average interest rate of 6.14% and 6.09%, respectively. In November 1995 Charter issued two notes totalling $20.2 million. Certain of the notes were due in 1996 and $3.2 million of notes were extended to be payable in three equal installments in 1997, 1998 and 1999. As of December 31, 1998 $1.1 million of the notes remained outstanding. The notes are collateralized by certain assets of Charter. During 1997 the Company reorganized its structure in order to strengthen Source One and make it a part of Fund American's operating group under White Mountains. Pursuant to this reorganization plan, White Mountains was merged into FAE and the combined entity was immediately renamed White Mountains. In addition, Source One received $139 million of capital infusions, consisting primarily of Fund American's investments in FSA, in order to improve Source One's debt ratings and reduce its borrowing costs. As a result of the reorganization plan, the Company currently owns 3% of the outstanding common stock of Source One and White Mountains owns the remaining 97% of the outstanding common stock of Source One. As part of the August 18, 1998 Folksamerica acquisition, Fund American agreed to repay or refinance Folksamerica's $55.6 million of outstanding long-term indebtedness during February 1999. On February 24, 1999, White Mountains repayed and replaced its $50.0 million five 40 year credit facility with a new $100 million facility at Folksamerica. The new credit agreement contains certain customary covenants and conditions. On February 11, 1999, White Mountains entered into a definitive agreement to sell VGI (which includes Valley, Charter and WMIC but excludes Valley National) to Unitrin, Inc. for total proceeds of approximately $215 million (consisting of approximately $130 million in cash upon closing and a special dividend consisting primarily of investment securities of approximately $85 million prior to close). The transaction is subject to certain Federal and state approvals and is expected to close during the 1999 second quarter. White Mountains expects to record an approximate $90 million pretax gain on the sale of VGI. In a separate transaction, White Mountains has entered a definitive contract to sell Valley National to Executive Risk Indemnity for an amount to be determined upon closing. The transaction is subject to certain Federal and state approvals and is expected to close during the 1999 second quarter. White Mountains expects to record an approximate $8 million pretax gain on the sale of Valley National. On March 25, 1999, Fund American and Citicorp Mortgage, Inc. ("Citicorp") reached a definitive agreement (the "Citicorp Agreement") under which Citicorp will acquire a substantial amount of Fund American's mortgage-banking related assets and certain of its mortgage banking liabilities. Fund American will retain the Source One legal entity which will continue to own all of Fund American's investments in FSA and certain other mortgage-related and other assets and liabilities. Fund American will likely sell or run-off the residual mortgage-banking assets remaining after the sale and extinguish the remaining liabilities. Fund American expects to record an after tax gain of approximate $15.0 million gain on the Citicorp Agreement. The amount of prospective gain on the sale of Source One's residual net mortgage-banking assets cannot be accurately determined at this time. Under the insurance laws of the various states under which Folksamerica, Valley, Charter and WMIC are incorporated or licensed to write business, an insurer is restricted with respect to the amount of dividends it may pay without prior approval by state regulatory authorities. Accordingly, there is no assurance that dividends may be paid by Folksamerica, Valley, Charter and WMIC in the future. SOURCE ONE Source One's primary cash flow requirements relate to funding mortgage loan production and investments in mortgage servicing rights. To meet these financing needs, Source One relies on various short-term and long-term credit facilities, early funding programs and cash flow from operations. Source One's investments, mortgage loans held for sale and mortgage loan servicing portfolio provide a liquidity reserve since these assets may be sold to meet cash needs. 41 During 1998 Source One sold the rights to service $10.6 billion of nonrecourse mortgage loans for cash proceeds of $227.9 million. During 1997 Source One sold the rights to service $17.0 billion of nonrecourse mortgage loans for cash proceeds of $266.9 million. As part of the 1998 and 1997 servicing sales, Source One retained the right to subservice $4.1 billion and $17.0 billion, respectively, of these loans for a contracted fee through 2001. The proceeds of the 1997 and 1998 servicing sales were used by Source One to retire debt and to distribute its excess capital to common shareholders. During 1996 Source One sold the rights to service $3.3 billion of mortgage loans for cash proceeds of $55.9 million. In July 1998 Source One amended and restated its $600.0 million secured revolving credit agreement to increase its borrowing capacity and flexibility. The provisions of the amended agreement increased Source One's borrowing capacity to $800.0 million. The facility expires on July 9, 1999. At December 31, 1998, Source One had $650.5 million of borrowings outstanding under this facility. In July 1997 Source One amended and restated its secured revolving credit agreement to decrease its borrowing capacity from $750.0 million to $600.0 million and to reduce its borrowing costs by lowering the facility fee. At December 31, 1997, Source One had $559.0 million of borrowings outstanding under this facility. During the second quarter of 1998 Source One entered into two additional secured credit agreements whereby it may borrow up to $35.0 million and $175.0 million through July 1999 and April 1999, respectively. At December 31, 1998, Source One had a total of $21.6 million in borrowings outstanding under these agreements. In April 1998 Source One replaced its existing $15.0 million unsecured revolving credit agreement under which it can borrow up to $40.0 million through April 15, 1999. As of December 31, 1998, there was $25.2 million outstanding under the revolving credit agreement. In May 1997 Source One entered into a unsecured revolving credit agreement under which it can borrow up to $15.0 million through June 1, 1998. As of December 31, 1997, there was $10.5 million outstanding under the revolving credit agreement. In December 1995, Source One exchanged and retired 2,239,061 shares of preferred stock (the "Source One Preferred Stock") for $56.0 million in principal amount of 9.375% subordinated debentures. The subordinated debentures are due in 2025 but are redeemable at the option of Source One, in whole or part, at any time on or after May 1, 1999. Dividends paid on the Source One Preferred Stock were $3.7 million for 1998, 1997 and 1996. Dividends on the Source One Preferred Stock accrue at an annual rate of 8.42% or $2.105 per share of Source One Preferred Stock outstanding. 42 In 1991 Source One issued $160.0 million of 8.875% medium-term notes due in 2001 of which $138.4 million remained outstanding at December 31, 1996. During 1997 Source One repurchased and retired in principal amount $119.7 million of these notes leaving $18.7 million outstanding at December 31, 1997 and 1998. In 1992 Source One issued $100.0 million of 9% debentures due in 2012 pursuant to a $250.0 million shelf registration statement. The debentures may not be redeemed by Source One prior to maturity. The proceeds from issuance were used for general corporate purposes. Source One must comply with certain financial covenants provided in its secured and unsecured revolving credit facilities, including restrictions relating to tangible net worth and leverage. In addition, the secured facility contains certain covenants which limit Source One's ability to pay dividends or make distributions of its capital in excess of preferred stock dividends and subordinated debt interest requirements each year. Source One is currently in compliance with all such covenants. 43 MARKET RISK Fund American's consolidated balance sheet includes a substantial amount of assets and liabilities whose fair values are subject to market risk. The term market risk refers to the risk of loss arising from adverse changes in: interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates and prices such as prices for common equity securities. Due to Fund American's sizable investments in fixed maturity investments and common equity securities at its insurance and reinsurance subsidiaries, derivative securities and mortgage-related assets and liabilities at its mortgage banking subsidiary and its use of medium and long-term debt financing at the Company and certain of its operating companies, market risk can have a significant affect on Fund American's consolidated financial position. INTEREST RATE RISK FIXED MATURITY PORTFOLIO. In connection with the Company's consolidated insurance and reinsurance subsidiaries, Fund American invests in interest rate sensitive securities, primarily debt securities. Fund American's strategy is to purchase fixed maturity investments that are attractively priced in relation to perceived credit risks. Fund American's investments in fixed maturity investments are held as available for sale and, accordingly, Fund American accepts that realized and unrealized losses on these instruments may occur. Fund American does not use derivative securities to manage its interest rate risk associated with its fixed maturity investments, rather it manages the average duration of the fixed maturity portfolio in the anticipation of achieving an adequate yield without subjecting the portfolio to an unreasonable level of interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of fixed maturity investments, respectively. Additionally, fair values of interest rate sensitive instruments may be affected by the credit worthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions. These investments are carried at fair value on the balance sheet with unrealized gains reported net of tax in a separate component of shareholders equity. DERIVATIVE SECURITIES. In connection with its mortgage banking operations, Source One utilizes derivative contracts, consisting of interest rate floor contracts, interest rate swap agreements and principal-only swap agreements, in an attempt to offset the effect on earnings of impairment of its capitalized servicing asset caused by changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into increases and decreases in fair values of these financial instruments, respectively. These financial instruments are carried at fair value on the balance 44 sheet (as other investments) with unrealized and realized gains reported as net gains on financial instruments on the income statement. INDEBTEDNESS. Fund American utilizes debt financing at all levels of its businesses, particularly at Source One. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of fixed rate indebtedness, respectively, particularly long-term debt. Additionally, fair values of interest rate sensitive instruments may be affected by the credit worthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions. The table below summarizes the estimated effects of hypothetical increases and decreases in market interest rates on Fund American's fixed maturity portfolio, derivative securities and long-term fixed rate indebtedness outstanding. Significant variations in market interest rates could produce changes in the timing of repayments due to prepayment options available to the issuer or the holder which are not reflected herein. It is assumed that the changes occur immediately and uniformly to each category of instrument containing interest rate risk. 45
Estimated Fair Percentage Increase Fair Value at Assumed Change Value after Change (Decrease) to Dollars in Millions December 31, 1998 in Interest Rate in Interest Rate Shareholders' Equity - ------------------------------------------------------------------------------------------------------------- Fixed maturity investments $929.6 50 bp decrease $946.4 1.6% 50 bp increase $913.2 (1.5)% 100 bp increase $897.1 (3.0)% 200 bp increase $866.2 (5.9)% - ------------------------------------------------------------------------------------------------------------- Derivative securities $ 17.5 50 bp decrease $31.5 1.3% 50 bp increase $5.4 (1.1)% 100 bp increase $(4.7) (2.1)% 200 bp increase $(20.7) (3.5)% - ------------------------------------------------------------------------------------------------------------- Fixed rate indebtedness (a) $233.1 50 bp decrease $239.4 (.6)% 50 bp increase $227.0 .6% 100 bp increase $221.2 1.1% 200 bp increase $210.1 2.1% - ------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------
(a) Excludes short-term indebtedness, long-term indebtedness refinanced or callable by Fund American during 1999 and variable rate obligations. MORTGAGE-RELATED ASSETS. Source One's mortgage loan production and servicing activities are subject to interest rate risk and are generally counter cyclical in nature. In addition, Source One utilizes various financial instruments, including derivatives, to manage the interest rate risk related specifically to its mortgage loan pipeline, mortgage loans held for sale and gain or loss on sales of mortgage servicing rights. The overall objective of Source One's interest rate risk management policies is to offset changes in the values of these items resulting from changes in interest rates. As part of the interest rate risk management process, Source One performs various sensitivity analyses that quantify the net financial impact of changes in interest rate-sensitive assets and commitments. These analyses incorporate scenarios including assumed shifts in the yield curve. Various modeling techniques are employed to forecast the value of these assets and commitments. For pipeline commitments, an option-adjusted spread model is used which incorporates implied market volatilities and prepayment speeds. For mortgage servicing rights, a 46 discounted cash flow model is used which incorporates prepayment speeds, discount rates and credit losses. Utilizing the sensitivity analyses described above, the table below summarizes the estimated effects of hypothetical increases and decreases in market interest rates on Source One's mortgage servicing values:
Estimated Fair Percentage Increase Carrying Value at Assumed Change Value after Change (Decrease) to Dollars in Millions December 31, 1998 in Interest Rate in Interest Rate Shareholders' Equity - -------------------------------------------------------------------------------------------------------------------------- Mortgage servicing rights (a) $171.3 50 bp decrease $156.0 (1.4)% 50 bp increase $183.9 1.2% Mortgage forward contracts $ - 50 bp decrease $ 11.6 1.1% 50 bp increase $(11.6) (1.1)% Mortgage loan pipeline $ - 50 bp decrease $(11.7) (1.1)% 50 bp increase $ 11.4 1.1% - -------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------
(a) Represents the carrying value of capitalized mortgage servicing excluding $1.6 million of capitalized subservicing. 47 As shown above, the projected increase or decrease in the value of the mortgage loan pipeline would be expected to be substantially offset by a decrease or increase in the related mortgage loan forward contracts. In addition, the projected increase or decrease in the value of the mortgage servicing rights would be expected to be substantially offset by a decrease or increase in the value of the related financial instruments as previously described herein. This analysis is limited by the fact that it was performed at a specific point in time and does not incorporate other factors that would impact Source One's financial performance. Actual results would likely vary. FOREIGN CURRENCY EXCHANGE RATES Folksamerica operates a branch office in Toronto, Canada to service its Canadian customers. Net unrealized foreign currency translation gains and losses, after tax, associated with Folksamerica's Canadian operations are reported as a net amount in a separate component of shareholders' equity. Changes in the values of these operations due to currency fluctuations, after tax, are reported on the income statement as a component of comprehensive net income. At December 31, 1998, Folksamerica's net assets denominated in Canadian dollars represented approximately one percent of Fund American's consolidated shareholders' equity, therefore, any significant change in foreign currency rates would not have a material impact on Fund American's financial position. EQUITY PRICE RISK The carrying values of Fund American's common equity securities, a significant portion of its other investments (primarily restricted common equity securities and partnership interests invested in common equity securities) and its investments in FSA Options and Preferred Stock are based on quoted market prices or management's estimates of fair value (which is based, in part, on quoted market prices) as of the balance sheet date. Market prices of common equity securities are subject to fluctuations which could cause the amount to be realized upon sale of the investment to differ significantly from the current reported value. The fluctuations may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments, general market conditions and supply and demand imbalances for a particular security. The table below summarizes Fund American's equity price risks as of December 31, 1998 and shows the effects of a hypothetical 20% increase and a 20% decrease in market prices as of that date. 48
Estimated Fair Percentage Increase Fair Value at Assumed Value after Assumed (Decrease) to Dollars in Millions December 31, 1998 Price Change Price Change Shareholders' Equity - ------------------------------------------------------------------------------------------------------------------ Common equity securities $241.7 20% increase $290.0 4.5% 20% decrease $193.4 (4.5)% Other investments (a) $ 77.3 20% increase $ 92.8 1.4% 20% decrease $ 61.8 (1.4)% FSA Options and $114.4 20% increase $136.6 2.1% Preferred Stock 20% decrease $ 91.5 (2.1)% - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------
(a) Excludes $17.5 million of derivative securities (see "Interest Rate Risk") and $2.1 million of other investments which would not be directly affected by the assumed changes in equity prices. 49 OTHER MATTERS ACCOUNTING FOR FSA OPTIONS AND CONVERTIBLE PREFERRED STOCK Fund American currently owns 3,460,200 shares of the common stock of FSA ("FSA Shares") and various fixed price options and shares of convertible preferred stock of FSA (the "FSA Options and FSA Preferred Stock") which, in total, give Fund American the right to acquire up to 4,560,607 additional FSA Shares. Fund American's investment in FSA Shares is accounted for using the equity method of accounting pursuant to which the investment is reported at FSA's book value ($35.87 per FSA Share at December 31, 1998). Fund American's investments in FSA Options and FSA Preferred Stock are currently accounted for under the provisions of SFAS No. 115 pursuant to which the investments are reported at fair value ($52.62 per underlying FSA Share at December 31, 1998). Fund American currently expects to exercise the FSA Options during 1999 and convert the FSA Preferred Stock during 2004. Assuming that equity accounting continues to be the proper accounting method for valuing Fund American's investment in FSA Shares, upon exercise of the FSA Options and conversion of the FSA Preferred Stock, Fund American expects that it would be required to restate its historic balance sheets to account for its investments in FSA Options and FSA Preferred Stock from fair value to their original cost. Upon exercise, Fund American's original cost basis in the FSA Shares acquired will be increased by the exercise price paid. Because the new cost basis of Fund American's investment in FSA Shares is expected to be considerably less than its portion of the fair value of FSA's net identifiable assets at the date of exercise, Fund American would be required to record a deferred credit that would be amortized to income over an anticipated five year period. Assuming the FSA Options were exercised and the FSA Preferred Stock converted as of December 31, 1998, Fund American would be required to reduce its book value by $72.9 million ($10.67 per share) and would record a deferred credit of $35.7 million ($5.23 per share). This net difference in carrying value of $37.2 million (which represents the effective write-down of the FSA Options and FSA Preferred Stock from fair value to FSA's book value) would continue to exist until such time as equity accounting is no longer appropriate for Fund American's investment in FSA Shares. This analysis is based solely on Fund American's current circumstances concerning its investments in FSA Options and FSA Preferred Stock. Fund American's actual accounting valuation will be determined at the point of exercise for the FSA Options and upon the conversion of the FSA Preferred Stock and will be based on the circumstances concerning such investments existing at that time. YEAR 2000 STATUS. Since 1996 Fund American has been identifying, modifying and testing its internal systems and controls to ensure that these systems can accurately process transactions involving the Year 2000 and beyond with no material adverse effects to its customers or disruption to its business operations. As of December 31, 1998, the Company has substantially completed its testing phase (the final phase of its Year 2000 remediation plan). Fund American estimates that its total pretax cost of Year 2000 remediation, excluding its unconsolidated insurance 50 affiliates, is approximately $3.0 million of which the majority of this amount has been expensed as of December 31, 1998. This estimate does not include the cost of hardware and software replacements and upgrades made in the normal course of business and represents less than 20% of Fund American's total Information Technology budget. Fund American has also been closely monitoring the year 2000 issues of its third party constituents that it voluntarily interacts with (e.g. customers, suppliers, reinsurers, creditors, borrowers...). Fund American's third party constituents have been requested to provide Fund American with information concerning their Year 2000 remediation plans and the status of such plans. For those constituents who either fail to respond to this inquiry or are deemed to be unlikely to remedy their own Year 2000 issues in a timely manner, Fund American is in the process of either replacing that constituent or establishing similar relationships with new parties that are currently Year 2000 compliant. As of December 31, 1998, FSA and MSA had also substantially completed the testing phase of their Year remediation plans and are in the process of determining their third party exposures in a similar manner to that of Fund American. Fund American's nominees to the Boards of Directors of FSA and MSA have received detailed briefings concerning their respective Year 2000 plans and have determined that these plans appear to be on schedule for a timely completion and should reduce the risk of Year 2000 issues. Fund American's portion of the total estimated costs of the Year 2000 issue for its unconsolidated insurance affiliates are not material and the majority of such expenses have already been incurred. RISKS. The failure to identify or correct significant Year 2000 issues could result in an interruption in, or a failure of, certain normal business activities or operations concerning the Company, its consolidated insurance and mortgage banking subsidiaries and its unconsolidated insurance affiliates. Such failures could adversely affect Fund American's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of potential business interruptions caused by third party constituents in which Fund American must interact (including but not limited to suppliers of electrical power, various private and public markets for equity and debt securities, certain agencies of the Federal government and the states in which Fund American conducts business), Fund American is unable to determine at this time whether the consequences of any Year 2000 failures will have a material impact on its results of operation, liquidity or financial condition. However, Fund American currently believes that, with the implementation of its Year 2000 plan (which is in the final stages of completion), the possibility of significant interruptions of normal business activities due to the Year 2000 issue should be reduced. Folksamerica's approach towards underwriting against potential Year 2000 exposures is to seek coverages which contain Year 2000 event exclusions. In instances where exclusions are not provided, Folksamerica attempts to determine whether the risk is acceptable based on a variety of factors (a description of such factors is not provided herein as each situation is unique). Folksamerica has estimated that less that 9% of its property reinsurance coverage in force could be subject to Year 2000 exposures. However, these risks generally lie 51 with large corporations who have been aware of the issue for some time and have invested significant time and resources towards Year 2000 remediation. Additionally, Folksamerica does not anticipate significant Year 2000 exposures from its casualty reinsurance coverage in force due to the nature of such exposures. Further, Folksamerica generally writes such exposures on an excess of loss basis which provides Folksamerica with additional protections against potential losses of this nature. The Company is currently in the process of developing a Year 2000 contingency plan (the "Y2K Plan") which is designed to mitigate, to the extent possible, any adverse affects the Company may suffer due to any potential business interruptions caused by third party constituents in which Fund American must interact (as further explained above). It is expected that the Y2K Plan will be finalized during the third quarter of 1999. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Market Risk Disclosures" contained in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Financial Statements and Financial Statement Schedule appearing on page 38 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On March 10, 1999, the Audit Committee of the Board appointed PricewaterhouseCoopers LLP ("PWC") as its independent auditors for the fiscal year ending December 31, 1999, to succeed KPMG LLP ("KPMG") effective upon the date of their reports on such consolidated financial statements for the year ended December 31, 1998. PWC has served as Folksamerica's independent auditors since 1981 and has served as FSA's independent auditors since 1989. The Audit Committee has recommended that PWC succeed KPMG as the Company's independent auditors for 1999 due to the growing significance of Folksamerica and FSA to the Company's 1999 financial position and results of operations and the pending disposition of VGI. In connection with the audits of the years ended December 31, 1998 and 1997, there were no disagreements with KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to their satisfaction, would have caused them to make reference in connection with their opinion to the subject matter of the disagreement. The Company has requested KPMG furnish a letter addressed to the Commission stating whether it agrees with the above statements. A copy of this letter, dated March 25, 1999, is contained herein as Exhibit 16(a). 52 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS A. DIRECTORS (AS OF MARCH 22, 1999) Reported under the caption "Election of Directors" on pages 3 through 6 of the Company's 1999 Proxy Statement, herein incorporated by reference. B. EXECUTIVE OFFICERS (AS OF MARCH 22, 1999)
Executive officer Name Position Age since - --------------------------------------------------------------------------------------- Raymond Barrette Executive Vice President and 48 1997 Chief Financial Officer Terry L. Baxter President of White Mountains 53 1994 Reid T. Campbell Vice President and Director 31 1996 of Finance Morgan W. Davis Executive Vice President of 48 1994 White Mountains K. Thomas Kemp President and CEO 58 1991 Michael S. Paquette Senior Vice President and 35 1993 Controller David G. Staples Vice President and Director 38 1997 of Taxation - ---------------------------------------------------------------------------------------
All executive officers are elected by the Board for a term of one year or until their successors have been elected and have duly qualified. MR. BARRETTE joined Fund American in 1997 as the Company's Executive Vice President and Chief Financial Officer. Mr. Barrette is also Executive Vice President and Chief Financial Officer of White Mountains. He was formerly a consultant with Tillinghast-Towers Perrin from 1994 to 1996 and was President of the Personal Insurance Division of Fireman's Fund from 1991 to 1993. Mr. Barrette is a director of FAE, MSA, Source One, Folksamerica, White Mountains, Valley, Charter and WMIC. MR. BAXTER was elected President of White Mountains in 1997. Mr. Baxter previously served as Chairman of Source One from 1996 to 1997 and as President and Secretary of FAE from 1994 to 1997. Prior to joining Fund American in 1994, Mr. Baxter was Managing Director of the National Transportation Safety Board from 1990. Prior to that, he was the Assistant Director of OMB during the Reagan Administration. Mr. Baxter is a director of FAE, MSA, Source One, Folksamerica, White Mountains, Valley, Charter, WMIC and Sextant Underwriting Plc. MR. CAMPBELL was elected Vice President and Director of Finance in February 1998 and previously served as Assistant Controller from 1996 to 1998 and Director of Accounting from 1995 to 1996. Mr. Campbell has been with Fund American since 1994. Mr. Campbell is also 53 Vice President and Director of Finance of White Mountains. Prior to joining Fund American, Mr. Campbell was with KPMG Peat Marwick from 1990 to 1994. MR. DAVIS has served as White Mountains' Executive Vice President since 1997 and served as Senior Vice President since 1994. Mr. Davis is also President and Chief Executive Officer of WMIC and Chairman and President of VGI. Prior to joining Fund American in 1994, Mr. Davis was an independent consultant. Mr. Davis is a director of MSA, White Mountains, Valley, Charter, WMIC, ABRA, Inc. and CCC Information Services Group Inc. and is a trustee of Azusa Pacific University. MR. KEMP was appointed President and Chief Executive Officer in 1997. Mr. Kemp previously served as Executive Vice President since 1993 and as Vice President, Treasurer and Secretary from 1991 to 1993. Mr. Kemp also serves as a director of the Company, Chairman and Chief Executive Officer of White Mountains and Chairman of WMIC. He is also a director of Folksamerica, FSA, FAE, MSA and AMLIN Plc. MR. PAQUETTE was appointed Senior Vice President and Controller in 1997. Mr. Paquette previously served as Vice President and Controller since 1995 and as Vice President and Chief Accounting Officer from 1993 to 1995. Mr. Paquette is also Senior Vice President and Controller of White Mountains and WMIC. Mr. Paquette has been a member of the Fund American organization since 1989. MR. STAPLES was elected Vice President and Director of Taxation in 1997 and has been with Fund American since 1996. Prior to joining Fund American, Mr. Staples served as Vice President and Director of Taxation for Crum & Forster Holdings, Inc. from 1993 to 1996, and was with KPMG Peat Marwick from 1983 to 1993. ITEM 11. EXECUTIVE COMPENSATION Reported under the captions "Compensation of Executive Officers" on pages 9 through 11, "Reports of the Compensation Committees on Executive Compensation" on pages 11 though 13, "Shareholder Return Graph" on page 14, and "Compensation Plans" on page 15 of the Company's 1999 Proxy Statement, herein incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reported under the caption "Voting Securities and Principal Holders Thereof" on pages 7 through 8 of the Company's 1999 Proxy Statement, herein incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reported under the captions "Certain Relationships and Related Transactions" on page 11 and "Compensation Committee Interlocks and Insider Participation in Compensation Decisions" on page 16 of the Company's 1999 Proxy Statement, herein incorporated by reference. 54 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K A. DOCUMENTS FILED AS PART OF THE REPORT The financial statements and financial statement schedules and reports of independent auditors have been filed as part of this Annual Report on Form 10-K as indicated in the Index to Financial Statements and Financial Statement Schedules appearing on page 38 of this report. A listing of exhibits filed as part of the report appear on pages 56 through 58 of this report. B. REPORTS ON FORM 8-K During the fourth quarter of 1998 the Company filed two amendments to its Current Report on Form 8-K dated August 18, 1998 which was filed in connection with its acquisition of Folksamerica on that date. The amendments served to provide the requisite pro forma financial information concerning the Folksamerica transaction and were filed on October 16, 1998 and November 13, 1998. 55 C. EXHIBITS
EXHIBIT NUMBER NAME - -------------------------------------------------------------------------------- 3(i) -- Amended and Restated Certificate of Incorporation of the Company (incorporated by reference herein to Exhibit 3(a) of the Company's 1993 Annual Report on Form 10-K) (ii) -- Amended and Restated By-Laws of the Company (incorporated by reference herein to Exhibit 3(b) of the Company's 1993 Annual Report on Form 10-K) 4 -- Indenture dated January 1, 1993, with The First National Bank of Chicago, as trustee, pursuant to the Company's offering of $150 million of medium-term notes (incorporated by reference herein to Exhibit (4) of the Company's Report on Form 8-K dated January 15, 1993) 9 -- Voting Trust Agreement dated September 2, 1994 between the Company, U S WEST Capital Corporation and First Chicago Trust Company of New York (incorporated by reference herein to Exhibit 10(a) of the Company's Report on Form 8-K dated April 10, 1994) 10(a) -- Second Amended and Restated Credit Agreement dated August 14, 1998 among the Company, the Lenders (as named therein) and The First National Bank of Chicago (*) (b) -- Second Amended and Restated Credit Agreement dated August 14, 1998 among White Mountains, the Lenders (as named therein) and The First National Bank of Chicago (*) (c) -- Second Amended and Restated Credit Agreement dated August 14, 1998 among VGI, the Lenders (as named therein) and The First National Bank of Chicago (*) (d) -- Amendment No. 1 dated November 20, 1998 to the Second Amended and Restated Credit Agreement dated August 14, 1998 among the Company, the Lenders (as named therein) and The First National Bank of Chicago (*) (e) -- Amendment No. 1 dated November 20, 1998 to the Second Amended and Restated Credit Agreement dated August 14, 1998 among White Mountains, the Lenders (as named therein) and The First National Bank of Chicago (*) (f) -- Amendment No. 1 dated November 20, 1998 to the Second Amended and Restated Credit Agreement dated August 14, 1998 among VGI, the Lenders (as named therein) and The First National Bank of Chicago (*) (g) -- Securities Purchase Agreement dated April 10, 1994 between the Company, U S WEST, Inc., U S WEST Capital Corporation and FSA (incorporated by reference herein to Exhibit 10(a) of the Company's Report on Form 8-K dated April 10, 1994) (h) -- Folksamerica Stock Purchase Agreement dated as of July 1, 1998 by and among the Company, White Mountains, Folksam Mutual General Insurance Company, Folksam International Insurance Co. Ltd, Weiner Staedtische Allgemeine Versicherung AG, P&V Assurances S.C. and Samvirke Skadeforsikring AS (incorporated by reference herein to Exhibit 10(a) of the Company's Report on Form 8-K dated August 18, 1998)
56 (i) -- Assignment and Assumption Agreement dated as of August 18, 1998 by and among Folksam Omsesidig Sakforsakring, Samvirke Skadeforsikring AS and the Company (incorporated by reference herein to Exhibit 10(b) of the Company's Report on Form 8-K dated August 18, 1998) (j) -- Subscription Agreement dated November 6, 1997 between Folksamerica, the Company, White Mountains, Folksam Mutual General Insurance Company, Folksam International Insurance Co. Ltd, Weiner Staedtische Allgemeine Versicherung AG, P&V Assurances S.C. and Samvirke Skadeforsikring AS (incorporated by reference herein to Exhibit 10(l) of the Company's 1997 Annual Report on Form 10-K) (k) -- Securities Purchase Agreement dated March 6, 1996 between the Company and Folksamerica (incorporated by reference herein to Exhibit 10(a) of the Company's Report on Form 8-K dated June 19, 1996) (l) -- Folksamerica Stock Purchase Agreement dated August 8, 1995 between the Company, Skandia U.S. Holding Corporation, and Skandia America Corporation (incorporated by reference herein to Exhibit 10(e) of the Company's 1995 Annual Report on Form 10-K) (m) -- Guaranty, dated February 28, 1997, by the Company to and for the benefit of Chemical Mortgage Company (incorporated by reference herein to Exhibit 10(y) of the Company's 1996 Annual Report on Form 10-K) (n) -- VGI Stock Acquisition Agreement dated February 10, 1999 between Unitrin, Inc. and the Company (*) (o) -- Transition Services Agreement dated March 25, 1999 between the Company and Citicorp Mortgage, Inc. (*) (p) -- Source One Asset Purchase Agreement dated March 25, 1999 between the Company, Source One and Citicorp Mortgage Inc.(*) (q) -- Common Stock Warrant Agreement with respect to shares of the Company's Common stock between the Company and John J. Byrne (incorporated by reference herein to Exhibit 10(v) of the Company's Registration Statement on Form S-1 (No. 33-0199)) (**) (r) -- The Company's Retirement Plan for Non-Employee Directors (incorporated by reference herein to Exhibit 10(aa) of the Company's 1992 Annual Report on Form 10-K) (**) (s) -- The Company's Voluntary Deferred Compensation Plan, as amended on November 15, 1996 (incorporated by reference herein to Exhibit 10(o) of the Company's 1996 Annual Report on Form 10-K) (**) (t) -- The Company's Deferred Benefit Plan, as amended on November 15, 1996 (incorporated by reference herein to Exhibit 10(p) of the Company's 1996 Annual Report on Form 10-K) (**) (u) -- The Company's Long-Term Incentive Plan, as amended February 15, 1995 (incorporated by reference to Appendix I of the Company's Notice of 1995 Annual Meeting of Shareholders and Proxy Statement) (**) (v) -- Valley Group Employees' 401(k) Savings Plan (incorporated by reference herein to Exhibit 4(c) of the Company's Registration Statement on Form S-8 (No. 333-30233) (**) 11 -- Statement Re Computation of Per Share Earnings (***) 16 -- Letter of KPMG LLP dated March 25, 1999 (*) 21 -- Subsidiaries of the Registrant (*)
57 23(a) -- Consent of KPMG LLP dated March 25, 1999 (*) (b) -- Consent of Ernst & Young LLP dated March 25, 1999 (*) (c) -- Consent of PricewaterhouseCoopers LLP dated March 25, 1999 relating to Valley, Folksamerica and FSA (*) 24 -- Powers of Attorney (*) 27 -- 1998 Financial Data Schedule (*) 99(a) -- Report of PricewaterhouseCoopers LLP dated February 2, 1999 relating to Folksamerica(*) (b) -- The Consolidated Financial Statements of FSA and the related Report of Independent Accountants as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998 (*) (c) -- Report of Coopers & Lybrand L.L.P. dated February 14, 1997 relating to VGI (*)
(*) Included herein. (**) Management contracts or compensation plans/arrangements required to be filed as an exhibit pursuant to Item 14(a)3 of Form 10-K. (***) Not included herein as the information is contained elsewhere within report. See Note 1 of the Notes to Consolidated Financial Statements. D. FINANCIAL STATEMENT SCHEDULE The financial statement schedule and report of independent auditors have been filed as part of this Annual Report on Form 10-K as indicated in the Index to Financial Statements and Financial Statement Schedule appearing on page 61 of this report. 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FUND AMERICAN ENTERPRISES HOLDINGS, INC. Date: March 26, 1999 By: /s/ MICHAEL S. PAQUETTE -------------------------------- Senior Vice President and Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date RAYMOND BARRETTE* Executive Vice President and March 26, 1999 - -------------------------- Chief Financial Officer Raymond Barrette JOHN J. BYRNE* Chairman March 26, 1999 - -------------------------- John J. Byrne PATRICK M. BYRNE* Director March 26, 1999 - -------------------------- Patrick M. Byrne HOWARD L. CLARK, JR.* Director March 26, 1999 - -------------------------- Howard L. Clark, Jr. ROBERT P. COCHRAN* Director March 26, 1999 - -------------------------- Robert P. Cochran GEORGE J. GILLESPIE, III* Director March 26, 1999 - -------------------------- George J. Gillespie, III /s/ K. THOMAS KEMP President, Chief Executive March 26, 1999 - -------------------------- Officer and Director K. Thomas Kemp GORDON S. MACKLIN* Director March 26, 1999 - -------------------------- Gordon S. Macklin
59 FRANK A. OLSON* Director March 26, 1999 - -------------------------- Frank A. Olson MICHAEL S. PAQUETTE* Senior Vice President March 26, 1999 - -------------------------- and Controller Michael S. Paquette
*By: /s/ K. THOMAS KEMP -------------------------------- K. Thomas Kemp, Attorney-in-Fact 60 FUND AMERICAN ENTERPRISES HOLDINGS, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Form 10-K page(s) - ----------------------------------------------------------------------------------------------- FINANCIAL STATEMENTS: Consolidated balance sheets as of December 31, 1998 and 1997.................... F-1 Consolidated income statements for each of the years ended December 31, 1998, 1997 and 1996........................................... F-2 Consolidated statements of shareholders' equity for each of the years ended December 31, 1998, 1997 and 1996........................................... F-3 Consolidated statements of cash flows for each of the years ended December 31, 1998, 1997 and 1996........................................... F-4 Notes to consolidated financial statements...................................... F-5 OTHER FINANCIAL INFORMATION: Report on management's responsibilities......................................... F-48 Independent auditors' reports................................................... F-49 Selected quarterly financial data (unaudited)................................... F-52 FINANCIAL STATEMENT SCHEDULES: I. Summary of investments other than investments in related parties......... FS-1 II. Condensed financial information of the Registrant........................ FS-2 III. Reinsurance.............................................................. FS-4 IV. Valuation and qualifying accounts......................................... FS-5 VI. Supplementary insurance information....................................... FS-6 - -----------------------------------------------------------------------------------------------
All other schedules are omitted as they are not applicable or the information required is included in the financial statements or notes thereto. 61 CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------- December 31, --------------------------- Dollars in millions 1998 1997 - ------------------------------------------------------------------------------------------------------------------- ASSETS Fixed maturity investments, at fair value (cost $916.1 and $165.4) $ 929.6 $ 168.3 Common equity securities, at fair value (cost $195.4 and $64.7) 241.7 104.2 Other investments (cost $88.5 and $103.1) 96.9 167.9 Short-term investments, at amortized cost (which approximated fair value) 79.0 62.8 --------------------------- Total investments 1,347.2 503.2 Cash 22.4 7.0 Mortgage loans held for sale 676.3 519.3 Capitalized mortgage servicing, net of accumulated amortization 169.7 181.0 Pool loan purchases 165.0 149.8 Mortgage claims receivable and real estate acquired 33.1 41.2 Receivable from sale of mortgage servicing 73.8 27.3 Investments in unconsolidated insurance affiliates 354.3 360.1 Insurance and reinsurance balances receivable 124.7 56.1 Reinsurance recoverable on paid and unpaid losses 137.3 9.6 Other assets 176.9 155.7 --------------------------- Total assets $ 3,280.7 $ 2,010.3 LIABILITIES Short-term debt $ 748.5 $ 571.4 Long-term debt 359.7 304.3 Loss and loss adjustment expense reserves 811.7 71.9 Unearned insurance and reinsurance premiums 153.1 78.0 Deferred credit 37.1 - Accounts payable and other liabilities 424.1 281.8 --------------------------- Total liabilities 2,534.2 1,307.4 - ------------------------------------------------------------------------------------------------------------------- MINORITY INTEREST - PREFERRED STOCK OF SUBSIDIARY 44.0 44.0 - ------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common stock - authorized 125,000,000 shares, issued 30,863,547 and 31,015,463 shares 30.9 31.0 Paid-in surplus 354.2 355.9 Retained earnings 1,063.2 1,008.9 Common stock in treasury, at cost: 25,034,939 shares (871.0) (871.0) Accumulated other comprehensive net income, after tax 125.2 134.1 --------------------------- Total shareholders' equity 702.5 658.9 - ------------------------------------------------------------------------------------------------------------------- Total liabilities, minority interest and shareholders' equity $ 3,280.7 $ 2,010.3 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-1 CONSOLIDATED INCOME STATEMENTS
- -------------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, --------------------------------------- Millions, except per share amounts 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- REVENUES: Earned property and casualty insurance premiums $246.0 $145.3 $ 109.7 Earnings from unconsolidated insurance affiliates 24.3 21.3 12.0 Other insurance operations revenue 12.2 7.8 9.4 Net investment income 118.4 65.1 57.3 Gross mortgage servicing revenue 78.1 94.9 139.6 Amortization and impairment of capitalized mortgage servicing (55.2) (68.0) (79.2) Net gain on financial instruments 20.4 11.3 9.9 --------------------------------------- Net mortgage servicing revenue 43.3 38.2 70.3 Net gain on sales of mortgages 86.8 21.5 38.3 Gain (loss) on sales of mortgage servicing rights and assumption of subservicing 15.2 (8.0) 10.1 Other mortgage operations revenue 31.9 19.1 18.1 --------------------------------------- Total revenues 578.1 310.3 325.2 - -------------------------------------------------------------------------------------------------------------------------------- EXPENSES: Insurance losses and loss adjustment expenses 174.8 97.1 85.9 Compensation and benefits 130.2 101.8 91.3 Interest expense 83.9 46.0 46.3 General expenses 75.4 60.5 64.9 Insurance and reinsurance acquisition expenses 54.8 23.2 15.2 Write-off of goodwill and other intangible assets - - 32.6 --------------------------------------- Total expenses 519.1 328.6 336.2 - -------------------------------------------------------------------------------------------------------------------------------- Pretax operating earnings (loss) 59.0 (18.3) (11.0) Net realized investment gains 71.0 96.7 38.5 --------------------------------------- Pretax earnings 130.0 78.4 27.5 Income tax provision 47.8 29.4 18.9 --------------------------------------- AFTER TAX EARNINGS 82.2 49.0 8.6 Loss on early extinguishment of debt, after tax - (6.0) - --------------------------------------- NET INCOME 82.2 43.0 8.6 Net unrealized investment holdings gains and other, after tax 37.2 104.6 79.6 Reclasses of realized gains included in net income, after tax (46.1) (62.9) (25.0) --------------------------------------- COMPREHENSIVE NET INCOME 73.3 84.7 63.2 Preferred stock dividends of subsidiary (3.7) (3.7) (3.7) --------------------------------------- Comprehensive net income applicable to common stock $ 69.6 $ 81.0 $ 59.5 --------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS PER COMMON SHARE: After tax earnings $13.38 $ 6.89 $ .66 Loss on early extinguishment of debt, after tax - (.91) - --------------------------------------- Net income $13.38 $ 5.98 $ .66 --------------------------------------- --------------------------------------- Comprehensive net income $11.87 $12.33 $ 8.01 --------------------------------------- --------------------------------------- DILUTED EARNINGS PER COMMON SHARE: After tax earnings $11.94 $ 6.22 $ .60 Loss on early extinguishment of debt, after tax - (.82) - --------------------------------------- Net income $11.94 $ 5.40 $ .60 --------------------------------------- --------------------------------------- Comprehensive net income $10.58 $11.15 $ 7.33 - -------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-2 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Net Foreign stock and Common unrealized currency paid-in Retained stock in investment translation Millions Total surplus earnings treasury gains adjustment - ------------------------------------------------------------------------------------------------------------------- Balances at January 1, 1996 $699.7 $408.2 $1,124.6 $(871.0) $ 37.9 $ - - ------------------------------------------------------------------------------------------------------------------- Net income 8.6 - 8.6 - - - Dividends to shareholders (9.6) - (9.6) - - - Purchases of common stock retired (66.3) (9.8) (56.5) - - - Change in net unrealized investment gains and losses, after tax 54.6 - - - 54.6 - - ------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 687.0 398.4 1,067.1 (871.0) 92.5 - - ------------------------------------------------------------------------------------------------------------------- Net income 43.0 - 43.0 - - - Dividends to shareholders (9.0) - (9.0) - - - Purchases of common stock retired (103.7) (11.5) (92.2) - - - Change in net unrealized investment gains and losses, after tax 41.6 - - - 41.6 - - ------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 658.9 386.9 1,008.9 (871.0) 134.1 - - ------------------------------------------------------------------------------------------------------------------- Net income 82.2 - 82.2 - - - Dividends to shareholders (13.1) - (13.1) - - - Purchases of common stock retired (19.8) (1.8) (18.0) - - - Change in net unrealized investment gains and losses and other, after tax (8.9) - - - (8.0) (.9) Other 3.2 - 3.2 - - - - ------------------------------------------------------------------------------------------------------------------- BALANCES AT DECEMBER 31, 1998 $702.5 $385.1 $1,063.2 $(871.0) $126.1 $(.9) - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-3 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, --------------------------------------- Millions 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Net income $ 82.2 $ 43.0 $ 8.6 Reconciliation of net income to cash flows from operating activities: Undistributed earnings from unconsolidated insurance affiliates (19.1) (14.7) (8.2) Net realized investment gains (71.0) (96.7) (38.5) Net unrealized gains on financial instruments (12.1) (11.1) (1.7) Depreciation and amortization of servicing assets, goodwill and other 63.1 71.0 92.8 Amortization of deferred credit (2.7) - - Write-off of goodwill and other intangible assets - - 32.6 Mortgage loan production (10,866.3) (4,403.3) (3,831.6) Mortgage loan sales and amortization 10,709.2 4,198.9 3,897.7 (Gain) loss on sales of mortgage servicing rights (15.2) 8.0 (10.1) (Decrease) increase in unearned insurance premiums (7.0) 5.4 37.6 Increase in insurance premiums receivable (2.4) (3.9) (6.9) Decrease (increase) in deferred insurance policy acquisition costs 2.5 (1.1) (6.5) Increase in insurance loss reserves 13.7 6.5 21.2 Net change in current and deferred income taxes receivable and payable 12.0 4.5 11.8 Change in other assets 26.4 55.9 (29.3) Change in accounts payable and other liabilities 120.5 11.1 33.7 Other, net (5.0) 17.4 (1.4) --------------------------------------- Net cash provided from (used for) operating activities 28.8 (109.1) 201.8 - ------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Net decrease in short-term investments 47.0 4.7 36.1 Sales of common stocks and other investments 168.5 207.9 231.6 Sales of fixed maturity investments 132.8 92.5 131.7 Purchases of common stocks and other investments (61.1) (54.8) (85.0) Purchases of fixed maturity investments (122.7) (102.6) (180.8) Acquisitions of consolidated insurance affiliates, net of cash balances acq(167.5) - (13.2) Investments in unconsolidated insurance affiliates (70.3) (44.4) (107.6) Collections on other mortgage origination and servicing assets 278.4 274.2 175.3 Additions to capitalized mortgage servicing rights (249.1) (139.5) (88.6) Proceeds from sales of mortgage servicing rights 182.8 242.6 11.7 Additions to other mortgage origination and servicing assets (296.9) (285.1) (205.7) Collections on notes receivable 7.0 - - Net purchases of fixed assets (5.4) (2.9) (7.3) --------------------------------------- Net cash (used for) provided from investing activities (156.5) 192.6 (101.8) - ------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net issuances (repayments) of short-term debt 176.8 162.4 (36.2) Issuances of long-term debt - - 15.0 Repayments of long-term debt (1.1) (131.0) - Purchases of common stock retired (19.5) (103.7) (66.3) Cash dividends paid to common and preferred shareholders (13.1) (9.0) (9.6) Other - - (.8) --------------------------------------- Net cash provided from (used for) financing activities 143.1 (81.3) (97.9) - ------------------------------------------------------------------------------------------------------------------- Net increase in cash during year 15.4 2.2 2.1 Cash balance at beginning of year 7.0 4.8 2.7 --------------------------------------- Cash balance at end of year $ 22.4 $ 7.0 $ 4.8 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries and have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP"). All significant intercompany transactions have been eliminated in consolidation. The financial statements include all adjustments considered necessary by management to fairly present the financial position, results of operations and cash flows of Fund American. 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 as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts in the prior year financial statements have been restated to conform with the current year presentation. INVESTMENT SECURITIES Fund American's portfolio of fixed maturity investments, common equity securities and other investments are mainly classified as available for sale and are reported at fair value as of the balance sheet date. Net unrealized investment gains and losses, after tax, associated with such investments are reported as a net amount in a separate component of shareholders' equity. Changes in net unrealized investment gains and losses, after tax, are reported on the income statement as a component of comprehensive net income. Premiums and discounts on fixed maturity investments are accreted to income over the anticipated life of the investment. Other investments include: (i) equity securities having no established public market value which are recorded at an internally appraised fair value; (ii) securities which, due to restrictions regarding resale, are recorded at a discount to the quoted market value for similar unrestricted securities; (iii) investment limited partnership interests which are recorded using the equity method of accounting; (iv) mortgage loans held for investment which are recorded at the lower of cost or fair value, determined on an individual loan basis; and (v) financial instruments which are classified as trading securities and are recorded at fair value with realized and unrealized gains and losses reported on the income statement as gains or losses on financial instruments. Realized gains and losses resulting from sales of investment securities or from other than temporary impairments of value are accounted for using the specific identification method. Short-term investments are carried at amortized cost, which approximated fair value as of December 31, 1998 and 1997, and comprise securities which mature or become available for use within one year. Fund American's consolidated insurance operations are required to maintain deposits with insurance regulators of certain states in order to maintain their insurance licenses. The total fair value of such F-5 deposits totalled $12.0 million and $11.3 million as of December 31, 1998 and 1997, respectively. INSURANCE AND REINSURANCE OPERATIONS Premiums written are recognized as revenues as earned ratably over the terms of the related policies or reinsurance treaties. Unearned premiums represent the portion of premiums applicable to future insurance or reinsurance coverage provided by policies or treaties in force. Deferred policy acquisition costs represent commissions, premium taxes, brokerage expenses and other costs which are directly attributable to and vary with the production of new business and are deferred and amortized over the applicable premium recognition period. Deferred acquisition costs are limited to the amount expected to be recovered from future earned premiums and anticipated investment income. F-6 Losses and loss adjustment expenses are charged against income as incurred. Unpaid insurance losses and loss adjustment expenses are based on estimates by claims adjusters, legal counsel and actuarial staff of the ultimate costs of settling claims, including the effects of inflation and other societal and economic factors. Unpaid reinsurance losses and loss adjustment expenses are based on reports received from ceding companies. Unpaid loss and loss adjustment expense reserves represent management's best estimate of ultimate losses and loss adjustment expenses net of estimated salvage and subrogation recoveries, if applicable. Such estimates are regularly reviewed and updated and any adjustments resulting therefrom are reflected in current operations. The process of estimating loss and loss adjustment expenses involves a considerable degree of judgement by management and the ultimate amount of expense to be incurred could be considerably greater than or less than the amounts currently reflected in the financial statements. In the normal course of business, Fund American's insurance subsidiaries seek to limit losses that may arise from catastrophes or other events that may cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Fund American remains contingently liable for risks reinsured with third parties to the extent that the reinsurer is unable to honor its obligations under reinsurance contracts at the time of loss. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of premiums written. Amounts applicable to reinsurance ceded for unearned premium reserves and loss and loss adjustment expense reserves (e.g., prepaid reinsurance premiums and reinsurance recoverable on unpaid losses, respectively) are not material and have been included as a component of other assets. Expense allowances received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs and are deferred and amortized accordingly. MORTGAGE BANKING OPERATIONS Fund American acquired Source One in 1986. The purchase price paid for Source One in 1986 was in excess of the estimated fair value of the net assets acquired on that date and was allocated to goodwill. Prior to December 1996 Source One's goodwill was being amortized over 20 years. During 1996 Fund American re-assessed the recoverability of goodwill and certain other intangible assets related to Source One and determined that it should write-off all such assets related to Source One. This resulted in a $32.6 million pretax write-off of goodwill and other intangible assets. Factors considered in the determination to write-off all Source One's goodwill and other assets were (i) increased competition and industry consolidation during 1996 which had adversely impacted the value of both the mortgage loan production and servicing operations of Source One and (ii) the attainment of a definitive agreement in the fourth quarter of 1996 to sell the majority of Source One's mortgage servicing portfolio at essentially book value. F-7 Mortgage loans held for sale are stated at the lower of aggregate cost or fair value, including the fair value of commitments to originate and sell mortgage loans. Conventional mortgage loans are placed on a non-accrual basis when delinquent 90 days or more as to interest or principal. Interest on delinquent FHA insured loans is accrued at the insured rate beginning on the sixty-first day of delinquency. Interest on delinquent VA guaranteed loans is accrued at the loan rate during the period of delinquency. Gains and losses from sales of mortgage loans are recognized when the proceeds are received. Loan origination fees, net of certain direct costs, are deferred and recognized as income when the related mortgage loans are sold. Discounts from the origination of mortgage loans held for sale are deferred and recognized as adjustments to gains or losses on sales. F-8 Capitalized mortgage servicing includes certain costs incurred in the origination and acquisition of mortgage servicing rights which are deferred and amortized over the expected life of the loan. The total cost of acquiring mortgage loans, either through origination activities or purchase transactions, is allocated between the mortgage servicing rights and the loans based on their relative fair values. The fair values of mortgage servicing rights are estimated by calculating the present value of the expected future net cash flows associated with such rights, incorporating assumptions that market participants would use in their estimates of future servicing income and expense. A current market rate is used to discount estimated future cash flows. Impairment of capitalized mortgage servicing rights is measured on a disaggregated basis by stratifying the mortgage servicing rights based on one or more predominant risk characteristics of the underlying loans. Impairment is recognized through a valuation allowance for each individual stratum. The valuation allowance for Source One's principal recourse portfolio includes a reserve for estimated losses on the corresponding loans. Pool loan purchases, which are carried at cost, represent FHA insured, VA guaranteed and conventional loans which were either delinquent or in the process of foreclosure at the time they were purchased from GNMA, FNMA or FHLMC mortgage-backed security pools which Source One services. Interest is accrued on these purchased loans at a rate based on expected recoveries. Mortgage claims receivable represent claims filed primarily with FHA and VA. These receivables are carried at cost less an estimated allowance for amounts that are not fully recoverable from the claims filed with the underlying mortgage insuring agencies. Real estate acquired is stated at the lower of fair value less estimated selling costs or the recorded balance satisfied at the date of acquisition, as determined on an individual property basis. Costs related to maintaining the properties are charged to expense as incurred. Mortgage servicing revenue represents fees earned for servicing real estate mortgage loans owned by investors and late charge income. The servicing fees are calculated based on the outstanding principal balances of the loans serviced and are recognized together with late charge income when received. FOREIGN CURRENCY TRANSLATION Folksamerica operates a branch office in Toronto, Canada to service its Canadian customers. Net unrealized foreign currency translation gains and losses, after tax, associated with Folksamerica's Canadian operation are reported as a net amount in a separate component of shareholders' equity. Changes in the values of these operations due to currency fluctuations, after tax, are reported on the income statement as a component of comprehensive net income. EARNINGS PER SHARE Basic earnings per share amounts are based on the weighted average number of Shares outstanding. In the basic earnings per share calculation, net income is reduced by preferred stock dividends to arrive at earnings applicable to common stock. Diluted earnings per share amounts are based on the weighted average number of Shares and potential dilutive Shares outstanding. Potential F-9 dilutive Shares include stock options, warrants and preferred stock redeemable for Shares. In the diluted earnings per share calculation, net income is reduced by preferred stock dividends to arrive at earnings applicable to common stock. F-10 The following table outlines the Company's computation of earnings per share for the years ended December 31, 1998, 1997 and 1996:
- ------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ----------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS PER SHARE NUMERATORS (IN MILLIONS): After tax earnings $ 82.2 $ 49.0 $ 8.6 Preferred stock dividends of subsidiary (3.7) (3.7) (3.7) ----------------------------------- After tax earnings applicable to common stock 78.5 45.3 4.9 Loss on early extinguishment of debt, after tax - (6.0) - ----------------------------------- Net income available applicable to common stock $ 78.5 $ 39.3 $ 4.9 ----------------------------------- ----------------------------------- Comprehensive net income applicable to common stock $ 69.6 $ 81.0 $ 59.5 - ------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE NUMERATORS (IN MILLION): After tax earnings applicable to common stock $ 78.5 $ 45.3 $ 4.9 After tax dilution to earnings from unconsolidated insurance affiliates (.4) (.2) - ----------------------------------- Diluted after tax earnings available applicable to common stock 78.1 45.1 4.9 Loss on early extinguishment of debt, after tax - (6.0) - ----------------------------------- Diluted net income available applicable to common stock $ 78.1 $ 39.1 $ 4.9 ----------------------------------- ----------------------------------- Diluted comprehensive net income applicable to common stock $ 69.2 $ 80.8 $ 59.5 ----------------------------------- - ------------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE DENOMINATORS (IN THOUSANDS): Basic earnings per share numerator (average common shares outstanding) 5,866 6,570 7,429 Dilutive stock options and warrants to acquire common stock (a) 669 674 681 ----------------------------------- Diluted earnings per share denominator 6,535 7,244 8,110 ----------------------------------- - ------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS PER SHARE (IN DOLLARS): After tax earnings $13.38 $ 6.89 $ .66 Loss on early extinguishment of debt, after tax - (.91) - ----------------------------------- Net income applicable to common stock $13.38 $ 5.98 $ .66 ----------------------------------- ----------------------------------- Comprehensive net income $11.87 $12.33 $ 8.01 ----------------------------------- - ------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE (IN DOLLARS): After tax earnings $11.94 $ 6.22 $ .60 Loss on early extinguishment of debt, after tax - (.82) - ----------------------------------- Net income applicable to common stock and assumed conversions $11.94 $ 5.40 $ .60 ----------------------------------- ----------------------------------- Comprehensive net income $10.58 $11.15 $ 7.33 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
(a) See Note 11 for detailed information concerning the Company's outstanding dilutive stock options and warrants to acquire common stock. F-11 ACCOUNTING STANDARDS RECENTLY ADOPTED AND ISSUED In December 1996 the Financial Accounting Standards Board (the "FASB") issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125" which deferred the adoption of certain transfer and collateral provisions of SFAS No. 125 to periods beginning after December 31, 1997. The adoption of SFAS No. 127, did not have a material effect on Fund American's current financial position or results of operations. In June 1997 the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprises and Related Information" which establishes new standards for reporting information about operating segments. The required information under SFAS No. 131 is contained in Note 14. In March 1998, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position ("SOP") 98-1 entitled "Accounting For the Cost of Computer Software Developed or Obtained for Internal Use" which requires the capitalization of certain prospective costs in connection with developing or obtaining software for current use. The adoption of SOP 98-1 is not expected to have a material impact on Fund American's financial position or results of operations. In June 1998 the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which requires companies to record all derivatives on the balance sheet as either assets or liabilities and measure those instruments at fair value. The manner in which companies are to record gains and losses resulting from changes in the values of those derivatives depends on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 is effective beginning in 2000 with earlier adoption permitted. The adoption of SFAS No. 133, is not expected to have a material effect on Fund American's financial position or results of operations. In October 1998, the AICPA issued SOP 98-7 entitled "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk". SOP 98-7 provides guidance on how to account for all insurance and reinsurance contracts that do not transfer insurance risk, except for long-duration life and health insurance contracts. SOP 98-7 is effective for periods beginning January 1, 2000, with early adoption permitted. Fund American is currently evaluating the impact of the adoption of SOP 98-7 and the potential effects on its financial position and results of operations. NOTE 2. REINSURANCE OPERATIONS On August 18, 1998, Fund American acquired all of the remaining outstanding shares of Folksamerica Common Stock for $169.1 million thereby causing Folksamerica to become a consolidated subsidiary of the F-12 Company as of that date. Before the August 18th transaction, Fund American owned a 50% non-consolidated interest in Folksamerica, primarily through the Folksamerica Preferred Stock with fixed price warrants to acquire common stock. As a result of the Folksamerica transaction, Fund American has restated its December 31, 1997 balance sheet and its income statement for the year ended December 31, 1997 to account for the portion of its investment in Folksamerica that was reported at fair value in accordance with SFAS No. 115 entitled "Accounting for Certain Investments in Debt and Equity Securities" to its original cost in accordance with the purchase accounting principles of Accounting Principles Board Opinion ("APB") No. 18 entitled "The Equity Method of Accounting for Investments in Common Stock". Because the cost of Fund American's investment in Folksamerica was less than the fair value of Folksamerica's net identifiable assets at August 18, 1998, Fund American recorded a $39.8 million deferred credit ($37.1 million as of December 31, 1998) that will be amortized to income over 5 years. Supplemental condensed pro forma financial information for the year ended December 31, 1998, which assumes that Fund American's acquisition of all the outstanding Folksamerica Common Stock had occurred as of January 1, 1998, follows:
- --------------------------------------------------------------------------------------------------------------------- PRO FORMA YEAR ENDED Millions, except per share amounts DECEMBER 31, 1998 - --------------------------------------------------------------------------------------------------------------------- Total revenues $756.0 Net income $ 98.7 Comprehensive net income $ 99.5 BASIC EARNINGS PER SHARE: Net income $16.19 Comprehensive net income $16.33 DILUTED EARNINGS PER SHARE: Net income $14.46 Comprehensive net income $14.59 - ---------------------------------------------------------------------------------------------------------------------
The pro forma information presented does not purport to represent what Fund American's results of operations actually would have been had Fund American acquired all the outstanding common stock of Folksamerica as of January 1, 1998, or to project Fund American's results of operations for any future date or period. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE ACTIVITY The following table summarizes Fund American's loss and loss adjustment expense reserve activity relating to Folksamerica for the interim period from August 18, 1998 to December 31, 1998: F-13
- ------------------------------------------------------------------------------------------------------------------- Millions YEAR ENDED DECEMBER 31, 1998 - ------------------------------------------------------------------------------------------------------------------- Beginning balance $ - Gross loss and loss adjustment expenses acquired 726.1 Less beginning reinsurance recoverable (124.1) ----------------- Net loss and loss adjustment expenses acquired 602.0 Losses and loss adjustment expenses incurred relating to: Current year losses 58.6 Prior year losses 1.1 Loss and loss adjustment expenses paid relating to: Current year losses (13.0) Prior year losses (54.5) ----------------- Net ending balance 594.2 Plus ending reinsurance recoverable 129.0 ----------------- Gross ending balance $ 723.2 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
As of December 31, 1998, Folksamerica carried reported case reserves for environmental and asbestos exposures of $14.9 million ($10.9 million net of reinsurance) and $29.5 million ($17.9 million net of reinsurance), respectively. Folksamerica also holds IBNR for these exposures of $25.2 million ($19.2 million net of reinsurance). ADDITIONAL REINSURANCE OPERATIONS INFORMATION For the period from August 18, 1998 to December 31, 1998, Fund American recorded $73.7 million of premiums written, $85.4 million of premiums earned, $29.1 million of reinsurance acquisition costs and $59.7 million of loss and loss adjustment expenses relating to Folksamerica. These amounts are shown net of reinsurance ceded by Folksamerica of $9.4 million of premiums written, $8.7 million of premiums earned, $.9 million of reinsurance acquisition costs and $18.9 million of loss and loss adjustment expenses. Folksamerica's policyholders' surplus, as reported to various regulatory authorities as of December 31, 1998 was $328.5 million and its statutory net income for the period from August 18, 1998 to December 31, 1998 was $9.0 million. The principal differences between Folksamerica's statutory amounts and the amounts reported in accordance with GAAP (Folksamerica's stand-alone shareholders' equity was $302.0 million at December 31, 1998 and its net income was $5.5 million for the year then ended) include deferred taxes, deferred acquisition costs and market value adjustments for debt securities. Folksamerica's statutory policyholders' surplus at December 31, 1998 was in excess of the minimum requirements of relevant state insurance regulations. Under the insurance laws of the states under which Folksamerica is incorporated or licensed to write business, an insurer is restricted with respect to the amount of dividends it may pay without prior approval by state regulatory authorities. Accordingly, there is no assurance that dividends may be paid by Folksamerica in the future. At December 31, 1998, Folksamerica had the ability to pay dividends to its shareholders of $32.9 million without prior approval of regulatory authorities. F-14 NOTE 3. INSURANCE OPERATIONS CONSOLIDATED INSURANCE OPERATIONS In 1995 White Mountains created WMIC and commenced its operations. On December 1, 1995, White Mountains acquired Valley and Charter for $41.7 million in cash less $3.0 million of purchase price adjustments. The purchase price paid for Valley and Charter was $.9 million less than the aggregate book value and estimated fair value of the net assets of the companies on the date of acquisition. The resulting negative goodwill is being amortized to income on a straight-line basis over five years. On January 19, 1996, VIC purchased Valley National for $13.2 million, net of cash balances acquired. Assets acquired pursuant to the Valley National acquisition included an investment portfolio, consisting principally of fixed maturity investments, totalling $6.7 million. The excess purchase price of $6.4 million is being amortized over a five year period. In 1998, 1997 and 1996, Valley, Charter and WMIC had $167.8 million, $157.5 million and $154.3 million of gross written premiums, respectively, primarily in California, Oregon, Texas and Washington. In 1998, 1997 and 1996 Valley, Charter and WMIC had $160.6 million, $145.3 million and $109.7 million of earned premiums. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE ACTIVITY The following table summarizes Valley, Charter and WMIC's loss and loss adjustment expense reserve activity for the years ended December 31, 1998, 1997 and 1996:
- ------------------------------------------------------------------------------------------------------------------- Year Ended Millions December 31, --------------------------- 1998 1997 1996 --------------------------- Beginning balance $ 71.9 $ 65.4 $ 44.1 Less beginning reinsurance recoverable (8.7) (9.2) (7.3) --------------------------- Net loss and loss adjustment reserve 63.2 56.2 36.8 Losses and loss adjustment expenses incurred relating to: Current year losses 108.4 99.6 82.1 Prior year losses 6.7 (2.5) 3.5 Loss and loss adjustment expenses paid relating to: Current year losses (65.5) (59.7) (47.8) Prior year losses (33.2) (30.4) (18.4) --------------------------- Net ending balance 79.6 63.2 56.2 Plus ending reinsurance recoverable 8.9 8.7 9.2 --------------------------- Ending balance $ 88.5 $ 71.9 $ 65.4 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
F-15 ADDITIONAL INSURANCE OPERATIONS INFORMATION Total policyholders' surplus of Valley, Charter and WMIC, as reported to various regulatory authorities, as of December 31, 1998 and 1997, was $105.7 million and $97.7 million, respectively. Statutory net income for the years ended December 31, 1998 and 1997 for Valley, Charter and WMIC totalled $8.4 million and $11.0 million, respectively. For the year ended December 31, 1996, Valley had a statutory net loss of $6.4 million. The principal differences between Valley, Charter and WMIC's statutory amounts and the amounts reported in accordance with GAAP (VGI's stand-alone shareholders' equity was $109.4 million at December 31, 1998 and its net income was $4.8 million for the year then ended) include deferred taxes, surplus debentures and deferred acquisition costs. Valley, Charter and WMIC's statutory policyholders' surplus at December 31, 1998 and 1997, was in excess of the minimum requirements of relevant state insurance regulations. Under the insurance laws of the various states under which Valley, Charter and WMIC are incorporated or licensed to write business, an insurer is restricted with respect to the amount of dividends it may pay without prior approval by state regulatory authorities. Accordingly, there is no assurance that dividends may be paid by Valley, Charter and WMIC in the future. At December 31, 1998 and 1997, $1.1 million and $9.8 million, respectively, of Valley, Charter and WMIC's statutory surplus was available for the payment of dividends to its shareholders without prior approval of regulatory authorities. NOTE 4. INVESTMENT SECURITIES Fund American's net investment income is comprised primarily of interest income earned on mortgage loans held for sale (gross of related interest expense on short-term borrowings used to finance such loans), interest income from its fixed maturity investments, dividend income from its equity investments and interest income from its short-term investments. Net investment income consisted of the following:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Investment income: Mortgage loans held for sale $ 81.4 $ 43.1 $ 39.3 Fixed maturity investments 28.4 11.3 10.4 Common equity securities 3.6 7.3 4.3 Short-term investments 3.5 3.9 6.6 Other 2.3 - (2.3) ------------------------------------- Total investment income 119.2 65.6 58.3 Less investment expenses and other charges (.8) (.5) (1.0) ------------------------------------- Net investment income, before tax $118.4 $ 65.1 $ 57.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-16 Total net investment gains, before tax, associated with Fund American's investment portfolio consisted of the following:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Gross realized investment gains $ 74.0 $ 98.6 $ 43.3 Gross realized investment losses (3.0) (1.9) (4.8) ------------------------------------- Net realized investment gains 71.0 96.7 38.5 Change in net unrealized investment holding gains (a) (44.2) (10.1) 68.0 ------------------------------------- Total net investment gains, before tax $ 26.8 $ 86.6 $ 106.5 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Excludes net unrealized investment gains and losses recorded from Fund American's investments in unconsolidated insurance affiliates. The components of Fund American's ending net unrealized investment gains and losses on its investment portfolio and its investments in unconsolidated insurance affiliates were as follows:
- --------------------------------------------------------------------------------------------------------------------- December 31, ------------------------ Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Investment securities: Gross unrealized investment gains $ 68.4 $ 112.1 Gross unrealized investment losses (2.5) (2.0) ------------------------ Net unrealized gains from investment securities 65.9 110.1 Net unrealized gains from investments in unconsolidated insurance affiliates 128.1 96.2 ------------------------ Total net unrealized investment gains, before tax $ 194.0 $ 206.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-17 The cost or amortized cost, gross unrealized investment gains and losses, and carrying values of Fund American's fixed maturity investments as of December 31, 1998 and 1997, were as follows:
- --------------------------------------------------------------------------------------------------------------------- December 31, 1998 --------------------------------------------------------- Cost or Gross Gross amortized unrealized unrealized Carrying Millions cost gains losses value - --------------------------------------------------------------------------------------------------------------------- Debt securities issued by industrial corporations $351.9 $ 7.0 $(1.0) $357.9 U. S. Government and agency obligations 217.6 4.7 (.3) 222.0 Municipal obligations 189.1 2.8 (.1) 191.8 GNMA Mortgage-backed securities 79.0 .9 (.7) 79.2 MediaOne redeemable preferred stock 49.8 - - 49.8 Foreign government obligations 26.7 .3 (.1) 26.9 Aggregate of holdings less than $10 million 2.0 - - 2.0 --------------------------------------------------------- Total fixed maturity investments $916.1 $15.7 $(2.2) $929.6 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
December 31, 1997 --------------------------------------------------------- Cost or Gross Gross amortized unrealized unrealized Carrying Millions cost gains losses value - --------------------------------------------------------------------------------------------------------------------- MediaOne redeemable preferred stock $ 49.4 $ - $ - $ 49.4 Municipal obligations 33.3 .6 - 33.9 Debt securities issued by industrial corporations 32.4 1.0 (.7) 32.7 U. S. Government and agency obligations 32.3 .9 - 33.2 GNMA Mortgage-backed securities 15.4 1.0 - 16.4 Aggregate of holdings less than $10 million 2.6 .1 - 2.7 --------------------------------------------------------- Total fixed maturity investments $165.4 $3.6 $(.7) $168.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
The cost or amortized cost and carrying value of Fund American's fixed maturity investments at December 31, 1998 and 1997, are presented below by contractual maturity. Actual maturities could differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
- --------------------------------------------------------------------------------------------------------------------- December 31, 1998 -------------------------- Cost or Amortized Carrying Millions Cost Value - --------------------------------------------------------------------------------------------------------------------- Due in one year or less $109.4 $108.1 Due after one year through five years 278.9 279.9 Due after five years through ten years 352.8 365.9 Due after ten years 98.0 99.1 GNMA Mortgage-backed securities 77.0 76.6 ---------------------------- Total $916.1 $929.6 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-18 Sales of investments, excluding short-term investments, totalled $301.3 million, $300.4 million and $363.3 million for the years ended December 31, 1998, 1997 and 1996, respectively. A non-cash exchange of investment securities totalling $2.3 million is not reflected in the 1996 Consolidated Statement of Cash Flows. There were no non-cash exchanges of investment securities during 1998 or 1997. Fund American adopted the provisions of SFAS No. 130 during 1997 and now reports the change in net unrealized investment gains, after tax, on its income statement to arrive at comprehensive net income. All prior period income statements have been restated to reflect application of this statement. The components of the change in net unrealized investment gains, after tax, are as follows:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Net realized investment gains $ 71.0 $ 96.7 $ 38.5 Income tax expense applicable to net realized investment gains (24.9) (33.8) (13.5) -------------------------------------- Net realized investment gains, after tax $ 46.1 $ 62.9 $ 25.0 -------------------------------------- -------------------------------------- Net unrealized investment holding gains arising during the year $ 58.6 $ 160.9 $ 122.5 Income tax expense applicable to net unrealized investment holding gains (20.5) (56.3) (42.9) -------------------------------------- Net unrealized investment holding gains arising during the year, after tax 38.1 104.6 79.6 Net unrealized gains reclassed to realized gains for investments sold, after tax(46.1) (62.9) (25.0) -------------------------------------- Change in net unrealized investment gains, after tax $(8.0)(a) $ 41.7 $ 54.6 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Excludes a $.9 million after tax unrealized loss associated with foreign currency translation adjustments NOTE 5. CAPITALIZED MORTGAGE SERVICING Source One estimates the fair values of its mortgage servicing rights by calculating the present value of the expected future net cash flows associated with such rights. In making those estimates, Source One incorporates assumptions that market participants would use in their estimates of future servicing income and expense. To measure impairment of its owned mortgage servicing rights, Source One has determined that the predominant risk characteristics inherent in the portfolio are prepayment risk, risk of default and operational risk. As a result, Source One has stratified its owned mortgage loan servicing portfolio by interest rate, loan type (investor), original term to maturity and principal recourse. In estimating the fair value of its owned mortgage loan servicing portfolio, Source One uses market consensus prepayment rates and discounts future net cash flows using representative market interest rates which were 10.5% for conventional loans, 12.0% for insured loans, and 21.0% for recourse loans. The fair value of each stratum is computed and compared to its recorded book value to determine if an F-19 impairment valuation allowance, or recovery of a previously established valuation allowance, is required. As a result of the 1997 servicing sale, Source One's recourse portfolio has become a significant component of its total remaining owned servicing portfolio. Included in Source One's calculation for measuring impairment of its capitalized servicing asset is an $5.2 million and $8.2 million pretax reserve for estimated recourse losses on the corresponding loans in determining the fair value of its principal recourse portfolio as of December 31, 1998 and 1997, respectively. The discount rate and prepayment assumptions are significant factors used in estimating the fair value of Source One's mortgage servicing rights. Accordingly, the value of mortgage servicing rights can be significantly impacted by changes in interest rates. Source One adopted certain provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" in the 1997 first quarter. SFAS No. 125 served to eliminate the distinction between "normal" servicing rights and excess servicing receivables. Source One estimated the fair value of its portfolio during 1997 in accordance with SFAS No. 125 which did not materially effect Source One's 1997 results. Prior to the adoption of SFAS No. 125, Source One estimated the fair value of its capitalized excess servicing asset by discounting the anticipated future cash flows over the estimated life of the related loans. Source One uses "interest only strip" interest rates to determine the appropriate discount rates and prepayment speed assumption rates that are based on interest rates, loan types (investor) and original term to maturity. The discount rate used to capitalize excess servicing for the year ended December 31, 1996, ranged from 12.0% to 12.6%. For the year ended December 31, 1996, the weighted average discount rate inherent in the carrying amount of the capitalized excess servicing asset was 10.4%. The following table summarizes the fair value of mortgage servicing rights and certain characteristics of Source One's servicing portfolio related to such mortgage servicing rights by loan type as of December 31, 1998:
- --------------------------------------------------------------------------------------------------------------------- Fair value Principal Weighted Weighted Weighted of mortgage balance average average average servicing rights serviced(a) interest maturity service (millions) (millions) rate (months) fee - --------------------------------------------------------------------------------------------------------------------- Loan Type: Insured $117.4 $4,901 7.47% 334 .50% Conventional 33.0 1,573 7.78 271 .39 Recourse 25.9 1,787 8.43 202 .47 Adjustable 1.7 106 7.89 256 .41 -------------------------------- Total servicing portfolio $178.0 $8,367 7.74% 293 .47% - ---------------------------------------------------------------------------------------------------------------------
F-20 (a) Excludes $635 million of principal balance of mortgage servicing rights not capitalized prior to the adoption of an accounting standard implemented by Source One in 1995 and $195 million of originations funded but not yet capitalized. The following table summarizes changes in Source One's capitalized servicing asset:
- --------------------------------------------------------------------------------------------------------------------- Deferred gain on Total Mortgage Valuation sale of capitalized Millions servicing allowance Subservicing servicing servicing - --------------------------------------------------------------------------------------------------------------------- Balances at January 1, 1996 $438.1 $(28.0) $ - $(13.0) $397.1 Additions 125.5 - - - 125.5 Scheduled amortization (69.9) - - - (69.9) Impairment/unscheduled amortization (1.1) (8.2) - - (9.3) Amortization of deferred gain - - - 6.1 6.1 Recourse loan losses - 7.3 - - 7.3 Sales (45.9) - - - (45.9) - --------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 446.7 (28.9) - (6.9) 410.9 Additions 90.4 (1.2) - - 89.2 Scheduled amortization (37.5) - (8.9) - (46.4) Impairment/unscheduled amortization - (21.2) (.5) - (21.7) Amortization of deferred gain - - - 6.9 6.9 Recourse loan losses - 3.9 - - 3.9 Sales (273.7) 2.3 9.6 - (261.8) - --------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 225.9 (45.1) .2 - 181.0 Additions 240.8 - - - 240.8 Scheduled amortization (38.6) - (1.8) - (40.4) Impairment/unscheduled amortization - (14.7) - - (14.7) Recourse loan losses - 2.7 - - 2.7 Sales (221.2) 21.5 - - (199.7) - --------------------------------------------------------------------------------------------------------------------- BALANCES AT DECEMBER 31, 1998 $206.9 $(35.6) $(1.6) $ - $169.7 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-21 During 1998 Source One sold the rights to service $10.6 billion of nonrecourse mortgage loans for cash proceeds of $227.9 million resulting in a pretax gain on sale of $15.2 million. During 1997 Source One sold the rights to service $17.0 billion of nonrecourse mortgage loans for cash proceeds of $266.9 million resulting in a pretax loss on sale of $8.0 million including a related loss on the assumption of subservicing. During 1996 Source One sold the rights to service $3.3 billion of mortgage loans for net proceeds of $55.9 million, resulting in a pretax gain of $10.1 million. As part of the 1998 and 1997 servicing sales, Source One retained the right to subservice $4.1 billion and $17.0 billion of these loans, respectively, for a contracted fee through 2001. Subservicing assets are amortized on a straight-line basis over the subservicing period and are tested for impairment. During 1994 Source One sold the rights to service $3.9 billion of mortgage loans to a third party and retained the rights to subservice those loans pursuant to a subservicing agreement. In connection with the servicing sale, a pretax gain of $19.9 million was deferred in 1994 and was to be recognized as income over the five-year life of the subservicing agreement. In 1996, the third party sold the rights to service approximately $1.0 billion of these loans subserviced by Source One which resulted in Source One recognizing $2.4 million of the deferred gain on an accelerated basis. In 1997, the third party sold the remainder of the loans subserviced by Source One which resulted in Source One recognizing the remaining balance of the deferred gain during 1997. NOTE 6. MORTGAGE SERVICING Source One services loans throughout the United States. Source One's portfolio of mortgage loans serviced (including loans subserviced, interim servicing contracts and portfolios under contract to acquire but excluding loans sold but not transferred) totalled $25.1 billion and $26.5 billion as of December 31, 1998 and 1997, respectively. The following table summarizes the mortgage loan servicing portfolio as of December 31, 1998:
- --------------------------------------------------------------------------------------------------------------------- Weighted average --------------------------------------------------------------- Principal Remaining balance Loan contractual serviced balance Interest Net servicing life Loan type (millions) (thousands) rate fee rate (months) - --------------------------------------------------------------------------------------------------------------------- Residential Conventional $ 3,929 $ 64 8.14% .396% 237 FHA 2,486 75 7.74 .398 334 VA 2,736 81 7.26 .400 331 Commercial 46 927 7.16 .189 173 ------------- Owned servicing portfolio $ 9,197 $ 72 7.76% .397% 291 Subservicing portfolio 15,915 ------------- - --------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------- Total mortgage servicing portfolio $25,112 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
The servicing fee rates in the preceding table are shown after deducting applicable guarantee fees. Guarantee fees, when applicable, range from 6 basis points for governmental loans to approximately 30 basis points for certain conventional loans. Certain loans sold to private investors have no guarantee fees. F-22 The following tables summarize Source One's owned mortgage loan servicing portfolio by interest rate range and by location of property:
- --------------------------------------------------------------------------------------------------------------------- December 31, 1998 December 31, 1997 ------------------------------------------- -------------------------------------------- Aggregate Weighted Aggregate Weighted Number principal average Number principal average Interest rate of balance interest of balance interest range loans (millions) rate loans (millions) rate - --------------------- ------------------------------------------- -------------------------------------------- 5.99% and lower 438 35 5.17% 843 $ 66 5.41% 6.00% - 6.49% 1,193 127 6.22 1,823 159 6.13 6.50% - 6.99% 10,870 1,111 6.64 4,166 319 6.66 7.00% - 7.49% 28,036 2,337 7.08 12,968 729 7.17 7.50% - 7.99% 30,928 2,550 7.58 29,240 2,455 7.63 8.00% - 8.49% 15,778 1,155 8.12 27,989 2,280 8.13 8.50% - 8.99% 17,999 809 8.62 32,178 1,867 8.59 9.00% - 9.49% 5,934 275 9.12 13,452 722 9.07 9.50% - 9.99% 7,580 339 9.64 29,142 1,420 9.55 10% and above 9,574 459 10.73 32,488 1,610 10.49 ------------------------------------------- -------------------------------------------- Total 128,330 $9,197 7.76% 184,289 $11,627 8.52% - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------- December 31, 1998 December 31, 1997 ------------------------------------------- --------------------------------------------- Aggregate Aggregate Number principal Percentage Number principal Percentage of balance of servicing of balance of servicing State loans (millions) portfolio loans (millions) portfolio - --------------------- ------------------------------------------- --------------------------------------------- California 17,617 $1,795 19.5% 20,459 $ 1,889 16.3% New York 17,572 935 10.2 22,118 1,162 10.0 Texas 11,448 676 7.4 15,655 736 6.3 Washington 5,033 486 5.3 7,889 690 5.9 Florida 7,849 471 5.1 12,894 663 5.7 Michigan 7,810 393 4.3 10,773 520 4.5 Maryland 4,159 377 4.1 5,020 362 3.1 New Jersey 5,145 364 4.0 7,088 503 4.3 Ohio 4,461 298 3.2 6,658 357 3.1 Illinois 3,441 260 2.8 6,335 420 3.6 Other 43,795 3,142 34.1 69,400 4,325 37.2 ------------------------------------------- --------------------------------------------- Total 128,330 $9,197 100.0% 184,289 $11,627 100.0% - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
Escrow funds of approximately $207.9 million and $196.8 million as of December 31, 1998 and 1997, respectively, relating to mortgages serviced and subserviced, were held in non-interest bearing accounts at non-affiliated banks and are not included in the consolidated financial statements. F-23 NOTE 7. MORTGAGE LOANS HELD FOR SALE AND POOL LOAN PURCHASES The following tables summarize Source One's mortgage loans held for sale and pool loan purchases:
- --------------------------------------------------------------------------------------------------------------------- December 31, --------------------------- Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Adjustable rate mortgage loans, weighted average interest rates of 6.39% and 6.36% $ 15.1 $ 51.6 Fixed rate 5 year through 25 year mortgage loans, weighted average interest rates of 7.10 and 7.68% 240.0 60.4 Fixed rate 30 year mortgage loans, weighted average interest rates of 7.33% and 7.76% 420.3 405.0 --------------------------- Total principal amount 675.4 517.0 Net premiums .9 2.3 --------------------------- Total mortgage loans held for sale $676.3 $ 519.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------- December 31, ---------------------------------------------------- Principal balance Number of loans ---------------------- --------------------- Dollars in Millions 1998 1997 1998 1997 - --------------------------------------------------------------------------------------- --------------------- Loan type: FHA $119.6 $103.1 1,640 1,781 VA 45.3 43.3 550 669 Conventional .1 3.4 4 45 ---------------------- --------------------- Total pool loan purchases $165.0 $149.8 2,194 2,495 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-24 NOTE 8. DEBT SHORT-TERM DEBT Short-term debt outstanding consisted of the following:
- --------------------------------------------------------------------------------------------------------------------- December 31, ---------------------------- Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- White Mountains: Credit facility $ 50.0 $ - Charter: Notes payable and lease obligations 1.5 2.0 Source One: Credit agreement borrowings 697.3 569.5 Less net discounts (.3) (.1) ---------------------------- Total Source One 697.0 569.4 ---------------------------- Total short-term debt $748.5 $ 571.4 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
The weighted average interest rates of short-term debt outstanding during the year ended December 31, 1998 and 1997 were as follows:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ------------------------- 1998 1997 - --------------------------------------------------------------------------------------------------------------------- White Mountains: Credit facility 6.20% 6.04% Charter: Notes payable 6.50% 6.50% Source One: Credit agreement borrowings 5.79% 6.34% Commercial paper and short-term borrowings - % 5.81% - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
In August 1998 the Company entered into a $35.0 million revolving credit agreement with a syndicate of banks which served to replace an expiring arrangement in the same amount. Under the agreement, through August 12, 1999 the Company may borrow up to $35.0 million at short-term market interest rates. The credit agreement contains certain customary covenants and conditions. At December 31, 1998 the Company was in compliance with all covenants under the facility and had no borrowings outstanding under the agreement. At December 31, 1997 the Company had no outstanding borrowings under the former facility. In November 1996 White Mountains entered into a five year revolving credit facility under which it may borrow up to $50.0 million at market interest rates. At December 31, 1998 White Mountains had $50.0 million of borrowings outstanding under the facility which was used to partially fund White Mountains additional investment in MSA and its acquisition of Folksamerica during 1998. White Mountains had no borrowings outstanding at December 31, 1997 under the facility. During 1996 Charter extended $3.2 million of notes payable to be repaid in three equal installments in 1997, 1998 and 1999. As of December 31, 1998 $1.1 million of the notes remained outstanding. The notes are collateralized by certain assets of Charter. F-25 In July 1998 Source One amended and restated its $600.0 million secured revolving credit agreement to increase its borrowing capacity and flexibility. The provisions of the amended agreement increased Source One's borrowing capacity to $800.0 million. The facility expires on July 9, 1999. At December 31, 1998, Source One was in compliance with all covenants under the agreement and had $650.5 million of borrowings outstanding under this agreement. During the second quarter of 1998 Source One entered into two additional secured credit agreements whereby it may borrow up to $35.0 million and $175.0 million through July 1999 and April 1999, respectively. At December 31, 1998, Source One had a total of $21.6 million in borrowings outstanding under these agreements. In April 1998 Source One replaced its existing $15.0 million unsecured revolving credit agreement under which it can borrow up to $40.0 million through April 15, 1999. As of December 31, 1998, there was $25.2 million outstanding under the revolving credit agreement. In July 1997 Source One amended and restated its secured revolving credit agreement to reflect a reduction in its borrowing requirements resulting from the 1997 servicing sale. The provisions of the amended agreement decreased Source One's revolving credit facility from $750.0 million to $600.0 million and reduced Source One's borrowing costs by lowering the facility fee. At December 31, 1997, Source One was in compliance with all covenants and had $559.0 million of borrowing outstanding under this facility. In May 1997 Source One entered a unsecured revolving credit agreement under which it can borrow up to $15.0 million through June 1, 1998. As of December 31, 1997, there was $10.5 million outstanding under the revolving credit agreement. Source One must comply with certain financial covenants provided in its secured and unsecured revolving credit facilities, including restrictions relating to tangible net worth and leverage. In addition, the secured facility contains certain covenants which limit Source One's ability to pay dividends or make distributions of its capital in excess of preferred stock dividends and subordinated debt interest requirements each year. Source One is currently in compliance with all such covenants. F-26 LONG-TERM DEBT Long-term debt outstanding consisted of the following:
- --------------------------------------------------------------------------------------------------------------------- December 31, ---------------------------- Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Parent Company: Medium-term notes $116.3 $116.3 Less net discounts (.6) (.7) ---------------------------- Total Parent Company 115.7 115.6 ---------------------------- Folksamerica: Medium-term notes 55.6 - Valley: Medium-term notes 15.0 15.0 Charter: Notes payable in 1999 - 1.1 Source One: Medium-term notes, 8.875% due in 2001 18.7 18.7 Debentures, 9.0% due in 2012 100.0 100.0 Subordinate debentures, 9.375% due in 2025 56.0 56.0 Less net discounts (1.3) (2.1) ---------------------------- Total Source One 173.4 172.6 ---------------------------- Total long-term debt $359.7 $304.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
At December 31, 1998, the Parent Company had $116.3 million of outstanding medium-term notes with an average maturity of 4.4 years and a yield to maturity of 7.82%. Folksamerica has $55.6 million of medium-term notes outstanding which are guaranteed by one of the European Mutuals. As part of the August 18, 1998 Folksamerica acquisition, Fund American guaranteed Folksamerica's debt to the former owner and agreed to repay or refinance the obligation during the 1999 first quarter. The Folksamerica medium-term notes had scheduled maturities from 2001 to 2005 and had a weighted average interest rate of approximately 5.65% from August 18, 1998 to December 31, 1998. Valley has a five year credit facility under which it may borrow up to $15.0 million at market interest rates. During 1998 and 1997 Valley had $15.0 million of borrowings outstanding under the facility with a weighted average interest rate of 6.14% and 6.09%, respectively. In 1991 Source One issued $160.0 million of 8.875% medium-term notes due in 2001 of which $138.4 million remained outstanding at December 31, 1996. During 1997 Source One repurchased and retired in principal amount $119.7 million of these notes leaving $18.7 million outstanding at December 31, 1997 and 1998. In 1992 Source One issued $100.0 million of 9% debentures due in 2012 pursuant to a $250.0 million shelf registration statement. The debentures may not be redeemed by Source One prior to maturity. The proceeds from issuance were used for general corporate purposes. In December 1995, Source One exchanged and retired 2,239,061 shares Source One Preferred Stock for $56.0 million in principal amount of 9.375% subordinated debentures. The subordinated debentures are due in F-27 2025 but are redeemable at the option of Source One, in whole or part, at any time on or after May 1, 1999. In connection with Source One's February 28, 1997 sale of approximately $17.0 billion of mortgage servicing rights to a third party, the Company has made certain collection, payment and performance guarantees to the buyer for a period of no more than ten years. The aggregate amount of the Company's guaranty is initially limited to $20.0 million and amortizes down to $15.0 million as mortgage loans serviced under agreement are repaid. During 1998, the Company permitted the third party to include an additional $2.9 billion of mortgage servicing rights that it purchased from Source One during 1998 to be included in the guaranty, however, the inclusion of the 1998 servicing rights sold did not serve to change the maximum amount of the guarantee or the original term of the agreement. Total interest paid by Fund American for both short-term and long-term debt was $83.5 million, $51.9 million and $51.5 million in 1998, 1997 and 1996, respectively. Fund American's long-term debt maturities, including the current portion of long-term debt, for 1999, 2000, 2001, 2002, 2003 and beyond are $57.7 million, $6.0 million, $20.7 million, $10.0 million, $102.3 million and $166.0 million, respectively. NOTE 9. INCOME TAXES The Company and its subsidiaries file a consolidated Federal income tax return. The Federal income tax provision is computed on the consolidated taxable income of the Company and those subsidiaries. The total income tax provision consisted of the following:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Tax on pretax earnings: Federal $ 45.2 $26.7 $ 18.1 State and local 2.6 2.7 .8 --------------------------------------------- Income tax provision on pretax earnings 47.8 29.4 18.9 Tax benefit from loss on early extinguishment of debt - 3.2 - --------------------------------------------- Total income tax provision $ 47.8 $32.6 $ 18.9 --------------------------------------------- - --------------------------------------------------------------------------------------------------------------------- Net income tax payments $ 35.7 $24.9 $ 7.0 --------------------------------------------- - --------------------------------------------------------------------------------------------------------------------- Tax provision recorded directly to shareholders' equity related to: Changes in net unrealized investment gains and losses $(4.3) $22.5 $ 29.4 Changes in net foreign currency translation gains and losses $ (.5) $ - $ - - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-28 The components of the income tax provision (benefit) on pretax earnings follow:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, --------------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Current provision $ 49.0 $33.5 $ 22.5 Deferred benefit (1.2) (4.1) (3.6) --------------------------------------------- Total income tax provision on pretax earnings $ 47.8 $29.4 $ 18.9 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax return purposes. Fund American recorded a net deferred Federal income tax asset of $7.8 million as of December 31, 1998 and a net deferred Federal income tax liability of $19.6 million as of December 31, 1997. Significant components of Fund American's net deferred Federal income tax asset and liability follow:
- --------------------------------------------------------------------------------------------------------------------- December 31, Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Deferred tax assets related to: Employee compensation and benefit accruals $ 51.1 $ 39.1 Discounting of loss reserves 40.1 2.9 Capitalized mortgage servicing 21.1 26.2 Unearned insurance premiums 10.5 5.3 Allowance for mortgage loan losses 4.3 4.8 Other items 15.8 10.1 -------------------------- Total deferred tax assets $ 142.9 $ 88.4 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
F-29
- --------------------------------------------------------------------------------------------------------------------- December 31, -------------------------- Millions 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Deferred tax liabilities related to: Net unrealized investment holding gains $ 83.0 $ 71.4 Earnings from insurance affiliates 17.5 11.8 Deferred acquisition costs 12.4 5.0 Purchase accounting adjustments 4.8 5.5 Unrealized gains on financial instruments 4.3 4.6 Other items 13.1 9.7 -------------------------- Total deferred tax liabilities $135.1 $108.0 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
A reconciliation of taxes calculated using the 35% Federal statutory rate to the income tax provision on pretax earnings follows:
- --------------------------------------------------------------------------------------------------------------------- Year Ended December 31, --------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Tax provision at Federal statutory rate $45.4 $27.4 $ 9.6 Differences in taxes resulting from: Dividends received deduction (2.6) (3.1) (2.3) Nonconventional fuel source tax credits (1.1) (2.4) - Tax reserve adjustments 5.4 5.1 4.2 State income taxes 1.7 1.8 .5 Write-off of goodwill and other intangible assets - - 8.1 Other, net (1.0) .6 (1.2) --------------------------------------- Total income tax provision on pretax earnings $47.8 $29.4 $18.9 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
The Company believes that it is more likely than not that results of future operations will generate sufficient taxable income to realize the deferred tax asset balances carried as of December 31, 1998 and 1997. NOTE 10. RETIREMENT AND POST-RETIREMENT PLANS The Company has an unfunded, nonqualified defined contribution plan for a select group of management employees for the purpose of providing retirement benefits (the "Deferred Benefit Plan"). The amount of annual contribution to the Deferred Benefit Plan is determined using actuarial assumptions. At December 31, 1998 and 1997, Fund American's liability to participants pursuant to the Deferred Benefit Plan was $4.8 million and $3.9 million, respectively. The Company also has an unfunded, nonqualified plan for a select group of management employees for the purpose of deferring current compensation for retirement savings (the "Deferred Compensation Plan"). Pursuant to the Deferred Compensation Plan, participants may voluntarily defer all or a portion of qualifying remuneration payable by Fund American. At December 31, 1998 and 1997, Fund American's liability to participants pursuant to the Deferred Compensation Plan was $65.1 million and $37.6 million, respectively. Source One, Folksamerica and Valley have defined contribution employee savings plans for the benefit of substantially all their employees. The costs of these plans are not material to Fund American's financial statements. F-30 Fund American also has various defined benefit pension plans for the benefit of the majority of its employees. Benefits under these plans are based on years of service and each employee's highest average eligible compensation over five consecutive years in his or her last ten years of employment. Cash contributions made by Fund American totalled less than $1.0 million for the years ended December 31, 1998 and 1997 and the projected benefit obligation of such plans totalled $11.0 million and $11.3 million, respectively, as of those dates. Fund American's postretirement benefit costs, included in accounts payable and other liabilities, were $3.8 million and $3.7 million at December 31, 1998 and 1997, respectively. NOTE 11. EMPLOYEE STOCK PLANS Fund American's Long-Term Incentive Plan (the "Incentive Plan") provides for granting to executive officers and other key employees of the Company (and certain of its subsidiaries) various types of stock-based incentive awards including stock options and performance shares. At December 31, 1998, 329,200 Shares remained available for grants under the Incentive Plan. Performance shares are conditional grants of a specified maximum number of Shares or an equivalent amount of cash. The grants are generally payable, subject to the attainment of a specified after tax return on equity at the end of a three year period or as otherwise determined by the Compensation Committee of the Board. The Compensation Committee consists solely of disinterested, non-management directors. Pursuant to the Incentive Plan 47,800, 50,000 and 73,000 performance shares were granted in 1998, 1997 and 1996, respectively, of which 5,150, 4,300 and 14,000 of the performance shares granted, respectively, remain unallocated to participants as of December 31, 1998 and are not deemed to be outstanding. During 1998, 1997 and 1996, 47,129, 22,944 and 0 performance shares were paid in cash, respectively. At December 31, 1998, 147,350 performance shares were outstanding. The financial goal for full payment of the performance shares is the achievement of a 13% annual after tax return on equity as measured over the applicable performance periods. As of December 31, 1998, 1997 and 1996 there were 2,000, 2,000 and 3,000 stock options outstanding, respectively, which had exercise prices ranging from $24.82 to $32.60 per Share. All Fund American stock options outstanding during the three year period ended December 31, 1998, were fully vested and exercisable. No new stock options have been issued to Fund American employees since 1990. In 1985 the Company's Chairman purchased warrants (the "Warrants") from American Express Company ("American Express") entitling him to buy 1,700,000 Shares for $25.75 per Share. Warrants to purchase 420,000 Shares, 130,000 Shares and 150,000 Shares were exercised by the Chairman during 1992, 1994 and 1995, respectively, leaving Warrants to purchase 1,000,000 Shares outstanding at December 31, 1995. Pursuant to a proposal approved by shareholders at the Company's 1995 Annual Meeting, the expiration date with respect to the Warrants was extended from January 2, 1996, to January 2, 2002. In accordance with APB No. 25, the F-31 extension of the Warrants resulted in a $46.2 million pretax charge to compensation expense which was recorded in the second quarter of 1995. No Warrants were exercised by the Chairman during 1998 and 1997. Pursuant to certain anti-dilution adjustments related to the distribution of White River Shares to the Company's shareholders, the exercise price for the Warrants to purchase Fund American Shares was reduced to $21.66 per Share. All employees (other than employees of Source One, FAE and Folksamerica are eligible to participate in an employee savings plan qualified under Section 401(k) of the Internal Revenue Code ("IRC") (the "Valley 401(k) Plan"). Contributions to the Valley 401(k) Plan can be invested in various investment options including Shares. There is an employer match provision to the Valley 401(k) Plan which is equal to 50% of the first 6% of employee compensation contributed to the plan, subject to IRC limits. Fund American added Shares to the investment options offered under the Valley 401(k) Plan as of July 1, 1997. As of December 31, 1998 participants of the Valley 401(k) Plan owned a total of 3,949 Shares. All employees of Folksamerica are eligible to participate in an employee savings plan qualified under Section 401(k) of the Internal Revenue Code ("IRC") (the "Folksamerica 401(k) Plan"). Contributions to the Folksamerica 401(k) Plan can be invested in various investment options. The Folksamerica 401(k) Plan does not currently provide for investments in Shares. There is an employer match provision to the Folksamerica 401(k) Plan which is equal to 100% of the first 6% of employee compensation contributed to the plan, subject to IRC limits. Source One also has a qualified employee savings plan (the "Source One 401(k) Plan"). Contributions to the Source One 401(k) Plan can be invested in various investments including Shares. In 1997, Source One added a matching contribution feature to the Source One 401(k) Plan which is equal to a certain percentage of employee contributions, up to a maximum of 5%, dependent upon Source One's return on equity. As of December 31, 1998, participants of the Source One 401(k) Plan owned a total of 38,046 Shares. SFAS No. 123, "Accounting for Stock Based Compensation," requires disclosure regarding all employee stock options and encourages companies to recognize compensation expense for stock-based awards based on the fair value of such awards on the date of grant. Alternatively, companies may continue following existing accounting standards provided that disclosures are made regarding the net income and earnings per share impact as if the value recognition and measurement criteria of SFAS No. 123 had been adopted. Fund American has not adopted the recognition and measurement criteria of SFAS No. 123 and alternatively has chosen to disclose the pro forma effects of SFAS No. 123 as it relates to outstanding Warrants and performance shares granted in 1998, 1997 and 1996, as follows: F-32
- ------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ------------------------------------- Millions, except per share amounts 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Net income: As reported $ 82.2 $43.0 $ 8.6 Pro forma 77.4 39.4 - - ------------------------------------------------------------------------------------------------------------------- Basic net income per share: As reported $13.38 $5.98 $ .66 Pro forma 12.56 5.99 - - ------------------------------------------------------------------------------------------------------------------- Diluted net income per share: As reported $11.94 $5.40 $ .60 Pro forma 11.20 5.41 - - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
SFAS No. 123 provides for the expense of Warrants, stock options and performance shares over the life of the award using the Black Scholes option pricing model. Significant assumptions used include a 5.0% risk-free interest rate, an expected Share volatility of .167 and an expected life of five years for Warrants and three years for performance shares. In determining the pro forma effects of SFAS No. 123, the Company recognizes the pro forma expense of the Warrants over time. The pro forma net income figures disclosed above may not be representative of the effects on reported net income to be reported in future years. NOTE 12. MINORITY INTEREST - PREFERRED STOCK OF SUBSIDIARY In 1994 Source One issued 4,000,000 shares of 8.42% Source One Preferred Stock, having a liquidation preference of $25.00 per share, for net cash proceeds of $96.8 million. On December 8, 1995, Source One exchanged and retired 2,239,061 shares of Source One Preferred Stock for $56.0 million in principal amount of subordinated debentures. The Source One Preferred Stock is not redeemable prior to May 1, 1999. NOTE 13. SHAREHOLDERS' EQUITY COMMON SHARE REPURCHASES During 1998, 1997 and 1996 the Company repurchased 151,916 Shares, 924,739 Shares and 779,077 Shares, respectively, for $19.8 million, $103.7 million and $66.3 million, respectively. All Shares repurchased during 1998, 1997 and 1996 have been retired. At December 31, 1998, the Company had outstanding authorization to purchase an additional 41,501 Shares. CAPITAL STOCK DIVIDENDS During 1998 and 1997 the Company declared and paid quarterly cash dividends of $.40 per Share and $.20 per Share, respectively. During 1998 and 1997 Source One declared and paid quarterly cash dividends of $2.105 per share of Source One Preferred Stock. F-33 NOTE 14. SEGMENT INFORMATION Fund American has determined that its reportable segments include Mortgage Banking (Source One), Property and Casualty Insurance (Valley, Charter and WMIC), Reinsurance (Folksamerica), Investments in Unconsolidated Insurance Affiliates and other (primarily the Company, FAE and White Mountains, all on a stand-alone basis). This determination was based on the provisions of SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information" which was adopted by Fund American in December 1998. Prior year segment information has been restated to conform to the current presentation under SFAS No. 131. Investment results are included within the segment to which the investments relate. The Company has made this determination based on consideration of the following criteria: (i) the nature of the business activities of each of the Company's subsidiaries and affiliates; (ii) the manner in which the Company's subsidiaries and affiliates are organized; (iii) the existence of primary managers responsible for specific subsidiaries and affiliates; and (iv) the organization of information provided to the Board. There are no significant intercompany transactions among Fund American's segments. Revenues, pretax earnings and ending assets for Fund American's segments are shown below:
- ------------------------------------------------------------------------------------------------------------------- Property and Investments in Casualty Unconsolidated Mortgage Insurance Affiliates Millions Banking Reinsurance Other Total - ------------------------------------------------------------------------------------------------------------------- 1998 - ------------------------------------------------------------------------------------------------------------------- Revenues for external customers $212.0 $170.0 $ 85.4 $ - $ - $467.4 Net investment income 81.6 8.2 18.1 3.8 6.7 118.4 Equity in earnings of unconsolidated affiliates - - - 24.3 - 24.3 Amortization of deferred credit - - 2.7 - - 2.7 Other (34.8)(a) - - - .1 (34.7) ---------------------------------------------------------------------- Total revenues 258.8 178.2 106.2 28.1(b) 6.8578.1 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- 1997 - ------------------------------------------------------------------------------------------------------------------- Revenues for external customers 127.5 153.1 - - - 280.6 Net investment income 43.5 8.9 - 3.8 8.9 65.1 Equity in earnings of unconsolidated affiliates - - - 21.3 - 21.3 Other (56.7)(a) - - - - (56.7) ---------------------------------------------------------------------- Total revenues 114.3 162.0 - 25.1(b) 8.9310.3 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- 1996 - ------------------------------------------------------------------------------------------------------------------- Revenues for external customers 206.2 119.1 - - - 325.3 Net investment income 40.8 7.5 - 3.7(a) 5.2 57.2 Equity in earnings of unconsolidated affiliates - - - 12.0 - 12.0 Other (69.3)(a) - - - - (69.3) ---------------------------------------------------------------------- Total revenues $177.7 $126.6 $ - $15.7(b) $5.2$325.2 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
(a) Represents amortization and impairment of capitalized mortgage servicing of $55.2 million, $68.0 million and $79.2 million for 1998, 1997 and 1996, respectively, partially offset of net gains on financial instruments of $20.4 million, $11.3 million and $9.9 million, respectively. (b) Includes interest income on Fund American's investment in MediaOne preferred stock (considered to be related to Fund American's investment in FSA) of $3.8 million for 1998, 1997 and 1996. F-34
- ------------------------------------------------------------------------------------------------------------------- Property and Investments in Casualty Unconsolidated Mortgage Insurance Affiliates Millions Banking Reinsurance Other Total - ------------------------------------------------------------------------------------------------------------------- 1998 - ------------------------------------------------------------------------------------------------------------------- Income (loss) before realized gains, taxes and $123.7 $ 5.3 $ 8.9 $28.1 $(16.6) $149.4 certain other expenses Net realized investment gains (losses) 2.2 5.4 (.8) - 64.2 71.0 Interest expense (70.2) (1.1) (1.4) - (11.2) (83.9) Depreciation and amortization (3.1) (3.0) - - (.4) (6.5) ---------------------------------------------------------------------- Pretax earnings 52.6 6.6 6.7 28.1 36.0 130.0 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Income tax expense (19.3) (1.8) (1.2) (7.6) (17.9)(47.8) - ------------------------------------------------------------------------------------------------------------------- 1997 - ------------------------------------------------------------------------------------------------------------------- Income (loss) before realized gains, taxes and 18.2 11.5 - 25.1 (18.7) 36.1 certain other expenses Net realized investment gains (losses) (.7) 4.1 - - 93.3 96.7 Interest expense (35.4) (1.2) - - (9.4) (46.0) Depreciation and amortization (5.0) (3.0) - - (.4) (8.4) ---------------------------------------------------------------------- Pretax earnings (loss) (22.9) 11.4 - 25.1 64.8 78.4 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Income tax (expense) benefit 7.0 (4.3) - (6.1) (26.0) (29.4) ---------------------------------------------------------------------- Loss on early extinguishment of debt (6.0) - - - - (6.0) - ------------------------------------------------------------------------------------------------------------------- 1996 - ------------------------------------------------------------------------------------------------------------------- Income (loss) before realized gains, taxes and 44.1 (2.7) - 15.7 (9.3) 47.8 certain other expenses Net realized investment gains (losses) (.2) (.3) - - 39.0 38.5 Interest expense (36.0) (.7) - - (9.6) (46.3) Depreciation and amortization (6.5) (3.2) - - (2.8) (12.5) ---------------------------------------------------------------------- Pretax earnings (loss) 1.4 (6.9) - 15.7 17.3 27.5 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Income tax (expense) benefit $ (9.5) $ 3.4 $ - $(3.5) $ (9.3) $ (18.9) - -------------------------------------------------------------------------------------------------------------------
F-35
- ------------------------------------------------------------------------------------------------------------------- Millions Property and Investments in Casualty Unconsolidated Mortgage Insurance Affiliates Ending assets: Banking Reinsurance Other Total - ------------------------------------------------------------------------------------------------------------------- December 31, 1998 $1,234.1 $311.5 $1,220.5 $404.1 $110.5 $3,280.7 December 31, 1997 1,063.1 288.8 - 409.6 248.8 2,010.3 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
NOTE 15. INVESTMENTS IN UNCONSOLIDATED AFFILIATES INVESTMENT IN FSA Fund American owned 3,460,200 shares of FSA Common Stock at December 31, 1998, 1997 and 1996. This represented approximately 11.6%, 12.1% and 11.5%, respectively, of the total shares of FSA Common Stock outstanding at those times. Fund American had voting rights to an additional 3,893,940 shares of FSA Common Stock at December 31, 1998, 1997 and 1996, raising Fund American's voting control of FSA to approximately 23.1%, 24.0% and 23.0%, respectively. At December 31, 1998, 1997 and 1996, Fund American also owned FSA Options and Preferred Stock which, in total, give Fund American the right to acquire up to 4,560,607 additional shares of FSA Common Stock for aggregate consideration of $125.7 million. As of December 31, 1998, 1997 and 1996, Fund American's economic interest in FSA was 25.1%, 26.2% and 25.1%, respectively. Fund American's investment in FSA Common Stock is accounted for using the equity method. FSA Common Stock is publicly traded on the NYSE. The market value of the FSA Common Stock as of December 31, 1998 and 1997, as quoted on the NYSE, exceeded Fund American's carrying value of F-36 the FSA Common Stock on the equity method. Fund American's investments in FSA Options and Preferred Stock are accounted for under the provisions of SFAS No. 115 whereby the investments are reported at fair value as of the balance sheet date, with related unrealized investment gains and losses, after tax, reported as a net amount in a separate component of shareholders' equity and reported on the income statement as a component of comprehensive net income. The following table summarizes financial information for FSA:
- --------------------------------------------------------------------------------------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- FSA BALANCE SHEET DATA: Total investments $ 1,874.8 $ 1,431.6 $1,154.4 Total assets 2,405.5 1,900.6 1,537.7 Deferred premium revenue 721.7 595.2 511.2 Loss and loss adjustment expense reserve 63.9 75.4 72.1 Preferred shareholder's equity .7 .7 .7 Common shareholders' equity 1,072.7 881.7 800.6 FSA INCOME STATEMENT DATA: Gross premiums written $ 319.3 $ 236.4 $ 177.0 Net premiums written 219.9 172.9 121.0 Net premiums earned 137.9 109.5 90.4 Net investment income 78.8 72.1 65.1 Net income 117.0 100.5 80.8 - --------------------------------------------------------------------------------------------------------------------- AMOUNTS RECORDED BY FUND AMERICAN: Investment in FSA Common Stock $ 119.7 $ 104.3 $ 92.3 Investment in FSA Options and Preferred Stock 114.4 87.8 19.8 ------------------------------------ Total Investment in FSA $ 234.1 $ 192.1 $ 112.1 ------------------------------------ ------------------------------------ Equity in earnings from FSA Common Stock (a) $ 13.8 $ 11.4 $ 7.8 Equity in net unrealized investment gains (losses) from FSA's investment portfolio, before tax (b) 3.1 2.1 (1.0) Unrealized investment gains on FSA Options and Preferred Stock, before tax (b) 26.6 68.0 17.3 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Recorded net of related amortization of goodwill. (b) Recorded directly to shareholders' equity (after tax) with related changes in net unrealized investment gains and losses (after tax) reported on the income statement as a component of comprehensive net income. At December 31, 1998 and 1997, Fund American's consolidated retained earnings included $35.9 million and $23.6 million, respectively, of F-37 accumulated undistributed earnings of FSA (net of related amortization of goodwill). INVESTMENT IN MSA At December 31, 1998, 1997 and 1996, Fund American owned 222,093, 90,606 and 90,606 shares of MSA Common Stock. This represented approximately 50.0%, 33.1% and 33.1% of the total shares of MSA Common Stock outstanding at those times. Fund American's investment in MSA is accounted for using the equity method. The following tables summarize financial information for MSA:
- --------------------------------------------------------------------------------------------------------------------- Millions 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- MSA BALANCE SHEET DATA: Total investments $ 465.9 $280.1 $ 249.4 Total assets 588.6 337.2 316.2 Unearned premium reserve 113.0 71.8 64.0 Loss and loss adjustment expense reserves 212.2 123.7 120.1 Shareholders' equity 232.5 120.6 101.4 MSA INCOME STATEMENT DATA: Net premiums written $ 258.5 $156.6 $ 147.2 Net premiums earned 226.3 148.7 141.6 Net investment income 22.1 15.4 14.9 Net income 13.4 11.9 9.7 - --------------------------------------------------------------------------------------------------------------------- AMOUNTS RECORDED BY FUND AMERICAN: Investment in MSA Common Stock $ 120.2 $ 40.9 $ 34.7 Equity in earnings from MSA Common Stock (a) 4.9 3.8 1.5 Equity in net unrealized investment gains (losses) from MSA's investment portfolio, before tax (b) 4.1 2.4 (.5) - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Recorded net of related amortization of goodwill. (b) Recorded directly to shareholders' equity (after tax) with related changes in net unrealized investment gains and losses (after tax) reported on the income statement as a component of comprehensive net income. At December 31, 1998 and 1997, Fund American's consolidated retained earnings included $14.2 million and $9.3 million, respectively, of F-38 accumulated undistributed earnings of MSA (net of related amortization of goodwill). INVESTMENT IN FOLKSAMERICA On August 18, 1998, Fund American acquired all of the remaining outstanding shares of the common stock of Folksamerica for $169.1 million which resulted in Folksamerica becoming a consolidated subsidiary of the Company as of that date. As of December 31, 1997 and 1996, Folksamerica was an unconsolidated subsidiary of Fund American. Prior to the consolidation of Folksamerica in 1998, White Mountains owned 6,920,000 shares of Folksamerica Preferred Stock at December 31, 1997 and 1996 and owned 1,563,907 shares of Folksamerica Common Stock at December 31, 1997. White Mountains ownership percentage of Folksamerica at December 31, 1997 and 1996 represented 50.0% of the total Folksamerica voting shares outstanding at those times. At December 31, 1997 and 1996, White Mountains also owned ten year Folksamerica Warrants to purchase up to 6,920,000 shares of Folksamerica Common Stock for aggregate consideration of $79.4 million. Fund American acquired its investment in Folksamerica Preferred Stock and Folksamerica Warrants on June 19, 1996. White Mountains acquired its investment in Folksamerica Common Stock on November 20, 1997. Prior to the consolidation of Folksamerica in 1998, White Mountains' investment in Folksamerica Common Stock was accounted for using the equity method and Fund American's investment in Folksamerica Preferred Stock and Folksamerica Warrants were accounted for under the provisions of SFAS No. 115 whereby the investments were reported at fair value as of the balance sheet date, with related unrealized investment gains and losses, after tax, reported as a net amount in a separate component of shareholders' equity and reported on the income statement as a component of comprehensive net income. Dividends earned on Folksamerica Preferred Stock were recorded as earnings from unconsolidated insurance affiliates on the income statement. F-39 The following table summarizes financial information for Folksamerica:
- --------------------------------------------------------------------------------------------------------------------- Millions 1997 1996 - --------------------------------------------------------------------------------------------------------------------- FOLKSAMERICA BALANCE SHEET DATA: Total investments $ 926.2 $ 711.4 Total assets 1,213.6 994.8 Unearned premium reserve 96.5 61.5 Loss and loss adjustment expense reserve 739.1 628.9 Preferred shareholder's equity 79.4 79.4 Common shareholders' equity 175.6 88.2 FOLKSAMERICA INCOME STATEMENT DATA: Gross premiums written $ 251.0 $ 187.2 Net premiums written 232.4 171.9 Net premiums earned 238.0 181.4 Net investment income 46.7 32.4 Net income 35.9 17.1 - --------------------------------------------------------------------------------------------------------------------- AMOUNTS RECORDED BY FUND AMERICAN: Investment in Folksamerica Common Stock $ 23.5 $ - Investment in Folksamerica Preferred Stock and Warrants 80.0 80.0 ------------------------- Total Investment in Folksamerica $ 103.5 $ 80.0 ------------------------- Equity in earnings from Folksamerica Common Stock (a) $ .9 $ - Dividends from Folksamerica Preferred Stock (a) 5.2 2.7 Equity in net unrealized investment gains from Folksamerica's investment portfolio, before tax (b)1.8 .2 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Recorded net of related amortization of goodwill and accretion of discount. (b) Recorded directly to shareholders' equity (after tax) with related changes in net unrealized investment gains and losses (after tax) reported on the income statement as a component of comprehensive net income. At December 31, 1997, Fund American's consolidated retained earnings included $1.0 million of accumulated undistributed earnings of Folksamerica. INVESTMENT IN AMLIN (FORMERLY MURRAY LAWRENCE) F-40 At December 31, 1997 White Mountains owned 38,651,270 shares of the common stock of Murray Lawrence which it had acquired on December 8, 1997 for $23.6 million. This represented approximately 15.8% of the total shares of Murray Lawrence common stock outstanding at that time. At December 31, 1997 White Mountains carried its investment in Murray Lawrence as an "investment in unconsolidated insurance affiliate" and valued the investment at its original cost of $23.6 million which approximated its fair value at that date.. During 1998 Murray Lawrence merged with Angerstein Underwriting which resulted in the creation of Amlin. White Mountains owns 13,980,861 shares of the common stock of Amlin, which represents an approximate 6.5% ownership stake as of December 31, 1998 . As a result of White Mountains' decreased ownership percentage of this investment resulting from the merger, White Mountains recharacterized its investment in Amlin as an "other investment" and carried the investment at its fair value of $25.1 million at December 31, 1998. NOTE 16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK Source One utilizes derivative financial instruments in the management of interest rate risk. Source One's use of derivative financial instruments is primarily limited to (i) commitments to extend credit, (ii) mandatory forward commitments and (iii) interest rate floor contracts, interest rate swap agreements and principal-only swap agreements. Although SFAS No. 115 requires that these financial instruments be classified as held for trading purposes, Fund American does not consider these investments to be speculative holdings. Source One is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates. These financial instruments primarily include commitments to extend credit and mandatory forward commitments. Those instruments involve, to varying degrees, elements of credit and market interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of risk Source One has related to the instruments. Source One's exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit is represented by the contractual notional amount of those commitments. Source One's locked mortgage loan commitments expected to close totalled $608.3 million and $284.5 million at December 31, 1998 and 1997, respectively. Fixed rate commitments result in Source One having market interest rate risk as well as credit risk. Variable rate commitments result primarily in credit risk. The amount of collateral required upon extension of credit is based on management's credit evaluation of the mortgagor and consists of the mortgagor's residential property. F-41 Source One obtains mandatory forward commitments of up to 120 days to sell mortgage-backed securities to hedge the market interest rate risk associated with a substantial portion of the Pipeline that is expected to close and all mortgage loans receivable. At December 31, 1998 and 1997, Source One had $1,805.3 million and $776.8 million, respectively, of mandatory forward commitments outstanding. If secondary market interest rates decline after Source One commits to an interest rate for a loan, the loan may not close and Source One may incur a loss from the cost of covering its obligations under a related mandatory forward commitment. If secondary market interest rates increase after Source One commits to an interest rate for a loan and Source One has not obtained a forward commitment, Source One may incur a loss when the loan is subsequently sold. Source One's risk management function closely monitors the Pipeline to determine appropriate forward commitment coverage on a daily basis in order to manage the risk inherent in these off-balance-sheet financial instruments. In addition, the risk management area seeks to reduce counterparty risk by committing to sell mortgage loans only to approved dealers with no dealer having in excess of 20% of current commitments. Source One sells loans through mortgage-backed securities issued pursuant to programs of GNMA, FNMA and FHLMC, or through institutional investors. Most loans are aggregated in pools of $1.0 million or more which are purchased by institutional investors after having been guaranteed by GNMA, FNMA or FHLMC. Substantially all GNMA securities are sold by Source One without recourse for loss of principal in the event of a subsequent default by the mortgagor due to the FHA and VA insurance underlying such securities. Prior to December 1992, substantially all conventional securities were sold with recourse to Source One, to the extent of insufficient proceeds from private mortgage insurance, foreclosure and other recoveries. Since December 1992 all conventional loans have been sold without recourse to Source One. Servicing agreements relating to mortgage-backed securities issued pursuant to programs of GNMA, FNMA or FHLMC require Source One to advance funds to make the required payments to investors in the event of a delinquency by the borrower. Source One expects that it would recover most funds advanced upon cure of default by the borrower or foreclosure. However, funds advanced in connection with VA partially guaranteed loans and certain conventional loans (which are at most partially insured by private mortgage insurers) may not be fully recovered due to potential declines in collateral value. Source One is subject to limited amounts of risk with respect to these loans since the insurer has the option to reimburse the servicer for the lower of fair value of the property or the mortgage loan outstanding, in addition to the VA guarantee on the loan. In addition, most of Source One's servicing agreements for mortgage-backed securities typically require the payment to investors of a full month's interest on each loan although the loan may be paid off (by optional prepayment or foreclosure) other than on a month-end basis. In this instance, Source One is obligated to pay the investor interest at the pass-thru rate from the date of loan payoff through the end of the calendar month without reimbursement. F-42 At December 31, 1998 and 1997, Source One serviced approximately $4.0 billion and $5.4 billion of GNMA loans (without substantial recourse), respectively, and $1.7 billion and $2.5 billion of conventional loans (with recourse), respectively. To cover loan losses that may result from these servicing arrangements and other losses, Source One has provided an allowance for loan losses of $11.5 million and $12.8 million at December 31, 1998 and 1997, respectively. In addition, the valuation allowance for Source One's capitalized servicing asset related to its principal recourse portfolio includes a $5.3 million and $8.2 million reserve for estimated losses at December 31, 1998 and 1997, respectively. Source One's management believes the allowance for loan losses is adequate to cover unreimbursed foreclosure advances and principal losses, including losses on loans with recourse. In order to offset changes in the value of Source One's capitalized servicing asset and to mitigate the effect on earnings of higher amortization and impairment of such rights which results from increased prepayment activity, Source One invests in various financial instruments. As interest rates decline, prepayment activity increases, thereby reducing the value of the capitalized servicing asset, while the value of the financial instrument increases. Conversely, as interest rates increase, the value of the capitalized servicing asset increases while the value of the financial instrument decreases. The financial instruments utilized by Source One include interest rate floor contracts, interest rate swap agreements and principal-only swap agreements. Source One's interest rate floor contracts derive their value from differences between the floor strike rate specified in the contract and prevailing market interest rates and are not subject to total losses in excess of their original cost. As of December 31, 1998, Source One's open interest rate contracts had a fair value of $9.9 million, an original cost of $5.3 million and a total notional value of $1.1 billion. The interest rate contracts have remaining terms ranging from 5 to 10 years with floor rates ranging from 3.54% to 5.05%. Source One's interest rate swap agreements, which were entered into in the 1998 third quarter, entitle Source One to receive interest at fixed rates and pay interest at variable rates based on a contracted notional amount. As of December 31, 1998, Source One's open interest rate swap agreements had a fair value of $4.8 million and had remaining terms ranging from 5 to 10 years. Source One's exposure to losses on the interest rate swap agreements is related to the differences between the contracted fixed interest rates assumed and the contracted variable interest rates ceded over the life of the contract. Source One's principal-only swap agreements derive their value from changes in the value of referenced principal-only securities. As of December 31, 1998, Source One's open principal-only swap agreements had a fair value of $2.7 million, a notional value of $50.0 million and had a remaining term of 5 years. Source One's exposure to losses on the principal-only swap agreements is related to changes in the market value of the underlying principal-only securities over the life of the contract. Contingent liabilities exist with respect to reinsurance ceded, which would become an ultimate liability of Folksamerica in the event that the F-43 assuming companies were unable to meet their obligations under reinsurance agreements in force. Folksamerica evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1998, reinsurance recoverables with a carrying value of $41.7 million were associated with a single reinsurer. Folksamerica holds collateral from this reinsurer in the form of a letter of credit totalling $21.4 million and funds withheld totalling $23.4 million that can be drawn on for amounts that remain unpaid. White Mountains' insurance subsidiaries extend credit to their policyholders in the normal course of business, perform credit evaluations and maintain allowances for potential credit losses. Concentration of credit risk with respect to receivables is limited due to the large number of policyholders and their dispersion across a multi-state area. NOTE 17. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of Fund American's financial instruments have been determined by using appropriate market information and valuation methodologies. Considerable judgement is required to develop the estimates of fair value. Therefore, the estimates provided herein are not necessarily indicative of the amounts that could be realized in a current market exchange. Carrying value equals or approximates fair value for FIXED MATURITY INVESTMENTS, COMMON EQUITY SECURITIES, FINANCIAL INSTRUMENTS (DERIVATIVES), SHORT-TERM INVESTMENTS, CASH, OTHER FINANCIAL ASSETS AND OTHER FINANCIAL LIABILITIES. For each other class of financial instrument for which it is practicable to estimate fair value, the following methods and assumptions were used to estimate such value: OTHER INVESTMENTS. Mortgage loans held for investment are carried at fair value. Financial instruments are carried at fair value which is estimated based on quoted market prices for those or similar investments. For all other securities classified as other investments, fair values have been determined using quoted market values or internal appraisal techniques. MORTGAGE LOANS HELD FOR SALE. Fair values are estimated using quoted market prices for securities backed by similar loans. POOL LOAN PURCHASES. Fair values are estimated based on discounted cash flow analyses using Source One's short-term incremental borrowing rate, quoted market prices for securities backed by similar loans or actual prices at which the loans were subsequently sold. MORTGAGE CLAIMS RECEIVABLE. Fair values are estimated by discounting anticipated future cash flows using Source One's short-term incremental borrowing rate. F-44 DEBT. Fair value is estimated by discounting future cash flows using incremental borrowing rates for similar types of borrowing arrangements or quoted market prices. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS. Fair value for commitments to sell mortgage loans is based on current settlement values for those commitments, net of the face amounts of the commitments. Fair value for commitments to extend credit is based on current quoted market prices for securities backed by similar loans, net of the principal amounts of the commitments. The carrying amounts and estimated fair values of Fund American's financial instruments were as follows:
- --------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 December 31, 1997 -------------------------- ------------------------- CARRYING FAIR Carrying Fair Millions AMOUNT VALUE amount value - --------------------------------------------------------------------------------------------------------------------- FINANCIAL ASSETS: Fixed maturity investments $929.6 $929.6 $168.3 $168.3 Common equity securities 241.7 241.7 104.2 104.2 Other investments (excluding derivative instruments) 79.4 85.9 147.2 156.7 Derivative instruments: Interest rate floor contracts 9.9 9.9 8.2 8.2 Interest rate swaps 4.9 4.9 - - Principal-only swaps 2.7 2.7 12.5 12.5 Short-term investments 79.0 79.0 62.8 62.8 Cash 22.4 22.4 7.0 7.0 Mortgage loans held for sale 676.3 680.0 519.3 529.3 Pool loan purchases 165.0 165.1 149.8 150.2 Mortgage claims receivable, net (a) 27.2 26.5 35.6 34.9 Receivables from sales of servicing 73.8 73.8 27.3 27.3 Other financial assets 39.6 39.6 43.4 43.4 FINANCIAL LIABILITIES: Short-term debt 748.5 748.5 571.4 571.4 Long-term debt 359.7 370.0 304.3 326.5 Other financial liabilities 5.9 5.9 22.3 22.3 OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS: Mandatory forward commitments - .6 - 1.6 Commitments to extend credit expected to close - 11.1 - 6.5 - --------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------
(a) Excludes $5.9 million and $5.6 million of real estate owned in 1998 and 1997, respectively. OTHER FINANCIAL ASSETS includes investment income receivable, accounts receivable from securities sales, notes receivable and, for 1997, White River Shares held for delivery upon exercise of existing employee stock options. OTHER FINANCIAL LIABILITIES includes accrued interest payable, accounts payable on securities purchases, dividends payable to F-45 shareholders and, for 1997, liability for existing employee stock options to purchase White River Shares. Fund American's investments in FSA Options and Preferred Stock, Folksamerica Preferred Stock and Folksamerica Warrants are not presented in the table above. These financial instruments are accounted for under the provisions of SFAS No. 115 and are carried on the balance sheet at fair value. See Note 15. The estimated fair value amounts for Fund American's financial instruments have been determined using available market information and valuation methodologies. Such estimates provided herein are not necessarily indicative of the amounts that would be potentially realized in a current market exchange. NOTE 18. RELATED PARTY TRANSACTIONS For corporate travel purposes Fund American jointly owns two short-range aircraft with Haverford Utah, LLC ("Haverford"). Messrs. Jack Byrne, Patrick M. Byrne, a director of the Company and White Mountains, and Kemp are principals of Haverford. Both aircraft were acquired from unaffiliated third parties during 1996. In exchange for Haverford's 20% ownership interest in the aircraft, Haverford contributed capital equal to 20% of the total initial cost of the aircraft and Haverford bears the full costs of its usage and maintenance of the aircraft pursuant to a Joint Ownership Agreement dated September 16, 1996. Prior to the Joint Ownership Agreement, Fund American was a party to a "dry lease" agreement dated January 2, 1995, for the use of aircraft owned by Haverford Transportation Inc. ("HTI") for corporate travel purposes. Messrs. Jack Byrne and Kemp are the sole shareholders of HTI. During 1996 Fund American paid HTI a total of $279,739 pursuant to the dry lease arrangement. The terms of the agreement provided for the use of HTI's aircraft (excluding pilot and fuel) for a fixed hourly charge of $200 for a single engine piston aircraft and $800 to $1,000 for a twin engine turbine aircraft. Based on the Company's experience in operating comparable aircraft, the hourly operating charges incurred pursuant to the HTI dry lease are considered to be representative of the actual hourly costs of operating HTI's aircraft. In September 1998 Fund American sold its 25% joint ownership interest in a private jet operated by a third party to Haverford for cash proceeds of $500,000. The purchase price received from Haverford represented a payment of $437,500 for Fund American's joint ownership interest (which resulted in Fund American recognizing a pretax gain on sale of approximately $75,000) and $62,500 for reimbursement of prepaid aircraft expenses which were required to be paid to the operator prior to the sale to Haverford. Mr. Howard Clark, Jr., a director of the Company, is Vice Chairman of Lehman Brothers Inc. Lehman Brothers Inc. has, from time to time, F-46 provided various services to Fund American including investment banking services, brokerage services, underwriting of debt and equity securities and financial consulting services. Mr. George J. Gillespie, III, a director of the Company, is a Partner in the firm Cravath, Swaine & Moore, which has been retained by Fund American from time to time to perform legal services. Fund American believes that all the above transactions were on terms that were reasonable and competitive. Additional transactions of this nature may be expected to take place in the ordinary course of business in the future. NOTE 19. SUBSEQUENT EVENT - SALE OF VGI On February 11, 1999, White Mountains entered into a definitive agreement to sell VGI (which includes Valley, Charter and WMIC but excludes Valley National) to Unitrin, Inc. The transaction is expected to close during the 1999 second quarter and is subject to state regulatory approvals. NOTE 20. SUBSEQUENT EVENT - SALE OF MORTGAGE BANKING ASSETS On March 25, 1999 Fund American and Citicorp reached a definitive agreement under which Citicorp will acquire a substantial amount of Fund American's mortgage-banking related assets and certain of its mortgage banking liabilities. Fund American will retain the Source One legal entity which will continue to own all of Fund American's investments in FSA and certain other mortgage-related and other assets and liabilities. The transaction is expected to close during the 1999 second quarter and is subject to various Federal, state and other regulatory approvals. F-47 REPORT ON MANAGEMENT'S RESPONSIBILITIES The financial information included in this annual report, including the audited consolidated financial statements, has been prepared by the management of Fund American. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and, where necessary, include amounts based on informed estimates and judgments. In those instances where there is no single specified accounting principle or standard, management makes a choice from reasonable, accepted alternatives which are believed to be most appropriate under the circumstances. Financial information presented elsewhere in this report is consistent with that shown in the financial statements. Fund American maintains internal financial and accounting controls designed to provide reasonable and cost effective assurance that assets are safeguarded from loss or unauthorized use, that transactions are recorded in accordance with management's policies and that financial records are reliable for preparing financial statements. The internal controls structure is documented by written policies and procedures which are communicated to all appropriate personnel and is updated as necessary. Fund American's business ethics policies require adherence to the highest ethical standards in the conduct of its business. Compliance with these controls, policies and procedures is continuously maintained and monitored by management. KPMG LLP have audited the consolidated financial statements of Fund American as of December 31, 1998 and 1997 and for each of the two years in the period ended December 31, 1998, and issued their unqualified report thereon dated February 12, 1999, which appears on page F-49. Ernst & Young LLP served as Fund American's independent auditors as of December 31, 1996 and for the year then ended, and issued their unqualified report thereon dated March 21, 1997, which appears on page F-51. PricewaterhouseCoopers LLP served as the independent auditors of Folksamerica during 1998 and Valley during 1996. The unqualified reports issued with respect to 1998 audit of Folksamerica and the 1996 audit of Valley have been included as exhibits to this report. In connection with their audits, the independent auditors provide an objective, independent review and evaluation of the structure of internal controls to the extent they consider necessary. Management reviews all recommendations of the independent auditors concerning the structure of internal controls and responds to such recommendations with corrective actions, as appropriate. The Audit Committee of the Board, which is comprised solely of non-management directors, has general responsibility for the oversight and surveillance of the accounting, reporting and financial control practices of Fund American. The Audit Committee, which reports to the full Board, annually reviews the effectiveness of the independent auditors, Fund American's internal auditors and management with respect to the financial reporting process and the adequacy of internal F-48 controls. Both the internal auditors and the independent auditors have, at all times, free access to the Audit Committee, without members of management present, to discuss the results of their audits, the adequacy of internal controls and any other matter that they believe should be brought to the attention of the Audit Committee. K. Thomas Kemp Raymond Barrette Michael S. Paquette Director, President Executive Vice President Senior Vice President and Chief Executive Officer and Chief Financial Officer and Controller
INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Fund American Enterprises Holdings, Inc. We have audited the accompanying consolidated balance sheets of Fund American Enterprises Holdings, Inc. and Subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated income statements, statements of shareholders' equity , and cash flows for the years then ended (collectively, the "consolidated financial statements"). In connection with our audits of the consolidated financial statements, we also have audited the 1998 and 1997 financial information in Schedule I Summary of investments other than investments in related parties, Schedule II Condensed financial information of the registrant, Schedule III Reinsurance, Schedule IV Valuation and qualifying accounts, and Schedule VI Supplementary insurance information (collectively, the "financial statement schedules"). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We did not audit the consolidated financial statements of Folksamerica Holding Company, Inc. ("Folksamerica"), a wholly-owned subsidiary and Financial Security Assurance Holdings, Ltd. ("FSA"), an 11.6 percent owned equity investee company. The financial statements of Folksamerica reflect total assets constituting 37.2 percent and total revenues of 18.4 percent in 1998 of the related consolidated totals. The Company's equity investment in FSA at December 31, 1998 and 1997 was $119.7 million and $104.3 million, respectively, and its equity in earnings of FSA were $13.8 million and $11.4 million for the years 1998 and 1997 respectively. The financial statements of Folksamerica and FSA were audited by other auditors, PricewaterhouseCoopers LLP, whose reports were furnished to us, and our opinion, insofar as it relates to the amounts included for Folksamerica F-49 and FSA, is based solely on the reports of other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fund American Enterprises Holdings, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Also in our opinion, based on our audits and the reports of other auditors, the 1998 and 1997 information in the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP February 12, 1999 Providence, Rhode Island except for Note 20 which is as of March 25, 1999 F-50 INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Fund American Enterprises Holdings, Inc. We have audited the accompanying consolidated income statement of Fund American Enterprises Holdings, Inc. and the related statements of shareholders' equity and cash flows for the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our audit also included the financial statement schedules listed at Item 14(d). Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the consolidated financial statements of Valley Group, Inc., a wholly-owned subsidiary, representing substantially all of the Company's consolidated insurance operations, which statements reflected total revenues of $126.9 million for the year ended December 31, 1996, and the consolidated financial statements of Financial Security Assurance Holdings Ltd. ("FSA"), an equity method investee. The Company's equity in FSA's earnings represents $7.8 million of total revenues for the year ended December 31, 1996. Those statements were audited by other auditors, PricewaterhouseCoopers LLP, whose reports have been furnished to us, and our opinion, insofar as it relates to data included for Valley Group, Inc. and FSA, with respect to the amounts in the two preceding sentences, is based solely on the reports of the other auditors. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audit and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, Fund American Enterprises Holdings, Inc.'s consolidated results of operations and its cash flows for the year ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules when considered in relation to the basic financial statements taken as a whole presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP New York, New York March 21, 1997 F-51 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Selected quarterly financial data for 1998 and 1997 is shown in the following table. The quarterly financial data includes, in the opinion of management, all recurring adjustments necessary for a fair presentation of the results of operations for the interim periods. Certain 1998 and 1997 items have been restated as a result of the Folksamerica transaction, see Note 2.
- -------------------------------------------------------------------------------------------------------------------- 1998 Three Months Ended (a) 1997 Three Months Ended (b) ---------------------------------- ----------------------------------- Millions, except per share amounts Dec. 31Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 - -------------------------------------------------------------------------------------------------------------------- Revenues $197.2 $ 153.6 $ 117.6 $109.7 $ 81.9 $78.0 $ 69.5 $ 80.9 Expenses 187.2 130.0 106.7 95.2 91.0 76.4 80.9 80.3 ------------------------------------------------------------------------ Pretax operating earnings (loss) 10.0 23.6 10.9 14.5 (9.1) 1.6 (11.4) .6 Net realized investment gains 5.2 61.6 1.7 2.5 49.1 21.8 16.2 9.6 ------------------------------------------------------------------------ Pretax earnings 15.2 85.2 12.6 17.0 40.0 23.4 4.8 10.2 Income tax provision 5.5 30.1 5.0 7.2 14.7 7.1 3.2 4.4 ------------------------------------------------------------------------ AFTER TAX EARNINGS 9.7 55.1 7.6 9.8 25.3 16.3 1.6 5.8 Loss on early extinguishment of debt, after tax - - - - - - (6.0) - ------------------------------------------------------------------------ NET INCOME (LOSS) 9.7 55.1 7.6 9.8 25.3 16.3 (4.4) 5.8 Other comprehensive net income, after tax 26.7 (73.1) 11.2 26.3 (20.1) 30.1 39.6 (7.9) ------------------------------------------------------------------------ COMPREHENSIVE NET INCOME (LOSS) $ 36.4 $(18.0) $ 18.8 $ 36.1 $ 5.2 $46.4 $ 35.2 $(2.1) ------------------------------------------------------------------------ ------------------------------------------------------------------------ BASIC EARNINGS PER COMMON SHARE: After tax earnings $ 1.51 $ 9.28 $ 1.13 $ 1.50 $ 3.89 $2.41 $ .09 $ .71 Net income (loss) 1.51 9.28 1.13 1.50 3.89 2.41 (.80) .71 Comprehensive net income (loss) 6.08 (3.22) 3.02 5.94 .68 7.12 5.10 (.43) DILUTED EARNINGS PER COMMON SHARE: After tax earnings 1.33 8.31 1.00 1.33 3.50 2.18 .08 .65 Net income (loss) 1.33 8.31 1.00 1.33 3.50 2.18 (.73) .65 Comprehensive net income (loss) 5.44 (2.90) 2.70 5.32 .61 6.44 4.63 (.40) - -------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------
(a) The quarterly amounts for the three month periods ended September 30, 1998 and December 31, 1998 reflect the consolidation of Folksamerica which became a wholly-owned subsidiary on August 18, 1998. The quarterly amounts for the three month period ended September 30, 1998 include $61.6 million of pretax realized investment gains which served to increase third quarter 1998 net income by $40.0 million. (b) The quarterly amounts for the three month period ended June 30, 1997 include a $9.2 million pretax loss on early extinguishment of Source One's debt which served to decrease second quarter 1997 net income by $6.0 million. The quarterly amounts for the three month period ended December 31, 1997 include $49.1 million of pretax realized investment gains which served to increase fourth quarter 1997 net income by $31.9 million. F-52 SCHEDULE I FUND AMERICAN ENTERPRISES HOLDINGS, INC. SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES AT DECEMBER 31, 1998
- ------------------------------------------------------------------------------------------------- Fair Millions Cost Value - ------------------------------------------------------------------------------------------------- Fixed maturities: Bonds: United States Government and government agencies and authorities $ 217.6 $ 222.0 States, municipalities and political subdivisions 189.1 191.8 Foreign governments 26.7 26.9 All other (primarily corporate bonds) 430.8 437.1 Redeemable preferred stock 51.8 51.8 ---------------------- Total fixed maturities 916.1 929.6 ---------------------- Common equity securities: Banks, trust and insurance companies 28.3 35.5 All other 167.1 206.2 ---------------------- Total common equity securities 195.4 241.7 Other investments 88.5 96.9 Short-term investments 79.0 79.0 - ------------------------------------------------------------------------------------------------- Total investments $ 1,279.0 $ 1,347.2 - ------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------
NOTE - fair value was equal to carrying value at December 31, 1998. FS-1 SCHEDULE II FUND AMERICAN ENTERPRISES HOLDINGS, INC. (PARENT COMPANY ONLY) CONDENSED BALANCE SHEETS
- --------------------------------------------------------------------------- December 31, -------------------- Millions 1998 1997 - --------------------------------------------------------------------------- Assets: Common equity securities and other investments $ - $ 49.2 Short-term investments, at amortized cost 10.8 2.3 Other assets 37.8 40.4 Investments in consolidated affiliates 972.2 843.1 -------------------- Total assets $ 1,020.8 $ 935.0 - --------------------------------------------------------------------------- - --------------------------------------------------------------------------- Liabilities: Long-term debt with third parties $ 115.7 $ 115.6 Intercompany borrowings 53.0 30.0 Accounts payable and other liabilities 149.6 130.5 -------------------- Total liabilities 318.3 276.1 Shareholders' equity 702.5 658.9 -------------------- Total liabilities and shareholders' equity $ 1,020.8 $ 935.0 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
CONDENSED INCOME STATEMENTS
- -------------------------------------------------------------------------------------- Year Ended December 31, ------------------------------- Millions 1998 1997 1996 - -------------------------------------------------------------------------------------- Revenues $ 2.2 $ 8.5 $ 11.7 Expenses 23.2 21.2 15.5 ------------------------------- Pretax operating loss (21.0) (12.7) (3.8) Net realized investment gains (losses) 26.7 44.2 (3.1) ------------------------------- Pretax earnings (loss) 5.7 31.5 (6.9) Income tax provision (benefit) 8.3 16.3 .5 ------------------------------- Parent company only operating income (loss) (2.6) 15.2 (7.4) Earnings from consolidated affiliates 84.8 27.8 16.0 ------------------------------- Consolidated net income 82.2 43.0 8.6 ------------------------------- Consolidated change in net unrealized investment gains, after tax (8.9) 41.7 54.6 ------------------------------- Consolidated comprehensive net income $ 73.3 $ 84.7 $ 63.2 ------------------------------- -------------------------------
FS-2 SCHEDULE II (CONTINUED) FUND AMERICAN ENTERPRISES HOLDINGS, INC. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31, 1998 --------------------------------- Millions 1998 1997 1996 - ------------------------------------------------------------------------------------------------- Net income $ 82.2 $ 43.0 $ 8.6 Reconciliation of net income to net cash from operating activities: Net realized investment (gains) losses (26.7) (44.2) 3.1 Undistributed earnings from consolidated subsidiaries (78.0) (24.1) (12.3) Undistributed earnings from unconsolidated insurance - (.4) (1.1) affiliates Changes in current income taxes receivable and 8.5 5.1 28.4 payable Deferred income tax provision (benefit) .1 (3.7) .1 Dividends and return of capital distributions received - - 65.0 from subsidiaries Other, net 1.7 (1.3) (19.6) --------------------------------- Net cash (used for) provided from operating activities (12.2) (25.6) 72.2 - ------------------------------------------------------------------------------------------------- Cash flows from investing activities: Net (increase) decrease in short-term investments (8.5) (2.0) 28.2 Sales of investment securities - 119.4 134.4 Purchases of investment securities - - (108.9) Investments in consolidated affiliates - (12.7) (25.2) Investments in unconsolidated affiliates - - (27.7) Sale of securities carried in other assets 26.8 - - Purchases of fixed assets - - (.8) --------------------------------- Net cash (used for) provided from investing activities 18.3 104.7 - - ------------------------------------------------------------------------------------------------- Cash flows from financing activities: Purchases of common stock retired (19.5) (103.8) (66.3) Intercompany borrowings from subsidiaries 23.0 30.0 - Cash dividends paid to common shareholders (9.4) (5.3) (5.9) --------------------------------- Net cash used for financing activities (5.9) (79.1) (72.2) - ------------------------------------------------------------------------------------------------- Net increase in cash during year .2 - - Cash balance at beginning of year - - - - ------------------------------------------------------------------------------------------------- Cash balance at end of year $ .2 $ - $ - - ------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------
FS-3 SCHEDULE III FUND AMERICAN ENTERPRISES HOLDINGS, INC. REINSURANCE
- ---------------------------------------------------------------------------------------------- Column A Column B Column C Column D Column E Column F - ---------------------------------------------------------------------------------------------- Percentage Ceded to Assumed of amount Premiums earned Gross other from other Net assumed to (Dollars in millions) amount companies companies amount net - ---------------------------------------------------------------------------------------------- Years ended: December 31, 1998: Property and casualty insurance $ 153.9 $ (6.7) $ -- $ 160.6 -- % Reinsurance (a) 2.4 (8.7) 91.7 85.4 107.4% December 31,1997: Property and casualty insurance 152.1 (6.8) -- 145.3 -- % December 31,1996: Property and casualty insurance 116.7 (7.0) -- 109.7 -- % - ----------------------------------------------------------------------------------------------
(a) Amounts shown in columns B through F represent activity for Folksamerica from August 18, 1998 through December 31,1998. FS-4 SCHEDULE IV FUND AMERICAN ENTERPRISES HOLDINGS, INC. VALUATION AND QUALIFYING ACCOUNTS
- -------------------------------------------------------------------------------------------------------------- Column A Column B Column C Column D Column E - -------------------------------------------------------------------------------------------------------------- Additions -------------------- Balance at Charged to Charged Balance beginning costs and to other Deductions at end Millions of period expenses accounts described of period - -------------------------------------------------------------------------------------------------------------- Years ended: December 31,1998: Reinsurance recoverable: Allowance for reinsurance balances (a) $ 1.2 $ -- $ -- $ -- (b) $ 1.2 Property and casualty insurance: Allowance for uncollectible accounts .3 1.9 -- (1.8)(b) .4 Mortgage banking: Allowance for mortgage loan losses 12.8 3.8 .1 (5.2)(b) 11.5 Impairment allowance for mortgage servicing 45.1 14.8 -- (24.3)(c) 35.6 December 31,1997: Property and casualty insurance: Allowance for uncollectible accounts .4 1.1 -- (1.2)(b) .3 Mortgage banking: Allowance for mortgage loan losses 15.4 4.7 -- (7.3)(b) 12.8 Impairment allowance for mortgage servicing 28.9 22.4 -- (6.2)(c) 45.1 December 31,1996: Property and casualty insurance: Allowance for uncollectible accounts .8 .7 -- (1.1)(b) .4 Mortgage banking: Allowance for mortgage loan losses 13.5 3.0 1.7 (2.8)(b) 15.4 Impairment allowance for mortgage servicing 28.0 8.2 -- (7.3)(c) 28.9 - --------------------------------------------------------------------------------------------------------------
(a) Represents allowances acquired from Folksamerica on August 18, 1998. (b) Represents charge-offs of balances receivable. (c) Represents charge-offs of balances receivable relating to recourse mortgage loans and allowance reductions for mortgage servicing sales. FS-5 SCHEDULE V FUND AMERICAN ENTERPRISES HOLDINGS, INC. SUPPLEMENTARY INSURANCE INFORMATION MILLIONS
Column A Column B Column C Column D Column E Column F - ----------------------------------------------------------------------------------------- Future policy Other Deferred benefits, policy policy losses, claims acquisition and loss Unearned benefits Premiums Segment cost expenses premiums payable earned - ----------------------------------------------------------------------------------------- Years ended: December 31, 1998: Reinsurance (a) $20.7 $723.2 $71.2 $ -- $ 85.4 Property casualty insurance 14.7 88.5 81.9 -- 160.6 December 31, 1997: Property and casualty insurance 14.3 71.9 78.0 -- 145.3 December 31, 1996: Property and casualty insurance 13.2 65.4 72.6 -- 109.7 - ----------------------------------------------------------------------------------------- Column A Column G Column H Column I Column J Column K - ----------------------------------------------------------------------------------------- Benefits, claims, losses, Amortization Net and of deferred Other investment settlement acquisition operating Premiums Segment income (b) expenses costs expenses written - --------------------------------------------------------------------------------------------- Years ended: December 31, 1998: Reinsurance (a) $18.1 $ 59.7 29.1 $36.0 $ 73.7 Property casualty insurance 8.3 115.1 30.0 62.3 164.9 December 31, 1997: Property and casualty insurance 9.0 97.1 27.5 58.9 150.8 December 31, 1996: Property and casualty insurance 7.8 85.9 19.9 53.9 147.0 - ---------------------------------------------------------------------------------------------
(a) The amounts shown for Reinsurance in columns F through K represent activity for Folksamerica from August 18, 1998 through December 31, 1998. (b) The amounts shown exclude net investment income relating to non-insurance operations of $92.0 million, $56.1 million and $49.5 million for the twelve months ended December 31,1 998, 1997 and 1996,respectively. FS-6


                                                                     Exhibit 10a

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------



                                   $35,000,000


                      AMENDED AND RESTATED CREDIT AGREEMENT


                                      AMONG

                    FUND AMERICAN ENTERPRISES HOLDINGS, INC.,


                                  as Borrower,


                            THE LENDERS NAMED HEREIN

                                       and

                       THE FIRST NATIONAL BANK OF CHICAGO,

                                    as Agent

                                   DATED AS OF

                                 August 14, 1998



- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------





                                TABLE OF CONTENTS


                                                                                                            
ARTICLE I

         DEFINITIONS..............................................................................................1

ARTICLE II

         THE CREDITS.............................................................................................15
         2.1.       ADVANCES.....................................................................................15
         2.2.       RATABLE LOANS................................................................................15
         2.3.       TYPES OF ADVANCES............................................................................15
         2.4.       FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT.............................................15
         2.5.       MINIMUM AMOUNT OF EACH ADVANCE...............................................................16
         2.6.       OPTIONAL PRINCIPAL PAYMENTS..................................................................16
         2.7.       METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR NEW ADVANCES..............................16
         2.8.       CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES..........................................17
         2.9.       CHANGES IN INTEREST RATE, ETC................................................................17
         2.10.      RATES APPLICABLE AFTER DEFAULT...............................................................17
         2.11.      METHOD OF PAYMENT............................................................................18
         2.12.      NOTES........................................................................................18
         2.13.      INTEREST PAYMENT DATES; INTEREST AND FEE BASIS...............................................18
         2.14.      NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS AND COMMITMENT REDUCTIONS..............19
         2.15.      LENDING INSTALLATIONS........................................................................19
         2.16.      NON-RECEIPT OF FUNDS BY THE AGENT............................................................19
         2.17.      TAXES........................................................................................19
         2.18.      AGENT'S FEES.................................................................................20

 ARTICLE III

         CHANGE IN CIRCUMSTANCES.................................................................................21
         3.1.       YIELD PROTECTION.............................................................................21
         3.2.       CHANGES IN CAPITAL ADEQUACY REGULATIONS......................................................21
         3.3.       AVAILABILITY OF TYPES OF ADVANCES............................................................22
         3.4.       FUNDING INDEMNIFICATION......................................................................22
         3.5.       LENDER STATEMENTS; SURVIVAL OF INDEMNITY.....................................................22

ARTICLE IV

         CONDITIONS PRECEDENT....................................................................................23
4.1. EFFECTIVENESS................................................................................23 4.2. EACH FUTURE ADVANCE..........................................................................24 ARTICLE V REPRESENTATIONS AND WARRANTIES..........................................................................25 5.1. CORPORATE EXISTENCE AND STANDING.............................................................25 5.2. AUTHORIZATION AND VALIDITY...................................................................25 5.3. COMPLIANCE WITH LAWS AND CONTRACTS...........................................................25 5.4. GOVERNMENTAL CONSENTS........................................................................26 5.5. FINANCIAL STATEMENTS.........................................................................26 5.6. MATERIAL ADVERSE CHANGE......................................................................26 5.7. TAXES........................................................................................26 5.8. LITIGATION AND CONTINGENT OBLIGATIONS........................................................27 5.9. CAPITALIZATION...............................................................................27 5.10. ERISA........................................................................................27 5.11. DEFAULTS.....................................................................................27 5.12. FEDERAL RESERVE REGULATIONS..................................................................28 5.13. INVESTMENT COMPANY...........................................................................28 5.14. CERTAIN FEES.................................................................................28 5.15. SOLVENCY.....................................................................................28 5.16. MATERIAL AGREEMENTS..........................................................................28 5.17. ENVIRONMENTAL LAWS...........................................................................28 5.18. INSURANCE....................................................................................29 5.19. DISCLOSURE...................................................................................29 5.20. YEAR 2000. ..................................................................................29 ARTICLE VI COVENANTS...............................................................................................29 6.1. FINANCIAL REPORTING..........................................................................29 6.2. USE OF PROCEEDS..............................................................................31 6.3. NOTICE OF DEFAULT............................................................................31 6.4. CONDUCT OF BUSINESS..........................................................................31 6.5. TAXES........................................................................................32 6.6. INSURANCE....................................................................................32 6.7. COMPLIANCE WITH LAWS.........................................................................32 6.8. MAINTENANCE OF PROPERTIES....................................................................32 6.9. INSPECTION...................................................................................32 6.10. DIVIDENDS....................................................................................32 6.11. INDEBTEDNESS.................................................................................33 6.12. MERGER.......................................................................................33 6.13. CONTINGENT OBLIGATIONS.......................................................................34
-iii- 6.14. LIENS........................................................................................34 6.15. INVESTMENTS AND PURCHASES....................................................................35 6.16. AFFILIATES...................................................................................36 6.17. ENVIRONMENTAL MATTERS........................................................................36 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR...................................................36 6.19. INCONSISTENT AGREEMENTS......................................................................37 6.20. FINANCIAL COVENANTS - MINIMUM NET WORTH.....................................................37 6.21. TAX CONSOLIDATION............................................................................37 6.22. ERISA COMPLIANCE.............................................................................37 6.23. YEAR 2000....................................................................................38 ARTICLE VII DEFAULTS................................................................................................38 ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES..........................................................40 8.1. ACCELERATION.................................................................................40 8.2. AMENDMENTS...................................................................................40 8.3. PRESERVATION OF RIGHTS.......................................................................41 ARTICLE IX GENERAL PROVISIONS......................................................................................41 9.1. SURVIVAL OF REPRESENTATIONS..................................................................41 9.2. GOVERNMENTAL REGULATION......................................................................41 9.3. TAXES........................................................................................41 9.4. HEADINGS.....................................................................................41 9.5. ENTIRE AGREEMENT.............................................................................41 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT..............................................41 9.7. EXPENSES; INDEMNIFICATION....................................................................42 9.8. NUMBERS OF DOCUMENTS.........................................................................42 9.9. ACCOUNTING...................................................................................42 9.10. SEVERABILITY OF PROVISIONS...................................................................42 9.11. NONLIABILITY OF LENDERS......................................................................42 9.12. CHOICE OF LAW................................................................................43 9.13. CONSENT TO JURISDICTION......................................................................43 9.14. WAIVER OF JURY TRIAL.........................................................................43 9.15. DISCLOSURE...................................................................................43 9.16. COUNTERPARTS.................................................................................44 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY............................................44
-iv- ARTICLE X THE AGENT...............................................................................................44 10.1. APPOINTMENT..................................................................................45 10.2. POWERS.......................................................................................45 10.3. GENERAL IMMUNITY.............................................................................45 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC...................................................45 10.5. ACTION ON INSTRUCTIONS OF LENDERS............................................................45 10.6. EMPLOYMENT OF AGENTS AND COUNSEL.............................................................46 10.7. RELIANCE ON DOCUMENTS; COUNSEL...............................................................46 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION....................................................46 10.9. NOTICE OF DEFAULT............................................................................46 10.10. RIGHTS AS A LENDER...........................................................................46 10.11. LENDER CREDIT DECISION.......................................................................47 10.12. SUCCESSOR AGENT..............................................................................47 ARTICLE XI SETOFF; RATABLE PAYMENTS................................................................................47 11.1. SETOFF.......................................................................................47 11.2. RATABLE PAYMENTS.............................................................................48 ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS.......................................................48 12.1. SUCCESSORS AND ASSIGNS.......................................................................48 12.2. PARTICIPATIONS...............................................................................48 12.2.1. PERMITTED PARTICIPANTS; EFFECT. ...................................................48 12.2.2. VOTING RIGHTS.......................................................................49 12.2.3. BENEFIT OF SETOFF...................................................................49 12.3. ASSIGNMENTS..................................................................................49 12.3.1. PERMITTED ASSIGNMENTS...............................................................49 12.3.2. EFFECT; EFFECTIVE DATE..............................................................49 12.4. DISSEMINATION OF INFORMATION.................................................................50 12.5. TAX TREATMENT................................................................................50 ARTICLE XIII NOTICES.................................................................................................50 13.1. GIVING NOTICE................................................................................50 13.2. CHANGE OF ADDRESS............................................................................50
-v- EXHIBITS Exhibit A (Article 1) Note Exhibit B (Section 6.1(c)) Compliance Certificate Exhibit C (Section 12.3.1) Assignment Agreement SCHEDULES Schedule 5.3 - Approvals and Consents Schedule 5.8 - Material Contingent Obligations Schedule 5.9 - Capitalization and Subsidiaries Schedule 5.10 - ERISA Schedule 5.16 - Material Restrictions Schedule 6.14 - Liens Schedule 6.15 - Investment Commitments -vi- AMENDED AND RESTATED CREDIT AGREEMENT This Amended and Restated Credit Agreement, dated as of August 14, 1998, is among FUND AMERICAN ENTERPRISES HOLDINGS, INC., a Delaware corporation, the Lenders and THE FIRST NATIONAL BANK OF CHICAGO, individually and as Agent. R E C I T A L S: A. The Borrower, the Lenders and the Agent are party to that certain $35,000,000 credit agreement, dated as of July 31, 1997 (the "Existing Credit Agreement"). B. The Borrower has requested that the Existing Credit Agreement be amended and restated in order to extend the maturity and to make certain other amendments to the Existing Credit Agreement. C. The Borrower, the Lenders and the Agent desire to amend and restate the Existing Credit Agreement on the terms and conditions set forth below to accomplish such amendments. NOW, THEREFORE, in consideration of the mutual covenants and undertakings herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, the Lenders and the Agent hereby agree as follows: ARTICLE I DEFINITIONS As used in this Agreement: "ABR Advance" means an Advance which bears interest at the Alternate Base Rate. "Advance" means a borrowing pursuant to SECTION 2.1 consisting of the aggregate amount of the several Loans made on the same Borrowing Date by the Lenders to the Borrower of the same Type and, in the case of Eurodollar Advances, for the same Interest Period. "Affiliate" of any Person means any other Person directly or indirectly controlling, controlled by or under common control with such Person. A Person shall be deemed to control another Person if the controlling Person owns 20% or more of any class of voting securities (or other ownership interests) of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management or policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Agent" means First Chicago in its capacity as agent for the Lenders pursuant to ARTICLE X, and not in its individual capacity as a Lender, and any successor Agent appointed pursuant to ARTICLE X. "Aggregate Commitment" means the aggregate of the Commitments of all the Lenders hereunder. The initial Aggregate Commitment is $35,000,000. "Agreement" means this Amended and Restated Credit Agreement, as it may be amended, modified or restated and in effect from time to time. "Agreement Accounting Principles" means generally accepted accounting principles as in effect from time to time; PROVIDED, HOWEVER, that if any changes in accounting principles from those in effect on the date of this Agreement are adopted which result in a material change in the method of calculation of any of the financial covenants, standards or terms in this Agreement, the parties agree to enter into negotiations to determine whether such provisions require amendment and, if so, the terms of such amendment so as to equitably reflect such changes. Until a resolution thereof is reached, all calculations made for the purposes of determining compliance with the terms of this Agreement shall be made by application of generally accepted accounting principles in effect on the date of this Agreement applied, to the extent applicable, on a basis consistent with that used in the preparation of the financial statements furnished to the Lenders pursuant to SECTION 5.5 hereof. "Alternate Base Rate" means, for any day, a rate of interest per annum equal to the higher of (a) the Corporate Base Rate for such day, and (b) the sum of the Federal Funds Effective Rate for such day plus 1/2% per annum, in each case changing when and as the Corporate Base Rate and the Federal Funds Effective Rate, as the case may be, changes. "Applicable Credit Rating" shall mean the highest rating level assigned by S&P or Moody's, as the case may be, to any long-term senior debt of the Borrower which ranks on parity, as to payment and security, with the Loans and the obligations of the Borrower under ARTICLE XIV. "Applicable Eurodollar Margin" means the applicable percentage set forth below based upon the Level then in effect:
Level Margin ----- ------ Level I .175% Level II .190% Level III .230% Level IV .270% Level V .300% Level VI .375% Level VII .550%
-2- "Applicable Facility Fee Margin" means the applicable percentage set forth below based upon the Level then in effect:
Level Margin ----- ------ Level I .050% Level II .060% Level III .070% Level IV .080% Level V .100% Level VI .125% Level VII .200%
"Article" means an article of this Agreement unless another document is specifically referenced. "Authorized Officer" means, with respect to the Borrower, any of the chief executive officer, president, chief financial officer, treasurer or controller thereof, acting singly. "Bankruptcy Code" means Title 11, United States Code, sections 1 ET SEQ., as the same may be amended from time to time, and any successor thereto or replacement therefor which may be hereafter enacted. "Benefit Plan" means any deferred benefit plan for the benefit of present, future or former employees, whether or not such benefit plan is a Plan. "Borrower" means Fund American Enterprises Holdings, Inc., a Delaware corporation, and its successors and assigns. "Borrowing Date" means a date on which an Advance is made hereunder. "Borrowing Notice" is defined in SECTION 2.7. "Business Day" means (a) with respect to any borrowing, payment or rate selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities and on which dealings in United States dollars are carried on in the London interbank market, and (b) for all other purposes, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities. "Capitalized Lease" of a Person means any lease of Property by such Person as lessee which would be capitalized on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. -3- "Capitalized Lease Obligations" of a Person means the amount of the obligations of such Person under Capitalized Leases which would be shown as a liability on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. "Cash Equivalents" means Investments maturing within one (1) year from the date of investment (in the case of Investments referenced in CLAUSES (A) through (E)) in (a) certificates of deposit, Eurodollar time deposits and other interest bearing deposits or accounts with United States commercial banks having a combined capital and surplus of at least $500,000,000 and rated C or better by Keefe Bruyette and Associates or with any Lender, (b) certificates of deposit, other interest bearing accounts or deposits and demand deposits with other United States commercial banks, which deposits and accounts are in amounts fully insured by the Federal Deposit Insurance Corporation, (c) obligations issued or unconditionally guaranteed by the United States government or issued by an agency thereof and backed by the full faith and credit of the United States, (d) direct obligations issued by any state of the United States or any political subdivision thereof which have the highest rating obtainable from S&P on the date of investment, (e) commercial paper rated A-1 or better by S&P and P-1 or better by Moody's, (f) shares in an open-end management investment company with U.S. dollar denominated investments in fixed income obligations, including repurchase agreements, fixed time deposits and other obligations, with a credit quality comparable to any of the Investments described in CLAUSES (A) through (E) above and a dollar weighted average maturity of not more than one (1) year, and for the calculation of this dollar weighted average maturity, certain instruments which have a variable rate of interest readjusted no less frequently than annually are deemed to have a maturity equal to the period remaining until the next readjustment of the interest rate and (g) money market mutual funds identified by the valuation office of the NAIC as requiring no investment reserve. "Change" is defined in SECTION 3.2. "Change in Control" means (a) the acquisition by any "person" or "group" (as such terms are used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) (other than John J. Byrne or any Plan or any Benefit Plan of the Borrower or any of its Subsidiaries), including without limitation any acquisition effected by means of any transaction contemplated by SECTION 6.12, of beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended) of 25% or more of the outstanding shares of voting stock of the Borrower, or (b) during any period of twelve (12) consecutive calendar months, commencing on the date of the Agreement, the ceasing of those individuals (the "CONTINUING DIRECTORS") who (i) were directors of the Borrower on the first day of each such period or (ii) subsequently became directors of the Borrower and whose initial election or initial nomination for election subsequent to that date was approved by a majority of the Continuing Directors then on the board of directors of the Borrower to constitute a majority of the board of directors of the Borrower, or (c) during any period of twelve (12) consecutive calendar months, commencing on the date of this Agreement, the ceasing of individuals who hold an office possessing the title Senior Vice President or such title that ranks senior to a Senior Vice President (collectively, "Senior Management") of the Borrower on the first day of each such period to constitute a majority of the Senior Management of the Borrower. -4- "Code" means the Internal Revenue Code of 1986, as amended, reformed or otherwise modified from time to time. "Commitment" means, for each Lender, the obligation of such Lender to make Loans not exceeding the amount set forth opposite its signature below and as set forth in any Notice of Assignment relating to any assignment which has become effective pursuant to SECTION 12.3.2, as such amount may be modified from time to time pursuant to the terms hereof. "Consolidated" or "consolidated", when used in connection with any calculation, means a calculation to be determined on a consolidated basis for a Person and its Subsidiaries in accordance with Agreement Accounting Principles. "Consolidated Person" means, for the taxable year of reference, each Person which is a member of the affiliated group of the Borrower if Consolidated returns are or shall be filed for such affiliated group for federal income tax purposes or any combined or unitary group of which the Borrower is a member for state income tax purposes. "Contingent Obligation" of a Person means any agreement, undertaking or arrangement by which such Person assumes, guarantees, endorses, contingently agrees to purchase or provide funds for the payment of, or otherwise becomes or is contingently liable upon, the obligation or liability of any other Person, or agrees to maintain the net worth or working capital or other financial condition of any other Person, or otherwise assures any creditor of such other Person against loss, including, without limitation, any comfort letter, operating agreement or take-or-pay contract or application for a Letter of Credit, excluding however (a) insurance policies and insurance contracts issued in the ordinary course of business and (b) any financial guarantees issued by FSA. "Controlled Group" means all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower or any of its Subsidiaries, are treated as a single employer under Section 414 of the Code. "Conversion/Continuation Notice" is defined in SECTION 2.8. "Corporate Base Rate" means a rate per annum equal to the corporate base rate of interest publicly announced by First Chicago from time to time, changing when and as said corporate base rate changes. The Corporate Base Rate is a reference rate and does not necessarily represent the lowest or best rate of interest actually charged to any customer. First Chicago may make commercial loans or other loans at rates of interest at, above or below the Corporate Base Rate. "Default" means an event described in ARTICLE VII. "Environmental Laws" is defined in SECTION 5.18. -5- "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "Eurodollar Advance" means an Advance which bears interest at the Eurodollar Rate. "Eurodollar Base Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the rate determined by the Agent to be the rate at which deposits in U.S. dollars are offered by First Chicago to first-class banks in the London interbank market at approximately 11 a.m. (London time) two (2) Business Days prior to the first day of such Interest Period, in the approximate amount of First Chicago's relevant Eurodollar Advance and having a maturity approximately equal to such Interest Period. "Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the sum of (a) the quotient of (i) the Eurodollar Base Rate applicable to such Interest Period, divided by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to such Interest Period, plus (b) the Applicable Eurodollar Margin. The Eurodollar Rate shall be rounded to the next higher multiple of 1/100 of 1% if the rate is not such a multiple. "Existing Credit Agreement" is defined in the recitals to this Agreement. "Facility Fee" is defined in SECTION 2.4(A). "Federal Funds Effective Rate" means, for any day, an interest 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 for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10 a.m. (Chicago time) on such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent in its sole discretion. "Financial Statements" is defined in SECTION 5.5. "First Chicago" means The First National Bank of Chicago in its individual capacity, and its successors. "Fiscal Quarter" means one of the four three-month accounting periods comprising a Fiscal Year. "Fiscal Year" means the twelve-month accounting period ending December 31 of each year. "Folksamerica" means Folksamerica Holding Company, Inc., a New York corporation. "Folksamerica Assumption" is defined in the definition of Folksamerica Transaction. -6- "Folksamerica Transaction" means that certain transaction by which (a) White Mountains and/or Fund American Enterprises, Inc. (formerly known as Fund American Enterprises II, Inc.), a Delaware corporation, acquires all of the outstanding capital stock of Folksamerica not already owned by White Mountains, (b) the Borrower assumes the obligations of each of Folksam Omsesidig Sakforsakring (Sweden) and Samvirke Skadeforsikring AS (Norway) (collectively, the "Folksamerica Guarantors") to guarantee the obligations of Folksamerica (the "Folksamerica Guaranty") under a certain $70,000,000 ($56,000,000 of which is outstanding on the date hereof) loan agreement with Swedbank (Sparbanken Sverige AB (publ)), New York branch, dated as of November 12, 1991, as amended, and (c) the Borrower indemnifies the Folksamerica Guarantors and their respective affiliates, successors and assigns with respect to various matters relating to the Folksamerica Guaranty. "Folksamerica Assumption" means the obligations of the Borrower under CLAUSES (B) and (C). "FSA" means Financial Security Assurance Holdings Ltd., a New York corporation. "FSA Amount" means an amount equal to that which is ultimately utilized by SOMSC on or before May 13, 1999 to excercise certain options, in existence on the date hereof, on the capital stock of FSA, such amount not to exceed $18,000,000. "Funded Indebtedness" means Indebtedness of the type described in clauses (a), (d), (e) and (h) of the definition "Indebtedness". "Governmental Authority" means any government (foreign or domestic) or any state or other political subdivision thereof or any governmental body, agency, authority, department or commission (including without limitation any taxing authority or political subdivision) or any instrumentality or officer thereof (including without limitation any court or tribunal) exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government and any corporation, partnership or other entity directly or indirectly owned or controlled by or subject to the control of any of the foregoing. "Guaranteed Obligations" means, collectively, (i) the Obligations and (ii) all Rate Hedging Obligations owing to one or more Lenders. "Hazardous Materials" is defined in SECTION 5.18. "Indebtedness" of a Person means such Person's (a) obligations for borrowed money, (b) obligations representing the deferred purchase price of Property or services (other than accounts payable arising in the ordinary course of such Person's business payable on terms customary in the trade), (c) obligations, whether or not assumed, secured by Liens or payable out of the proceeds or production from Property now or hereafter owned or acquired by such Person, (d) obligations which are evidenced by notes, acceptances, or similar instruments, (e) Capitalized Lease Obligations, (f) Rate Hedging Obligations, (g) Contingent Obligations, (h) obligations for which such Person is obligated pursuant to or in respect of a Letter of Credit and (i) repurchase obligations or liabilities of such Person with respect to accounts or notes receivable sold by such Person. -7- "Insurance Subsidiaries" means Subsidiaries which are engaged in the insurance business as an issuer or underwriter of insurance policies and/or insurance contracts. "Interest Period" means, with respect to a Eurodollar Advance, a period of one, two, three or six months commencing on a Business Day selected by the Borrower pursuant to this Agreement. Such Interest Period shall end on (but exclude) the day which corresponds numerically to such date one, two, three or six months thereafter; PROVIDED, HOWEVER, that if there is no such numerically corresponding day in such next, second, third or sixth succeeding month, such Interest Period shall end on the last Business Day of such next, second, third or sixth succeeding month. If an Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall end on the next succeeding Business Day; PROVIDED, HOWEVER, that if said next succeeding Business Day falls in a new calendar month, such Interest Period shall end on the immediately preceding Business Day. "Investment" of a Person means any loan, advance (other than commission, travel and similar advances to officers and employees made in the ordinary course of business), extension of credit (other than accounts receivable arising in the ordinary course of business on terms customary in the trade) or contribution of capital by such Person; stocks, bonds, mutual funds, partnership interests, notes, debentures or other securities owned by such Person; any deposit accounts and certificate of deposit owned by such Person; and structured notes, derivative financial instruments and other similar instruments or contracts owned by such Person. "Lenders" means the lending institutions listed on the signature pages of this Agreement and their respective successors and assigns. "Lending Installation" means, with respect to a Lender or the Agent, any office, branch, subsidiary or affiliate of such Lender or the Agent. "Letter of Credit" of a Person means a letter of credit or similar instrument which is issued upon the application of such Person or upon which such Person is an account party or for which such Person is in any way liable. "Level" means, and includes, Level I, Level II, Level III, Level IV, Level V, Level VI or Level VII, whichever is in effect at the relevant time. "Level I" shall exist at any time the Applicable Credit Rating of S&P is equal to or greater than A+ OR the Applicable Credit Rating of Moody's is equal to or greater than A1. "Level II" shall exist at any time (a) the Applicable Credit Rating of S&P is equal to or greater than A OR the Applicable Credit Rating of Moody's is equal to or greater than A2 and (b) Level I does not exist. -8- "Level III" shall exist at any time (a) the Applicable Credit Rating of S&P is equal to or greater than A- OR the Applicable Credit Rating of Moody's is equal to or greater than A3 and (b) Levels I and II do not exist. "Level IV" shall exist at any time (a) the Applicable Credit Rating of S&P is equal to or greater than BBB+ OR the Applicable Credit Rating of Moody's is equal to or greater than Baa1 and (b) Levels I, II and III do not exist. "Level V" shall exist at any time (a) the Applicable Credit Rating of S&P is equal to or greater than BBB OR the Applicable Credit Rating of Moody's is equal to or greater than Baa2 and (b) Levels I, II, III and IV do not exist. "Level VI" shall exist at any time the Applicable Credit Rating of S&P is BBB- AND the Applicable Credit Rating of Moody's is Baa3. "Level VII" shall exist at any time the Applicable Credit Rating of S&P is less than BBB- OR the Applicable Credit Rating of Moody's is less than Baa3 OR at any time neither S&P nor Moody's assigns an Applicable Credit Rating. "Lien" means any security interest, lien (statutory or other), mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance or preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever (including, without limitation, the interest of a vendor or lessor under any conditional sale, Capitalized Lease or other title retention agreement), save in respect of liabilities and obligations arising out of the underwriting of insurance policies and contracts of insurance. "Loan" means, with respect to a Lender, such Lender's portion of any Advance and "Loans" means, with respect to the Lenders, the aggregate of all Advances. "Loan Documents" means this Agreement, the Notes and the other documents and agreements contemplated hereby and executed by the Borrower in favor of the Agent or any Lender. "Margin Stock" has the meaning assigned to that term under Regulation U. "Material Adverse Effect" means a material adverse effect on (a) the business, Property, condition (financial or other), performance, results of operations, or prospects of the Borrower and its Subsidiaries taken as a whole, (b) the ability of the Borrower or any Subsidiary to perform its obligations under the Transaction Documents, or (c) the validity or enforceability of any of the Transaction Documents or the rights or remedies of the Agent or the Lenders thereunder. "Maturity Date" means February 12, 2000. "Moody's" means Moody's Investors Services, Inc., and any successor thereto. -9- "Multiemployer Plan" means a Plan maintained pursuant to a collective bargaining agreement or any other arrangement to which the Borrower or any member of the Controlled Group is a party to which more than one employer is obligated to make contributions. "NAIC" means the National Association of Insurance Commissioners or any successor thereto, or in lieu thereof, any other association, agency or other organization performing advisory, coordination or other like functions among insurance departments, insurance commissioners and similar Governmental Authorities of the various states of the United States toward the promotion of uniformity in the practices of such Governmental Authorities. "Net Worth" means, with respect to any Person, at any date the consolidated shareholders' equity of such Person and its Consolidated Subsidiaries determined in accordance with Agreement Accounting Principles (but excluding the effect of Statement of Financial Accounting Standards No. 115). "Non-Excluded Taxes" is defined in SECTION 2.17(A). "Note" means a promissory note in substantially the form of EXHIBIT A hereto, with appropriate insertions, duly executed and delivered to the Agent by the Borrower and payable to the order of a Lender in the amount of its Commitment, including any amendment, modification, renewal or replacement of such promissory note. "Notice of Assignment" is defined in SECTION 12.3.2. "Obligations" means all unpaid principal of and accrued and unpaid interest on the Notes, all accrued and unpaid fees and all expenses, reimbursements, indemnities and other obligations of the Borrower to the Lenders or to any Lender, the Agent or any indemnified party hereunder arising under any of the Transaction Documents. "Participants" is defined in SECTION 12.2.1. "Payment Date" means the last day of each March, June, September and December. "PBGC" means the Pension Benefit Guaranty Corporation or any successor thereto. "Person" means any natural person, corporation, firm, joint venture, partnership, association, enterprise, trust or other entity or organization, or any government or political subdivision or any agency, department or instrumentality thereof. "Plan" means an employee pension benefit plan, as defined in Section 3(2) of ERISA, as to which the Borrower or any member of the Controlled Group may have any liability. "Proceeding" is defined in SECTION 5.18. -10- "Property" of a Person means any and all property, whether real, personal, tangible, intangible, or mixed, of such Person, or other assets owned, leased or operated by such Person. "pro-rata" means, when used with respect to a Lender, and any described aggregate or total amount, an amount equal to such Lender's pro-rata share or portion based on its percentage of the Aggregate Commitment or if the Aggregate Commitment has been terminated, its percentage of the aggregate principal amount of outstanding Advances. "Purchase" means any transaction, or any series of related transactions, consummated on or after the date of this Agreement, by which the Borrower or any of its Subsidiaries (a) acquires any going business or all or substantially all of the assets of any firm, corporation or division or line of business thereof, whether through purchase of assets, merger or otherwise, or (b) directly or indirectly acquires (in one transaction or as the most recent transaction in a series of transactions) at least a majority (in number of votes) of the securities of a corporation which have ordinary voting power for the election of directors (other than securities having such power only by reason of the happening of a contingency) or a majority (by percentage or voting power) of the outstanding partnership interests of a partnership or membership interests of a limited liability company. "Purchasers" is defined in SECTION 12.3.1. "Rate Hedging Obligations" of a Person means any and all obligations of such Person, whether absolute or contingent and howsoever and whensoever created, arising, evidenced or acquired (including all renewals, extensions and modifications thereof and substitutions therefor), under (a) any and all agreements, devices or arrangements designed to protect at least one of the parties thereto from the fluctuations of interest rates, exchange rates or forward rates applicable to such party's assets, liabilities or exchange transactions, including, but not limited to, dollar-denominated or cross-currency interest rate exchange agreements, forward currency exchange agreements, interest rate cap or collar protection agreements, forward rate currency or interest rate options, puts and warrants, and (b) any and all cancellations, buy backs, reversals, terminations or assignments of any of the foregoing. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor thereto or other regulation or official interpretation of said Board of Governors relating to reserve requirements applicable to depositary institutions. "Regulation T" means Regulation T of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of such Board of Governors relating to the extension of credit by securities brokers and dealers for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor or other regulation or official interpretation -11- of said Board of Governors relating to the extension of credit by banks for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation X" means Regulation X of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by the specified lenders for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Release" is defined in the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. 39601 ET SEQ. "Reportable Event" means a reportable event as defined in Section 4043 of ERISA and the regulations issued under such section, with respect to a Plan, excluding, however, such events as to which the PBGC has by regulation waived the requirement of Section 4043(a) of ERISA that it be notified within thirty (30) days of the occurrence of such event; PROVIDED, that a failure to meet the minimum funding standard of Section 412 of the Code and of Section 302 of ERISA shall be a Reportable Event regardless of the issuance of any such waiver of the notice requirement in accordance with either Section 4043(a) of ERISA or Section 412(d) of the Code. "Required Lenders" means Lenders in the aggregate having at least 66-2/3% of the Aggregate Commitment or, if the Aggregate Commitment has been terminated, Lenders in the aggregate holding at least 66-2/3% of the aggregate unpaid principal amount of the outstanding Loans. "Reserve Requirement" means, with respect to an Interest Period, the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed under Regulation D on Eurocurrency liabilities. "Revolver Termination Date" means August 13, 1999. "Risk-Based Capital Guidelines" is defined in SECTION 3.2. "S&P" means Standard & Poor's Ratings Group, and any successor thereto. "Section" means a numbered section of this Agreement, unless another document is specifically referenced. "Significant Subsidiary" shall mean and include, at any time, each Subsidiary of the Borrower to the extent that the Net Worth of such Subsidiary is equal to or greater than $5,000,000. "Single Employer Plan" means a Plan subject to Title IV of ERISA maintained by the Borrower or any member of the Controlled Group for employees of the Borrower or any member of the Controlled Group, other than a Multiemployer Plan. -12- "Solvent" means, when used with respect to a Person, that (a) the fair saleable value of the assets of such Person is in excess of the total amount of the present value of its liabilities (including for purposes of this definition all liabilities (including loss reserves as determined by such Person), whether or not reflected on a balance sheet prepared in accordance with Agreement Accounting Principles and whether direct or indirect, fixed or contingent, secured or unsecured, disputed or undisputed), (b) such Person is able to pay its debts or obligations in the ordinary course as they mature and (c) such Person does not have unreasonably small capital to carry out its business as conducted and as proposed to be conducted. "Solvency" shall have a correlative meaning. "SOMSC" means Source One Mortgage Services Corporation, a Delaware corporation. "SOMSC Credit Agreements" means the credit agreement or credit agreements from time to time in effect among SOMSC, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented, restated, replaced or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "Subsidiary" of a Person means (a) any corporation more than 50% of the outstanding securities having ordinary voting power of which shall at the time be owned or controlled, directly or indirectly, by such Person or by one or more of its Subsidiaries or by such Person and one or more of its Subsidiaries, or (b) any partnership, association, joint venture, limited liability company or similar business organization more than 50% of the ownership interests having ordinary voting power of which shall at the time be so owned or controlled. Unless otherwise expressly provided, all references herein to a "Subsidiary" shall mean a Subsidiary of the Borrower. "Termination Event" means, with respect to a Plan which is subject to Title IV of ERISA, (a) a Reportable Event, (b) the withdrawal of the Borrower or any other member of the Controlled Group from such Plan during a plan year in which the Borrower or any other member of the Controlled Group was a "substantial employer" as defined in Section 4001(a)(2) of ERISA or was deemed such under Section 4068(f) of ERISA, (c) the termination of such Plan, the filing of a notice of intent to terminate such Plan or the treatment of an amendment of such Plan as a termination under Section 4041 of ERISA, (d) the institution by the PBGC of proceedings to terminate such Plan or (e) any event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or appointment of a trustee to administer, such Plan. "Transaction Documents" means, collectively, the Loan Documents and the White Mountains Guaranty. "Transferee" is defined in SECTION 12.4. "Type" means, with respect to any Advance, its nature as an ABR Advance or Eurodollar Advance. -13- "Unfunded Liability" means the amount (if any) by which the present value of all vested and unvested accrued benefits under a Single Employer Plan exceeds the fair market value of assets allocable to such benefits, all determined as of the then most recent valuation date for such Plans using PBGC actuarial assumptions for single employer plan terminations. "Unmatured Default" means an event which but for the lapse of time or the giving of notice, or both, would constitute a Default. "Unrestricted Subsidiary" means SOMSC and any Subsidiary thereof. "Valley Credit Agreement" means the Second Amended and Restated Credit Agreement, dated as of August 14, 1998 among Valley Group, Inc., the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "White Mountains" means White Mountains Holdings, Inc., a Delaware corporation formerly known as Fund American Enterprises, Inc. and the survivor of a merger with White Mountains Holdings, Inc., a New Hampshire corporation. "White Mountains Credit Agreement" means the Second Amended and Restated Credit Agreement, dated as of August 14, 1998, among White Mountains, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "White Mountains Guaranty" means a guaranty of the Guaranteed Obligations in form and substance satisfactory to the Agent and the Lenders, dated as of the date hereof and duly executed and delivered to the Agent by White Mountains, as the same may be amended or modified and in effect from time to time. "Wholly-Owned Subsidiary" of a Person means (a) any Subsidiary all of the outstanding voting securities of which (other than directors' qualifying or similar shares) shall at the time be owned or controlled, directly or indirectly, by such Person or one or more Wholly-Owned Subsidiaries of such Person, or by such Person and one or more Wholly-Owned Subsidiaries of such Person, or (b) any partnership, association, joint venture, limited liability company or similar business organization 100% of the ownership interests having ordinary voting power of which (other than directors' qualifying shares) shall at the time be so owned or controlled. "Year 2000 Issues" means anticipated costs, problems and uncertainties associated with the inability of certain computer applications and hardware to effectively function on and after January 1, 2000, as such inability affects the business, operations and financial condition of the Borrower and its Subsidiaries and of the Borrower's and its Subsidiaries' material customers, suppliers and vendors. -14- "Year 2000 Program" is defined in SECTION 5.20. The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms. ARTICLE II THE CREDITS 2.1. ADVANCES. (a) From and including the date hereof to but excluding the Revolver Termination Date, each Lender severally (and not jointly) agrees, on the terms and conditions set forth in this Agreement, to make Advances to the Borrower from time to time in amounts not to exceed in the aggregate at any one time outstanding the amount of its pro-rata share of the Aggregate Commitment existing at such time. Subject to the terms of this Agreement, the Borrower may borrow, repay and reborrow Advances at any time prior to the Revolver Termination Date. The Commitments to lend hereunder shall expire on the Revolver Termination Date. Principal payments made after the Revolver Termination Date may not be reborrowed. (b) The Borrower hereby agrees that if at any time, prior to the Revolver Termination Date, as a result of reductions in the Aggregate Commitment pursuant to SECTION 2.4 or otherwise, the aggregate balance of the Loans exceeds the Aggregate Commitment, it shall repay, or cause to be repaid, immediately outstanding Loans in such amount as may be necessary to eliminate such excess. (c) The Borrower's obligation to pay the principal of, and interest on, the Loans shall be evidenced by the Notes. Although the Notes shall be dated the date of this Agreement, interest in respect thereof shall be payable only for the periods during which the Loans evidenced thereby are outstanding and, although the stated amount of each Note shall be equal to the applicable Lender's Commitment, each Note shall be enforceable, with respect to the Borrower's obligation to pay the principal amount thereof, only to the extent of the unpaid principal amount of the Loans at the time evidenced thereby. (d) All Advances and all Loans shall mature, and the principal amount thereof and the unpaid accrued interest thereon shall be due and payable in full, on the Maturity Date. 2.2. RATABLE LOANS. Each Advance hereunder shall consist of Loans made from the several Lenders ratably in proportion to the ratio that their respective Commitments bear to the Aggregate Commitment. 2.3. TYPES OF ADVANCES. The Advances may be ABR Advances or Eurodollar Advances, or a combination thereof, selected by the Borrower in accordance with SECTIONS 2.7 and 2.8. -15- 2.4. FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT. (a) The Borrower agrees to pay to the Agent for the account of each Lender a facility fee ("Facility Fee") in an amount equal to the Applicable Facility Fee Margin per annum times the daily average Commitment (or, on and after the Revolver Termination Date, times the aggregate outstanding principal amount of the Loans) of such Lender from the date hereof to and including the Maturity Date, payable on each Payment Date hereafter and on the Maturity Date. All accrued Facility Fees shall be payable on the effective date of any termination of the obligations of the Lenders to make Loans hereunder. (b) The Borrower may permanently reduce the Aggregate Commitment in whole, or in part ratably among the Lenders in a minimum aggregate amount of $2,000,000, upon at least three (3) Business Days' written notice to the Agent, which notice shall specify the amount of any such reduction; PROVIDED, HOWEVER, that the amount of the Aggregate Commitment may not be reduced below the aggregate principal amount of the outstanding Advances. 2.5. MINIMUM AMOUNT OF EACH ADVANCE. Each Advance shall be in the minimum amount of $2,000,000 (and in integral multiples of $500,000 if in excess thereof), PROVIDED, HOWEVER, that (a) any ABR Advance may be in the amount of the unused Aggregate Commitment and (b) in no event shall more than six (6) Eurodollar Advances be permitted to be outstanding at any time. 2.6. OPTIONAL PRINCIPAL PAYMENTS. The Borrower may from time to time pay, without penalty or premium, all outstanding ABR Advances, or, in a minimum aggregate amount of $2,000,000, any portion of the outstanding ABR Advances, upon two (2) Business Days' prior notice to the Agent. Subject to SECTION 3.4 and upon like notice, a Eurodollar Advance may be paid prior to the last day of the applicable Interest Period in a minimum amount of $2,000,000 or an integral multiple of $500,000 in excess thereof. 2.7. METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR NEW ADVANCES. The Borrower shall select the Type of Advance and, in the case of each Eurodollar Advance, the Interest Period applicable to each Advance from time to time; PROVIDED, HOWEVER, that in the event Loans are incurred on the date of this Agreement, all Loans incurred on such date shall be ABR Advances. The Borrower shall give the Agent irrevocable notice (a "BORROWING NOTICE") not later than 10:00 a.m. (Chicago time) on the Borrowing Date of each ABR Advance and at least three (3) Business Days before the Borrowing Date for each Eurodollar Advance, specifying: (a) the Borrowing Date of such Advance, which shall be a Business Day; (b) the aggregate amount of such Advance; (c) the Type of Advance selected; (d) in the case of each Eurodollar Advance, the Interest Period applicable thereto, which shall end on or prior to the Maturity Date; and -16- (e) any changes to money transfer instructions previously delivered to the Agent. Not later than noon (Chicago time) on each Borrowing Date, each Lender shall make available its Loan or Loans, in funds immediately available in Chicago, to the Agent at its address specified pursuant to ARTICLE XIII. The Agent will make the funds so received from the Lenders available to the Borrower at the Agent's aforesaid address or at such account at such other institution in the United States of America as the Borrower may indicate in the Borrowing Notice. 2.8. CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES. ABR Advances shall continue as ABR Advances unless and until such ABR Advances are converted into Eurodollar Advances. Each Eurodollar Advance shall continue as a Eurodollar Advance until the end of the then applicable Interest Period therefor, at which time such Eurodollar Advance shall be automatically converted into an ABR Advance unless the Borrower shall have given the Agent a Conversion/Continuation Notice requesting that, at the end of such Interest Period, such Eurodollar Advance continue as a Eurodollar Advance for the same or another Interest Period. Subject to the terms of SECTION 2.5, the Borrower may elect from time to time to convert all or any part of an Advance of any Type into any other Type or Types of Advances; PROVIDED, HOWEVER, that any conversion of any Eurodollar Advance shall be made on, and only on, the last day of the Interest Period applicable thereto. The Borrower shall give the Agent irrevocable notice (a "CONVERSION/ CONTINUATION NOTICE") of each conversion of an ABR Advance or continuation of a Eurodollar Advance not later than 10:00 a.m. (Chicago time) on the conversion date, in the case of a conversion into an ABR Advance, or at least three (3) Business Days, in the case of a conversion into or continuation of a Eurodollar Advance, prior to the date of the requested conversion or continuation, specifying: (a) the requested date of such conversion or continuation, which shall be a Business Day; (b) the aggregate amount and Type of the Advance which is to be converted or continued; and (c) the amount and Type(s) of Advance(s) into which such Advance is to be converted or continued and, in the case of a conversion into or continuation of a Eurodollar Advance, the duration of the Interest Period applicable thereto, which shall end on or prior to the Maturity Date. 2.9. CHANGES IN INTEREST RATE, ETC. Each ABR Advance shall bear interest at the Alternate Base Rate from and including the date of such Advance or the date on which such Advance was converted into an ABR Advance to (but not including) the date on which such ABR Advance is paid or converted to a Eurodollar Advance. Changes in the rate of interest on that portion of any Advance maintained as an ABR Advance will take effect simultaneously with each change in the Alternate Base Rate. Each Eurodollar Advance shall bear interest from and including the first day of the Interest Period applicable thereto to, but not including, the last day of such Interest Period at the Eurodollar Rate determined as applicable to such Eurodollar Advance plus the Applicable -17- Eurodollar Margin. Changes in the Applicable Eurodollar Margin will take effect simultaneously with each change in a Level. No Interest Period may end after the Revolver Termination Date. 2.10. RATES APPLICABLE AFTER DEFAULT. Notwithstanding anything to the contrary contained in SECTIONS 2.7 or 2.8, no Advance may be made as, converted into or continued as a Eurodollar Advance (except with the consent of the Agent and the Required Lenders) when any Default or Unmatured Default has occurred and is continuing. During the continuance of a Default the Required Lenders may, at their option, by notice to the Borrower (which notice may be revoked at the option of the Required Lenders notwithstanding any provision of SECTION 8.2 requiring unanimous consent of the Lenders to changes in interest rates), declare that each Eurodollar Advance and ABR Advance shall bear interest (for the remainder of the applicable Interest Period in the case of Eurodollar Advances) at a rate per annum equal to the rate otherwise applicable plus two percent (2%) per annum; PROVIDED, HOWEVER, that such increased rate shall automatically and without action of any kind by the Lenders become and remain applicable until revoked by the Required Lenders in the event of a Default described in SECTIONS 7.6 or 7.7. 2.11. METHOD OF PAYMENT. All payments of the Obligations hereunder shall be made, without setoff, deduction or counterclaim, in immediately available funds to the Agent at the Agent's address specified pursuant to ARTICLE XIII, or at any other Lending Installation of the Agent specified in writing by the Agent to the Borrower (at least two (2) Business Days in advance), by noon (Chicago time) on the date when due and shall be applied ratably by the Agent among the Lenders. Each payment delivered to the Agent for the account of any Lender shall be delivered promptly by the Agent to such Lender in the same type of funds that the Agent received at its address specified pursuant to ARTICLE XIII or at any Lending Installation specified in a notice received by the Agent from such Lender. The Agent is hereby authorized to charge the account of the Borrower maintained with the Agent for each payment of principal, interest and fees as it becomes due hereunder. 2.12. NOTES. Each Lender is hereby authorized to record the principal amount of each of its Loans and each repayment on the schedule attached to its Note; PROVIDED, HOWEVER, that neither the failure to so record nor any error in such recordation shall affect the Borrower's obligations under such Note. 2.13. INTEREST PAYMENT DATES; INTEREST AND FEE BASIS. Interest accrued on each ABR Advance shall be payable on each Payment Date, commencing with the first such date to occur after the date hereof, on any date on which an ABR Advance is prepaid, whether due to acceleration or otherwise, and at maturity. Interest accrued on that portion of the outstanding principal amount of any ABR Advance converted into a Eurodollar Advance on a day other than a Payment Date shall be payable on the date of conversion. Interest accrued on each Eurodollar Advance shall be payable on the last day of its applicable Interest Period, on any date on which the Eurodollar Advance is prepaid, whether by acceleration or otherwise, and at maturity. Interest accrued on each Eurodollar Advance having an Interest Period longer than three (3) months shall also be payable on the last day of each three-month interval during such Interest Period. Interest and commitment fees shall be calculated for actual days elapsed on the basis of a 360-day year. Interest shall be payable for the day an Advance is made but not for the day of any payment on the amount paid if payment is -18- received prior to noon (Chicago time) at the place of payment. If any payment of principal of or interest on an Advance shall become due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day and, in the case of a principal payment, such extension of time shall be included in computing interest in connection with such payment. 2.14. NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS AND COMMITMENT REDUCTIONS. Promptly after receipt thereof, the Agent will notify each Lender of the contents of each Aggregate Commitment reduction notice, Borrowing Notice, Conversion/Continuation Notice, and repayment notice received by it hereunder. The Agent will notify each Lender of the interest rate applicable to each Eurodollar Advance promptly upon determination of such interest rate and will give each Lender prompt notice of each change in the Alternate Base Rate. 2.15. LENDING INSTALLATIONS. Each Lender may book its Loans at any Lending Installation selected by such Lender and may change its Lending Installation from time to time. All terms of this Agreement shall apply to any such Lending Installation and the Notes shall be deemed held by each Lender for the benefit of such Lending Installation. Each Lender may, by written or telex notice to the Agent and the Borrower, designate a Lending Installation through which Loans will be made by it and for whose account Loan payments are to be made. 2.16. NON-RECEIPT OF FUNDS BY THE AGENT. Unless the Borrower or a Lender, as the case may be, notifies the Agent prior to the date on which it is scheduled to make payment to the Agent of (a) in the case of a Lender, the proceeds of a Loan, or (b) in the case of the Borrower, a payment of principal, interest or fees to the Agent for the account of the Lenders, that it does not intend to make such payment, the Agent may assume that such payment has been made. The Agent may, but shall not be obligated to, make the amount of such payment available to the intended recipient in reliance upon such assumption. If the Borrower has not in fact made such payment to the Agent, the Lenders shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to the Federal Funds Effective Rate for such day. If any Lender has not in fact made such payment to the Agent, such Lender or the Borrower shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to (a) in the case of payment by a Lender, the Federal Funds Effective Rate for such day, or (b) in the case of payment by the Borrower, the interest rate applicable to the relevant Loan. 2.17. TAXES. (a) Any payments made by the Borrower under this Agreement shall be made free and clear of, and without deduction or withholding for or on account of, any present or future income, stamp or other taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed by any Governmental Authority, excluding net income taxes and franchise taxes or any other tax based upon any income imposed on the Agent or any Lender by the jurisdiction in which the Agent or such Lender is incorporated or has its principal place of business or maintains its Lending Installation. -19- If any such non-excluded taxes, levies, imposts, duties, charges, fees, deductions or withholdings ("Non-Excluded Taxes") are required to be withheld from any amounts payable to the Agent or any Lender hereunder, the amounts so payable to the Agent or such Lender shall be increased to the extent necessary to yield to the Agent or such Lender (after payment of all Non-Excluded Taxes) interest or any such other amounts payable hereunder at the rates or in the amounts specified in or pursuant to this Agreement; PROVIDED, HOWEVER, that the Borrower shall not be required to increase any such amounts payable to any Lender that is not organized under the laws of the U.S. or a state thereof if such Lender fails to comply with the requirements of paragraph (b) of this SECTION 2.17. Whenever any Non-Excluded Taxes are payable by the Borrower, as promptly as practicable thereafter the Borrower shall send to the Agent for its own account or for the account of such Lender, as the case may be, a certified copy of an original official receipt received by the Borrower showing payment thereof. If the Borrower fails to pay any Non-Excluded Taxes when due to the appropriate taxing authority or fails to remit to the Agent the required receipts or other required documentary evidence, the Borrower shall indemnify the Agent and the Lenders for any incremental taxes, interest or penalties that may become payable by any Agent or any Lender as a result of any such failure. The agreements in this SECTION 2.17 shall survive the termination of this Agreement and the payment of all other amounts payable hereunder. (b) At least five (5) Business Days prior to the first date on which interest or fees are payable hereunder for the account of any Lender, each Lender that is not incorporated under the laws of the United States of America, or a state thereof, agrees that it will deliver to the Borrower and the Agent two (2) duly completed and properly executed copies of United States Internal Revenue Service Form 1001 or 4224 (or a successor form), certifying in either case that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes. Each Lender which so delivers a Form 1001 or 4224 (or a successor form) further undertakes to deliver to the Borrower and the Agent two (2) additional duly completed and properly executed copies of such form (or a successor form) on or before the date that such form expires (currently, three (3) successive calendar years for Form 1001 and each tax year for Form 4224) or becomes obsolete or after the occurrence of any event requiring a change in the most recent forms so delivered by it, and such amendments thereto or extensions or renewals thereof as may be reasonably requested by the Borrower or the Agent, in each case certifying that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes, unless an event (including, without limitation, any change in treaty, law or regulation) has occurred prior to the date on which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Lender from duly completing and delivering any such form with respect to it and such Lender advises the Borrower and the Agent that it is not capable of receiving payments without any deduction or withholding of United States federal income tax. 2.18. AGENT'S FEES. The Borrower shall pay to the Agent those fees, in addition to the Facility Fees referenced in SECTION 2.4(A), in the amounts and at the times separately agreed to between the Agent and the Borrower. -20- ARTICLE III CHANGE IN CIRCUMSTANCES 3.1. YIELD PROTECTION. If, after the date hereof, the adoption of or any change in any law or any governmental or quasi-governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any new interpretation thereof, or the compliance of any Lender with such adoption, change or interpretation. (a) subjects any Lender or any applicable Lending Installation to any tax, duty, charge or withholding on or from payments due from the Borrower (excluding taxation of the overall net income of any Lender or applicable Lending Installation imposed by the jurisdiction in which such Lender or Lending Installation is incorporated or has its principal place of business), or changes the basis of taxation of principal, interest or any other payments to any Lender or Lending Installation in respect of its Loans or other amounts due it hereunder, or (b) imposes or increases or deems applicable any reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender or any applicable Lending Installation (other than reserves and assessments taken into account in determining the interest rate applicable to Eurodollar Advances), or (c) imposes any other condition the result of which is to increase the cost to any Lender or any applicable Lending Installation of making, funding or maintaining Loans or reduces any amount receivable by any Lender or any applicable Lending Installation in connection with any Loans, or requires any Lender or any applicable Lending Installation to make any payment calculated by reference to the amount of Loans held, or interest received by it, by an amount deemed material by such Lender, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender that portion of such increased expense incurred or resulting in an amount received which such Lender determines is attributable to making, funding and maintaining its Loans and its Commitment. 3.2. CHANGES IN CAPITAL ADEQUACY REGULATIONS. If a Lender determines the amount of capital required or expected to be maintained by such Lender, any Lending Installation of such Lender or any corporation controlling such Lender is increased as a result of a Change, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender the amount necessary to compensate for any shortfall in the rate of return on the portion of such increased capital which such Lender determines is attributable to this Agreement, its Loans or its obligation to make Loans hereunder (after taking into account such Lender's policies as to capital adequacy). "CHANGE" means (a) any change after the date of this Agreement in the Risk-Based Capital Guidelines, or (b) -21- any adoption of or change in any other law, governmental or quasi-governmental rule, regulation, policy, guideline, interpretation, or directive (whether or not having the force of law) after the date of this Agreement which affects the amount of capital required or expected to be maintained by any Lender or any Lending Installation or any corporation controlling any Lender. "RISK-BASED CAPITAL GUIDELINES" means (a) the risk-based capital guidelines in effect in the United States on the date of this Agreement and (b) the corresponding capital regulations promulgated by regulatory authorities outside the United States implementing the July 1988 report of the Basle Committee on Banking Regulation and Supervisory Practices entitled "International Convergence of Capital Measurements and Capital Standards" and any amendments to such regulations adopted prior to the date of this Agreement. 3.3. AVAILABILITY OF TYPES OF ADVANCES. If any Lender determines that maintenance of its Eurodollar Loans at a suitable Lending Installation would violate any applicable law, rule, regulation, or directive, whether or not having the force of law, or if the Required Lenders determine that (a) deposits of a type and maturity appropriate to match fund Eurodollar Advances are not available, or (b) the interest rate applicable to a Eurodollar Advance does not accurately or fairly reflect the cost of making or maintaining such Advance, then the Agent shall suspend the availability of Eurodollar Advances until such circumstance no longer exists and require any Eurodollar Advances to be repaid. 3.4. FUNDING INDEMNIFICATION. If any payment of a Eurodollar Advance occurs on a date which is not the last day of the applicable Interest Period, whether because of acceleration, prepayment or otherwise, or a Eurodollar Advance is not made on the date specified by the Borrower for any reason other than default by the Lenders, the Borrower will indemnify the Agent and each Lender for any loss or cost incurred by it resulting therefrom, including, without limitation, any loss or cost in liquidating or employing deposits acquired to fund or maintain the Eurodollar Advance. 3.5. LENDER STATEMENTS; SURVIVAL OF INDEMNITY. To the extent reasonably possible, each Lender shall designate an alternate Lending Installation with respect to its Eurodollar Advances to reduce any liability of the Borrower to such Lender under SECTIONS 2.17, 3.1 and 3.2 or to avoid the unavailability of a Type of Advance under SECTION 3.3, so long as such designation is not disadvantageous to such Lender. Each Lender shall deliver a written statement of such Lender to the Borrower (with a copy to the Agent) as to the amount due, if any, under SECTIONS 3.1, 3.2 or 3.4. Such written statement shall set forth in reasonable detail the calculations upon which such Lender determined such amount and shall be final, conclusive and binding on the Borrower in the absence of manifest error. Determination of amounts payable under such Sections in connection with a Eurodollar Advance shall be calculated as though each Lender funded its Eurodollar Advances through the purchase of a deposit of the type and maturity corresponding to the deposit used as a reference in determining the Eurodollar Rate applicable to such Loan, whether in fact that is the case or not. Unless otherwise provided herein, the amount specified in the written statement of any Lender shall be payable on demand after receipt by the Borrower of the written statement. The obligations of the Borrower under SECTIONS 3.1, 3.2 and 3.4 shall survive payment of the Obligations and termination of this Agreement. -22- ARTICLE IV CONDITIONS PRECEDENT 4.1. EFFECTIVENESS. This Agreement shall not become effective (in which case the Existing Credit Agreement shall remain in full force and effect) unless and until Borrower has furnished the following to the Agent with sufficient copies for the Lenders and the other conditions set forth below have been satisfied: (a) CHARTER DOCUMENTS; GOOD STANDING CERTIFICATES. Copies of the certificate of incorporation of the Borrower and White Mountains, together with all amendments thereto, both certified by the appropriate governmental officer in their respective jurisdictions of incorporation, together with a good standing certificate issued by the Secretary of State of their respective jurisdictions of incorporation and such other jurisdictions as shall be reasonably requested by the Agent. (b) BY-LAWS AND RESOLUTIONS. Copies, certified by the Secretary or Assistant Secretary of the Borrower and White Mountains, of their respective by-laws and of their respective Board of Directors' resolutions authorizing the execution, delivery and performance of the Loan Documents to which the Borrower and White Mountains are a party. (c) SECRETARY'S CERTIFICATE. An incumbency certificate, executed by the Secretary or Assistant Secretary of each of the Borrower and White Mountains, which shall identify by name and title and bear the signature of the officers of the Borrower and White Mountains authorized to sign the Loan Documents and to make borrowings hereunder, upon which certificate the Agent and the Lenders shall be entitled to rely until informed of any change in writing by the Borrower and White Mountains. (d) OFFICER'S CERTIFICATE. A certificate signed by an Authorized Officer of the Borrower, in form and substance satisfactory to the Agent, to the effect that on the date hereof (both before and after giving effect to the consummation of the other transactions contemplated hereby and the making of any Loans hereunder on such date): (i) no Default or Unmatured Default has occurred and is continuing; (ii) no injunction or temporary restraining order which would prohibit the making of the Loans or other litigation which could reasonably be expected to have a Material Adverse Effect is pending or, to the best of such Person's knowledge, threatened; (iii) all orders, consents, approvals, licenses, authorizations, or validations of, or filings, recordings or registrations with, or exemptions by, any Governmental Authority required in connection with the execution, delivery and performance of this Agreement have been or, prior to the time required, will have been, obtained, given, filed or taken and are or will be in full force and effect (or the Borrower has obtained effective judicial relief with respect to the application thereof) and all applicable waiting periods have expired; (iv) each of the representations and warranties set forth in -23- ARTICLE V of this Agreement is true and correct on and as of the date hereof; and (v) since December 31, 1997, no event or change has occurred that has caused or evidences a Material Adverse Effect. (e) LEGAL OPINION. (i) A written opinion of Brobeck, Phleger & Harrison LLP, counsel to the Borrower, addressed to the Agent and the Lenders in form and substance acceptable to the Agent and its counsel. (f) NOTES. Notes payable to the order of each of the Lenders duly executed by the Borrower. (g) LOAN DOCUMENTS. Executed originals of this Agreement and each of the Loan Documents, which shall be in full force and effect, together with all schedules, exhibits, certificates, instruments, opinions, documents and financial statements required to be delivered pursuant hereto and thereto. (h) LETTERS OF DIRECTION. Written money transfer instructions with respect to the initial Advances and to future Advances in form and substance acceptable to the Agent and its counsel addressed to the Agent and signed by an Authorized Officer, together with such other related money transfer authorizations as the Agent may have reasonably requested. (i) SOLVENCY CERTIFICATE. A written solvency certificate from the chief financial officer of the Borrower and White Mountains in form and content satisfactory to the Agent with respect to the value, Solvency and other factual information of, or relating to, as the case may be, the Borrower, on a consolidated basis, and White Mountains, on a consolidated basis. (j) WHITE MOUNTAINS GUARANTY. The White Mountains Guaranty duly executed by White Mountains, in the form substantially delivered to the Lenders. (k) OTHER. Such other documents as the Agent, any Lender or their counsel may have reasonably requested. 4.2. EACH FUTURE ADVANCE. The Lenders shall not be required to make any Advance unless on the applicable Borrowing Date: (a) There exists no Default or Unmatured Default and none would result from such Advance; (b) The representations and warranties contained in ARTICLE V are true and correct as of such Borrowing Date (except to the extent such representations and warranties are expressly made as of a specified date, in which event such representations and warranties shall be true and correct as of such specified date); -24- (c) A Borrowing Notice shall have been properly submitted; and (d) All legal matters incident to the making of such Advance shall be satisfactory to the Lenders and their counsel. Each Borrowing Notice with respect to each such Advance shall constitute a representation and warranty by the Borrower that the conditions contained in SECTIONS 4.2 (a), (b) and (c) have been satisfied. Any Lender may require a duly completed compliance certificate in substantially the form of EXHIBIT B hereto as a condition to making an Advance. ARTICLE V REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants to the Lenders that: 5.1. CORPORATE EXISTENCE AND STANDING. The Borrower and each Subsidiary is a corporation duly incorporated, validly existing and in good standing under the laws of its respective jurisdiction of incorporation and is duly qualified and in good standing as a foreign corporation and is duly authorized to conduct its business in each jurisdiction in which its business is conducted or proposed to be conducted, except where the failure to be so qualified could not reasonably be expected to have a Material Adverse Effect. As of the date of this Agreement, White Mountains is a Wholly-Owned Subsidiary of the Borrower. 5.2. AUTHORIZATION AND VALIDITY. The Borrower has all requisite power and authority (corporate and otherwise) and legal right to execute and deliver each of the Loan Documents and to perform its obligations thereunder. The execution and delivery by the Borrower of the Loan Documents and the performance of its respective obligations thereunder has been duly authorized by proper corporate proceedings and the Loan Documents constitute legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their terms, except as enforceability may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally. 5.3. COMPLIANCE WITH LAWS AND CONTRACTS. The Borrower and its Subsidiaries have complied in all material respects with all applicable statutes, rules, regulations, orders and restrictions of any domestic or foreign government or any instrumentality or agency thereof, having jurisdiction over the conduct of their respective businesses or the ownership of their respective properties, except where the failure to so comply could not reasonably be expected to have a Material Adverse Effect. Neither the execution and delivery by the Borrower of the Loan Documents, the application of the proceeds of the Loans or the consummation of the transactions contemplated in the Loan Documents, nor compliance with the provisions of the Loan Documents will, or at the relevant time did, (a) violate any law, rule, regulation (including Regulations T, U and -25- X), order, writ, judgment, injunction, decree or award binding on the Borrower or any Subsidiary or the Borrower's or any Subsidiary's charter, articles or certificate of incorporation or by-laws, (b) violate the provisions of or require the approval or consent of any party to any indenture, instrument or agreement to which the Borrower or any Subsidiary is a party or is subject, or by which it, or its property, is bound, or conflict with or constitute a default thereunder, or result in the creation or imposition of any Lien (other than Liens permitted by, the Loan Documents) in, of or on the property of the Borrower or any Subsidiary pursuant to the terms of any such indenture, instrument or agreement, or (c) require any consent of the stockholders of any Person, except for approvals or consents which will be obtained on or before the initial Advance and are disclosed on SCHEDULE 5.3, except for any violation of, or failure to obtain an approval or consent required under, any such indenture, instrument or agreement that could not reasonably be expected to have a Material Adverse Effect. 5.4. GOVERNMENTAL CONSENTS. No order, consent, approval, qualification, license, authorization, or validation of, or filing, recording or registration with, or exemption by, or other action in respect of, any court, governmental or public body or authority, or any subdivision thereof, any securities exchange or other Person is or at the relevant time was required to authorize, or is or at the relevant time was required in connection with the execution, delivery, consummation or performance of, or the legality, validity, binding effect or enforceability of, any of the Loan Documents. Neither the Borrower nor any Subsidiary is in default under or in violation of any foreign, federal, state or local law, rule, regulation, order, writ, judgment, injunction, decree or award binding upon or applicable to the Borrower or such Subsidiary, in each case the consequences of which default or violation could reasonably be expected to have a Material Adverse Effect. 5.5. FINANCIAL STATEMENTS. The Borrower has heretofore furnished to each of the Lenders (a) the December 31, 1997 audited consolidated financial statements of the Borrower and its Subsidiaries, and (b) the unaudited consolidated financial statements of the Borrower and its Subsidiaries through March 31, 1998 (collectively, the "FINANCIAL STATEMENTS"). Each of the Financial Statements was prepared in accordance with Agreement Accounting Principles and fairly presents the consolidated financial condition and operations of the Borrower and its Subsidiaries at such dates and the consolidated results of their operations for the respective periods then ended (except, in the case of such unaudited statements, for normal year-end audit adjustments). 5.6. MATERIAL ADVERSE CHANGE. No material adverse change in the business, Property, condition (financial or otherwise), performance, prospects or results of operations of the Borrower and its Subsidiaries has occurred since December 31, 1997. 5.7. TAXES. The Borrower and its Subsidiaries have filed or caused to be filed on a timely basis and in correct form all United States federal and applicable foreign, state and local tax returns and all other tax returns which are required to be filed and have paid all taxes due pursuant to said returns or pursuant to any assessment received by the Borrower or any Subsidiary, except such taxes, if any, as are being contested in good faith and as to which adequate reserves have been provided in accordance with Agreement Accounting Principles and as to which no Lien exists. As of the date hereof, the United States income tax returns of the Borrower on a consolidated basis have -26- been audited by the Internal Revenue Service through its fiscal period ending December 31, 1988, and all tax years beginning on or after January 1, 1989 are currently being audited or are subject to audit. No tax liens have been filed and no claims are being asserted with respect to any such taxes which could reasonably be expected to have a Material Adverse Effect. The charges, accruals and reserves on the books of the Borrower and its Subsidiaries in respect of any taxes or other governmental charges are in accordance with Agreement Accounting Principles. 5.8. LITIGATION AND CONTINGENT OBLIGATIONS. There is no litigation, arbitration, proceeding, inquiry or governmental investigation pending or, to the knowledge of any of their officers, threatened against or affecting the Borrower or any Subsidiary or any of their respective properties which could reasonably be expected to have a Material Adverse Effect or to prevent, enjoin or unduly delay the making of the Loans under this Agreement. Neither the Borrower nor any Subsidiary has any material contingent obligations incurred outside of the ordinary course of its business except as set forth on SCHEDULE 5.8 or disclosed in the Financial Statements or in financial statements required to be delivered under SECTIONS 6.1(A) and (B) and as permitted under this Agreement. 5.9. CAPITALIZATION. SCHEDULE 5.9 hereto contains (a) an accurate description of the Borrower's capitalization as of March 31, 1998 and (b) an accurate list of all of the existing Subsidiaries as of the date of this Agreement, setting forth their respective jurisdictions of incorporation and the percentage of their capital stock owned by the Borrower or other Subsidiaries. All of the issued and outstanding shares of capital stock of the Borrower and of each Subsidiary have been duly authorized and validly issued, are fully paid and non-assessable, and are free and clear of all Liens. 5.10. ERISA. Except as disclosed on SCHEDULE 5.10, neither the Borrower nor any other member of the Controlled Group maintains any Single Employer Plans, and no Single Employer Plan has any Unfunded Liability. Neither the Borrower nor any other member of the Controlled Group maintains, or is obligated to contribute to, any Multiemployer Plan or has incurred, or is reasonably expected to incur, any withdrawal liability to any Multiemployer Plan. Each Plan complies in all material respects with all applicable requirements of law and regulations other than any such failure to comply which could not reasonably be expected to have a Material Adverse Effect. Neither the Borrower nor any member of the Controlled Group has, with respect to any Plan, failed to make any contribution or pay any amount required under Section 412 of the Code or Section 302 of ERISA or the terms of such Plan. There are no pending or, to the knowledge of the Borrower, threatened claims, actions, investigations or lawsuits against any Plan, any fiduciary thereof, or the Borrower or any member of the Controlled Group with respect to a Plan. Neither the Borrower nor any member of the Controlled Group has engaged in any prohibited transaction (as defined in Section 4975 of the Code or Section 406 of ERISA) in connection with any Plan which would subject such Person to any material liability. Within the last five years neither the Borrower nor any member of the Controlled Group has engaged in a transaction which resulted in a Single Employer Plan with an Unfunded Liability being transferred out of the Controlled Group which could reasonably be expected to have a Material Adverse Effect. No Termination Event has -27- occurred or is reasonably expected to occur with respect to any Plan which is subject to Title IV of ERISA which could reasonably be expected to have a Material Adverse Effect. 5.11. DEFAULTS. No Default or Unmatured Default has occurred and is continuing. 5.12. FEDERAL RESERVE REGULATIONS. Neither the Borrower nor any Subsidiary is engaged, directly or indirectly, principally, or as one of its important activities, in the business of extending, or arranging for the extension of, credit for the purpose of purchasing or carrying Margin Stock. No part of the proceeds of any Loan will be used in a manner which would violate, or result in a violation of, Regulation T, Regulation U or Regulation X. Neither the making of any Advance hereunder nor the use of the proceeds thereof will violate or be inconsistent with the provisions of Regulation T, Regulation U or Regulation X. 5.13. INVESTMENT COMPANY. Neither the Borrower nor any Subsidiary is, or after giving effect to any Advance will be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 5.14. CERTAIN FEES. No broker's or finder's fee or commission was, is or will be payable by the Borrower or any Subsidiary with respect to any of the transactions contemplated by this Agreement, except as described in SECTION 9.5. The Borrower hereby agrees to indemnify the Agent and the Lenders against, and agrees that it will hold each of them harmless from, any claim, demand or liability for broker's or finder's fees or commissions alleged to have been incurred by the Borrower in connection with any of the transactions contemplated by this Agreement and any expenses (including, without limitation, attorneys' fees and time charges of attorneys for the Agent or any Lender, which attorneys may be employees of the Agent or any Lender) arising in connection with any such claim, demand or liability. No other similar fee or commissions will be payable by the Borrower or any Subsidiary for any other services rendered to the Borrower or any Subsidiary ancillary to any of the transactions contemplated by this Agreement. 5.15. SOLVENCY. As of the date hereof, after giving effect to the consummation of the transactions contemplated by the Loan Documents and the payment of all fees, costs and expenses payable by the Borrower or its Subsidiaries with respect to the transactions contemplated by the Loan Documents and the Loans incurred by the Borrower under this Agreement, the Borrower on a consolidated basis is Solvent. 5.16. MATERIAL AGREEMENTS. Except as set forth in SCHEDULE 5.16 and except for agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries or agreements of any Unrestricted Subsidiary, neither the Borrower nor any Subsidiary is a party to any agreement or instrument or subject to any charter or other corporate restriction which could reasonably be expected to have a Material Adverse Effect or which restricts or imposes conditions upon the ability of any Subsidiary to (a) pay dividends or make other distributions on its capital stock (b) make loans or advances to the Borrower, (c) repay loans or advances from Borrower or (d) grant Liens to the Agent to secure the Obligations. Neither the Borrower nor any Subsidiary is in default in the performance, observance or fulfillment of any of the obligations, covenants or -28- conditions contained in any agreement to which it is a party, which default could reasonably be expected to have a Material Adverse Effect. 5.17. ENVIRONMENTAL LAWS. There are no claims, investigations, litigation, administrative proceedings, notices, requests for information (each a "PROCEEDING"), whether pending or threatened, or judgments or orders asserting violations of applicable federal, state and local environmental, health and safety statutes, regulations, ordinances, codes, rules, orders, decrees, directives and standards ("ENVIRONMENTAL LAWS") or relating to any toxic or hazardous waste, substance or chemical or any pollutant, contaminant, chemical or other substance defined or regulated pursuant to any Environmental Law, including, without limitation, asbestos, petroleum, crude oil or any fraction thereof ("HAZARDOUS MATERIALS") asserted against the Borrower or any of its Subsidiaries other than in connection with an insurance policy issued in the ordinary course of business to any Person (other than the Borrower or any Subsidiary of the Borrower) which, in any case, could reasonably be expected to have a Material Adverse Effect. As of the date hereof, the Borrower and its Subsidiaries do not have liabilities exceeding $500,000 in the aggregate for all of them with respect to compliance by them with applicable Environmental Laws or related to the generation, treatment, storage, disposal, release, investigation or cleanup by them of Hazardous Materials, and no facts or circumstances exist which could give rise to such liabilities with respect to compliance with applicable Environmental Laws and the generation, treatment, storage, disposal, release, investigation or cleanup of Hazardous Materials. 5.18. INSURANCE. The Borrower and its Subsidiaries maintain with financially sound and reputable insurance companies insurance on their Property in such amounts and covering such risks as is consistent with sound business practice. 5.19. DISCLOSURE. No information, exhibit or report furnished by either Borrower or any of its Subsidiaries to the Agent or to any Lender in connection with the negotiation of, or compliance with, the Loan Documents contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statements contained therein not materially misleading. There is no fact known to the Borrower (other than matters of a general economic or political nature) that has had or could reasonably be expected to have a Material Adverse Effect and that has not been disclosed herein or in such other documents, certificates and statements furnished to the Lenders for use in connection with the transactions contemplated by this Agreement. 5.20. YEAR 2000. The Borrower has made a reasonable assessment of the Year 2000 Issues and has a realistic and achievable program for remediating the Year 2000 Issues on a timely basis (the "Year 2000 Program"). Based on such assessment and on the Year 2000 Program the Borrower does not reasonably anticipate that Year 2000 Issues will have a Material Adverse Effect. -29- ARTICLE VI COVENANTS During the term of this Agreement, unless the Required Lenders shall otherwise consent in writing: 6.1. FINANCIAL REPORTING. The Borrower will maintain, for itself and each Subsidiary, a system of accounting established and administered in accordance with generally accepted accounting principles, consistently applied, and furnish to the Lenders: (a) As soon as practicable and in any event within 100 days after the close of each of its Fiscal Years, an unqualified audit report certified by independent certified public accountants, acceptable to the Lenders, prepared in accordance with Agreement Accounting Principles on a consolidated and consolidating basis (consolidating statements need not be certified by such accountants) for itself and its Subsidiaries, including balance sheets as of the end of such period and related statements of income, retained earnings and cash flows. (b) As soon as practicable and in any event within sixty (60) days after the close of each of the first three Fiscal Quarters of each of its Fiscal Years, for itself and its Subsidiaries, consolidated and consolidating unaudited balance sheets as at the close of each such period and consolidated and consolidating statements of income, retained earnings and cash flows for the period from the beginning of such Fiscal Year to the end of such quarter, all certified by its chief financial officer. (c) Together with the financial statements required by CLAUSES (A) and (B) above, a compliance certificate in substantially the form of EXHIBIT B hereto signed by its chief financial officer showing the calculations necessary to determine compliance with this Agreement and stating that no Default or Unmatured Default exists, or if any Default or Unmatured Default exists, stating the nature and status thereof. (d) Promptly after available after the close of each Fiscal Year, a statement of the Unfunded Liabilities of each Single Employer Plan, certified as correct by an actuary enrolled under ERISA. (e) As soon as possible and in any event within ten (10) days after the Borrower knows that any Termination Event has occurred with respect to any Plan, a statement, signed by the chief financial officer of the Borrower, describing said Termination Event and the action which the Borrower proposes to take with respect thereto. (f) As soon as possible and in any event within ten (10) days after receipt by either Borrower, a copy of (i) any notice, claim, complaint or order to the effect that the Borrower or any of its Subsidiaries is or may be liable to any Person as a result of the release -30- by the Borrower or any of its Subsidiaries of any Hazardous Materials into the environment or requiring that action be taken to respond to or clean up a Release of Hazardous Materials into the environment, and (ii) any notice, complaint or citation alleging any violation of any Environmental Law or Environmental Permit by the Borrower or any of its Subsidiaries. Within ten (10) days of the Borrower or any Subsidiary having knowledge of the enactment or promulgation of any Environmental Law which could reasonably be expected to have a Material Adverse Effect, the Borrower shall provide the Agent with written notice thereof. (g) Promptly upon the furnishing thereof to the shareholders of the Borrower, copies of all financial statements, reports and proxy statements so furnished. (h) Promptly upon the filing thereof, copies of all registration statements and annual, quarterly, monthly or other regular reports which the Borrower or any of its Subsidiaries files with the Securities and Exchange Commission. (i) Promptly and in any event within ten (10) days after learning thereof, notification of (i) any tax assessment, demand, notice of proposed deficiency or notice of deficiency received by the Borrower or any other Consolidated Person or (ii) the filing of any tax Lien or commencement of any judicial proceeding by or against any such Consolidated Person, if any such assessment, demand, notice, Lien or judicial proceeding relates to tax liabilities in excess of ten percent (10%) of the net worth (determined according to generally accepted accounting standards and without reduction for any reserve for such liabilities) of the Borrower and its Subsidiaries taken as a whole. (j) Promptly after the same becomes available, any management letter prepared by the accountants conducting the audit of the financial statements delivered pursuant to SECTION 6.1 (A). (k) As soon as possible and in any event within two (2) Business Days after either Borrower obtains knowledge thereof, notice of any change in the Applicable Credit Rating of S&P or Moody's. (l) Such other information (including non-financial information) as the Agent or any Lender may from time to time reasonably request. 6.2. USE OF PROCEEDS. The Borrower will, and will cause each Subsidiary to, use the proceeds of the Advances to meet the working capital and general corporate needs of the Borrower and its Subsidiaries, including, but not limited to, the consummation of the Folksamerica Transaction and the making of other Investments permitted by SECTION 6.15. The Borrower will not, nor will it permit any Subsidiary to, use any of the proceeds of the Advances in a manner which would violate, or result in a violation of, Regulation T, Regulation U or Regulation X, or to finance the Purchase of any Person which has not been approved and recommended by the board of directors (or functional equivalent thereof) of such Person. -31- 6.3. NOTICE OF DEFAULT. The Borrower will give prompt notice in writing to the Lenders of the occurrence of (a) any Default or Unmatured Default and (b) of any other event or development, financial or other, relating specifically to the Borrower or any of its Subsidiaries (and not of a general economic or political nature) which could reasonably be expected to have a Material Adverse Effect. 6.4. CONDUCT OF BUSINESS. The Borrower will, and will cause each Subsidiary to, carry on and conduct its business in substantially the same manner and in substantially the same fields of as it is presently conducted, to not conduct any significant business except for financial services, and to do all things necessary to remain duly incorporated, validly existing and in good standing as a domestic corporation in its jurisdiction of incorporation and maintain all requisite authority to conduct its business in each jurisdiction in which its business is conducted. The Borrower shall cause White Mountains to remain a Wholly-Owned Subsidiary until the Borrower shall have repaid all outstanding Advances and other Obligations and the Lenders' Commitments hereunder have terminated. 6.5. TAXES. The Borrower will, and will cause each Subsidiary to, timely file complete and correct United States federal and applicable foreign, state and local tax returns required by applicable law and pay when due all taxes, assessments and governmental charges and levies upon it or its income, profits or Property, except those which are being contested in good faith by appropriate proceedings and with respect to which adequate reserves have been set aside. 6.6. INSURANCE. The Borrower will, and will cause each Subsidiary to, maintain with financially sound and reputable insurance companies insurance on all their Property in such amounts and covering such risks as is consistent with sound business practice, and the Borrower will furnish to the Agent and any Lender upon request full information as to the insurance carried. 6.7. COMPLIANCE WITH LAWS. The Borrower will, and will cause each Subsidiary to, comply with all laws, rules, regulations, orders, writs, judgments, injunctions, decrees or awards to which it may be subject, the failure to comply with which could reasonably be expected to have a Material Adverse Effect. 6.8. MAINTENANCE OF PROPERTIES. The Borrower will, and will cause each Subsidiary to, do all things necessary to maintain, preserve, protect and keep its Property in good repair, working order and condition, and make all necessary and proper repairs, renewals and replacements so that its business carried on in connection therewith may be properly conducted at all times. 6.9. INSPECTION. The Borrower will, and will cause each Subsidiary to, at reasonable times during normal business hours and upon reasonable notice, permit the Agent and the Lenders, by their respective representatives and agents, to inspect any of the Property, corporate books and financial records of the Borrower and each Subsidiary, to examine and make copies of the books of accounts and other financial records of the Borrower and each Subsidiary, and to discuss the affairs, finances and accounts of the Borrower and each Subsidiary with, and to be advised as to the same by, their respective officers at such reasonable times and intervals as the Lenders may designate. -32- The Borrower will keep or cause to be kept, and cause each Subsidiary to keep or cause to be kept, appropriate records and books of account in which complete entries are to be made reflecting its and their business and financial transactions, such entries to be made in accordance with Agreement Accounting Principles. 6.10. DIVIDENDS. The Borrower will not declare or pay any dividends or make any distributions on its capital stock (other than dividends payable in its own capital stock) or redeem, repurchase or otherwise acquire or retire any of its capital stock or any options or other rights in respect thereof at any time outstanding, except that so long as no Default or Unmatured Default exists before or after giving effect to the declaration or payment of such dividends or distributions or repurchase or redemption of such stock or other transaction, the Borrower may declare and pay dividends, and make distributions, on its common stock and repurchase and redeem and otherwise acquire or retire its common stock and any options or other rights in respect thereof. 6.11. INDEBTEDNESS. The Borrower will not, nor will it permit any Subsidiary (other than an Unrestricted Subsidiary) to, create, incur or suffer to exist any Indebtedness, except: (a) the Loans; (b) Indebtedness existing on the date hereof and any renewals, extensions, refundings or refinancings of such Indebtedness (including any necessary pre-payment premium payments on such Indebtedness); PROVIDED that the amount thereof is not increased and the maturity or scheduled amortization of principal thereof is not shortened (unless to a maturity or scheduled amortization occurring after the Maturity Date); (c) Indebtedness owing by (x) the Borrower to any Wholly-Owned Subsidiary and (y) any Wholly-Owned Subsidiary to a Wholly-Owned Subsidiary or the Borrower; (d) Indebtedness permitted under the White Mountains Credit Agreement and the Valley Credit Agreement; (e) Indebtedness of the Borrower, the proceeds of which are used directly or indirectly to refund or refinance Indebtedness of Wholly-Owned Subsidiaries of the Borrower (other than any Unrestricted Subsidiaries); PROVIDED, however that the amount thereof is not increased, the maturity or scheduled amortization of principal thereof is not set to a maturity or scheduled amortization occurring before the Maturity Date hereunder and the terms of the proposed Indebtedness are not otherwise, in the reasonable judgment of the Required Lenders, disadvantageous (relative to the terms of the Indebtedness refunded or refinanced) to the interests of the Lenders hereunder; (f) Contingent Obligations permitted by SECTION 6.13; and (g) other Indebtedness, so long as such other Indebtedness does not at any time exceed $10,000,000 in aggregate principal amount. -33- 6.12. MERGER. The Borrower will not, nor will it permit any Significant Subsidiary to, merge or consolidate with or into any other Person, except that: (a) a Wholly-Owned Subsidiary may merge into the Borrower or any Wholly-Owned Subsidiary of the Borrower; (b) a Significant Subsidiary (other than White Mountains) may merge or consolidate with any Person so long as either (x) (i) no Default or Unmatured Default shall have occurred or be continuing before and after giving effect to such merger or consolidation and (ii) such Significant Subsidiary is the continuing or surviving corporation or (y) neither the Borrower nor any Subsidiaries hold any capital stock of such Significant Subsidiary after giving effect to such merger or consolidation; and (c) the Borrower or White Mountains may merge or consolidate with any other Person, so long as immediately thereafter (and after giving effect thereto), (i) no Default or Unmatured Default exists, (ii) the Borrower or White Mountains, as applicable, is the continuing or surviving corporation and (iii) the covenants contained in SECTION 6.20 shall be complied with on a PRO FORMA basis on the date of, and after giving effect to, such merger or consolidation. 6.13. CONTINGENT OBLIGATIONS. The Borrower will not, nor will it permit any Subsidiary (other than an Unrestricted Subsidiary) to, make or suffer to exist any Contingent Obligation (including, without limitation, any Contingent Obligation with respect to the obligations of a Subsidiary), except (a) the issuance of financial guarantees in the ordinary course of business and consistent with past practices, (b) by endorsement of instruments for deposit or collection in the ordinary course of business, (c) for insurance policies issued in the ordinary course of business, (d) the issuance of intercompany guarantees so long as the primary obligation is permitted pursuant to this Agreement and (e) Contingent Obligations which are (i) permitted pursuant to the White Mountains Credit Agreement and the Valley Credit Agreement or (ii) created by the Folksamerica Assumption. 6.14. LIENS. The Borrower will not, nor will it permit any Subsidiary to, create, incur, or suffer to exist any Lien in, of or on the Property (other than Margin Stock) of the Borrower or any of its Subsidiaries (other than an Unrestricted Subsidiary), except: (a) Liens for taxes, assessments or governmental charges or levies on its Property if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being contested in good faith and by appropriate proceedings and for which adequate reserves in accordance with generally accepted principles of accounting shall have been set aside on its books; (b) Liens imposed by law, such as carriers', warehousemen's and mechanics' liens and other similar liens arising in the ordinary course of business which secure the payment -34- of obligations not more than sixty (60) days past due or which are being contested in good faith by appropriate proceedings and for which adequate reserves shall have been set aside on its books; (c) Liens arising out of pledges or deposits under worker's compensation laws, unemployment insurance, old age pensions, or other social security or retirement benefits, or similar legislation; (d) Utility easements, building restrictions and such other encumbrances or charges against real property as are of a nature generally existing with respect to properties of a similar character and which do not in any material way affect the marketability of the same or interfere with the use thereof in the business of the Borrower or its Subsidiaries; (e) Liens existing on the date hereof and described in SCHEDULE 6.14 hereto; (f) Liens in, of or on Property acquired after the date of this Agreement (by purchase, construction or otherwise), each of which Liens either (1) existed on such Property before the time of its acquisition and was not created in anticipation thereof, or (2) was created solely for the purpose of securing Indebtedness representing, or incurred to finance, refinance or refund, the cost (including the cost of construction) of such Property; PROVIDED that no such Lien shall extend to or cover any Property of the Borrower or such Subsidiary other than the Property so acquired and improvements thereon; and PROVIDED, FURTHER, that the principal amount of Indebtedness secured by any such Lien shall at the time the Lien is incurred not exceed 75% of the fair market value (as determined in good faith by a financial officer of the Borrower and, in the case of such Property having a fair market value in excess of $500,000, certified by such officer to the Agent, with a copy for each Lender) of the Property at the time it was so acquired; (g) Liens not otherwise permitted by the foregoing clauses (a) through (f) securing any Indebtedness of the Borrower, PROVIDED that the aggregate principal amount of Indebtedness secured by Liens permitted by this clause (g) shall not exceed $5,000,000 at any time; and (h) Liens permitted under the White Mountains Credit Agreement and the Valley Credit Agreement. 6.15. INVESTMENTS AND PURCHASES. The Borrower will not, and will not permit any Subsidiary (other than any Unrestricted Subsidiary) to, make or suffer to exist any Investments (including, without limitation, loans and advances to, and other Investments in, Subsidiaries), or commitments therefor, or to create any Subsidiary or to become or remain a partner in any partnership or joint venture, or to make any Purchases, except: (a) Cash and Cash Equivalents; -35- (b) Investments or commitments therefor (such commitments being set forth on SCHEDULE 6.15) in existence as of the date hereof (including Investments in Subsidiaries as of the date hereof); (c) Investments in debt securities rated BBB- or better by S&P, Baa-3 or better by Moody's or NAIC-2 or better by the NAIC; PROVIDED, that any such Investment which, at any time after which it is made, ceases to meet such rating requirements shall (A) cease to be permitted hereby if then permitted by SECTION 6.15(A)(VI) and (B) if not then permitted by SECTION 6.15(A)(VI) remain permitted hereby until the earlier of the time it is permitted under SECTION 6.15(A)(VI) and the date which is thirty (30) days after the date on which such rating requirement is no longer met; (d) Purchases of or Investments in businesses or entities engaged in the insurance business and/or insurance services or businesses reasonably incident thereto (including holding companies, the Subsidiaries of which on a consolidated basis are primarily engaged in such businesses) which do not constitute hostile takeovers (including the creation of Subsidiaries in connection therewith) so long as no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Purchase or Investment; (e) Other Investments by the Borrower in any Person which is a Subsidiary (other than any Unrestricted Subsidiary) as of the date hereof, so long as no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Investment; (f) Investments by the Borrower (in addition to those permitted by CLAUSES (A) through (E) of this SECTION 6.15) in an amount not exceeding in aggregate $40,000,000 PLUS the FSA Amount (including the creation of Subsidiaries and Investments therein and Investments in any partnership or joint venture) so long as at the time of such Investment no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Investment; PROVIDED, however, that any Investments pursuant to this CLAUSE (F) are made from net proceeds traceable to either (i) dividends, sales, transfers or other distributions of equity interests in SOMSC or (ii) the sale or issuance of equity securities of the Borrower after the date hereof. (g) Investments by the Borrower (in addition to those permitted by the other clauses of this SECTION 6.15) in an amount not exceeding $10,000,000 (including the creation of Subsidiaries and Investments therein and Investments in any partnership or joint venture) so long as at the time of such Investment no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Investment; and (h) With respect to White Mountains and its Subsidiaries, Investments permitted under the White Mountains Credit Agreement and the Valley Credit Agreement. 6.16. AFFILIATES. The Borrower will not, and will not permit any Subsidiary to, enter into any material transaction (including, without limitation, the purchase or sale of any Property or -36- service) with, or make any payment or transfer to, any Affiliate (other than a Wholly-Owned Subsidiary), except in the ordinary course of business and pursuant to the reasonable requirements of the Borrower's or such Subsidiary's business and upon fair and reasonable terms no less favorable to the Borrower or such Subsidiary than the Borrower or such Subsidiary would obtain in a comparable arms-length transaction, except that any Unrestricted Subsidiary may make loans to the Borrower. 6.17. ENVIRONMENTAL MATTERS. The Borrower shall and shall cause each of its Subsidiaries to (a) at all times comply in all material respects with all applicable Environmental Laws and (b) promptly take any and all necessary remedial actions in response to the presence, storage, use, disposal, transportation or Release of any Hazardous Materials on, under or about any real property owned, leased or operated by the Borrower or any of its Subsidiaries. 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR. The Borrower shall not, nor shall it permit any Subsidiary to, (a) permit any amendment or modification to be made to its certificate or articles of incorporation or by-laws which is materially adverse to the interests of the Lenders or (b) change its Fiscal Year to end on any date other than December 31 of each year. 6.19. INCONSISTENT AGREEMENTS. The Borrower shall not, nor shall it permit any Subsidiary (other than an Unrestricted Subsidiary) to, enter into any indenture, agreement, instrument or other arrangement which by its terms, (a) other than pursuant to the White Mountains Credit Agreement or the Valley Credit Agreement or pursuant to agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries, directly or indirectly contractually prohibits or restrains, or has the effect of contractually prohibiting or restraining, or contractually imposes materially adverse conditions upon, the incurrence of the Obligations, the granting of Liens to secure the Obligations, the amending of the Loan Documents or the ability of any Subsidiary to (i) pay dividends or make other distributions on its capital stock, (ii) make loans or advances to the Borrower or (iii) repay loans or advances from the Borrower or (b) contains any provision which would be violated or breached by the making of Advances or by the performance by the Borrower or any Subsidiary of any of its obligations under any Loan Document. 6.20. FINANCIAL COVENANTS - MINIMUM NET WORTH. The Borrower shall, at all times after the date hereof, maintain a minimum Net Worth at least equal to (a) the sum of (i) $537,870,000, PLUS (ii) an amount equal to 90% of the cash and non-cash proceeds of any equity securities issued by the Borrower after June 30, 1998, MINUS (b) an amount equal to the lesser of (i) $30,000,000 or (ii) the aggregate amount expended by the Borrower after the date hereof to repurchase its capital stock in compliance with SECTION 6.10. 6.21. TAX CONSOLIDATION. The Borrower will not and will not permit any of its Subsidiaries to (a) file or consent to the filing of any consolidated, combined or unitary income tax return with any Person other than the Borrower and its Subsidiaries or (b) amend, terminate or fail to enforce any existing tax sharing agreement or similar arrangement if such action would cause a Material Adverse Effect. -37- 6.22. ERISA COMPLIANCE. With respect to any Plan, neither the Borrower nor any Subsidiary shall: (a) engage in any "prohibited transaction" (as such term is defined in Section 406 of ERISA or Section 4975 of the Code) for which a civil penalty pursuant to Section 502(i) of ERISA or a tax pursuant to Section 4975 of the Code in excess of $500,000 could be imposed; (b) incur any "accumulated funding deficiency" (as such term is defined in Section 302 of ERISA) in excess of $500,000, whether or not waived, or permit any Unfunded Liability to exceed $500,000; (c) permit the occurrence of any Termination Event which could result in a liability to the Borrower or any other member of the Controlled Group in excess of $500,000; (d) be an "employer" (as such term is defined in Section 3(5) of ERISA) required to contribute to any Multiemployer Plan or a "substantial employer" (as such term in defined in Section 4001(a)(2) of ERISA) required to contribute to any Multiple Employer Plan; or (e) permit the establishment or amendment of any Plan or fail to comply with the applicable provisions of ERISA and the Code with respect to any Plan which could result in liability to the Borrower or any other member of the Controlled Group which, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect. 6.23. YEAR 2000. The Borrower will take and will cause each of its Subsidiaries to take all such actions as are reasonably necessary to successfully implement the Year 2000 Program and to assure that Year 2000 Issues will not have a Material Adverse Effect. At the request of the Agent or any Lender, the Borrower will provide a description of the Year 2000 Program, together with any updates or progress reports with respect thereto. ARTICLE VII DEFAULTS The occurrence of any one or more of the following events shall constitute a Default: 7.1. Any representation or warranty made or deemed made by or on behalf of the Borrower or any of its Subsidiaries to the Lenders or the Agent under or in connection with this Agreement, any other Loan Document, any Loan, or any certificate or information delivered in connection with this Agreement or any other Transaction Document shall be false in any material respect on the date as of which made. -38- 7.2. Nonpayment of (a) any principal of any Note when due, or (b) any interest upon any Note or any commitment fee or other fee or obligations under any of the Loan Documents within five (5) days after the same becomes due. 7.3. The breach by the Borrower of any of the terms or provisions of SECTION 6.2, SECTION 6.3(A) or SECTIONS 6.10 through 6.16 or SECTIONS 6.18 through 6.22. 7.4. The breach by the Borrower (other than a breach which constitutes a Default under SECTIONS 7.1, 7.2 or 7.3) of any of the terms or provisions of this Agreement which is not remedied within twenty (20) days after written notice from the Agent or any Lender. 7.5. The default by the Borrower or any of its Subsidiaries in the performance of any term, provision or condition contained in any agreement or agreements under which any Funded Indebtedness aggregating in excess of $10,000,000 ($20,000,000, or such lower cross-default threshold amount as is provided in the SOMSC Credit Agreements, in the case of SOMSC) was created or is governed, or the occurrence of any other event or existence of any other condition, the effect of any of which is to cause, or to permit the holder or holders of such Funded Indebtedness to cause, such Funded Indebtedness to become due prior to its stated maturity; or any such Funded Indebtedness of the Borrower or any of its Subsidiaries shall be declared to be due and payable or required to be prepaid (other than by a regularly scheduled payment) prior to the stated maturity thereof. 7.6. The Borrower or any of its Significant Subsidiaries shall (a) have an order for relief entered with respect to it under the Federal bankruptcy laws as now or hereafter in effect, (b) make an assignment for the benefit of creditors, (c) apply for, seek, consent to, or acquiesce in, the appointment of a receiver, custodian, trustee, examiner, liquidator or similar official for it or any substantial portion of its Property, (d) institute any proceeding seeking an order for relief under the Federal bankruptcy laws as now or hereafter in effect or seeking to adjudicate it a bankrupt or insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors or fail to file an answer or other pleading denying the material allegations of any such proceeding filed against it, (e) take any corporate action to authorize or effect any of the foregoing actions set forth in this SECTION 7.6, (f) fail to contest in good faith any appointment or proceeding described in SECTION 7.7 or (g) become unable to pay, not pay, or admit in writing its inability to pay, its debts generally as they become due. 7.7. Without the application, approval or consent of the Borrower or any of its Significant Subsidiaries, a receiver, trustee, examiner, liquidator or similar official shall be appointed for the Borrower or any of its Significant Subsidiaries or any substantial portion of its Property, or a proceeding described in SECTION 7.6(D) shall be instituted against the Borrower or any of its Significant Subsidiaries and such appointment continues undischarged or such proceeding continues undismissed or unstayed for a period of sixty (60) consecutive days. -39- 7.8. The Borrower or any of its Subsidiaries shall fail within thirty (30) days to pay, bond or otherwise discharge any judgment or order for the payment of money in excess of $2,000,000 (or multiple judgments or orders for the payment of an aggregate amount in excess of $10,000,000), which is not stayed on appeal or otherwise being appropriately contested in good faith and as to which no enforcement actions have been commenced. 7.9. The occurrence of any "default", as defined in any Transaction Document (other than this Agreement or the Notes), or the breach of any of the terms or provisions of any Transaction Document (other than this Agreement or the Notes), which default or breach continues beyond any period of grace therein provided. 7.10. The White Mountains Guaranty shall fail, after its execution, to remain in full force or effect or any action shall be taken to discontinue or to assert the invalidity or unenforceability of the White Mountains Guaranty, or White Mountains shall fail to comply with any of the terms or provisions of the White Mountains Guaranty within any applicable grace period provided therein. 7.11. Any Change in Control shall occur. ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES 8.1. ACCELERATION. If any Default described in SECTIONS 7.6 or 7.7 occurs with respect to the Borrower, the obligations of the Lenders to make Loans hereunder shall automatically terminate and the Obligations shall immediately become due and payable without any election or action on the part of the Agent or any Lender. If any other Default occurs, the Required Lenders (or the Agent with the consent of the Required Lenders) may terminate or suspend the obligations of the Lenders to make Loans hereunder, or declare the Obligations to be due and payable, or both, whereupon the Obligations shall become immediately due and payable, without presentment, demand, protest or notice of any kind, all of which the Borrower hereby expressly waives. If, within ten (10) Business Days after acceleration of the maturity of the Obligations or termination of the obligations of the Lenders to make Loans hereunder as a result of any Default (other than any Default as described in SECTIONS 7.6 or 7.7 with respect to the Borrower) and before any judgment or decree for the payment of the Obligations due shall have been obtained or entered, the Required Lenders (in their sole discretion) shall so direct, the Agent shall, by notice to the Borrower, rescind and annul such acceleration and/or termination. 8.2. AMENDMENTS. Subject to the provisions of this ARTICLE VIII, the Required Lenders (or the Agent with the consent in writing of the Required Lenders) and the Borrower may enter into agreements supplemental hereto for the purpose of adding or modifying any provisions to the Loan Documents or changing in any manner the rights of the Lenders or the Borrower hereunder or -40- waiving any Default hereunder; PROVIDED, HOWEVER, that no such supplemental agreement shall, without the consent of each Lender: (a) Extend the final maturity of any Loan or Note or reduce the principal amount thereof, or reduce the rate or, subject to SECTION 2.10, extend the time of payment of interest or fees thereon; (b) Reduce the percentage specified in the definition of Required Lenders; (c) Increase the amount of the Commitment of any Lender hereunder; (d) Extend the Revolver Termination Date or the Maturity Date; (e) Amend this SECTION 8.2; (f) Permit any assignment by the Borrower of its Obligations or its rights hereunder; or (g) Release the White Mountains Guaranty. No amendment of any provision of this Agreement relating to the Agent shall be effective without the written consent of the Agent. The Agent may waive payment of the fee required under SECTION 12.3.2 without obtaining the consent of any other party to this Agreement. 8.3. PRESERVATION OF RIGHTS. No delay or omission of the Lenders or the Agent to exercise any right under the Transaction Documents shall impair such right or be construed to be a waiver of any Default or an acquiescence therein, and the making of a Loan notwithstanding the existence of a Default or the inability of the Borrower to satisfy the conditions precedent to such Loan shall not constitute any waiver or acquiescence. Any single or partial exercise of any such right shall not preclude other or further exercise thereof or the exercise of any other right, and no waiver, amendment or other variation of the terms, conditions or provisions of the Transaction Documents whatsoever shall be valid unless in writing signed by the Lenders required pursuant to SECTION 8.2, and then only to the extent in such writing specifically set forth. All remedies contained in the Loan Documents or by law afforded shall be cumulative and all shall be available to the Agent and the Lenders until the Obligations have been paid in full. -41- ARTICLE IX GENERAL PROVISIONS 9.1. SURVIVAL OF REPRESENTATIONS. All representations and warranties of the Borrower or any Subsidiary contained in any Loan Document shall survive delivery of the Notes and the making of the Loans herein contemplated. 9.2. GOVERNMENTAL REGULATION. Anything contained in this Agreement to the contrary notwithstanding, no Lender shall be obligated to extend credit to the Borrower in violation of any limitation or prohibition provided by any applicable statute or regulation. 9.3. TAXES. Any stamp, documentary or similar taxes, assessments or charges payable or ruled payable by any governmental authority in respect of the Loan Documents shall be paid by the Borrower, together with interest and penalties, if any. 9.4. HEADINGS. Section headings in the Loan Documents are for convenience of reference only, and shall not govern the interpretation of any of the provisions of the Loan Documents. 9.5. ENTIRE AGREEMENT. The Transaction Documents embody the entire agreement and understanding among the Borrower, the Agent and the Lenders and supersede all prior agreements and understandings among the Borrower, the Agent and the Lenders relating to the subject matter thereof other than the fee letter, dated August 14, 1998, in favor of First Chicago. 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT. The respective obligations of the Lenders hereunder are several and not joint and no Lender shall be the partner or agent of any other (except to the extent to which the Agent is authorized to act as such). The failure of any Lender to perform any of its obligations hereunder shall not relieve any other Lender from any of its obligations hereunder. This Agreement shall not be construed so as to confer any right or benefit upon any Person other than the parties to this Agreement and their respective successors and assigns. 9.7. EXPENSES; INDEMNIFICATION. The Borrower shall reimburse the Agent for any reasonable costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent) paid or incurred by the Agent in connection with the preparation, negotiation, execution, delivery, review, amendment, modification, and administration of the Transaction Documents. The Borrower also agrees to reimburse the Agent and the Lenders for any reasonable costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent and the Lenders, which attorneys may be employees of the Agent or the Lenders) paid or incurred by the Agent or any Lender in connection with the collection and enforcement of the Transaction Documents. The Borrower further agrees to indemnify the Agent and each Lender, its directors, -42- officers and employees against all losses, claims, damages, penalties, judgments, liabilities and expenses (including, without limitation, all expenses of litigation or preparation therefor whether or not the Agent or any Lender is a party thereto) which any of them may pay or incur arising out of or relating to this Agreement, the other Transaction Documents, the transactions contemplated hereby or thereby or the direct or indirect application or proposed application of the proceeds of any Loan hereunder arising from claims or assertions by third parties except to the extent that they arise out of the gross negligence or willful misconduct of the party seeking indemnification. The obligations of the Borrower under this Section shall survive the termination of this Agreement. 9.8. NUMBERS OF DOCUMENTS. All statements, notices, closing documents, and requests hereunder shall be furnished to the Agent with sufficient counterparts so that the Agent may furnish one to each of the Lenders. 9.9. ACCOUNTING. Except as provided to the contrary herein, all accounting terms used herein shall be interpreted and all accounting determinations hereunder shall be made in accordance with Agreement Accounting Principles. 9.10. SEVERABILITY OF PROVISIONS. Any provision in any Loan Document that is held to be inoperative, unenforceable, or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability, or validity of that provision in any other jurisdiction, and to this end the provisions of all Loan Documents are declared to be severable. 9.11. NONLIABILITY OF LENDERS. The relationship between the Borrower and the Lenders and the Agent shall be solely that of borrower and lender. Neither the Agent nor any Lender shall have any fiduciary responsibilities to the Borrower. Neither the Agent nor any Lender undertakes any responsibility to the Borrower to review or inform the Borrower of any matter in connection with any phase of the Borrower's business or operations. The Borrower shall rely entirely upon its own judgment with respect to its business, and any review, inspection or supervision of, or information supplied to the Borrower by the Agent or the Lenders is for the protection of the Agent and the Lenders and neither the Borrower nor any other Person is entitled to rely thereon. Whether or not such damages are related to a claim that is subject to the waiver effected above and whether or not such waiver is effective, neither the Agent nor any Lender shall have any liability with respect to, and the Borrower hereby waives, releases and agrees not to sue for, any special, indirect or consequential damages suffered by the Borrower in connection with, arising out of, or in any way related to the Transaction Documents or the transactions contemplated thereby or the relationship established by the Transaction Documents, or any act, omission or event occurring in connection therewith. 9.12. CHOICE OF LAW. THE LOAN DOCUMENTS (OTHER THAN THOSE CONTAINING A CONTRARY EXPRESS CHOICE OF LAW PROVISION) SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS, WITHOUT REGARD TO CONFLICT OF LAWS PROVISIONS, OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. -43- 9.13. CONSENT TO JURISDICTION. THE BORROWER HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED STATES FEDERAL OR ILLINOIS STATE COURT SITTING IN CHICAGO IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY TRANSACTION DOCUMENT AND THE BORROWER HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT AND IRREVOCABLY WAIVES ANY OBJECTION IT MAY NOW OR HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN SUCH A COURT OR THAT SUCH COURT IS AN INCONVENIENT FORUM. NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR ANY LENDER TO BRING PROCEEDINGS AGAINST THE BORROWER IN THE COURTS OF ANY OTHER JURISDICTION. ANY JUDICIAL PROCEEDING BY THE BORROWER AGAINST THE AGENT OR ANY LENDER OR ANY AFFILIATE OF THE AGENT OR ANY LENDER INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY TRANSACTION DOCUMENT SHALL BE BROUGHT ONLY IN A COURT IN CHICAGO, ILLINOIS; PROVIDED, THAT SUCH PROCEEDINGS MAY BE BROUGHT IN OTHER COURTS IF JURISDICTION MAY NOT BE OBTAINED IN A COURT IN CHICAGO, ILLINOIS. 9.14. WAIVER OF JURY TRIAL. THE BORROWER, THE AGENT AND EACH LENDER HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY TRANSACTION DOCUMENT OR THE RELATIONSHIP ESTABLISHED THEREUNDER. 9.15. DISCLOSURE. The Borrower and each Lender hereby (a) acknowledge and agree that First Chicago and/or its Affiliates from time to time may hold other investments in, make other loans to or have other relationships with the Borrower, including, without limitation, in connection with any interest rate hedging instruments or agreements or swap transactions, and (b) waive any liability of First Chicago or such Affiliate to the Borrower or any Lender, respectively, arising out of or resulting from such investments, loans or relationships other than liabilities arising out of the gross negligence or willful misconduct of First Chicago or its Affiliates to the extent that such liability would not have arisen but for First Chicago's status as Agent hereunder. 9.16. COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. This Agreement shall be effective when it has been executed by the Borrower, the Agent and the Lenders and each party has notified the Agent that it has taken such action. -44- 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY. (a) The Borrower acknowledges that (i) services may be offered or provided to it (in connection with this Agreement or otherwise) by each Lender or by one or more Subsidiaries or Affiliates of such Lender and (ii) information delivered to each Lender by the Borrower and its Subsidiaries may be provided to each such Subsidiary and Affiliate, it being understood that any such Subsidiary or Affiliate receiving such information shall be bound by the provisions of clause (b) below as if it were a Lender hereunder. (b) Each Lender and the Agent agrees (on behalf of itself and each of its affiliates, directors, officers, employees and representatives) to use reasonable precautions to keep confidential, in accordance with their customary procedures for handling confidential information of this nature and in accordance with safe and sound banking practices, any non-public information supplied to it by the Borrower pursuant to this Agreement, provided that nothing herein shall limit the disclosure of any such information (i) to the extent required by statue, rule, regulation or judicial process, (ii) to counsel for any of the Lenders or the Agent, (iii) to bank examiners, auditors or accountants, (iv) to the Agent or any other Lender (or to First Chicago Capital Markets, Inc.), (v) in connection with any litigation to which any one or more of the Lenders or the Agent is a party, (vi) to a subsidiary or affiliate of such Lender as provided in clause (a) above, (vii) to any assignee or participant (or prospective assignee or participant) so long as such assignee or participant (or prospective assignee or participant) agrees with the respective Lender to keep such information confidential on substantially the terms set forth in this SECTION 9.17(B), (viii) to any other Person as may be reasonably required in the course of the enforcement of any Lender's rights or remedies hereunder or under any of such Lender's Note, or (ix) to any other creditor of either Borrower or any of its Subsidiaries at any time during the continuance of a Default; PROVIDED that in no event shall any Lender or the Agent be obligated or required to return any materials furnished by the Borrower. ARTICLE X THE AGENT 10.1. APPOINTMENT. First Chicago is hereby appointed Agent hereunder and under each other Transaction Document, and each of the Lenders authorizes the Agent to act as the agent of such Lender. The Agent agrees to act as such upon the express conditions contained in this ARTICLE X. The Agent shall not have a fiduciary relationship in respect of the Borrower or any Lender by reason of this Agreement or any other Transaction Document. 10.2. POWERS. The Agent shall have and may exercise such powers under the Transaction Documents as are specifically delegated to the Agent by the terms of each thereof, together with such powers as are reasonably incidental thereto. The Agent shall have no implied duties to the Lenders, or any obligation to the Lenders to take any action thereunder, except any action specifically provided by the Transaction Documents to be taken by the Agent. -45- 10.3. GENERAL IMMUNITY. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Borrower or any Lender for any action taken or omitted to be taken by it or them hereunder or under any other Transaction Document or in connection herewith or therewith except for its or their own gross negligence or willful misconduct. 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC. Neither the Agent nor any of its directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into, or verify (a) any statement, warranty or representation made in connection with any Transaction Document or any borrowing hereunder, (b) the performance or observance of any of the covenants or agreements of any obligor under any Transaction Document, including, without limitation, any agreement by an obligor to furnish information directly to each Lender; (c) the satisfaction of any condition specified in ARTICLE IV, except receipt of items required to be delivered to the Agent and not waived at closing, or (d) the validity, effectiveness, sufficiency, enforceability or genuineness of any Transaction Document or any other instrument or writing furnished in connection therewith. The Agent shall have no duty to disclose to the Lenders information that is not required to be furnished by the Borrower to the Agent at such time, but is voluntarily furnished by the Borrower to the Agent (either in its capacity as Agent or in its individual capacity). 10.5. ACTION ON INSTRUCTIONS OF LENDERS. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder and under any other Transaction Document in accordance with written instructions signed by the Required Lenders (or, to the extent required by SECTION 8.2, all Lenders), and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Lenders and on all holders of Notes. The Agent shall be fully justified in failing or refusing to take any action hereunder and under any other Transaction Document unless it shall first be indemnified to its satisfaction by the Lenders pro rata against any and all liability, cost and expense that it may incur by reason of taking or continuing to take any such action. 10.6. EMPLOYMENT OF AGENTS AND COUNSEL. The Agent may execute any of its duties as Agent hereunder and under any other Transaction Document by or through employees, agents and attorneys-in-fact and shall not be answerable to the Lenders, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. The Agent shall be entitled to advice of counsel concerning all matters pertaining to the agency hereby created and its duties hereunder and under any other Transaction Document. 10.7. RELIANCE ON DOCUMENTS; COUNSEL. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of counsel selected by the Agent, which counsel may be employees of the Agent. 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION. The Lenders agree to reimburse and indemnify the Agent ratably in proportion to their respective Commitments (or, if the Commitments have been terminated, in proportion to their Commitments immediately prior to such termination) -46- (a) for any amounts not reimbursed by the Borrower for which the Agent is entitled to reimbursement by the Borrower under the Transaction Documents, (b) for any other expenses incurred by the Agent on behalf of the Lenders, in connection with the preparation, execution, delivery, administration and enforcement of the Transaction Documents, and (c) for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of the Loan Documents or any other document delivered in connection therewith or the transactions contemplated thereby, or the enforcement of any of the terms thereof or of any such other documents; PROVIDED, that no Lender shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the Agent. The obligations of the Lenders under this SECTION 10.8 shall survive payment of the Obligations and termination of this Agreement. 10.9. NOTICE OF DEFAULT. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Unmatured Default hereunder unless the Agent has received written notice from a Lender or the Borrower referring to this Agreement describing such Default or Unmatured Default and stating that such notice is a "notice of default". In the event that the Agent receives such a notice, the Agent shall give prompt notice thereof to the Lenders. 10.10. RIGHTS AS A LENDER. In the event the Agent is a Lender, the Agent shall have the same rights and powers hereunder and under any other Transaction Document as any Lender, including, without limitation, pursuant to ARTICLE XII hereof, and may exercise the same as though it were not the Agent, and the term "Lender" or "Lenders" shall, at any time when the Agent is a Lender, unless the context otherwise indicates, include the Agent in its individual capacity. The Agent may accept deposits from, lend money to, and generally engage in any kind of trust, debt, equity or other transaction, in addition to those contemplated by this Agreement or any other Transaction Document, with the Borrower or any of its Subsidiaries in which the Borrower or such Subsidiary is not restricted hereby from engaging with any other Person. 10.11. LENDER CREDIT DECISION. Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender and based on the financial statements prepared by the Borrower and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement and the other Transaction Documents. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement and the other Transaction Documents. 10.12. SUCCESSOR AGENT. The Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower, such resignation to be effective upon the appointment of a successor Agent or, if no successor Agent has been appointed, forty-five (45) days after the retiring Agent gives notice of its intention to resign. Upon any such resignation, the Required Lenders shall have the right to appoint, on behalf of the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If no successor -47- Agent shall have been so appointed by the Required Lenders and shall have accepted such appointment within thirty (30) days after the resigning Agent's giving notice of its intention to resign, then the resigning Agent may appoint, on behalf of the Borrower and the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If the Agent has resigned and no successor Agent has been appointed, the Lenders may perform all the duties of the Agent hereunder and the Borrower shall make all payments in respect of the Obligations to the applicable Lender and for all other purposes shall deal directly with the Lenders. No successor Agent shall be deemed to be appointed hereunder until such successor Agent has accepted the appointment. Any such successor Agent shall be a commercial bank having capital and retained earnings of at least $50,000,000 and with a Lending Installation in the United States of America. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the resigning Agent. Upon the effectiveness of the resignation of the Agent, the resigning Agent shall be discharged from its duties and obligations hereunder and under the Transaction Documents. After the effectiveness of the resignation of an Agent, the provisions of this ARTICLE X shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent hereunder and under the other Transaction Documents. ARTICLE XI SETOFF; RATABLE PAYMENTS 11.1. SETOFF. In addition to, and without limitation of, any rights of the Lenders under applicable law, if the Borrower becomes insolvent, however evidenced, or any Default or Unmatured Default occurs, any and all deposits (including all account balances, whether provisional or final and whether or not collected or available) and any other Indebtedness at any time held or owing by any Lender to or for the credit or account of the Borrower may be offset and applied toward the payment of the Obligations owing to such Lender, whether or not the Obligations, or any part hereof, shall then be due. 11.2. RATABLE PAYMENTS. If any Lender, whether by setoff or otherwise, has payment made to it upon its Loans (other than payments received pursuant to SECTIONS 2.17, 3.1, 3.2 or 3.4) in a greater proportion than its pro-rata share of such Loans, such Lender agrees, promptly upon demand, to purchase a portion of the Loans held by the other Lenders so that after such purchase each Lender will hold its ratable proportion of Loans. If any Lender, whether in connection with setoff or amounts which might be subject to setoff or otherwise, receives collateral or other protection for its Obligations or such amounts which may be subject to setoff, such Lender agrees, promptly upon demand, to take such action necessary such that all Lenders share in the benefits of such collateral ratably in proportion to their Loans. In case any such payment is disturbed by legal process, or otherwise, appropriate further adjustments shall be made. If an amount to be setoff is to be applied to Indebtedness of the Borrower to a Lender, other than Indebtedness evidenced by any -48- of the Notes held by such Lender, such amount shall be applied ratably to such other Indebtedness and to the Indebtedness evidenced by such Notes. ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS 12.1. SUCCESSORS AND ASSIGNS. The terms and provisions of the Transaction Documents shall be binding upon and inure to the benefit of the Borrower and the Lenders and their respective successors and assigns, except that (a) the Borrower shall not have the right to assign its rights or obligations under the Loan Documents, and (b) any assignment by any Lender must be made in compliance with SECTION 12.3. Notwithstanding CLAUSE (B) of the preceding sentence, any Lender may at any time, without the consent of the Borrower or the Agent, assign all or any portion of its rights under this Agreement and its Notes to a Federal Reserve Bank; PROVIDED, HOWEVER, that no such assignment to a Federal Reserve Bank shall release the transferor Lender from its obligations hereunder. The Agent may treat the payee of any Note as the owner thereof for all purposes hereof unless and until such payee complies with SECTION 12.3 in the case of an assignment thereof or, in the case of any other transfer, a written notice of the transfer is filed with the Agent. Any assignee or transferee of a Note agrees by acceptance thereof to be bound by all the terms and provisions of the Transaction Documents. Any request, authority or consent of any Person, who at the time of making such request or giving such authority or consent is the holder of any Note, shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note or Notes issued in exchange therefor. 12.2. PARTICIPATIONS. 12.2.1. PERMITTED PARTICIPANTS; EFFECT. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks or other entities ("PARTICIPANTS") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender under the Transaction Documents. In the event of any such sale by a Lender of participating interests to a Participant, such Lender's obligations under the Transaction Documents shall remain unchanged, such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, such Lender shall remain the holder of any such Note for all purposes under the Transaction Documents, all amounts payable by the Borrower under this Agreement shall be determined as if such Lender had not sold such participating interests, and the Borrower and the Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Transaction Documents. 12.2.2. VOTING RIGHTS. Each Lender shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the -49- Transaction Documents other than any amendment, modification or waiver which effects any of the modifications referenced in clauses (a) through (h) of SECTION 8.2. 12.2.3. BENEFIT OF SETOFF. The Borrower agrees that each Participant shall be deemed to have the right of setoff provided in SECTION 11.1 in respect of its participating interest in amounts owing under the Transaction Documents to the same extent as if the amount of its participating interest were owing directly to it as a Lender under the Transaction Documents; PROVIDED, that each Lender shall retain the right of setoff provided in SECTION 11.1 with respect to the amount of participating interests sold to each Participant. The Lenders agree to share with each Participant, and each Participant, by exercising the right of setoff provided in SECTION 11.1, agrees to share with each Lender, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with SECTION 11.2 as if each Participant were a Lender. 12.3. ASSIGNMENTS. 12.3.1. PERMITTED ASSIGNMENTS. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more banks or other entities ("PURCHASERS") all or any part of its rights and obligations under the Transaction Documents; provided, however, that in the case of an assignment to an entity which is not a Lender or an Affiliate of a lender, such assignment shall be in a minimum amount of $5,000,000 (or, if less, the entire amount of such Lender's Commitment). Such assignment shall be substantially in the form of EXHIBIT C hereto or in such other form as may be agreed to by the parties thereto. The consent of the Agent and, so long as no Default under SECTIONS 7.2, 7.6 or 7.7 is continuing, the Borrower, shall be required prior to an assignment becoming effective with respect to a Purchaser which is not a Lender or an Affiliate thereof. Such consent shall not be unreasonably withheld. 12.3.2. EFFECT; EFFECTIVE DATE. Upon (a) delivery to the Agent of a notice of assignment, substantially in the form attached as Exhibit I to EXHIBIT C hereto (a "NOTICE OF ASSIGNMENT"), together with any consents required by SECTION 12.3.1, and (b) payment of a $3,000 fee to the Agent for processing such assignment, such assignment shall become effective on the effective date specified in such Notice of Assignment. On and after the effective date of such assignment, (a) such Purchaser shall for all purposes be a Lender party to this Agreement and any other Transaction Document executed by the Lenders and shall have all the rights and obligations of a Lender under the Transaction Documents, to the same extent as if it were an original party hereto, and (b) the transferor Lender shall be released with respect to the percentage of the Aggregate Commitment and Loans assigned to such Purchaser without any further consent or action by the Borrower, the Lenders or the Agent. Upon the consummation of any assignment to a Purchaser pursuant to this SECTION 12.3.2, the transferor Lender, the Agent and the Borrower shall make appropriate arrangements so that replacement Notes are issued to such transferor Lender and new Notes or, as appropriate, replacement Notes, are issued to such Purchaser, in each case in principal amounts reflecting their Commitment, as adjusted pursuant to such assignment. 12.4. DISSEMINATION OF INFORMATION. Subject to SECTION 9.17, the Borrower authorizes each Lender to disclose to any Participant or Purchaser or any other Person acquiring an interest in -50- the Transaction Documents by operation of law (each a "TRANSFEREE") and any prospective Transferee any and all information in such Lender's possession concerning the creditworthiness of the Borrower and its Subsidiaries. 12.5. TAX TREATMENT. If any interest in any Transaction Document is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the transferor Lender shall cause such Transferee, concurrently with the effectiveness of such transfer, to comply with the provisions of SECTION 2.17. ARTICLE XIII NOTICES 13.1. GIVING NOTICE. All notices and other communications provided to any party hereto under this Agreement or any other Loan Document shall be in writing, by facsimile, first class U.S. mail or overnight courier and addressed or delivered to such party at its address set forth below its signature hereto or at such other address as may be designated by such party in a notice to the other parties. Any notice, if mailed and properly addressed with first class postage prepaid, return receipt requested, shall be deemed given three (3) Business Days after deposit in the U.S. mail; any notice, if transmitted by facsimile, shall be deemed given when transmitted; and any notice given by overnight courier shall be deemed given when received by the addressee. 13.2. CHANGE OF ADDRESS. The Borrower, the Agent and any Lender may each change the address for service of notice upon it by a notice in writing to the other parties hereto. [signature pages to follow] -51- IN WITNESS WHEREOF, the Borrower, the Lenders and the Agent have executed this Agreement as of the date first above written. FUND AMERICAN ENTERPRISES HOLDINGS, INC. By: ----------------------------------------------- Print Name: --------------------------------------- Title: -------------------------------------------- Address: 80 South Main Street Hanover, New Hampshire 03755 Attn: Reid T. Campbell Vice President and Director of Finance Fax No.: (603) 640-2203 Tel. No.: (603) 643-4562 -52- COMMITMENTS THE FIRST NATIONAL BANK OF CHICAGO, Commitment $21,000,000 Individually and as Agent By: -------------------------------------- Print Name: ------------------------------ Title: ----------------------------------- Address: 153 West 51st Street New York, NY 10019 Attn: Samuel W. Bridges First Vice President Fax No.: (212) 373-1393 Tel. No.: (212) 373-1142 Commitment $14,000,000 FLEET NATIONAL BANK By: -------------------------------------- Print Name: ------------------------------ Title: ----------------------------------- Address: One Federal Street -MAOFD06H Boston, MA 02110-2010 Attn: David A. Bosselait ---------------- Fax No.: (617) 346-5825 Tel. No.: (617) 346-5823 Aggregate Initial Commitment $35,000,000 -53-


                                                                   Exhibit 10.B

                                                                 EXECUTION COPY

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                                   $50,000,000


                           SECOND AMENDED AND RESTATED


                                CREDIT AGREEMENT


                                      AMONG


                         WHITE MOUNTAINS HOLDINGS, INC.,

                                  as Borrower,

                            THE LENDERS NAMED HEREIN


                                       and



                       THE FIRST NATIONAL BANK OF CHICAGO,

                                    as Agent


                                   DATED AS OF


                                 August 14, 1998



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                                TABLE OF CONTENTS

                                                                       
ARTICLE I     DEFINITIONS..................................................   1

ARTICLE II    THE CREDITS..................................................  16
     2.1.        ADVANCES..................................................  16
     2.2.        RATABLE LOANS.............................................  16
     2.3.        TYPES OF ADVANCES.........................................  16
     2.4.        FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT..........  16
     2.5.        MINIMUM AMOUNT OF EACH ADVANCE............................  17
     2.6.        OPTIONAL PRINCIPAL PAYMENTS...............................  17
     2.7.        MANDATORY COMMITMENT REDUCTIONS...........................  17
     2.8.        METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR 
                 NEW ADVANCES .............................................  18
     2.9.        CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES.......  18
     2.10.       CHANGES IN INTEREST RATE, ETC.............................  19
     2.11.       RATES APPLICABLE AFTER DEFAULT............................  19
     2.12.       METHOD OF PAYMENT.........................................  20
     2.13.       NOTES.....................................................  20
     2.14.       INTEREST PAYMENT DATES; INTEREST AND FEE BASIS.  .........  20
     2.15.       NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS 
                  AND COMMITMENT REDUCTIONS................................  20
     2.16.       LENDING INSTALLATIONS.....................................  21
     2.17.       NON-RECEIPT OF FUNDS BY THE AGENT.........................  21
     2.18.       TAXES.....................................................  21
     2.19.       AGENT'S FEES..............................................  22
                                                                             
ARTICLE III   CHANGE IN CIRCUMSTANCES......................................  22
     3.1.        YIELD PROTECTION..........................................  22
     3.2.        CHANGES IN CAPITAL ADEQUACY REGULATIONS...................  23
     3.3.        AVAILABILITY OF TYPES OF ADVANCES.........................  24
     3.4.        FUNDING INDEMNIFICATION...................................  24
     3.5.        LENDER STATEMENTS; SURVIVAL OF INDEMNITY..................  24
                                                                          
ARTICLE IV    CONDITIONS PRECEDENT.........................................  24
     4.1.        EFFECTIVENESS.............................................  24
     4.2.        EACH FUTURE ADVANCE.......................................  26
                                                                             
ARTICLE V     REPRESENTATIONS AND WARRANTIES...............................  27
     5.1.        CORPORATE EXISTENCE AND STANDING..........................  27
     5.2.        AUTHORIZATION AND VALIDITY................................  27
     5.3.        COMPLIANCE WITH LAWS AND CONTRACTS........................  27

-i- 5.4. GOVERNMENTAL CONSENTS..................................... 28 5.5. FINANCIAL STATEMENTS...................................... 28 5.6. MATERIAL ADVERSE CHANGE................................... 28 5.7. TAXES..................................................... 28 5.8. LITIGATION AND CONTINGENT OBLIGATIONS..................... 29 5.9. CAPITALIZATION............................................ 29 5.10. ERISA..................................................... 29 5.11. DEFAULTS.................................................. 30 5.12. FEDERAL RESERVE REGULATIONS............................... 30 5.13. INVESTMENT COMPANY........................................ 30 5.14. CERTAIN FEES.............................................. 30 5.15. SOLVENCY.................................................. 30 5.16. INDEBTEDNESS.............................................. 30 5.17. INSURANCE LICENSES........................................ 31 5.18. MATERIAL AGREEMENTS....................................... 31 5.19. ENVIRONMENTAL LAWS........................................ 31 5.20. INSURANCE................................................. 32 5.21. DISCLOSURE................................................ 32 5.22. YEAR 2000................................................. 32 ARTICLE VI COVENANTS.................................................... 32 6.1. FINANCIAL REPORTING....................................... 32 6.2. USE OF PROCEEDS........................................... 34 6.3. NOTICE OF DEFAULT......................................... 35 6.4. CONDUCT OF BUSINESS....................................... 35 6.5. TAXES..................................................... 35 6.6. INSURANCE................................................. 36 6.7. COMPLIANCE WITH LAWS...................................... 36 6.8. MAINTENANCE OF PROPERTIES................................. 36 6.9. INSPECTION................................................ 36 6.11. INDEBTEDNESS.............................................. 37 6.12. MERGER.................................................... 38 6.13. INVESTMENTS AND PURCHASES................................. 38 6.14. CONTINGENT OBLIGATIONS.................................... 39 6.15. LIENS..................................................... 39 6.16. AFFILIATES................................................ 41 6.17. ENVIRONMENTAL MATTERS..................................... 41 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR................ 41 6.19. INCONSISTENT AGREEMENTS................................... 41 6.20. FINANCIAL COVENANTS....................................... 41 6.20.2. LEVERAGE RATIO................................... 42 6.20.3. FIXED CHARGES COVERAGE RATIO..................... 42 6.20.4. STATUTORY SURPLUS................................ 42
-ii- 6.21. TAX CONSOLIDATION......................................... 42 6.22. ERISA COMPLIANCE.......................................... 42 6.23. YEAR 2000................................................. 43 ARTICLE VII DEFAULTS..................................................... 43 ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES............... 45 8.1. ACCELERATION.............................................. 45 8.2. AMENDMENTS................................................ 45 8.3. PRESERVATION OF RIGHTS.................................... 46 ARTICLE IX GENERAL PROVISIONS........................................... 47 9.1. SURVIVAL OF REPRESENTATIONS............................... 47 9.2. GOVERNMENTAL REGULATION................................... 47 9.3. TAXES..................................................... 47 9.4. HEADINGS.................................................. 47 9.5. ENTIRE AGREEMENT.......................................... 47 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT........... 47 9.7. EXPENSES; INDEMNIFICATION................................. 47 9.8. NUMBERS OF DOCUMENTS...................................... 48 9.9. ACCOUNTING................................................ 48 9.10. SEVERABILITY OF PROVISIONS................................ 48 9.11. NONLIABILITY OF LENDERS................................... 48 9.12. CHOICE OF LAW............................................. 48 9.13. CONSENT TO JURISDICTION................................... 48 9.14. WAIVER OF JURY TRIAL...................................... 49 9.15. DISCLOSURE................................................ 49 9.16. COUNTERPARTS.............................................. 49 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY......... 49 ARTICLE X THE AGENT.................................................... 50 10.1. APPOINTMENT............................................... 50 10.2. POWERS.................................................... 50 10.3. GENERAL IMMUNITY.......................................... 50 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC................ 51 10.5. ACTION ON INSTRUCTIONS OF LENDERS......................... 51 10.6. EMPLOYMENT OF AGENTS AND COUNSEL.......................... 51 10.7. RELIANCE ON DOCUMENTS; COUNSEL............................ 51 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION................. 51 10.9. NOTICE OF DEFAULT......................................... 52 10.10. RIGHTS AS A LENDER........................................ 52 10.11. LENDER CREDIT DECISION.................................... 52 10.12. SUCCESSOR AGENT........................................... 52
-iii- ARTICLE XI SETOFF; RATABLE PAYMENTS..................................... 53 11.1. SETOFF.................................................... 53 11.2. RATABLE PAYMENTS.......................................... 53 ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS............ 54 12.1. SUCCESSORS AND ASSIGNS.................................... 54 12.2. PARTICIPATIONS............................................ 54 12.2.1. PERMITTED PARTICIPANTS; EFFECT. ................ 54 12.2.2. VOTING RIGHTS.................................... 54 12.2.3. BENEFIT OF SETOFF................................ 54 12.3. ASSIGNMENTS............................................... 55 12.3.1. PERMITTED ASSIGNMENTS............................ 55 12.3.2. EFFECT; EFFECTIVE DATE........................... 55 12.4. DISSEMINATION OF INFORMATION.............................. 55 12.5. TAX TREATMENT............................................. 56
-iv- ARTICLE XIII NOTICES...................................................... 56 13.1. GIVING NOTICE............................................. 56 13.2. CHANGE OF ADDRESS......................................... 56 ARTICLE XIV AMENDMENT AND RESTATEMENT................................... 56
-v- EXHIBITS Exhibit A (Article 1) Note Exhibit B (Section 6.1(g)) Compliance Certificate Exhibit C (Section 12.3.1) Assignment Agreement
SCHEDULES Schedule 1 - Margins Schedule 5.3 - Approvals and Consents Schedule 5.9 - Capitalization and Subsidiaries Schedule 5.10 - ERISA Schedule 5.16 - Indebtedness Schedule 5.17 - Insurance Licenses Schedule 5.18 - Material Restrictions Schedule 6.13 - Investment Commitments Schedule 6.15 - Liens -vi- SECOND AMENDED AND RESTATED CREDIT AGREEMENT This Second Amended and Restated Credit Agreement, dated as of August 14, 1998, is among WHITE MOUNTAINS HOLDINGS, INC., a Delaware corporation, the Lenders and THE FIRST NATIONAL BANK OF CHICAGO, individually and as Agent. R E C I T A L S: A. The Borrower, the Lenders and the Agent are party to that certain $50,000,000 amended and restated credit agreement, dated as of July 30, 1997, as amended by a certain First Amendment to Credit Agreement, dated as of November 20, 1997 (the "Existing Credit Agreement"). B. The Borrower has requested that the Existing Credit Agreement be amended and restated in order to make certain amendments to the Existing Credit Agreement. C. The Borrower, the Lenders and the Agent desire to amend and restate the Existing Credit Agreement on the terms and conditions set forth below to accomplish such amendments. NOW, THEREFORE, in consideration of the mutual covenants and undertakings herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, the Lenders and the Agent hereby agree as follows: ARTICLE I DEFINITIONS As used in this Agreement: "ABR Advance" means an Advance which bears interest at the Alternate Base Rate. "Adjusted Net Worth" means, with respect to the Borrower, Net Worth of the Borrower (on a consolidated basis) on the date of determination (without duplication for amounts already excluded), MINUS the aggregate book value of the Borrower's equity interest in SOMSC at such time, MINUS any intercompany loans or receivables owing from the Parent that are assets of the Borrower or its Subsidiaries at such time. "Advance" means a borrowing pursuant to SECTION 2.1 consisting of the aggregate amount of the several Loans made on the same Borrowing Date by the Lenders to the Borrower of the same Type and, in the case of Eurodollar Advances, for the same Interest Period. "Affiliate" of any Person means any other Person directly or indirectly controlling, controlled by or under common control with such Person. A Person shall be deemed to control another Person if the controlling Person owns 20% or more of any class of voting securities (or other ownership interests) of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management or policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Agent" means First Chicago in its capacity as agent for the Lenders pursuant to ARTICLE X, and not in its individual capacity as a Lender, and any successor Agent appointed pursuant to ARTICLE X. "Aggregate Commitment" means the aggregate of the Commitments of all the Lenders hereunder. The initial Aggregate Commitment is $50,000,000. "Agreement" means this Second Amended and Restated Credit Agreement, as it may be amended, modified or restated and in effect from time to time. "Agreement Accounting Principles" means generally accepted accounting principles as in effect from time to time; PROVIDED, HOWEVER, that if any changes in accounting principles from those in effect on the date of this Agreement are adopted which result in a material change in the method of calculation of any of the financial covenants, standards or terms in this Agreement, the parties agree to enter into negotiations to determine whether such provisions require amendment and, if so, the terms of such amendment so as to equitably reflect such changes. Until a resolution thereof is reached, all calculations made for the purposes of determining compliance with the terms of this Agreement shall be made by application of generally accepted accounting principles in effect on the date of this Agreement applied, to the extent applicable, on a basis consistent with that used in the preparation of the Financial Statements furnished to the Lenders pursuant to SECTION 5.5 hereof. "Alternate Base Rate" means, for any day, a rate of interest per annum equal to the higher of (a) the Corporate Base Rate for such day, and (b) the sum of the Federal Funds Effective Rate for such day plus 1/2% per annum, in each case changing when and as the Corporate Base Rate and the Federal Funds Effective Rate, as the case may be, changes. "Annual Statement" means the annual statutory financial statement of any Insurance Subsidiary required to be filed with the insurance commissioner (or similar authority) of its jurisdiction of incorporation, which statement shall be in the form required by such Insurance Subsidiary's jurisdiction of incorporation or, if no specific form is so required, in the form of financial statements permitted by such insurance commissioner (or such similar authority) to be used for filing annual statutory financial statements and shall contain the type of information permitted by such insurance commissioner (or such similar authority) to be disclosed therein, together with all exhibits or schedules filed therewith. "Applicable Eurodollar Margin" has the meaning ascribed to it by, and shall be determined in accordance with, SCHEDULE 1. -2- "Applicable Facility Fee Margin" has the meaning ascribed to it by, and shall be determined in accordance with, SCHEDULE 1. "Article" means an article of this Agreement unless another document is specifically referenced. "Asset Disposition" means any sale, transfer or other disposition (outside the ordinary course of business) of any material asset of the Borrower in a single transaction or in a series of related transactions (other than the sale of a Money Market Investment, the Borrower's equity interests in SOMSC or FAE's equity interest in San Juan Basin Trust, the net proceeds of which are utilized within one hundred eighty (180) days to pay dividends permitted by SECTION 6.10), including any such sale, transfer or disposition by means of a transaction permitted by SECTION 6.12. "Authorized Officer" means any of the chief executive officer, president, chief financial officer, treasurer or controller of the Borrower, acting singly. "Bankruptcy Code" means Title 11, United States Code, sections 1 ET SEQ., as the same may be amended from time to time, and any successor thereto or replacement therefor which may be hereafter enacted. "Benefit Plan" means any deferred benefit plan for the benefit of present, future or former employees, whether or not such benefit plan is a Plan. "Borrower" means White Mountains Holdings, Inc., a Delaware corporation, and its successors and assigns. "Borrowing Date" means a date on which an Advance is made hereunder. "Borrowing Notice" is defined in SECTION 2.8. "Business Day" means (a) with respect to any borrowing, payment or rate selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities and on which dealings in United States dollars are carried on in the London interbank market, and (b) for all other purposes, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities. "Capitalized Lease" of a Person means any lease of Property by such Person as lessee which would be capitalized on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. "Capitalized Lease Obligations" of a Person means the amount of the obligations of such Person under Capitalized Leases which would be shown as a liability on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. -3- "Change" is defined in SECTION 3.2. "Change in Control" means (a) the acquisition by any "person" or "group" (as such terms are used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) (other than Parent, any Wholly-Owned Subsidiary of Parent, John J. Byrne or any Plan or any Benefit Plan of Parent, the Borrower or any of their Subsidiaries), including without limitation any acquisition effected by means of any transaction contemplated by SECTION 6.12, of beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended) of 25% or more of the outstanding shares of voting stock of the Borrower; or (b) during any period of twelve (12) consecutive calendar months, commencing on the date of the Agreement, the ceasing of those individuals (the "CONTINUING DIRECTORS") who (i) were directors of the Borrower on the first day of each such period or (ii) subsequently became directors of the Borrower and whose initial election or initial nomination for election subsequent to that date was approved by a majority of the Continuing Directors then on the board of directors of the Borrower to constitute a majority of the board of directors of the Borrower; or (c) during any period of twelve (12) consecutive calendar months, commencing on the date of this Agreement, the ceasing of individuals who hold an office possessing the title Senior Vice President or such title that ranks senior to a Senior Vice President (collectively, "Senior Management") of the Borrower on the first day of each such period to constitute a majority of the Senior Management of the Borrower. "Code" means the Internal Revenue Code of 1986, as amended, reformed or otherwise modified from time to time. "Commitment" means, for each Lender, the obligation of such Lender to make Loans not exceeding the amount set forth opposite its signature below and as set forth in any Notice of Assignment relating to any assignment which has become effective pursuant to SECTION 12.3.2, as such amount may be modified from time to time pursuant to the terms hereof. "Consolidated" or "consolidated", when used in connection with any calculation, means a calculation to be determined on a consolidated basis for a Person and its Subsidiaries in accordance with Agreement Accounting Principles. "Consolidated Person" means, for the taxable year of reference, each Person which is a member of the affiliated group of the Borrower if Consolidated returns are or shall be filed for such affiliated group for federal income tax purposes or any combined or unitary group of which the Borrower is a member for state income tax purposes. "Contingent Obligation" of a Person means any agreement, undertaking or arrangement by which such Person assumes, guarantees, endorses, contingently agrees to purchase or provide funds for the payment of, or otherwise becomes or is contingently liable upon, the obligation or liability of any other Person, or agrees to maintain the net worth or working capital or other financial condition of any other Person, or otherwise assures any creditor of such other Person against loss, including, without limitation, any comfort letter, operating agreement or take-or-pay contract or -4- application for a Letter of Credit, excluding however (a) insurance policies and insurance contracts issued in the ordinary course of business and (b) any financial guarantees issued by FSA. "Controlled Group" means all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower or any of its Subsidiaries, are treated as a single employer under Section 414 of the Code. "Conversion/Continuation Notice" is defined in SECTION 2.9. "Corporate Base Rate" means a rate per annum equal to the corporate base rate of interest publicly announced by First Chicago from time to time, changing when and as said corporate base rate changes. The Corporate Base Rate is a reference rate and does not necessarily represent the lowest or best rate of interest actually charged to any customer. First Chicago may make commercial loans or other loans at rates of interest at, above or below the Corporate Base Rate. "Default" means an event described in ARTICLE VII. "Environmental Laws" is defined in SECTION 5.19. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "Eurodollar Advance" means an Advance which bears interest at the Eurodollar Rate. "Eurodollar Base Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the rate determined by the Agent to be the rate at which deposits in U.S. dollars are offered by First Chicago to first-class banks in the London interbank market at approximately 11 a.m. (London time) two (2) Business Days prior to the first day of such Interest Period, in the approximate amount of First Chicago's relevant Eurodollar Advance and having a maturity approximately equal to such Interest Period. "Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the sum of (a) the quotient of (i) the Eurodollar Base Rate applicable to such Interest Period, divided by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to such Interest Period, plus the Applicable Eurodollar Margin. The Eurodollar Rate shall be rounded to the next higher multiple of 1/100 of 1% if the rate is not such a multiple. "Existing Credit Agreement" is defined in the recitals to this Agreement. "Facility Fee" is defined in Section 2.4(a). "Facility Termination Date" means July 30, 2002. -5- "FAE" means Fund American Enterprises, Inc. (f/k/a Fund American Enterprises II, Inc.), a Delaware corporation and direct Wholly-Owned Subsidiary of the Borrower. "Federal Funds Effective Rate" means, for any day, an interest 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 for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10 a.m. (Chicago time) on such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent in its sole discretion. "Financial Statements" is defined in SECTION 5.5. "First Chicago" means The First National Bank of Chicago in its individual capacity, and its successors. "First-Tier Insurance Subsidiary" means any Insurance Subsidiary that is either (a) a direct Wholly-Owned Subsidiary of the Borrower or (b) a Wholly-Owned Subsidiary of a Subsidiary of the Borrower and there exists no Insurance Subsidiary in the chain of ownership between the Borrower and such Insurance Subsidiary. "Fiscal Quarter" means one of the four three-month accounting periods comprising a Fiscal Year. "Fiscal Year" means the twelve-month accounting period ending December 31 of each year. "Fixed Charges Coverage Ratio" means, as of the end of any Fiscal Quarter, the ratio of: (a) the sum, without duplication, of, (i) investments of the Borrower, Valley, FAE, Charter Group, Inc., Charter General Agency, Inc., NCM Management Corporation and Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of the Borrower) in cash and Money Market Investments as of the end of such Fiscal Quarter, PLUS (ii) an amount equal to the maximum amount of dividends and intercompany fees available to be paid to the Borrower, Valley, FAE and Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of the Borrower) without approval of any Governmental Authority by each present and future Wholly- Owned Subsidiary of the Borrower that is a First-Tier Insurance Subsidiary of either the Borrower or any of its Subsidiaries that is not an Insurance Subsidiary pursuant to applicable insurance statutes, rules and regulations of -6- the applicable Governmental Authority during the succeeding four Fiscal Quarters, to (b) Fixed Charges. "Fixed Charges" means, with respect to Parent and the Borrower, as of the end of any Fiscal Quarter, the sum, without duplication and after giving effect to consolidation, of (a) the sum of all interest expense on outstanding Indebtedness (determined by adjusting the principal amount of such Indebtedness for scheduled amortization payments and assuming that the applicable interest rate in effect as of the date of determination would remain constant during the succeeding four Fiscal Quarter period) payable by Parent, the Borrower and any of Borrower's Wholly-Owned Subsidiaries (other than any Unrestricted Subsidiary), (b) dividends payable on preferred stock by Parent, the Borrower and any of Borrower's Wholly-Owned Subsidiaries (other than any Unrestricted Subsidiary), (c) Indebtedness payable pursuant to the scheduled amortization of such Indebtedness by Parent, the Borrower and any of Borrower's Wholly-Owned Subsidiaries (other than any Unrestricted Subsidiary), (d) Loans payable pursuant to SECTION 2.1(b) as a result of reductions in the Aggregate Commitment occurring in any such period pursuant to SECTION 2.7(a) (subject to the last sentence of this definition with respect to the July 30, 2002 reduction), and Loans (as defined in the Valley Credit Agreement) payable pursuant to Section 2.1(b) of the Valley Credit Agreement as a result of reductions in the Aggregate Commitment (as determined in the Valley Credit Agreement) occurring in any such period pursuant to Section 2.7(a) of the Valley Credit Agreement (subject to the last sentence of this definition with respect to the July 30, 2002 reduction), in each case for the period of four Fiscal Quarters immediately following the date of determination. Solely for purposes of computing Fixed Charges under the preceding CLAUSE (c), the scheduled principal payment of approximately $56,000,000 due on or before March 31, 1999 under the Folksamerica Loan Agreement shall not be included. Solely for purposes of computing Fixed Charges under the preceding CLAUSE (d) for any period on or after June 30, 2001, the "Reduction Amount" on July 30, 2002 stated in SECTION 2.7(a) shall be deemed to be $4,000,000 and the "Reduction Amount" on July 30, 2002 stated in Section 2.7(a) of the Valley Credit Agreement shall be deemed to be $2,000,000. "Folksamerica" means Folksamerica Holding Company, Inc., a New York corporation. "Folksamerica Loan Agreement " means that certain $70,000,000 loan agreement between Folksamerica and Swedbank (Sparbanken Sverige AB (publ)), New York Branch, dated as of November 12, 1991, as amended. "Folksamerica Transaction" means that certain transaction by which (a) the Borrower and/or FAE acquires all of the outstanding capital stock of Folksamerica not already owned by the Borrower, (b) Parent assumes the obligations of each of Folksam Omsesidig Sakforsakring (Sweden) and Samvirke Skadeforsikring AS (Norway) (collectively, the "Folksamerica Guarantors") to guarantee the obligations of Folksamerica (the "Folksamerica Guaranty") under the Folksamerica Loan Agreement and (c) the Parent indemnifies the Folksamerica Guarantors and their respective affiliates, successors and assigns with respect to various matters relating to the Folksamerica Guaranty. -7- "FSA" means Financial Security Assurance Holdings Ltd., a New York corporation. "FSA Amount" means an amount equal to that immediately utilized by SOMSC to excercise certain options, in existence on the date hereof, on the capital stock of FSA, such amount not to exceed $18,000,000. "Funded Indebtedness" means Indebtedness of the type described in clauses (a), (d), (e) and (h) of the definition "Indebtedness". "Governmental Authority" means any government (foreign or domestic) or any state or other political subdivision thereof or any governmental body, agency, authority, department or commission (including without limitation any board of insurance, insurance department or insurance commissioner and any taxing authority or political subdivision) or any instrumentality or officer thereof (including without limitation any court or tribunal) exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government and any corporation, partnership or other entity directly or indirectly owned or controlled by or subject to the control of any of the foregoing. "Hazardous Materials" is defined in SECTION 5.19. "Indebtedness" of a Person means such Person's (a) obligations for borrowed money, (b) obligations representing the deferred purchase price of Property or services (other than accounts payable arising in the ordinary course of such Person's business payable on terms customary in the trade), (c) obligations, whether or not assumed, secured by Liens or payable out of the proceeds or production from Property now or hereafter owned or acquired by such Person, (d) obligations which are evidenced by notes, acceptances, or similar instruments, (e) Capitalized Lease Obligations, (f) Rate Hedging Obligations, (g) Contingent Obligations, (h) obligations for which such Person is obligated pursuant to or in respect of a Letter of Credit and (i) repurchase obligations or liabilities of such Person with respect to accounts or notes receivable sold by such Person. "Insurance Subsidiary" means any Subsidiary which is engaged in the insurance business as an issuer or underwriter of insurance policies and/or insurance contracts. "Interest Period" means, with respect to a Eurodollar Advance, a period of one, two, three or six months commencing on a Business Day selected by the Borrower pursuant to this Agreement. Such Interest Period shall end on (but exclude) the day which corresponds numerically to such date one, two, three or six months thereafter; PROVIDED, HOWEVER, that if there is no such numerically corresponding day in such next, second, third or sixth succeeding month, such Interest Period shall end on the last Business Day of such next, second, third or sixth succeeding month. If an Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall end on the next succeeding Business Day; PROVIDED, HOWEVER, that if said next succeeding Business Day falls in a new calendar month, such Interest Period shall end on the immediately preceding Business Day. -8- "Investment" of a Person means any loan, advance (other than commission, travel and similar advances to officers and employees made in the ordinary course of business), extension of credit (other than accounts receivable arising in the ordinary course of business on terms customary in the trade), deposit account or contribution of capital by such Person to any other Person or any investment in, or purchase or other acquisition of, the stock, partnership interests, notes, debentures or other securities of any other Person made by such Person. "Lenders" means the lending institutions listed on the signature pages of this Agreement and their respective successors and assigns. "Lending Installation" means, with respect to a Lender or the Agent, any office, branch, subsidiary or affiliate of such Lender or the Agent. "Letter of Credit" of a Person means a letter of credit or similar instrument which is issued upon the application of such Person or upon which such Person is an account party or for which such Person is in any way liable. "Leverage Ratio" means, at any time, the ratio of (a) the consolidated Funded Indebtedness of Parent (excluding SOMSC) at such time to (b) the sum of the consolidated Funded Indebtedness of the Borrower and its Subsidiaries, other than SOMSC, at such time PLUS Adjusted Net Worth at such time, in all cases determined in accordance with Agreement Accounting Principles. "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 business. "Lien" means any security interest, lien (statutory or other), mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance or preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever (including, without limitation, the interest of a vendor or lessor under any conditional sale, Capitalized Lease or other title retention agreement), save in respect of liabilities and obligations arising out of the underwriting of insurance policies and contracts of insurance. "Loan" means, with respect to a Lender, such Lender's portion of any Advance and "Loans" means, with respect to the Lenders, the aggregate of all Advances. "Loan Documents" means this Agreement, the Notes and the other documents and agreements contemplated hereby and executed by the Borrower in favor of the Agent or any Lender. "Margin Stock" has the meaning assigned to that term under Regulation U. "Material Adverse Effect" means a material adverse effect on (a) the business, Property, condition (financial or other), performance, results of operations, or prospects of the Borrower and -9- its Subsidiaries taken as a whole, (b) the ability of the Borrower or any Subsidiary to perform its obligations under the Loan Documents, or (c) the validity or enforceability of any of the Loan Documents or the rights or remedies of the Agent or the Lenders thereunder. "Money Market Investments" means (a) direct obligations of the United States of America, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States of America, or of any agency thereof, in either case maturing not more than one year from the date of acquisition thereof; (b) certificates of deposit issued by any bank or trust company organized under the laws of the United States of America or any state thereof and having capital, surplus and undivided profits of at least $500,000,000, maturing not more than ninety (90) days from the date of acquisition thereof; (c) commercial paper rated A-1 or better P-1 or better by Standard & Poor's Ratings Group or Moody's Investors Services, Inc., respectively, maturing not more than ninety (90) days from the date of acquisition thereof; and (d) shares in an open-end management investment company with U.S. dollar denominated investments in fixed income obligations, including repurchase agreements, fixed time deposits and other obligations, with a dollar weighted average maturity of not more than one year, and for the calculation of this dollar weighted average maturity, certain instruments which have a variable rate of interest readjusted no less frequently than annually are deemed to have a maturity equal to the period remaining until the next readjustment of the interest rate. "Multiemployer Plan" means a Plan maintained pursuant to a collective bargaining agreement or any other arrangement to which the Borrower or any member of the Controlled Group is a party to which more than one employer is obligated to make contributions. "NAIC" means the National Association of Insurance Commissioners or any successor thereto, or in lieu thereof, any other association, agency or other organization performing advisory, coordination or other like functions among insurance departments, insurance commissioners and similar Governmental Authorities of the various states of the United States toward the promotion of uniformity in the practices of such Governmental Authorities. "Net Available Proceeds" means (a) with respect to any Asset Disposition, the sum of cash or readily marketable cash equivalents received (including by way of a cash generating sale or discounting of a note or account receivable) therefrom, whether at the time of such disposition or subsequent thereto, in excess in the case of any Asset Disposition of any amounts derived from such sale used (and permitted by this Agreement to be used) within one hundred eighty (180) days after such sale to make a Permitted Reinvestment, or (b) with respect to any sale or issuance of equity securities of the Borrower, cash or readily marketable cash equivalents received therefrom, whether at the time of such sale or issuance or subsequent thereto, net, in the case of either CLAUSE (a) or CLAUSE (b), of all legal, title and recording tax expenses, commissions and other fees and all costs and expenses incurred, including, without limitation, incremental income taxes resulting from such transaction. "Net Worth" means, with respect to any Person, at any date the consolidated shareholders' equity of such Person and its Consolidated Subsidiaries determined in accordance with Agreement -10- Accounting Principles (but excluding the effect of Statement of Financial Accounting Standards No. 115). "Non-Excluded Taxes" is defined in SECTION 2.18(a). "Note" means a promissory note in substantially the form of EXHIBIT A hereto, with appropriate insertions, duly executed and delivered to the Agent by the Borrower and payable to the order of a Lender in the amount of its Commitment, including any amendment, modification, renewal or replacement of such promissory note. "Notice of Assignment" is defined in SECTION 12.3.2. "Obligations" means all unpaid principal of and accrued and unpaid interest on the Notes, all accrued and unpaid fees and all expenses, reimbursements, indemnities and other obligations of the Borrower to the Lenders or to any Lender, the Agent or any indemnified party hereunder arising under any of the Loan Documents. "Parent" means Fund American Enterprises Holdings, Inc., a Delaware corporation. "Parent Credit Agreement" means the Amended and Restated Credit Agreement dated as of August 14, 1998, among Parent, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented or otherwise modified from time to time. "Participants" is defined in SECTION 12.2.1. "Payment Date" means the last day of each March, June, September and December. "PBGC" means the Pension Benefit Guaranty Corporation or any successor thereto. "Permitted Reinvestment" means an Investment in Subsidiaries (other than any Unrestricted Subsidiary) in existence on the date hereof, an Investment in Main Street America Holdings, Inc., or any other Investment approved by the Required Lenders. "Person" means any natural person, corporation, firm, joint venture, partnership, association, enterprise, trust or other entity or organization, or any government or political subdivision or any agency, department or instrumentality thereof. "Plan" means an employee pension benefit plan, as defined in Section 3(2) of ERISA, as to which the Borrower or any member of the Controlled Group may have any liability. "Proceeding" is defined in SECTION 5.19. -11- "Property" of a Person means any and all property, whether real, personal, tangible, intangible, or mixed, of such Person, or other assets owned, leased or operated by such Person. "pro-rata" means, when used with respect to a Lender, and any described aggregate or total amount, an amount equal to such Lender's pro-rata share or portion based on its percentage of the Aggregate Commitment or if the Aggregate Commitment has been terminated, its percentage of the aggregate principal amount of outstanding Advances. "Purchase" means any transaction, or any series of related transactions, consummated on or after the date of this Agreement, by which the Borrower or any of its Subsidiaries (a) acquires any going business or all or substantially all of the assets of any firm, corporation or division or line of business thereof, whether through purchase of assets, merger or otherwise, or (b) directly or indirectly acquires (in one transaction or as the most recent transaction in a series of transactions) at least a majority (in number of votes) of the securities of a corporation which have ordinary voting power for the election of directors (other than securities having such power only by reason of the happening of a contingency) or a majority (by percentage or voting power) of the outstanding partnership interests of a partnership. "Purchasers" is defined in SECTION 12.3.1. "Quarterly Statement" means the quarterly statutory financial statement of any Insurance Subsidiary required to be filed with the insurance commissioner (or similar authority) of its jurisdiction of incorporation or, if no specific form is so required, in the form of financial statements permitted by such insurance commissioner (or such similar authority) to be used for filing quarterly statutory financial statements and shall contain the type of financial information permitted by such insurance commissioner (or such similar authority) to be disclosed therein, together with all exhibits or schedules filed therewith. "Rate Hedging Obligations" of a Person means any and all obligations of such Person, whether absolute or contingent and howsoever and whensoever created, arising, evidenced or acquired (including all renewals, extensions and modifications thereof and substitutions therefor), under (a) any and all agreements, devices or arrangements designed to protect at least one of the parties thereto from the fluctuations of interest rates, exchange rates or forward rates applicable to such party's assets, liabilities or exchange transactions, including, but not limited to, dollar-denominated or cross-currency interest rate exchange agreements, forward currency exchange agreements, interest rate cap or collar protection agreements, forward rate currency or interest rate options, puts and warrants, and (b) any and all cancellations, buy backs, reversals, terminations or assignments of any of the foregoing. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor thereto or other regulation or official interpretation of said Board of Governors relating to reserve requirements applicable to depositary institutions. -12- "Regulation T" means Regulation T of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of such Board of Governors relating to the extension of credit by securities brokers and dealers for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by banks for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation X" means Regulation X of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by the specified lenders for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Release" is defined in the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. 39601 ET SEQ. "Reportable Event" means a reportable event as defined in Section 4043 of ERISA and the regulations issued under such section, with respect to a Plan, excluding, however, such events as to which the PBGC has by regulation waived the requirement of Section 4043(a) of ERISA that it be notified within thirty (30) days of the occurrence of such event; PROVIDED, that a failure to meet the minimum funding standard of Section 412 of the Code and of Section 302 of ERISA shall be a Reportable Event regardless of the issuance of any such waiver of the notice requirement in accordance with either Section 4043(a) of ERISA or Section 412(d) of the Code. "Required Lenders" means Lenders in the aggregate having at least 66-2/3% of the Aggregate Commitment or, if the Aggregate Commitment has been terminated, Lenders in the aggregate holding at least 66-2/3% of the aggregate unpaid principal amount of the outstanding Loans. "Reserve Requirement" means, with respect to an Interest Period, the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed under Regulation D on Eurocurrency liabilities. "Restatement Effective Date" means the date on which all conditions precedent set forth in SECTION 4.1 are satisfied or waived by all of the Lenders. "Risk-Based Capital Guidelines" is defined in SECTION 3.2. "SAP" means, with respect to any Insurance Subsidiary, the statutory accounting practices prescribed or permitted by the insurance commissioner (or other similar authority) in the jurisdiction of such Person for the preparation of annual statements and other financial reports by insurance companies of the same type as such Person in effect from time to time; PROVIDED, HOWEVER, that if -13- any changes in statutory accounting practices from those in effect on the date of this Agreement are adopted which result in a material change in the method of calculation of any of the financial covenants, standards or terms in this Agreement, the parties agree to enter into negotiations to determine whether such provisions require amendment and, if so, the terms of such amendment so as to equitably reflect such changes. Until a resolution thereof is reached, all calculations made for the purposes of determining compliance with the terms of this Agreement shall be made by application of statutory accounting practices in effect on the date of this Agreement applied, to the extent applicable, on a basis consistent with that used in the preparation of the Financial Statements furnished to the Lenders pursuant to SECTION 5.5 (j) AND (k) hereof. "Section" means a numbered section of this Agreement, unless another document is specifically referenced. "Significant Subsidiary" shall mean and include, at any time, each Subsidiary of the Borrower to the extent that the Net Worth of such Subsidiary is equal to or greater than $5,000,000. "Single Employer Plan" means a Plan subject to Title IV of ERISA maintained by the Borrower or any member of the Controlled Group for employees of the Borrower or any member of the Controlled Group, other than a Multiemployer Plan. "Solvent" means, when used with respect to a Person, that (a) the fair saleable value of the assets of such Person is in excess of the total amount of the present value of its liabilities (including for purposes of this definition all liabilities (including loss reserves as determined by such Person), whether or not reflected on a balance sheet prepared in accordance with Agreement Accounting Principles and whether direct or indirect, fixed or contingent, secured or unsecured, disputed or undisputed), (b) such Person is able to pay its debts or obligations in the ordinary course as they mature and (c) such Person does not have unreasonably small capital to carry out its business as conducted and as proposed to be conducted. "Solvency" shall have a correlative meaning. "SOMSC" means Source One Mortgage Services Corporation, a Delaware corporation. "SOMSC Credit Agreements" means the credit agreement or credit agreements from time to time in effect among SOMSC, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented, restated, replaced or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "Statutory Surplus" means, with respect to any Insurance Subsidiary at any time, the statutory capital and surplus of such Insurance Subsidiary at such time, as determined in accordance with SAP ("Liabilities, Surplus and Other Funds" statement, page 3, line 25 of the Annual Statement for the 1995 Fiscal Year entitled "Surplus as Regards Policyholders"). "Subsidiary" of a Person means (a) any corporation more than 50% of the outstanding securities having ordinary voting power of which shall at the time be owned or controlled, directly -14- or indirectly, by such Person or by one or more of its Subsidiaries or by such Person and one or more of its Subsidiaries, or (b) any partnership, association, joint venture, limited liability company or similar business organization more than 50% of the ownership interests having ordinary voting power of which shall at the time be so owned or controlled. Unless otherwise expressly provided, all references herein to a "Subsidiary" shall mean a Subsidiary of the Borrower. "Termination Event" means, with respect to a Plan which is subject to Title IV of ERISA, (a) a Reportable Event, (b) the withdrawal of the Borrower or any other member of the Controlled Group from such Plan during a plan year in which the Borrower or any other member of the Controlled Group was a "substantial employer" as defined in Section 4001(a)(2) of ERISA or was deemed such under Section 4068(f) of ERISA, (c) the termination of such Plan, the filing of a notice of intent to terminate such Plan or the treatment of an amendment of such Plan as a termination under Section 4041 of ERISA, (d) the institution by the PBGC of proceedings to terminate such Plan or (e) any event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or appointment of a trustee to administer, such Plan. "Transferee" is defined in SECTION 12.4. "Type" means, with respect to any Advance, its nature as an ABR Advance or Eurodollar Advance. "Unfunded Liability" means the amount (if any) by which the present value of all vested and unvested accrued benefits under a Single Employer Plan exceeds the fair market value of assets allocable to such benefits, all determined as of the then most recent valuation date for such Plans using PBGC actuarial assumptions for single employer plan terminations. "Unmatured Default" means an event which but for the lapse of time or the giving of notice, or both, would constitute a Default. "Unrestricted Subsidiary" means SOMSC and its Subsidiaries. "Valley Credit Agreement" means the Second Amended and Restated Credit Agreement, dated as of August 14, 1998, among Valley, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented or otherwise modified from time to time. "Valley" means Valley Group, Inc., an Oregon corporation. "Wholly-Owned Subsidiary" of a Person means (a) any Subsidiary all of the outstanding voting securities of which (other than directors' qualifying or similar shares) shall at the time be owned or controlled, directly or indirectly, by such Person or one or more Wholly-Owned Subsidiaries of such Person, or by such Person and one or more Wholly-Owned Subsidiaries of such Person, or (b) any partnership, association, joint venture, limited liability company or similar -15- business organization 100% of the ownership interests having ordinary voting power of which (other than directors' qualifying or similar shares) shall at the time be so owned or controlled. "Year 2000 Issues" means anticipated costs, problems and uncertainties associated with the inability of certain computer applications and hardware to effectively function on and after January 1, 2000, as such inability affects the business, operations and financial condition of the Borrower and its Subsidiaries and of the Borrower's and its Subsidiaries' material customers, suppliers and vendors. "Year 2000 Program" is defined in SECTION 5.22. The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms. References herein to particular columns, lines or sections of any Person's Annual Statement shall be deemed, where appropriate, to be references to the corresponding column, line or section of such Person's Quarterly Statement, or if no such corresponding column, line or section exists or if any report form changes, then to the corresponding item referenced thereby. In the event that the columns, lines or sections of the Annual Statement referenced herein are changed or renumbered, all such references shall be deemed references to such column, line or section as so renumbered or changed. Each accounting term used herein which is not otherwise defined herein shall be defined in accordance with Agreement Accounting Principles or SAP, as applicable, unless otherwise specified. ARTICLE II THE CREDITS 2.1.ADVANCES. (a) From and including the date hereof to but excluding the Facility Termination Date, each Lender severally (and not jointly) agrees, on the terms and conditions set forth in this Agreement, to make Advances to the Borrower from time to time in amounts not to exceed in the aggregate at any one time outstanding the amount of its pro-rata share of the Aggregate Commitment existing at such time. Subject to the terms of this Agreement, the Borrower may borrow, repay and reborrow Advances at any time prior to the Facility Termination Date. (b) The Borrower hereby agrees that if at any time, as a result of reductions in the Aggregate Commitment pursuant to SECTION 2.7 or otherwise, the aggregate balance of the Loans exceeds the Aggregate Commitment, the Borrower shall repay immediately its then outstanding Loans in such amount as may be necessary to eliminate such excess. (c) The Borrower's obligation to pay the principal of, and interest on, the Loans shall be evidenced by the Notes. Although the Notes shall be dated the date of this Agreement, interest in respect thereof shall be payable only for the periods during which the Loans evidenced thereby are outstanding and, although the stated amount of each Note shall be equal to the applicable Lender's Commitment, each Note shall be enforceable, with respect to the Borrower's obligation to -16- pay the principal amount thereof, only to the extent of the unpaid principal amount of the Loans at the time evidenced thereby. (d) All Advances and all Loans shall mature, and the principal amount thereof and the unpaid accrued interest thereon shall be due and payable, on the Facility Termination Date. 2.2. RATABLE LOANS. Each Advance hereunder shall consist of Loans made from the several Lenders ratably in proportion to the ratio that their respective Commitments bear to the Aggregate Commitment. 2.3. TYPES OF ADVANCES. The Advances may be ABR Advances or Eurodollar Advances, or a combination thereof, selected by the Borrower in accordance with SECTIONS 2.8 and 2.9. 2.4. FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT. (a) The Borrower agrees to pay to the Agent for the account of each Lender a facility fee ("Facility Fee") in an amount equal to the Applicable Facility Fee Margin per annum times the daily average Commitment of such Lender from the date hereof to and including the Facility Termination Date, payable on each Payment Date hereafter and on the Facility Termination Date. All accrued Facility Fees shall be payable on the effective date of any termination of the obligations of the Lenders to make Loans hereunder. (b) The Borrower may permanently reduce the Aggregate Commitment in whole, or in part ratably among the Lenders in a minimum aggregate amount of $2,000,000 upon at least three (3) Business Days' written notice to the Agent, which notice shall specify the amount of any such reduction; PROVIDED, HOWEVER, that the amount of the Aggregate Commitment may not be reduced below the aggregate principal amount of the outstanding Advances. Such reductions shall be in addition to reductions occurring pursuant to SECTION 2.7(b). Voluntary commitment reductions pursuant to this SECTION 2.4(b) shall be applied to the mandatory commitment reductions required to be made pursuant to SECTION 2.7(a) in direct order of maturity. 2.5. MINIMUM AMOUNT OF EACH ADVANCE. Each Advance shall be in the minimum amount of $2,000,000 (and in integral multiples of $500,000 if in excess thereof); PROVIDED, HOWEVER, that (a) any ABR Advance may be in the amount of the unused Aggregate Commitment and (b) in no event shall more than six (6) Eurodollar Advances be permitted to be outstanding at any time. 2.6. OPTIONAL PRINCIPAL PAYMENTS. The Borrower may from time to time pay, without penalty or premium, all outstanding ABR Advances, or, in a minimum aggregate amount of $2,000,000 any portion of the outstanding ABR Advances upon two (2) Business Days' prior notice to the Agent. Subject to SECTION 3.4 and upon like notice, a Eurodollar Advance may be paid prior to the last day of the applicable Interest Period in a minimum amount of $2,000,000 or an integral multiple of $500,000 in excess thereof. -17- 2.7. MANDATORY COMMITMENT REDUCTIONS. (a) The Aggregate Commitment shall be automatically and permanently reduced by the following amounts (or such lesser amount as a result of reductions pursuant to SECTION 2.7(c)) on the following dates:
Date Reduction Amount ---- ---------------- June 30, 1999 $3,000,000 June 30, 2000 $3,000,000 June 30, 2001 $4,000,000 July 30, 2002 $40,000,000
(b) The Aggregate Commitment shall also be automatically and permanently reduced in the amounts and at the times set forth below: (i) within one hundred eighty (180) days after the receipt in the form of cash or cash equivalents thereof by the Borrower, 100% of the aggregate Net Available Proceeds in excess of $1,000,000 realized upon all Asset Dispositions in any Fiscal Year of the Borrower; and (ii) within five (5) Business Days after the receipt in the form of cash or cash equivalents thereof by the Borrower, 85% of the Net Available Proceeds realized upon the sale by the Borrower of any equity securities issued by it after the date of this Agreement in excess of an aggregate amount of $1,000,000 (other than a sale of common stock of the Borrower to Parent). (c) Mandatory commitment reductions under SECTION 2.7(b) shall be cumulative and in addition to reductions occurring pursuant to SECTION 2.4(b). Any mandatory commitment reductions under SECTION 2.7(b) shall be applied to the mandatory commitment reductions required to be made pursuant to SECTION 2.7(a) in the inverse order of maturity. (d) Any reduction in the Aggregate Commitment pursuant to this SECTION 2.7 or otherwise shall ratably reduce the Commitment of each Lender. 2.8. METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR NEW ADVANCES. The Borrower shall select the Type of Advance and, in the case of each Eurodollar Advance, the Interest Period applicable to each Advance from time to time; PROVIDED, HOWEVER, that in the event Loans are incurred on the date of this Agreement, all Loans incurred on such date shall be ABR Advances. The Borrower shall give the Agent irrevocable notice (a "BORROWING NOTICE") not later than 10:00 a.m. (Chicago time) on the Borrowing Date of each ABR Advance and at least three (3) Business Days before the Borrowing Date for each Eurodollar Advance, specifying: (a) the Borrowing Date of such Advance, which shall be a Business Day; (b) the aggregate amount of such Advance; -18- (c) the Type of Advance selected; (d) in the case of each Eurodollar Advance, the Interest Period applicable thereto, which shall end on or prior to the Facility Termination Date; and (e) any changes to money transfer instructions previously delivered to the Agent. Not later than noon (Chicago time) on each Borrowing Date, each Lender shall make available its Loan or Loans, in funds immediately available in Chicago, to the Agent at its address specified pursuant to ARTICLE XIII. The Agent will make the funds so received from the Lenders available to the Borrower at the Agent's aforesaid address or at such account at such other institution in the United States of America as the Borrower may indicate in the Borrowing Notice. 2.9. CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES. ABR Advances shall continue as ABR Advances unless and until such ABR Advances are converted into Eurodollar Advances. Each Eurodollar Advance shall continue as a Eurodollar Advance until the end of the then applicable Interest Period therefor, at which time such Eurodollar Advance shall be automatically converted into an ABR Advance unless the Borrower shall have given the Agent a Conversion/Continuation Notice requesting that, at the end of such Interest Period, such Eurodollar Advance continue as a Eurodollar Advance for the same or another Interest Period. Subject to the terms of SECTION 2.5, the Borrower may elect from time to time to convert all or any part of an Advance of any Type into any other Type or Types of Advances; PROVIDED, HOWEVER, that any conversion of any Eurodollar Advance shall be made on, and only on, the last day of the Interest Period applicable thereto. The Borrower shall give the Agent irrevocable notice (a "CONVERSION/ CONTINUATION NOTICE") of each conversion of an ABR Advance or continuation of a Eurodollar Advance not later than 10:00 a.m. (Chicago time) on the conversion date, in the case of a conversion into an ABR Advance, or at least three (3) Business Days, in the case of a conversion into or continuation of a Eurodollar Advance, prior to the date of the requested conversion or continuation, specifying: (a) the requested date of such conversion or continuation, which shall be a Business Day; (b) the aggregate amount and Type of the Advance which is to be converted or continued; and (c) the amount and Type(s) of Advance(s) into which such Advance is to be converted or continued and, in the case of a conversion into or continuation of a Eurodollar Advance, the duration of the Interest Period applicable thereto, which shall end on or prior to the Facility Termination Date. 2.10. CHANGES IN INTEREST RATE, ETC. Each ABR Advance shall bear interest at the Alternate Base Rate from and including the date of such Advance or the date on which such Advance was converted into an ABR Advance to (but not including) the date on which such ABR Advance is paid or converted to a Eurodollar Advance. Changes in the rate of interest on that portion of any Advance maintained as an ABR Advance will take effect simultaneously with each change in the -19- Alternate Base Rate. Each Eurodollar Advance shall bear interest from and including the first day of the Interest Period applicable thereto to, but not including, the last day of such Interest Period at the Eurodollar Rate determined as applicable to such Eurodollar Advance plus the Applicable Eurodollar Margin. No Interest Period may end after the Facility Termination Date. The Borrower shall select Interest Periods so that it is not necessary to repay any portion of a Eurodollar Advance prior to the last day of the applicable Interest Period in order to make a mandatory repayment required pursuant to SECTION 2.7(a). 2.11. RATES APPLICABLE AFTER DEFAULT. Notwithstanding anything to the contrary contained in SECTIONS 2.8 or 2.9, no Advance may be made as, converted into or continued as a Eurodollar Advance (except with the consent of the Agent and the Required Lenders) when any Default or Unmatured Default has occurred and is continuing. During the continuance of a Default the Required Lenders may, at their option, by notice to the Borrower (which notice may be revoked at the option of the Required Lenders notwithstanding any provision of SECTION 8.2 requiring unanimous consent of the Lenders to changes in interest rates), declare that each Eurodollar Advance and ABR Advance shall bear interest (for the remainder of the applicable Interest Period in the case of Eurodollar Advances) at a rate per annum equal to the rate otherwise applicable plus two percent (2%) per annum; PROVIDED, HOWEVER, that such increased rate shall automatically and without action of any kind by the Lenders become and remain applicable until revoked by the Required Lenders in the event of a Default described in SECTIONS 7.6 or 7.7. 2.12. METHOD OF PAYMENT. All payments of the Obligations hereunder shall be made, without setoff, deduction or counterclaim, in immediately available funds to the Agent at the Agent's address specified pursuant to ARTICLE XIII, or at any other Lending Installation of the Agent specified in writing by the Agent to the Borrower (at least two (2) Business Days in advance) by noon (Chicago time) on the date when due and shall be applied ratably by the Agent among the Lenders. Each payment delivered to the Agent for the account of any Lender shall be delivered promptly by the Agent to such Lender in the same type of funds that the Agent received at its address specified pursuant to ARTICLE XIII or at any Lending Installation specified in a notice received by the Agent from such Lender. The Agent is hereby authorized to charge the account of the Borrower maintained with the Agent for each payment of principal, interest and fees as it becomes due hereunder. 2.13. NOTES. Each Lender is hereby authorized to record the principal amount of each of its Loans and each repayment on the schedule attached to its Note; PROVIDED, HOWEVER, that neither the failure to so record nor any error in such recordation shall affect the Borrower's obligations under such Note. 2.14. INTEREST PAYMENT DATES; INTEREST AND FEE BASIS. Interest accrued on each ABR Advance shall be payable on each Payment Date, commencing with the first such date to occur after the date hereof, on any date on which an ABR Advance is prepaid, whether due to acceleration or otherwise, and at maturity. Interest accrued on that portion of the outstanding principal amount of any ABR Advance converted into a Eurodollar Advance on a day other than a Payment Date shall be payable on the date of conversion. Interest accrued on each Eurodollar Advance shall be payable on the last day of its applicable Interest Period, on any date on which the Eurodollar Advance is -20- prepaid, whether by acceleration or otherwise, and at maturity. Interest accrued on each Eurodollar Advance having an Interest Period longer than three (3) months shall also be payable on the last day of each three-month interval during such Interest Period. Interest and commitment fees shall be calculated for actual days elapsed on the basis of a 360-day year. Interest shall be payable for the day an Advance is made but not for the day of any payment on the amount paid if payment is received prior to noon (Chicago time) at the place of payment. If any payment of principal of or interest on an Advance shall become due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day and, in the case of a principal payment, such extension of time shall be included in computing interest in connection with such payment. 2.15. NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS AND COMMITMENT REDUCTIONS. Promptly after receipt thereof, the Agent will notify each Lender of the contents of each Aggregate Commitment reduction notice, Borrowing Notice, Conversion/Continuation Notice, and repayment notice received by it hereunder. The Agent will notify each Lender of the interest rate applicable to each Eurodollar Advance promptly upon determination of such interest rate and will give each Lender prompt notice of each change in the Alternate Base Rate. 2.16. LENDING INSTALLATIONS. Each Lender may book its Loans at any Lending Installation selected by such Lender and may change its Lending Installation from time to time. All terms of this Agreement shall apply to any such Lending Installation and the Notes shall be deemed held by each Lender for the benefit of such Lending Installation. Each Lender may, by written or telex notice to the Agent and the Borrower, designate a Lending Installation through which Loans will be made by it and for whose account Loan payments are to be made. 2.17. NON-RECEIPT OF FUNDS BY THE AGENT. Unless the Borrower or a Lender, as the case may be, notifies the Agent prior to the date on which it is scheduled to make payment to the Agent of (a) in the case of a Lender, the proceeds of a Loan, or (b) in the case of the Borrower, a payment of principal, interest or fees to the Agent for the account of the Lenders, that it does not intend to make such payment, the Agent may assume that such payment has been made. The Agent may, but shall not be obligated to, make the amount of such payment available to the intended recipient in reliance upon such assumption. If the Borrower has not in fact made such payment to the Agent, the Lenders shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to the Federal Funds Effective Rate for such day. If any Lender has not in fact made such payment to the Agent, such Lender or the Borrower shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to (a) in the case of payment by a Lender, the Federal Funds Effective Rate for such day, or (b) in the case of payment by the Borrower, the interest rate applicable to the relevant Loan. 2.18. TAXES. (a) Any payments made by the Borrower under this Agreement shall be made free and clear of, and without deduction or withholding for or on account of, any present or -21- future income, stamp or other taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed by any Governmental Authority, excluding net income taxes and franchise taxes or any other tax based upon any income imposed on the Agent or any Lender by the jurisdiction in which the Agent or such Lender is incorporated or has its principal place of business or maintains its Lending Installation. If any such non-excluded taxes, levies, imposts, duties, charges, fees, deductions or withholdings ("Non-Excluded Taxes") are required to be withheld from any amounts payable to the Agent or any Lender hereunder, the amounts so payable to the Agent or such Lender shall be increased to the extent necessary to yield to the Agent or such Lender (after payment of all Non-Excluded Taxes) interest or any such other amounts payable hereunder at the rates or in the amounts specified in or pursuant to this Agreement; PROVIDED, HOWEVER, that the Borrower shall not be required to increase any such amounts payable to any Lender that is not organized under the laws of the U.S. or a state thereof if such Lender fails to comply with the requirements of paragraph (b) of this SECTION 2.18. Whenever any Non-Excluded Taxes are payable by the Borrower, as promptly as practicable thereafter the Borrower shall send to the Agent for its own account or for the account of such Lender, as the case may be, a certified copy of an original official receipt received by the Borrower showing payment thereof. If the Borrower fails to pay any Non-Excluded Taxes when due to the appropriate taxing authority or fails to remit to the Agent the required receipts or other required documentary evidence, the Borrower shall indemnify the Agent and the Lenders for any incremental taxes, interest or penalties that may become payable by any Agent or any Lender as a result of any such failure. The agreements in this SECTION 2.18 shall survive the termination of this Agreement and the payment of all other amounts payable hereunder. (b) At least five (5) Business Days prior to the first date on which interest or fees are payable hereunder for the account of any Lender, each Lender that is not incorporated under the laws of the United States of America, or a state thereof, agrees that it will deliver to each of the Borrower and the Agent two (2) duly completed and properly executed copies of United States Internal Revenue Service Form 1001 or 4224 (or a successor form), certifying in either case that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes. Each Lender which so delivers a Form 1001 or 4224 (or a successor form) further undertakes to deliver to each of the Borrower and the Agent two (2) additional duly completed and properly executed copies of such form (or a successor form) on or before the date that such form expires (currently, three (3) successive calendar years for Form 1001 and each tax year for Form 4224) or becomes obsolete or after the occurrence of any event requiring a change in the most recent forms so delivered by it, and such amendments thereto or extensions or renewals thereof as may be reasonably requested by the Borrower or the Agent, in each case certifying that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes, unless an event (including, without limitation, any change in treaty, law or regulation) has occurred prior to the date on which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Lender from duly completing and delivering any such form with respect to it and such Lender advises the Borrower and the Agent that it is not capable of receiving payments without any deduction or withholding of United States federal income tax. -22- 2.19. AGENT'S FEES. The Borrower shall pay to the Agent those fees, in addition to the Facility Fees referenced in SECTION 2.4(A), in the amounts and at the times separately agreed to between the Agent and the Borrower. ARTICLE III CHANGE IN CIRCUMSTANCES 3.1. YIELD PROTECTION. If, after the date hereof, the adoption of or any change in any law or any governmental or quasi-governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any new interpretation thereof, or the compliance of any Lender with such adoption, change or interpretation, (a) subjects any Lender or any applicable Lending Installation to any tax, duty, charge or withholding on or from payments due from the Borrower (excluding taxation of the overall net income of any Lender or applicable Lending Installation imposed by the jurisdiction in which such Lender or Lending Installation is incorporated or has its principal place of business), or changes the basis of taxation of principal, interest or any other payments to any Lender or Lending Installation in respect of its Loans or other amounts due it hereunder, or (b) imposes or increases or deems applicable any reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender or any applicable Lending Installation (other than reserves and assessments taken into account in determining the interest rate applicable to Eurodollar Advances), or (c) imposes any other condition the result of which is to increase the cost to any Lender or any applicable Lending Installation of making, funding or maintaining Loans or reduces any amount receivable by any Lender or any applicable Lending Installation in connection with any Loans, or requires any Lender or any applicable Lending Installation to make any payment calculated by reference to the amount of Loans held, or interest received by it, by an amount deemed material by such Lender, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender that portion of such increased expense incurred or resulting in an amount received which such Lender determines is attributable to making, funding and maintaining its Loans and its Commitment. 3.2. CHANGES IN CAPITAL ADEQUACY REGULATIONS. If a Lender determines the amount of capital required or expected to be maintained by such Lender, any Lending Installation of such Lender or any corporation controlling such Lender is increased as a result of a Change, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender the amount -23- necessary to compensate for any shortfall in the rate of return on the portion of such increased capital which such Lender determines is attributable to this Agreement, its Loans or its obligation to make Loans hereunder (after taking into account such Lender's policies as to capital adequacy). "CHANGE" means (a) any change after the date of this Agreement in the Risk-Based Capital Guidelines, or (b) any adoption of or change in any other law, governmental or quasi-governmental rule, regulation, policy, guideline, interpretation, or directive (whether or not having the force of law) after the date of this Agreement which affects the amount of capital required or expected to be maintained by any Lender or any Lending Installation or any corporation controlling any Lender. "RISK-BASED CAPITAL GUIDELINES" means (a) the risk-based capital guidelines in effect in the United States on the date of this Agreement and (b) the corresponding capital regulations promulgated by regulatory authorities outside the United States implementing the July 1988 report of the Basle Committee on Banking Regulation and Supervisory Practices entitled "International Convergence of Capital Measurements and Capital Standards" and any amendments to such regulations adopted prior to the date of this Agreement. 3.3. AVAILABILITY OF TYPES OF ADVANCES. If any Lender determines that maintenance of its Eurodollar Loans at a suitable Lending Installation would violate any applicable law, rule, regulation, or directive, whether or not having the force of law, or if the Required Lenders determine that (a) deposits of a type and maturity appropriate to match fund Eurodollar Advances are not available, or (b) the interest rate applicable to a Eurodollar Advance does not accurately or fairly reflect the cost of making or maintaining such Advance, then the Agent shall suspend the availability of the Eurodollar Advances until such circumstance no longer exists and require any Eurodollar Advances to be repaid. 3.4. FUNDING INDEMNIFICATION. If any payment of a Eurodollar Advance occurs on a date which is not the last day of the applicable Interest Period, whether because of acceleration, prepayment or otherwise, or a Eurodollar Advance is not made on the date specified by the Borrower for any reason other than default by the Lenders, the Borrower will indemnify the Agent and each Lender for any loss or cost incurred by it resulting therefrom, including, without limitation, any loss or cost in liquidating or employing deposits acquired to fund or maintain the Eurodollar Advance. 3.5. LENDER STATEMENTS; SURVIVAL OF INDEMNITY. To the extent reasonably possible, each Lender shall designate an alternate Lending Installation with respect to its Eurodollar Advances to reduce any liability of the Borrower to such Lender under SECTIONS 2.18, 3.1 and 3.2 or to avoid the unavailability of a Type of Advance under SECTION 3.3, so long as such designation is not disadvantageous to such Lender. Each Lender shall deliver a written statement of such Lender to the Borrower (with a copy to the Agent) as to the amount due, if any, under SECTIONS 3.1, 3.2 or 3.4. Such written statement shall set forth in reasonable detail the calculations upon which such Lender determined such amount and shall be final, conclusive and binding on the Borrower in the absence of manifest error. Determination of amounts payable under such Sections in connection with a Eurodollar Advance shall be calculated as though each Lender funded its Eurodollar Advances through the purchase of a deposit of the type and maturity corresponding to the deposit used as a reference in determining the Eurodollar Rate applicable to such Loan, whether in fact that is the case or not. Unless otherwise provided herein, the amount specified in the written statement of any -24- Lender shall be payable on demand after receipt by the Borrower of the written statement. The obligations of the Borrower under SECTIONS 3.1, 3.2 and 3.4 shall survive payment of the Obligations and termination of this Agreement. ARTICLE IV CONDITIONS PRECEDENT 4.1. EFFECTIVENESS. The Lenders shall not be required to make the initial Advance hereunder unless and until the Borrower has furnished the following to the Agent with sufficient copies for the Lenders and the other conditions set forth below have been satisfied: (a) CHARTER DOCUMENTS; GOOD STANDING CERTIFICATES. Copies of the certificate of incorporation of the Borrower, together with all amendments thereto, both certified by the appropriate governmental officer in its jurisdiction of incorporation, together with a good standing certificate issued by the Secretary of State of the jurisdiction of its incorporation and such other jurisdictions as shall be reasonably requested by the Agent. (b) BY-LAWS AND RESOLUTIONS. Copies, certified by the Secretary or Assistant Secretary of the Borrower, of its by-laws and of its Board of Directors' resolutions authorizing the execution, delivery and performance of the Loan Documents to which the Borrower is a party. (c) SECRETARY'S CERTIFICATE. An incumbency certificate, executed by the Secretary or Assistant Secretary of the Borrower, which shall identify by name and title and bear the signature of the officers of the Borrower authorized to sign the Loan Documents and to make borrowings hereunder, upon which certificate the Agent and the Lenders shall be entitled to rely until informed of any change in writing by the Borrower. (d) OFFICER'S CERTIFICATE. A certificate signed by an Authorized Officer of the Borrower, in form and substance satisfactory to the Agent, to the effect that on the Restatement Effective Date (both before and after giving effect to the consummation of the transactions contemplated hereby and the making of the Loans hereunder, if any, being made on such date): (i) no Default or Unmatured Default has occurred and is continuing; (ii) no injunction or temporary restraining order which would prohibit the making of any Loans or other litigation which could reasonably be expected to have a Material Adverse Effect is pending or, to the best of such Person's knowledge, threatened; (iii) all orders, consents, approvals, licenses, authorizations, or validations of, or filings, recordings or registrations with, or exemptions by, any Governmental Authority required in connection with the execution, delivery and performance of this Agreement have been or, prior to the time required, will have been, obtained, given, filed or taken and are or will be in full force and effect (or the Borrower has obtained effective judicial relief with respect to the application thereof) and all applicable waiting periods have expired; (iv) each of the representations and -25- warranties set forth in ARTICLE V of this Agreement is true and correct on and as of the Restatement Effective Date; and (v) since December 31, 1997, no event or change has occurred that has caused or evidences a Material Adverse Effect. (e) LEGAL OPINION. A written opinion of Brobeck, Phleger & Harrison LLP, counsel to the Borrower, addressed to the Agent and the Lenders in form and substance acceptable to the Agent and its counsel. (f) NOTES. Notes payable to the order of each of the Lenders duly executed by the Borrower. (g) LOAN DOCUMENTS. Executed originals of this Agreement and each of the Loan Documents, which shall be in full force and effect, together with all schedules, exhibits, certificates, instruments, opinions, documents and financial statements required to be delivered pursuant hereto and thereto. (h) LETTERS OF DIRECTION. Written money transfer instructions with respect to the initial Advances and to future Advances in form and substance acceptable to the Agent and its counsel addressed to the Agent and signed by an Authorized Officer, together with such other related money transfer authorizations as the Agent may have reasonably requested. (i) SOLVENCY CERTIFICATE. A written solvency certificate from the chief financial officer of the Borrower in form and content satisfactory to the Agent with respect to the value, Solvency and other factual information, or relating to, as the case may be of the Borrower on a consolidated basis. (j) REGULATORY MATTERS. Receipt of any required regulatory approvals from any Governmental Authority. (k) INVESTMENT POLICY GUIDELINES. Certified copy of the investment policy guidelines adopted by the finance committee of the board of directors of the Borrower. (l) PAYMENT OF FEES. The Borrower shall have paid all fees due to First Chicago. (m) FOLKSAMERICA LOAN AGREEMENT. A copy of the Folksamerica Loan Agreement, including all amendments thereto. (n) OTHER. Such other documents as the Agent, any Lender or their counsel may have reasonably requested. 4.2. EACH FUTURE ADVANCE. The Lenders shall not be required to make any Advance unless on the applicable Borrowing Date: (a) There exists no Default or Unmatured Default and none would result from such Advance; -26- (b) The representations and warranties contained in ARTICLE V are true and correct as of such Borrowing Date (except to the extent such representations and warranties are expressly made as of a specified date, in which event such representations and warranties shall be true and correct as of such specified date); (c) A Borrowing Notice shall have been properly submitted; and (d) All legal matters incident to the making of such Advance shall be satisfactory to the Lenders and their counsel. Each Borrowing Notice with respect to each such Advance shall constitute a representation and warranty by the Borrower that the conditions contained in SECTIONS 4.2(A), (B) AND (C) have been satisfied. Any Lender may require a duly completed compliance certificate in substantially the form of EXHIBIT B hereto as a condition to making an Advance. ARTICLE V REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants to the Lenders that: 5.1. CORPORATE EXISTENCE AND STANDING. Each of the Borrower and each Subsidiary is a corporation duly incorporated, validly existing and in good standing under the laws of its respective jurisdiction of incorporation and is duly qualified and in good standing as a foreign corporation and is duly authorized to conduct its business in each jurisdiction in which its business is conducted or proposed to be conducted, except where the failure to be so qualified could not reasonably be expected to have a Material Adverse Effect. 5.2. AUTHORIZATION AND VALIDITY. The Borrower has all requisite power and authority (corporate and otherwise) and legal right to execute and deliver each of the Loan Documents and to perform its obligations thereunder. The execution and delivery by the Borrower of the Loan Documents and the performance of its obligations thereunder have been duly authorized by proper corporate proceedings and the Loan Documents constitute legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their terms, except as enforceability may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally. 5.3. COMPLIANCE WITH LAWS AND CONTRACTS. The Borrower and its Subsidiaries have complied in all material respects with all applicable statutes, rules, regulations, orders and restrictions of any domestic or foreign government or any instrumentality or agency thereof, having jurisdiction over the conduct of their respective businesses or the ownership of their respective properties, except where the failure to so comply could not reasonably be expected to have a -27- Material Adverse Effect. Neither the execution and delivery by the Borrower of the Loan Documents, the application of the proceeds of the Loans or the consummation of the transactions contemplated in the Loan Documents, nor compliance with the provisions of the Loan Documents will, or at the relevant time did, (a) violate any law, rule, regulation (including Regulations T, U and X), order, writ, judgment, injunction, decree or award binding on the Borrower or any Subsidiary or the Borrower's or any Subsidiary's charter, articles or certificate of incorporation or by-laws, (b) violate the provisions of or require the approval or consent of any party to any indenture, instrument or agreement to which the Borrower or any Subsidiary is a party or is subject, or by which it, or its property, is bound, or conflict with or constitute a default thereunder, or result in the creation or imposition of any Lien (other than Liens permitted by, the Loan Documents) in, of or on the property of the Borrower or any Subsidiary pursuant to the terms of any such indenture, instrument or agreement, or (c) require any consent of the stockholders of any Person, except for approvals or consents which will be obtained on or before the initial Advance and are disclosed on SCHEDULE 5.3, except for any violation of, or failure to obtain an approval or consent required under, any such indenture, instrument or agreement that could not reasonably be expected to have a Material Adverse Effect. 5.4. GOVERNMENTAL CONSENTS. No order, consent, approval, qualification, license, authorization, or validation of, or filing, recording or registration with, or exemption by, or other action in respect of, any court, governmental or public body or authority, or any subdivision thereof, any securities exchange or other Person is or at the relevant time was required to authorize, or is or at the relevant time was required in connection with the execution, delivery, consummation or performance of, or the legality, validity, binding effect or enforceability of, any of the Loan Documents or the application of the proceeds of the Loans or any other transaction contemplated in the Loan Documents. Neither the Borrower nor any Subsidiary is in default under or in violation of any foreign, federal, state or local law, rule, regulation, order, writ, judgment, injunction, decree or award binding upon or applicable to the Borrower or such Subsidiary, in each case the consequences of which default or violation could reasonably be expected to have a Material Adverse Effect. 5.5. FINANCIAL STATEMENTS. The Borrower has heretofore furnished to each of the Lenders (a) the December 31, 1997 audited consolidated financial statements of the Borrower and its Subsidiaries, (b) the unaudited consolidated financial statements of the Borrower and its Subsidiaries as of March 31, 1998, (c) the December 31, 1997 audited financial statements of Charter Group, Inc. and its Subsidiaries, (d) the December 31, 1997 audited financial statements of Valley Insurance Co. and its Subsidiaries, (e) the December 31, 1997 audited financial statements of Valley and its Subsidiaries, (f) the December 31, 1997 audited financial statements of SOMSC and its Subsidiaries, (g) the December 31, 1997 audited financial statements of Parent and its Subsidiaries, (h) the December 31, 1997 audited financial statements of Folksamerica and its Subsidiaries, (i) the December 31, 1997 audited financial statements of Main Street America Holdings, Inc. and its Subsidiaries, (j) the March 31, 1998 unaudited balance sheets and income statements of Parent, the Borrower, Valley, SOMSC, Folksamerica and Main Street America Holdings, Inc., (k) the December 31, 1997 Annual Statement of each Insurance Subsidiary and Folksamerica Reinsurance Company and (l) the March 31, 1998 Quarterly Statement of each Insurance Subsidiary and -28- Folksamerica Reinsurance Company (collectively, the "FINANCIAL STATEMENTS"). Each of the Financial Statements (other than as described in CLAUSE (j)) was prepared in accordance with Agreement Accounting Principles or SAP, as applicable, and fairly presents the consolidated financial condition and operations of the Person which is the subject of such Financial Statements at such dates and the consolidated results of their operations for the respective periods then ended (except, in the case of such unaudited statements, for normal year-end audit adjustments). 5.6. MATERIAL ADVERSE CHANGE. No material adverse change in the business, Property, condition (financial or otherwise), performance, prospects or results of operations of the Borrower and its Subsidiaries has occurred since December 31, 1997, except as specifically disclosed in the Financial Statements. 5.7. TAXES. Neither the Borrower nor any of its Subsidiaries are required to file United States federal, foreign, state or local tax returns. As of the date hereof, the United States income tax returns of Parent on a consolidated basis have been audited by the Internal Revenue Service through its fiscal period ending December 31, 1988, and all tax years beginning on or after January 1, 1989 are currently being audited or are subject to audit. No tax liens have been filed and no claims are being asserted with respect to any taxes of Parent which could reasonably be expected to have a Material Adverse Effect. The charges, accruals and reserves on the books of Parent in respect of any taxes or other governmental charges of Parent are in accordance with Agreement Accounting Principles. 5.8. LITIGATION AND CONTINGENT OBLIGATIONS. There is no litigation, arbitration, proceeding, inquiry or governmental investigation pending or, to the knowledge of any of their officers, threatened against or affecting the Borrower or any Subsidiary or any of their respective properties which could reasonably be expected to have a Material Adverse Effect or to prevent, enjoin or unduly delay the making of the Loans under this Agreement. Neither the Borrower nor any Subsidiary has any material contingent obligations incurred outside of the ordinary course of its business except as set forth on SCHEDULE 5.16 or disclosed in the Financial Statements or in financial statements required to be delivered under SECTIONS 6.1(a) and (b) and as permitted under this Agreement. 5.9. CAPITALIZATION. SCHEDULE 5.9 hereto contains (a) an accurate description of the Borrower's capitalization as of March 31, 1998 and (b) an accurate list of all of the existing Subsidiaries as of the date of this Agreement, setting forth their respective jurisdictions of incorporation and the percentage of their capital stock owned by the Borrower or other Subsidiaries. All of the issued and outstanding shares of capital stock of the Borrower and of each Subsidiary have been duly authorized and validly issued, are fully paid and non-assessable, and are free and clear of all Liens. No authorized but unissued or treasury shares of capital stock of the Borrower or any Subsidiary are subject to any option, warrant, right to call or commitment of any kind or character. Except as set forth on SCHEDULE 5.9 or pursuant to management incentive plans implemented after the date of this Agreement, neither the Borrower nor any Subsidiary has any outstanding stock or securities convertible into or exchangeable for any shares of its capital stock, or any right issued to any Person (either preemptive or other) to subscribe for or to purchase, or any -29- options for the purchase of, or any agreements providing for the issuance (contingent or otherwise) of, or any calls, commitments or claims of any character relating to any of its capital stock or any stock or securities convertible into or exchangeable for any of its capital stock other than as expressly set forth in the certificate or articles of incorporation of the Borrower or such Subsidiary. Neither the Borrower nor any Subsidiary is subject to any obligation (contingent or otherwise) to repurchase or otherwise acquire or retire any shares of its capital stock or any convertible securities, rights or options of the type described in the preceding sentence except as otherwise set forth on SCHEDULE 5.9 or pursuant to management incentive plans implemented after the date of this Agreement. 5.10. ERISA. Except as disclosed on SCHEDULE 5.10, neither the Borrower nor any other member of the Controlled Group maintains any Single Employer Plans, and no Single Employer Plan has any Unfunded Liability. Neither the Borrower nor any other member of the Controlled Group maintains, or is obligated to contribute to, any Multiemployer Plan or has incurred, or is reasonably expected to incur, any withdrawal liability to any Multiemployer Plan. Each Plan complies in all material respects with all applicable requirements of law and regulations other than any such failure to comply which could not reasonably be expected to have a Material Adverse Effect. Neither the Borrower nor any member of the Controlled Group has, with respect to any Plan, failed to make any contribution or pay any amount required under Section 412 of the Code or Section 302 of ERISA or the terms of such Plan. There are no pending or, to the knowledge of the Borrower, threatened claims, actions, investigations or lawsuits against any Plan, any fiduciary thereof, or the Borrower or any member of the Controlled Group with respect to a Plan. Neither the Borrower nor any member of the Controlled Group has engaged in any prohibited transaction (as defined in Section 4975 of the Code or Section 406 of ERISA) in connection with any Plan which would subject such Person to any material liability. Within the last five (5) years neither the Borrower nor any member of the Controlled Group has engaged in a transaction which resulted in a Single Employer Plan with an Unfunded Liability being transferred out of the Controlled Group which could reasonably be expected to have a Material Adverse Effect. No Termination Event has occurred or is reasonably expected to occur with respect to any Plan which is subject to Title IV of ERISA which could reasonably be expected to have a Material Adverse Effect. 5.11. DEFAULTS. No Default or Unmatured Default has occurred and is continuing. 5.12. FEDERAL RESERVE REGULATIONS. Neither the Borrower nor any Subsidiary is engaged, directly or indirectly, principally, or as one of its important activities, in the business of extending, or arranging for the extension of, credit for the purpose of purchasing or carrying Margin Stock. No part of the proceeds of any Loan will be used in a manner which would violate, or result in a violation of, Regulation T, Regulation U or Regulation X. Neither the making of any Advance hereunder nor the use of the proceeds thereof will violate or be inconsistent with the provisions of Regulation T, Regulation U or Regulation X. 5.13. INVESTMENT COMPANY. Neither the Borrower nor any Subsidiary is, or after giving effect to any Advance will be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. -30- 5.14. CERTAIN FEES. No broker's or finder's fee or commission was, is or will be payable by the Borrower or any Subsidiary with respect to any of the transactions contemplated by this Agreement, except as described in SECTION 9.5. The Borrower hereby agrees to indemnify the Agent and the Lenders against and agrees that it will hold each of them harmless from any claim, demand or liability for broker's or finder's fees or commissions alleged to have been incurred by the Borrower in connection with any of the transactions contemplated by this Agreement and any expenses (including, without limitation, attorneys' fees and time charges of attorneys for the Agent or any Lender, which attorneys may be employees of the Agent or any Lender) arising in connection with any such claim, demand or liability. No other similar fee or commissions will be payable by the Borrower or any Subsidiary for any other services rendered to the Borrower or any Subsidiary ancillary to any of the transactions contemplated by this Agreement. 5.15. SOLVENCY. As of the date hereof, after giving effect to the consummation of the transactions contemplated by the Loan Documents and the payment of all fees, costs and expenses payable by the Borrower or its Subsidiaries with respect to the transactions contemplated by the Loan Documents and the application of the proceeds of Loans incurred by the Borrower on the initial Borrowing Date, each of the Borrower and each Subsidiary is Solvent. 5.16. INDEBTEDNESS. Attached hereto as SCHEDULE 5.16 is a complete and correct list of all Indebtedness of the Borrower and its Subsidiaries outstanding on the date of this Agreement (other than Indebtedness in a principal amount not exceeding $500,000 for a single item of Indebtedness and $2,000,000 in the aggregate for all such Indebtedness listed, it being understood and agreed that any such Indebtedness shall be permitted to exist pursuant to SECTION 6.11(b) notwithstanding the absence thereof on SCHEDULE 5.16), showing the aggregate principal amount which was outstanding on such date after giving effect to the application of the proceeds of Loans incurred by the Borrower on the initial Borrowing Date. 5.17. INSURANCE LICENSES. SCHEDULE 5.17 hereto lists all of the jurisdictions in which any Insurance Subsidiary holds a License and is authorized to and does transact insurance business as of the date of this Agreement. No such License, the loss of which could reasonably be expected to have a Material Adverse Effect, is the subject of a proceeding for suspension or revocation. To the Borrower's knowledge, there is no sustainable basis for such suspension or revocation, and no such suspension or revocation has been threatened by any Governmental Authority. 5.18. MATERIAL AGREEMENTS. Except as set forth in SCHEDULE 5.18 and except for agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries, neither the Borrower nor any Subsidiary is a party to any agreement or instrument or subject to any charter or other corporate restriction which could reasonably be expected to have a Material Adverse Effect or which restricts or imposes conditions upon the ability of any Subsidiary (other than an Unrestricted Subsidiary) to (a) pay dividends or make other distributions on its capital stock (b) make loans or advances to the Borrower, (c) repay loans or advances from Borrower or (d) grant Liens to the Agent to secure the Obligations. Neither the Borrower nor any Subsidiary is in default in the performance, observance or fulfillment of any of the obligations, covenants or conditions -31- contained in any agreement to which it is a party, which default could reasonably be expected to have a Material Adverse Effect. 5.19. ENVIRONMENTAL LAWS. There are no claims, investigations, litigation, administrative proceedings, notices, requests for information (each a "PROCEEDING"), whether pending or threatened, or judgments or orders asserting violations of applicable federal, state and local environmental, health and safety statutes, regulations, ordinances, codes, rules, orders, decrees, directives and standards ("ENVIRONMENTAL LAWS") or relating to any toxic or hazardous waste, substance or chemical or any pollutant, contaminant, chemical or other substance defined or regulated pursuant to any Environmental Law, including, without limitation, asbestos, petroleum, crude oil or any fraction thereof ("HAZARDOUS MATERIALS") asserted against the Borrower or any of its Subsidiaries, other than in connection with an insurance policy issued in the ordinary course of business to any Person (other than Parent or any Subsidiary of Parent), which, in any case, could reasonably be expected to have a Material Adverse Effect. As of the date hereof, the Borrower and its Subsidiaries do not have liabilities exceeding $100,000 in the aggregate for all of them with respect to compliance with applicable Environmental Laws or related to the generation, treatment, storage, disposal, release, investigation or cleanup of Hazardous Materials, and no facts or circumstances exist which could give rise to such liabilities with respect to compliance with applicable Environmental Laws and the generation, treatment, storage, disposal, release, investigation or cleanup of Hazardous Materials. 5.20. INSURANCE. The Borrower and its Subsidiaries maintain with financially sound and reputable insurance companies insurance on their Property in such amounts and covering such risks as is consistent with sound business practice. 5.21. DISCLOSURE. No information, exhibit or report furnished by the Borrower or any of its Subsidiaries to the Agent or to any Lender in connection with the negotiation of, or compliance with, the Loan Documents contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statements contained therein not materially misleading. There is no fact known to the Borrower (other than matters of a general economic or political nature) that has had or could reasonably be expected to have a Material Adverse Effect and that has not been disclosed herein or in such other documents, certificates and statements furnished to the Lenders for use in connection with the transactions contemplated by this Agreement. 5.22. YEAR 2000. The Borrower has made a reasonable assessment of the Year 2000 Issues and has a realistic and achievable program for remediating the Year 2000 Issues on a timely basis (the "Year 2000 Program"). Based on such assessment and on the Year 2000 Program the Borrower does not reasonably anticipate that Year 2000 Issues will have a Material Adverse Effect. ARTICLE VI COVENANTS During the term of this Agreement, unless the Required Lenders shall otherwise consent in writing: -32- 6.1. FINANCIAL REPORTING. The Borrower will maintain, for itself and each Subsidiary, a system of accounting established and administered in accordance with generally accepted accounting principles, consistently applied, and furnish to the Lenders: (a) As soon as practicable and in any event within 100 days after the close of each of its Fiscal Years, an unqualified audit report certified by independent certified public accountants, acceptable to the Lenders, prepared in accordance with Agreement Accounting Principles on a consolidated and consolidating basis (consolidating statements need not be certified by such accountants) for itself and its Subsidiaries, including balance sheets as of the end of such period and related statements of income, retained earnings and cash flows accompanied by a certificate of said accountants that, in the course of the examination necessary for their certification of the foregoing, they have obtained no knowledge of any Default or Unmatured Default, or if, in the opinion of such accountants, any Default or Unmatured Default shall exist, stating the nature and status thereof. (b) As soon as practicable and in any event within sixty (60) days after the close of each of the first three Fiscal Quarters of each of its Fiscal Years, for itself and its Subsidiaries, consolidated and consolidating unaudited balance sheets as at the close of each such period and consolidated and consolidating statements of income, retained earnings and cash flows for the period from the beginning of such Fiscal Year to the end of such quarter, all certified by its chief financial officer. (c) (i) Upon the earlier of (A) fifteen (15) days after the regulatory filing date or (B) seventy-five (75) days after the close of each fiscal year of each Insurance Subsidiary, copies of the unaudited Annual Statement of such Insurance Subsidiary, certified by the chief financial officer or the treasurer of such Insurance Subsidiary, all such statements to be prepared in accordance with SAP and (ii) no later than each June 15, copies of financial statements prepared in accordance with SAP, or generally accepted accounting principles with a reconciliation to SAP, and certified by independent certified public accountants of recognized national standing. (d) Upon the earlier of (i) ten (10) days after the regulatory filing date or (ii) sixty (60) days after the close of each of the first three (3) fiscal quarters of each fiscal year of each Insurance Subsidiary, copies of the unaudited Quarterly Statement of each of the Insurance Subsidiaries, certified by the chief financial officer or the treasurer of such Insurance Subsidiary, all such statements to be prepared in accordance with SAP. (e) Promptly and in any event within ten (10) days after (i) learning thereof, notification of any changes after the date of this Agreement in the rating given by A.M. Best & Co. in respect of any Insurance Subsidiary and (ii) receipt thereof, copies of any ratings analysis by A.M. Best & Co. relating to any Insurance Subsidiary. -33- (f) Copies of any outside actuarial reports prepared with respect to any valuation or appraisal of any Insurance Subsidiary, promptly after the receipt thereof. (g) Together with the financial statements required by CLAUSES (a) and (b) above, a compliance certificate in substantially the form of EXHIBIT B hereto signed by the Borrower's chief financial officer showing the calculations necessary to determine compliance with this Agreement and stating that no Default or Unmatured Default exists, or if any Default or Unmatured Default exists, stating the nature and status thereof. (h) Promptly after the same becomes available after the close of each Fiscal Year, a statement of the Unfunded Liabilities of each Single Employer Plan, certified as correct by an actuary enrolled under ERISA. (i) As soon as possible and in any event within ten (10) days after the Borrower knows that any Termination Event has occurred with respect to any Plan, a statement, signed by the chief financial officer of the Borrower, describing said Termination Event and the action which the Borrower proposes to take with respect thereto. (j) As soon as possible and in any event within ten (10) days after receipt by the Borrower, a copy of (i) any notice, claim, complaint or order to the effect that the Borrower or any of its Subsidiaries is or may be liable to any Person as a result of the release by the Borrower or any of its Subsidiaries of any Hazardous Materials into the environment or requiring that action be taken to respond to or clean up a Release of Hazardous Materials into the environment, and (ii) any notice, complaint or citation alleging any violation of any Environmental Law or Environmental Permit by the Borrower or any of its Subsidiaries. Within ten (10) days of the Borrower or any Subsidiary having knowledge of the enactment or promulgation of any Environmental Law which could reasonably be expected to have a Material Adverse Effect, the Borrower shall provide the Agent with written notice thereof. (k) Promptly upon the furnishing thereof to the shareholders of the Borrower, copies of all financial statements, reports and proxy statements so furnished. (l) Promptly upon the filing thereof, copies of all registration statements and annual, quarterly, monthly or other regular reports which the Borrower or any of its Subsidiaries files with the Securities and Exchange Commission, the National Association of Securities Dealers, any securities exchange, the NAIC or any insurance commission or department or analogous Governmental Authority (including any filing made by the Borrower or any Subsidiary pursuant to any insurance holding company act or related rules or regulations), but excluding routine or non-material filings with the NAIC, any insurance commissioner or department or analogous Governmental Authority. (m) Promptly and in any event within ten (10) days after learning thereof, notification of (i) any material tax assessment, demand, notice of proposed deficiency or notice of deficiency received by Parent or any other Consolidated Person or (ii) the filing of -34- any tax Lien or commencement of any judicial proceeding by or against any such Consolidated Person, if any such assessment, demand, notice, Lien or judicial proceeding relates to tax liabilities in excess of ten percent (10%) of the net worth (determined according to generally accepted accounting standards and without reduction for any reserve for such liabilities) of the Borrower and its Subsidiaries taken as a whole. (n) Promptly after available, any management letter prepared by the accountants conducting the audit of the financial statements delivered pursuant to Section 6.1(a). (o) Promptly after reviewed by the board of directors of the Borrower, a copy of the Borrower's investment policy compliance report. (p) Such other information (including, without limitation, the annual Best's Advance Report Service report prepared with respect to each Insurance Subsidiary rated by A.M. Best & Co. and non-financial information) as the Agent or any Lender may from time to time reasonably request. 6.2. USE OF PROCEEDS. The Borrower will, and will cause each Subsidiary to, use the proceeds of the Advances to meet the working capital and general corporate needs of the Borrower and its Subsidiaries, including, but not limited to, the consummation of the Folksamerica Transaction and the making of any other Investments permitted by SECTION 6.13. The Borrower will not, nor will it permit any Subsidiary to, use any of the proceeds of the Advances in any manner which would violate, or result in the violation of, Regulation T, Regulation U or Regulation X or to finance the Purchase of any Person which has not been approved and recommended by the board of directors (or functional equivalent thereof) of such Person. 6.3. NOTICE OF DEFAULT. The Borrower will give prompt notice in writing to the Lenders of the occurrence of (a) any Default or Unmatured Default, (b) of any other event or development, financial or other, relating specifically to the Borrower or any of its Subsidiaries (and not of a general economic or political nature) which could reasonably be expected to have a Material Adverse Effect, (c) receipt by the Borrower or any Subsidiary of any notice from any Governmental Authority of the expiration without renewal, revocation or suspension of, or the institution of any proceedings to revoke or suspend, any License now or hereafter held by any Insurance Subsidiary which is required to conduct insurance business in compliance with all applicable laws and regulations and the expiration, revocation or suspension of which could reasonably be expected to have a Material Adverse Effect, (d) receipt by the Borrower or any Subsidiary of any notice from any Governmental Authority of the institution of any disciplinary proceedings against or in respect of any Insurance Subsidiary, or the issuance of any order, the taking of any action or any request for an extraordinary audit for cause by any Governmental Authority which, if adversely determined, could reasonably be expected to have a Material Adverse Effect, (e) any material judicial or administrative order of which the Borrower or any Subsidiary is aware limiting or controlling the insurance business of any Insurance Subsidiary (and not the insurance industry generally) which has been issued or adopted or (f) the commencement of any litigation of which the Borrower or any Subsidiary is aware which could reasonably be expected to create a Material Adverse Effect. 6.4. CONDUCT OF BUSINESS. The Borrower will, and will cause each Subsidiary to, (a) carry on and conduct its business in substantially the same manner as it is presently conducted, (b) -35- not conduct any significant business except for financial services, (c) do all things necessary to remain duly incorporated, validly existing and in good standing as a domestic corporation in its jurisdiction of incorporation and maintain all requisite authority to conduct its business in each jurisdiction in which its business is conducted except where the failure to maintain such authority could not reasonably be expected to have a Material Adverse Effect and (d) do all things necessary to renew, extend and continue in effect all Licenses which may at any time and from time to time be necessary for any Insurance Subsidiary to operate its insurance business in compliance with all applicable laws and regulations except for any License the loss of which could not reasonably be expected to have a Material Adverse Effect; PROVIDED, that any Insurance Subsidiary may withdraw from one or more states (other than its state of domicile) as an admitted insurer if such withdrawal is determined by the Borrower's Board of Directors to be in the best interest of the Borrower and could not reasonably be expected to have a Material Adverse Effect. The Borrower shall cause Folksamerica to remain a Wholly-Owned Subsidiary (but only after it becomes a Wholly-Owned Subsidiary) until the Borrower shall have repaid all outstanding Advances and other Obligations and the Lenders' Commitments hereunder have terminated. 6.5. TAXES. At any time on and after the date the Borrower or any of its Subsidiaries is required to do so, the Borrower will, and will cause each Subsidiary to, timely file complete and correct United States federal and applicable foreign, state and local tax returns required by applicable law and pay when due all taxes, assessments and governmental charges and levies upon it or its income, profits or Property, except those which are being contested in good faith by appropriate proceedings and with respect to which adequate reserves have been set aside in accordance with generally accepted accounting principles or SAP, as applicable. 6.6. INSURANCE. The Borrower will, and will cause each Subsidiary to, maintain with financially sound and reputable insurance companies insurance on all their Property in such amounts and covering such risks as is consistent with sound business practice, and the Borrower will furnish to the Agent and any Lender upon request full information as to the insurance carried. 6.7. COMPLIANCE WITH LAWS. The Borrower will, and will cause each Subsidiary to, comply with all laws, rules, regulations, orders, writs, judgments, injunctions, decrees or awards to which it may be subject, the failure to comply with which could reasonably be expected to have a Material Adverse Effect. 6.8. MAINTENANCE OF PROPERTIES. The Borrower will, and will cause each Subsidiary to, do all things necessary to maintain, preserve, protect and keep its Property in good repair, working order and condition, and make all necessary and proper repairs, renewals and replacements so that its business carried on in connection therewith may be properly conducted at all times. 6.9. INSPECTION. The Borrower will, and will cause each Subsidiary to, at reasonable times during normal business hours and upon reasonable notice, permit the Agent and the Lenders, by their respective representatives and agents, to inspect any of the Property, corporate books and financial records of the Borrower and each Subsidiary, to examine and make copies of the books of accounts and other financial records of the Borrower and each Subsidiary, and to discuss the affairs, -36- finances and accounts of the Borrower and each Subsidiary with, and to be advised as to the same by, their respective officers at such reasonable times and intervals as the Lenders may designate. The Borrower will keep or cause to be kept, and cause each Subsidiary to keep or cause to be kept, appropriate records and books of account in which complete entries are to be made reflecting its and their business and financial transactions, such entries to be made in accordance with Agreement Accounting Principles or SAP, as applicable. 6.10. DIVIDENDS. The Borrower will not declare or pay any dividends or make any distributions on its capital stock (other than dividends payable in its own capital stock) or redeem, repurchase or otherwise acquire or retire any of its capital stock or any options or other rights in respect thereof at any time outstanding, except that so long as no Default or Unmatured Default exists before or after giving effect to the declaration or payment of such dividends or distributions or repurchase or redemption of such stock or other transaction, (a) the Borrower may declare and pay dividends, and make distributions, on its common stock and repurchase and redeem and otherwise acquire or retire its common stock and any options or other rights thereof in an aggregate amount not to exceed, when aggregated with the principal amount of loans (exclusive of loans described in SECTION 6.13(e)(II)) made during such Fiscal Year from the Borrower or its Subsidiaries to Parent, (i) during the Borrower's 1998 Fiscal Year, 2% of Adjusted Net Worth as of December 31, 1997, and (ii) during any Fiscal Year thereafter, 3% of Adjusted Net Worth as of the end of the Fiscal Year preceding the Fiscal Year during which such transaction is consummated and (b) in addition to any dividends, distributions, repurchases, redemptions, acquisitions or retirements which may be declared, paid or made pursuant to the preceding CLAUSE (a), the Borrower may declare and pay dividends, and make distributions, on its common stock and repurchase and redeem and otherwise acquire or retire its common stock, and any options or rights thereof, (x) in an amount equal to (1) the net proceeds received by the Borrower from dividends, sales, transfers or other dispositions of its equity interests in SOMSC or FAE's equity interest in San Juan Basin Trust, MINUS (2) the amount of loans made pursuant to SECTION 6.13(e)(II), PROVIDED, that such dividend is paid within one hundred eighty (180) days of receipt of such net proceeds, (y) its equity interests in SOMSC and (z) in an amount equal to that immediately utilized by Parent to repay all or a portion of a certain $40,000,000 loan from FAE to Parent. 6.11. INDEBTEDNESS. The Borrower will not, nor will it permit any Subsidiary (other than an Unrestricted Subsidiary) to, create, incur or suffer to exist any Indebtedness, except: (a) the Loans; (b) Indebtedness existing on the date hereof and described in SCHEDULE 5.16 hereto and any renewals, extensions, refundings or refinancings of such Indebtedness; PROVIDED that the amount thereof is not increased and the maturity or scheduled amortization of principal thereof is not shortened (unless to a maturity or scheduled amortization occurring after the Facility Termination Date); (c) Indebtedness owing by (x) the Borrower to any Wholly-Owned Subsidiary and (y) any Wholly-Owned Subsidiary to a Wholly-Owned Subsidiary or the Borrower; -37- (d) Indebtedness permitted under the Valley Credit Agreement; (e) Indebtedness of Folksamerica or its Subsidiaries in existence at the time of the Folksamerica Transaction; PROVIDED, however, such Indebtedness of Folksamerica or its Subsidiaries may not be renewed, extended, refunded or refinanced by Folksamerica without the prior written consent of the Required Lenders; (f) Indebtedness of the Borrower, the proceeds of which are used directly or indirectly to refund or refinance the Indebtedness described in SECTION 6.11(e); PROVIDED, however that the amount thereof is not increased, the maturity or scheduled amortization of principal thereof is not set to a maturity or weighted average maturity occurring before the Facility Termination Date hereunder and the terms of the proposed Indebtedness are not otherwise, in the reasonable judgment of the Required Lenders, disadvantageous (relative to the terms of the Indebtedness refunded or refinanced) to the interests of the Lenders hereunder; (g) Indebtedness secured by Liens permitted pursuant to SECTION 6.15(f); (h) Contingent Obligations permitted under SECTION 6.14; and (i) other Indebtedness of the Borrower or any Subsidiary to the extent not otherwise included in subparagraphs (a) through (h) of this SECTION 6.11 or in SECTION 6.14, in an aggregate amount outstanding at any one time not to exceed $5,000,000. 6.12. MERGER. The Borrower will not, nor will it permit any Significant Subsidiary to, merge or consolidate with or into any other Person, except that: (a) a Wholly-Owned Subsidiary (other than any Unrestricted Subsidiary) may merge with (i) the Borrower, (ii) any Wholly-Owned Subsidiary of the Borrower or (iii) any other Person so long as no Default or Unmatured Default shall have occurred or be continuing before and after giving effect to such merger and the surviving entity of such merger is the Borrower or a Wholly-Owned Subsidiary of the Borrower; (b) a Significant Subsidiary (other than Valley) may merge or consolidate with any Person so long as neither the Borrower nor any of its Subsidiaries shall hold any capital stock of such Significant Subsidiary after giving effect to such merger or consolidation; and (c) the Borrower or Valley may merge into any Person so long as (i) the Borrower or Valley, as the case may be, is the surviving entity of such merger, (ii) no Default or Unmatured Default shall have occurred or be continuing before and after giving effect to such merger and (iii) the covenants contained in SECTION 6.20 shall be complied with on a PRO FORMA basis on the date of, and after giving effect to, such merger. -38- 6.13. INVESTMENTS AND PURCHASES. The Borrower will not, and will not permit any Subsidiary (other than an Unrestricted Subsidiary) to, make or suffer to exist any Investments (including, without limitation, loans and advances to, and other Investments in, Parent or Subsidiaries), or commitments therefor, or create any Subsidiary or become or remain a partner in any partnership or joint venture, or make any Purchases, except: (a) Investments or commitments therefor (such commitments being set forth on SCHEDULE 6.13) in existence on the date hereof (including a certain $40,000,000 loan from FAE to Parent); (b) loans and advances to employees in the ordinary course of business and consistent with past practices; (c) Investments made in Subsidiaries (other than any Unrestricted Subsidiary) and Main Street America Holdings, Inc.; (d) Purchases of or Investments in businesses or entities engaged in the insurance and/or insurance services business or businesses reasonably incident thereto (including holding companies, the Subsidiaries of which on a consolidated basis are primarily engaged in such businesses) which do not constitute hostile takeovers (including the creation of Subsidiaries in connection therewith) so long as no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Purchase or Investment; (e) Investments by the Borrower made on or before May 13, 1999 directly in SOMSC in an amount equal to the FSA Amount so long as at the time of such Investment no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Investment; PROVIDED, however, that any Investments pursuant to this CLAUSE (E) are made from net proceeds traceable to dividends, sales, transfers or other distributions of equity interests in SOMSC after the date hereof; (f) loans made by the Borrower or its Subsidiaries to Parent (i) so long as at all times, after giving effect to the aggregate outstanding principal amount of such loans, the Borrower would be permitted to pay at least $1.00 in incremental dividends pursuant to SECTION 6.10(a) or (ii) that are made out of the net proceeds described in SECTION 6.10(b)(x) in lieu of utilizing such net proceeds to pay a dividend; (g) other Investments (other than any direct or indirect Investments in Parent), so long as any such Investment is materially consistent with the Borrower's investment policy guidelines as approved from time to time by the finance committee of the board of directors of the Borrower (a copy of the current version of such guidelines having been delivered to each Lender); provided that any change from the guidelines previously submitted to the Lenders shall not materially adversely affect the Lenders; and -39- (h) other Investments (other than any direct or indirect Investments in Parent) by Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of the Borrower) at any time prior to March 31, 1999, so long as any such Investment is permitted under the insurance laws of the State of New York and is materially consistent with Folksamerica's investment policy guidelines as approved from time to time by the board of directors of Folksamerica (a copy of the current version of such guidelines having been delivered to each Lender); provided that any change from the guidelines previously submitted to the Lenders shall not materially adversely affect the Lenders. 6.14. CONTINGENT OBLIGATIONS. The Borrower will not, nor will it permit any Subsidiary (other than an Unrestricted Subsidiary) to, make or suffer to exist any Contingent Obligation (including, without limitation, any Contingent Obligation with respect to the obligations of a Subsidiary), except (a) the issuance of financial guarantees in the ordinary course of business, (b) by endorsement of instruments for deposit or collection in the ordinary course of business, (c) for insurance policies issued in the ordinary course of business, (d) the issuance of intercompany guarantees so long as the primary obligation is permitted under this Agreement and (e) issuance of financial guarantees to the holders of seller notes issues by ML (Bermuda) Holdings Ltd. or any of its Subsidiaries, provided that the aggregate principal amount of all such financial guarantees shall not at any time exceed 6,500,000 British Pounds. 6.15. LIENS. The Borrower will not, nor will it permit any Subsidiary (other than an Unrestricted Subsidiary) to, create, incur, or suffer to exist any Lien in, of or on the Property (other than Margin Stock) of the Borrower or any of its Subsidiaries (other than an Unrestricted Subsidiary), except: (a) Liens for taxes, assessments or governmental charges or levies on its Property if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being contested in good faith and by appropriate proceedings and for which adequate reserves in accordance with generally accepted principles of accounting shall have been set aside on its books; (b) Liens imposed by law, such as carriers', warehousemen's and mechanics' liens and other similar liens arising in the ordinary course of business which secure the payment of obligations not more than sixty (60) days past due or which are being contested in good faith by appropriate proceedings and for which adequate reserves shall have been set aside on its books; (c) Liens arising out of pledges or deposits under worker's compensation laws, unemployment insurance, old age pensions, or other social security or retirement benefits, or similar legislation; (d) Utility easements, building restrictions and such other encumbrances or charges against real property as are of a nature generally existing with respect to properties -40- of a similar character and which do not in any material way affect the marketability of the same or interfere with the use thereof in the business of the Borrower or its Subsidiaries; (e) Liens existing on the date hereof and described in SCHEDULE 6.15 hereto; (f) Liens in, of or on Property acquired after the date of this Agreement (by purchase, construction or otherwise), each of which Liens either (1) existed on such Property before the time of its acquisition and was not created in anticipation thereof, or (2) was created solely for the purpose of securing Indebtedness representing, or incurred to finance, refinance or refund, the cost (including the cost of construction) of such Property; PROVIDED that no such Lien shall extend to or cover any Property of the Borrower or such Subsidiary other than the Property so acquired and improvements thereon; and PROVIDED, FURTHER, that the principal amount of Indebtedness secured by any such Lien shall at the time the Lien is incurred not exceed 75% of the fair market value (as determined in good faith by a financial officer of the Borrower and, in the case of such Property having a fair market value in excess of $500,000, certified by such officer to the Agent, with a copy for each Lender) of the Property at the time it was so acquired; (g) Liens on assets securing letters of credit issued on behalf of Insurance Subsidiaries in the ordinary course of business; and (h) Liens not otherwise permitted by the foregoing clauses (a) through (g) securing any Indebtedness of the Borrower, provided that the aggregate principal amount of Indebtedness secured by Liens permitted by this clause (h) shall not exceed $3,000,000 at any time. 6.16. AFFILIATES. The Borrower will not, and will not permit any Subsidiary to, enter into any material transaction (including, without limitation, the purchase or sale of any Property or service) with, or make any payment or transfer to, any Affiliates (other than a Wholly-Owned Subsidiary), except in the ordinary course of business and pursuant to the reasonable requirements of the Borrower's or such Subsidiary's business and upon fair and reasonable terms no less favorable to the Borrower or such Subsidiary than the Borrower or such Subsidiary would obtain in a comparable arms-length transactions, except that any Unrestricted Subsidiary may make loans to Parent. 6.17. ENVIRONMENTAL MATTERS. The Borrower shall and shall cause each of its Subsidiaries to (a) at all times comply in all material respects with all applicable Environmental Laws and (b) promptly take any and all necessary remedial actions in response to the presence, storage, use, disposal, transportation or Release of any Hazardous Materials on, under or about any real property owned, leased or operated by the Borrower or any of its Subsidiaries. 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR. The Borrower shall not, nor shall it permit any Subsidiary to, (a) permit any amendment or modification to be made to its certificate or -41- articles of incorporation or by-laws which is materially adverse to the interests of the Lenders or (b) change its Fiscal Year to end on any date other than December 31 of each year. 6.19. INCONSISTENT AGREEMENTS. The Borrower shall not, nor shall it permit any Subsidiary (other than an Unrestricted Subsidiary) to, enter into any indenture, agreement, instrument or other arrangement which by its terms, (a) other than pursuant to the Valley Credit Agreement or pursuant to agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries, directly or indirectly contractually prohibits or restrains, or has the effect of contractually prohibiting or restraining, or contractually imposes materially adverse conditions upon, the incurrence of the Obligations, the granting of Liens to secure the Obligations, the amending of the Loan Documents or the ability of any Subsidiary to (i) pay dividends or make other distributions on its capital stock, (ii) make loans or advances to the Borrower or (iii) repay loans or advances from the Borrower or (b) contains any provision which would be violated or breached by the making of Advances or by the performance by the Borrower or any Subsidiary of any of its obligations under any Loan Document. 6.20. FINANCIAL COVENANTS. The Borrower shall (or, in the case of Section 6.20.4, shall cause its Insurance Subsidiaries to): 6.20.1 MINIMUM ADJUSTED NET WORTH. At all times after the date hereof, maintain a minimum Adjusted Net Worth at least equal to the sum of, without duplication, (a) $465,000,000, PLUS (b) an amount equal to 85% of the cash and non-cash proceeds of any equity securities issued or capital contributions received by the Borrower after June 30, 1998, PLUS (c) an amount equal to 50% of the Borrower's positive consolidated net income (excluding from such calculation (i) SOMSC and its Subsidiaries, (ii) any net realized gain from the sale of Borrower's equity interests in White River Corp. or Travelers Property Casualty Corp. and (iii) any net income directly arising out of the consummation of the Folksamerica Transaction) after June 30, 1998, PLUS (d) an amount equal to 85% of the proceeds of any sale of the Borrower's equity interest in SOMSC to the extent such proceeds are not paid out by the Borrower as dividends within one hundred eighty (180) days after receipt thereof. 6.20.2. LEVERAGE RATIO. At all times after the date hereof, maintain a Leverage Ratio of (a) not greater than 45% through and including December 31, 2000 and (b) not greater than 30% at all times thereafter. 6.20.3. FIXED CHARGES COVERAGE RATIO. As of the end of each Fiscal Quarter maintain a Fixed Charges Coverage Ratio of not less than 1.5:1.0. 6.20.4. STATUTORY SURPLUS. At all times, maintain Statutory Surplus for each First-Tier Insurance Subsidiary in an amount not less than an amount equal to (a) 85% of the Statutory Surplus of each such First-Tier Insurance Subsidiary, in existence on the date hereof, as of March 31, 1998 (or, in the case of any First-Tier Insurance Subsidiary acquired after the date hereof, 85% of the Statutory Surplus of each such acquired First-Tier Insurance -42- Subsidiary as of the most recently ended Fiscal Quarter preceding such acquisition), PLUS (b) 85% of all subsequent capital contributions to each such First-tier Insurance Subsidiary, MINUS (c) in the event such First-Tier Insurance Subsidiary dividends or otherwise distributes to its parent all the capital stock of a Wholly-Owned Insurance Subsidiary, 100% of the book value (calculated in accordance with SAP) of such Wholly-Owned Insurance Subsidiary at the time of such dividend or distribution. 6.21. TAX CONSOLIDATION. The Borrower will not and will not permit any of its Subsidiaries to (a) file or consent to the filing of any consolidated, combined or unitary income tax return with any Person other than Parent and its Subsidiaries or (b) amend, terminate or fail to enforce any existing tax sharing agreement or similar arrangement if such action would cause a Material Adverse Effect. 6.22. ERISA COMPLIANCE. With respect to any Plan, neither the Borrower nor any Subsidiary shall: (a) engage in any "prohibited transaction" (as such term is defined in Section 406 of ERISA or Section 4975 of the Code) for which a civil penalty pursuant to Section 502(i) of ERISA or a tax pursuant to Section 4975 of the Code in excess of $100,000 could be imposed; (b) incur any "accumulated funding deficiency" (as such term is defined in Section 302 of ERISA) in excess of $100,000, whether or not waived, or permit any Unfunded Liability to exceed $100,000; (c) permit the occurrence of any Termination Event which could result in a liability to the Borrower or any other member of the Controlled Group in excess of $100,000; (d) be an "employer" (as such term is defined in Section 3(5) of ERISA) required to contribute to any Multiemployer Plan or a "substantial employer" (as such term in defined in Section 4001(a)(2) of ERISA) required to contribute to any Multiple Employer Plan; or (e) permit the establishment or amendment of any Plan or fail to comply with the applicable provisions of ERISA and the Code with respect to any Plan which could result in liability to the Borrower or any other member of the Controlled Group which, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect. 6.23. YEAR 2000. The Borrower will take and will cause each of its Subsidiaries to take all such actions as are reasonably necessary to successfully implement the Year 2000 Program and to assure that Year 2000 Issues will not have a Material Adverse Effect. At the request of the Agent or any Lender, the Borrower will provide a description of the Year 2000 Program, together with any updates or progress reports with respect thereto. -43- ARTICLE VII DEFAULTS The occurrence of any one or more of the following events shall constitute a Default: 7.1. Any representation or warranty made or deemed made by or on behalf of the Borrower or any of its Subsidiaries to the Lenders or the Agent under or in connection with this Agreement, any other Loan Document, any Loan, or any certificate or information delivered in connection with this Agreement or any other Loan Document shall be false in any material respect on the date as of which made. 7.2. Nonpayment of (a) any principal of any Note when due, or (b) any interest upon any Note or any commitment fee or other fee or obligations under any of the Loan Documents within five (5) days after the same becomes due. 7.3. The breach by the Borrower of any of the terms or provisions of SECTION 6.2, SECTION 6.3(a) or SECTIONS 6.10 THROUGH 6.16 or SECTIONS 6.18 through 6.22. 7.4. The breach by the Borrower (other than a breach which constitutes a Default under SECTIONS 7.1, 7.2 or 7.3) of any of the terms or provisions of this Agreement which is not remedied within twenty (20) days after written notice from the Agent or any Lender. 7.5. The default by the Borrower or any of its Subsidiaries (or, at any time the Borrower is a Subsidiary of Parent, by Parent) in the performance of any term, provision or condition contained in any agreement or agreements under which any Funded Indebtedness aggregating in excess of $2,000,000 ($10,000,000 in the case of Parent and $20,000,000, or such lower cross-default threshold amount as is provided in the SOMSC Credit Agreements, in the case of SOMSC) was created or is governed, or the occurrence of any other event or existence of any other condition, the effect of any of which is to cause, or to permit the holder or holders of such Funded Indebtedness to cause, such Funded Indebtedness to become due prior to its stated maturity; or any such Funded Indebtedness of the Borrower, any of its Subsidiaries or Parent shall be declared to be due and payable or required to be prepaid (other than by a regularly scheduled payment) prior to the stated maturity thereof. 7.6. The Borrower or any of its Significant Subsidiaries shall (a) have an order for relief entered with respect to it under the Federal bankruptcy laws as now or hereafter in effect, (b) make an assignment for the benefit of creditors, (c) apply for, seek, consent to, or acquiesce in, the appointment of a receiver, custodian, trustee, examiner, liquidator or similar official for it or any substantial portion of its Property, (d) institute any proceeding seeking an order for relief under the Federal bankruptcy laws as now or hereafter in effect or seeking to adjudicate it a bankrupt or insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization -44- or relief of debtors or fail to file an answer or other pleading denying the material allegations of any such proceeding filed against it, (e) take any corporate action to authorize or effect any of the foregoing actions set forth in this SECTION 7.6, (f) fail to contest in good faith any appointment or proceeding described in SECTION 7.7 or (g) become unable to pay, not pay, or admit in writing its inability to pay, its debts generally as they become due. 7.7. Without the application, approval or consent of the Borrower or any of its Significant Subsidiaries, a receiver, trustee, examiner, liquidator or similar official shall be appointed for the Borrower or any of its Significant Subsidiaries or any substantial portion of its Property, or a proceeding described in SECTION 7.6(d) shall be instituted against the Borrower or any of its Significant Subsidiaries and such appointment continues undischarged or such proceeding continues undismissed or unstayed for a period of sixty (60) consecutive days. 7.8. The Borrower or any of its Subsidiaries shall fail within thirty (30) days to pay, bond or otherwise discharge any judgment or order for the payment of money in excess of $1,000,000 (or multiple judgments or orders for the payment of an aggregate amount in excess of $5,000,000), which is not stayed on appeal or otherwise being appropriately contested in good faith and as to which no enforcement actions have been commenced. 7.9. Any Change in Control shall occur. 7.10. The occurrence of any "default", as defined in any Loan Document (other than this Agreement or the Notes) or the breach of any of the terms or provisions of any Loan Document (other than this Agreement or the Notes), which default or breach continues beyond any period of grace therein provided. 7.11. Any License of any Insurance Subsidiary (a) shall be revoked by the Governmental Authority which issued such License, or any action (administrative or judicial) to revoke such License shall have been commenced against such Insurance Subsidiary and shall not have been dismissed within thirty (30) days after the commencement thereof, (b) shall be suspended by such Governmental Authority for a period in excess of thirty (30) days or (c) shall not be reissued or renewed by such Governmental Authority upon the expiration thereof following application for such reissuance or renewal of such Insurance Subsidiary, which, in any case, could reasonably be expected to have a Material Adverse Effect. 7.12. Any Insurance Subsidiary shall be the subject of a final non-appealable order imposing a fine by or at the request of any state insurance regulatory agency as a result of the violation by such Insurance Subsidiary of such state's applicable insurance laws or the regulations promulgated in connection therewith which could reasonably be expected to have a Material Adverse Effect. 7.13. Any Insurance Subsidiary shall become subject to any conservation, rehabilitation or liquidation order, directive or mandate issued by any Governmental Authority or any Insurance Subsidiary shall become subject to any other directive or mandate issued by any Governmental -45- Authority in either case which could reasonably be expected to have a Material Adverse Effect and which is not stayed within thirty (30) days. ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES 8.1. ACCELERATION. If any Default described in SECTIONS 7.6 or 7.7 occurs with respect to the Borrower, the obligations of the Lenders to make Loans hereunder shall automatically terminate and the Obligations shall immediately become due and payable without any election or action on the part of the Agent or any Lender. If any other Default occurs, the Required Lenders (or the Agent with the consent of the Required Lenders) may terminate or suspend the obligations of the Lenders to make Loans hereunder, or declare the Obligations to be due and payable, or both, whereupon the Obligations shall become immediately due and payable, without presentment, demand, protest or notice of any kind, all of which the Borrower hereby expressly waives. If, within ten (10) Business Days after acceleration of the maturity of the Obligations or termination of the obligations of the Lenders to make Loans hereunder as a result of any Default (other than any Default as described in SECTIONS 7.6 or 7.7 with respect to the Borrower) and before any judgment or decree for the payment of the Obligations due shall have been obtained or entered, the Required Lenders (in their sole discretion) shall so direct, the Agent shall, by notice to the Borrower, rescind and annul such acceleration and/or termination. 8.2. AMENDMENTS. Subject to the provisions of this ARTICLE VIII, the Required Lenders (or the Agent with the consent in writing of the Required Lenders) and the Borrower may enter into agreements supplemental hereto for the purpose of adding or modifying any provisions to the Loan Documents or changing in any manner the rights of the Lenders or the Borrower hereunder or waiving any Default hereunder; PROVIDED, HOWEVER, that no such supplemental agreement shall, without the consent of each Lender: (a) Extend the final maturity of any Loan or Note or reduce the principal amount thereof, or, subject to SECTION 2.11, reduce the rate or extend the time of payment of interest or fees thereon; (b) Reduce the percentage specified in the definition of Required Lenders; (c) Reduce the amount of or extend the date for the mandatory payments and commitment reductions required under SECTIONS 2.1(b) or 2.7, or increase the amount of the Commitment of any Lender hereunder; (d) Extend the Facility Termination Date or reduce the amount or extend the time of any mandatory commitment reduction required by SECTION 2.7; -46- (e) Amend this SECTION 8.2; or (f) Permit any assignment by the Borrower of its Obligations or its rights hereunder. No amendment of any provision of this Agreement relating to the Agent shall be effective without the written consent of the Agent. The Agent may waive payment of the fee required under SECTION 12.3.2 without obtaining the consent of any other party to this Agreement. 8.3. PRESERVATION OF RIGHTS. No delay or omission of the Lenders or the Agent to exercise any right under the Loan Documents shall impair such right or be construed to be a waiver of any Default or an acquiescence therein, and the making of a Loan notwithstanding the existence of a Default or the inability of the Borrower to satisfy the conditions precedent to such Loan shall not constitute any waiver or acquiescence. Any single or partial exercise of any such right shall not preclude other or further exercise thereof or the exercise of any other right, and no waiver, amendment or other variation of the terms, conditions or provisions of the Loan Documents whatsoever shall be valid unless in writing signed by the Lenders required pursuant to SECTION 8.2, and then only to the extent in such writing specifically set forth. All remedies contained in the Loan Documents or by law afforded shall be cumulative and all shall be available to the Agent and the Lenders until the Obligations have been paid in full. ARTICLE IX GENERAL PROVISIONS 9.1. SURVIVAL OF REPRESENTATIONS. All representations and warranties of the Borrower contained in this Agreement or of the Borrower or any Subsidiary contained in any Loan Document shall survive delivery of the Notes and the making of the Loans herein contemplated. 9.2. GOVERNMENTAL REGULATION. Anything contained in this Agreement to the contrary notwithstanding, no Lender shall be obligated to extend credit to the Borrower in violation of any limitation or prohibition provided by any applicable statute or regulation. 9.3. TAXES. Any stamp, documentary or similar taxes, assessments or charges payable or ruled payable by any governmental authority in respect of the Loan Documents shall be paid by the Borrower, together with interest and penalties, if any. 9.4. HEADINGS. Section headings in the Loan Documents are for convenience of reference only, and shall not govern the interpretation of any of the provisions of the Loan Documents. -47- 9.5. ENTIRE AGREEMENT. The Loan Documents embody the entire agreement and understanding among the Borrower, the Agent and the Lenders and supersede all prior agreements and understandings among the Borrower, the Agent and the Lenders relating to the subject matter thereof other than the fee letter, dated August 14, 1998, in favor of First Chicago. 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT. The respective obligations of the Lenders hereunder are several and not joint and no Lender shall be the partner or agent of any other (except to the extent to which the Agent is authorized to act as such). The failure of any Lender to perform any of its obligations hereunder shall not relieve any other Lender from any of its obligations hereunder. This Agreement shall not be construed so as to confer any right or benefit upon any Person other than the parties to this Agreement and their respective successors and assigns. 9.7. EXPENSES; INDEMNIFICATION. The Borrower shall reimburse the Agent for any reasonable costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent) paid or incurred by the Agent in connection with the preparation, negotiation, execution, delivery, review, actual or proposed amendment, modification, and administration of the Loan Documents. The Borrower also agrees to reimburse the Agent and the Lenders for any reasonable costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent and the Lenders, which attorneys may be employees of the Agent or the Lenders) paid or incurred by the Agent or any Lender in connection with the collection and enforcement of the Loan Documents. The Borrower further agrees to indemnify the Agent and each Lender, its directors, officers and employees against all losses, claims, damages, penalties, judgments, liabilities and expenses (including, without limitation, all expenses of litigation or preparation therefor whether or not the Agent or any Lender is a party thereto) which any of them may pay or incur arising out of or relating to this Agreement, the other Loan Documents, the transactions contemplated hereby or thereby or the direct or indirect application or proposed application of the proceeds of any Loan hereunder arising from claims or assertions by third parties except to the extent that they arise out of the gross negligence or willful misconduct of the party seeking indemnification. The obligations of the Borrower under this Section shall survive the termination of this Agreement. 9.8. NUMBERS OF DOCUMENTS. All statements, notices, closing documents, and requests hereunder shall be furnished to the Agent with sufficient counterparts so that the Agent may furnish one to each of the Lenders. 9.9. ACCOUNTING. Except as provided to the contrary herein, all accounting terms used herein shall be interpreted and all accounting determinations hereunder shall be made in accordance with Agreement Accounting Principles. 9.10. SEVERABILITY OF PROVISIONS. Any provision in any Loan Document that is held to be inoperative, unenforceable, or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability, or validity of that provision in any other jurisdiction, and to this end the provisions of all Loan Documents are declared to be severable. -48- 9.11. NONLIABILITY OF LENDERS. The relationship between the Borrower and the Lenders and the Agent shall be solely that of borrower and lender. Neither the Agent nor any Lender shall have any fiduciary responsibilities to the Borrower. Neither the Agent nor any Lender undertakes any responsibility to the Borrower to review or inform the Borrower of any matter in connection with any phase of the Borrower's business or operations. The Borrower shall rely entirely upon its own judgment with respect to its business, and any review, inspection or supervision of, or information supplied to the Borrower by the Agent or the Lenders is for the protection of the Agent and the Lenders and neither the Borrower nor any other Person is entitled to rely thereon. Whether or not such damages are related to a claim that is subject to the waiver effected above and whether or not such waiver is effective, neither the Agent nor any Lender shall have any liability with respect to, and the Borrower hereby waives, releases and agrees not to sue for, any special, indirect or consequential damages suffered by the Borrower in connection with, arising out of, or in any way related to the Loan Documents or the transactions contemplated thereby or the relationship established by the Loan Documents, or any act, omission or event occurring in connection therewith. 9.12. CHOICE OF LAW. THE LOAN DOCUMENTS (OTHER THAN THOSE CONTAINING A CONTRARY EXPRESS CHOICE OF LAW PROVISION) SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS, WITHOUT REGARD TO CONFLICT OF LAWS PROVISIONS, OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 9.13. CONSENT TO JURISDICTION. THE BORROWER HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED STATES FEDERAL OR ILLINOIS STATE COURT SITTING IN CHICAGO IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY LOAN DOCUMENTS AND THE BORROWER HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT AND IRREVOCABLY WAIVES ANY OBJECTION IT MAY NOW OR HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN SUCH A COURT OR THAT SUCH COURT IS AN INCONVENIENT FORUM. NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR ANY LENDER TO BRING PROCEEDINGS AGAINST THE BORROWER IN THE COURTS OF ANY OTHER JURISDICTION. ANY JUDICIAL PROCEEDING BY THE BORROWER AGAINST THE AGENT OR ANY LENDER OR ANY AFFILIATE OF THE AGENT OR ANY LENDER INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT SHALL BE BROUGHT ONLY IN A COURT IN CHICAGO, ILLINOIS; PROVIDED, THAT SUCH PROCEEDINGS MAY BE BROUGHT IN OTHER COURTS IF JURISDICTION MAY NOT BE OBTAINED IN A COURT IN CHICAGO, ILLINOIS. 9.14. WAIVER OF JURY TRIAL. THE BORROWER, THE AGENT AND EACH LENDER HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, -49- DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT OR THE RELATIONSHIP ESTABLISHED THEREUNDER. 9.15. DISCLOSURE. The Borrower and each Lender hereby (a) acknowledge and agree that First Chicago and/or its Affiliates from time to time may hold other investments in, make other loans to or have other relationships with the Borrower, including, without limitation, in connection with any interest rate hedging instruments or agreements or swap transactions, and (b) waive any liability of First Chicago or such Affiliate to the Borrower or any Lender, respectively, arising out of or resulting from such investments, loans or relationships other than liabilities arising out of the gross negligence or willful misconduct of First Chicago or its Affiliates to the extent that such liability would not have arisen but for First Chicago's status as Agent hereunder. 9.16. COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. This Agreement shall be effective when it has been executed by the Borrower, the Agent and the Lenders and each party has notified the Agent that it has taken such action. 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY. (a) The Borrower acknowledges that (i) services may be offered or provided to it (in connection with this Agreement or otherwise) by each Lender or by one or more subsidiaries or affiliates of such Lender and (ii) information delivered to each Lender by the Borrower and its Subsidiaries may be provided to each such Subsidiary and Affiliate, it being understood that any such Subsidiary or Affiliate receiving such information shall be bound by the provisions of clause (b) below as if it were a Lender hereunder. (b) Each Lender and the Agent agrees (on behalf of itself and each of its affiliates, directors, officers, employees and representatives) to use reasonable precautions to keep confidential, in accordance with their customary procedures for handling confidential information of this nature and in accordance with safe and sound banking practices, any non-public information supplied to it by the Borrower pursuant to this Agreement, provided that nothing herein shall limit the disclosure of any such information (i) to the extent required by statue, rule, regulation or judicial process, (ii) to counsel for any of the Lenders or the Agent, (iii) to bank examiners, auditors or accountants, (iv) to the Agent or any other Lender (or to First Chicago Capital Markets, Inc.), (v) in connection with any litigation to which any one or more of the Lenders or the Agent is a party, (vi) to a subsidiary or affiliate of such Lender as provided in clause (a) above, (vii) to any assignee or participant (or prospective assignee or participant) so long as such assignee or participant (or prospective assignee or participant) agrees with the respective Lender to keep such information confidential on substantially the terms set forth in this SECTION 9.17(b), (viii) to any other Person as may be reasonably required in the course of the enforcement of any Lender's rights or remedies hereunder or under any of such Lender's Note, or (ix) to any other creditor of the Borrower or any -50- of its Subsidiaries at any time during the continuance of a Default; PROVIDED that in no event shall any Lender or the Agent be obligated or required to return any materials furnished by the Borrower. ARTICLE X THE AGENT 10.1. APPOINTMENT. First Chicago is hereby appointed Agent hereunder and under each other Loan Document, and each of the Lenders authorizes the Agent to act as the agent of such Lender. The Agent agrees to act as such upon the express conditions contained in this ARTICLE X. The Agent shall not have a fiduciary relationship in respect of the Borrower or any Lender by reason of this Agreement. 10.2. POWERS. The Agent shall have and may exercise such powers under the Loan Documents as are specifically delegated to the Agent by the terms of each thereof, together with such powers as are reasonably incidental thereto. The Agent shall have no implied duties to the Lenders, or any obligation to the Lenders to take any action thereunder, except any action specifically provided by the Loan Documents to be taken by the Agent. 10.3. GENERAL IMMUNITY. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Borrower or any Lender for any action taken or omitted to be taken by it or them hereunder or under any other Loan Document or in connection herewith or therewith except for its or their own gross negligence or willful misconduct. 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC. Neither the Agent nor any of its directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into, or verify (a) any statement, warranty or representation made in connection with any Loan Document or any borrowing hereunder, (b) the performance or observance of any of the covenants or agreements of any obligor under any Loan Document, including, without limitation, any agreement by an obligor to furnish information directly to each Lender; (c) the satisfaction of any condition specified in ARTICLE IV, except receipt of items required to be delivered to the Agent and not waived at closing, or (d) the validity, effectiveness, sufficiency, enforceability or genuineness of any Loan Document or any other instrument or writing furnished in connection therewith. The Agent shall have no duty to disclose to the Lenders information that is not required to be furnished by the Borrower to the Agent at such time, but is voluntarily furnished by the Borrower to the Agent (either in its capacity as Agent or in its individual capacity). 10.5. ACTION ON INSTRUCTIONS OF LENDERS. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder and under any other Loan Document in accordance with written instructions signed by the Required Lenders (or, to the extent required by SECTION 8.2, all Lenders), and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Lenders and on all holders of Notes. The Agent shall be fully justified in failing -51- or refusing to take any action hereunder and under any other Loan Document unless it shall first be indemnified to its satisfaction by the Lenders pro rata against any and all liability, cost and expense that it may incur by reason of taking or continuing to take any such action. 10.6. EMPLOYMENT OF AGENTS AND COUNSEL. The Agent may execute any of its duties as Agent hereunder and under any other Loan Document by or through employees, agents and attorneys-in-fact and shall not be answerable to the Lenders, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. The Agent shall be entitled to advice of counsel concerning all matters pertaining to the agency hereby created and its duties hereunder and under any other Loan Document. 10.7. RELIANCE ON DOCUMENTS; COUNSEL. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of counsel selected by the Agent, which counsel may be employees of the Agent. 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION. The Lenders agree to reimburse and indemnify the Agent ratably in proportion to their respective Commitments (or, if the Commitments have been terminated, in proportion to their Commitments immediately prior to such termination) (a) for any amounts not reimbursed by the Borrower for which the Agent is entitled to reimbursement by the Borrower under the Loan Documents, (b) for any other expenses incurred by the Agent on behalf of the Lenders, in connection with the preparation, execution, delivery, administration and enforcement of the Loan Documents, and (c) for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of the Loan Documents or any other document delivered in connection therewith or the transactions contemplated thereby, or the enforcement of any of the terms thereof or of any such other documents; PROVIDED, that no Lender shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the Agent. The obligations of the Lenders under this SECTION 10.8 shall survive payment of the Obligations and termination of this Agreement. 10.9. NOTICE OF DEFAULT. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Unmatured Default hereunder unless the Agent has received written notice from a Lender or the Borrower referring to this Agreement describing such Default or Unmatured Default and stating that such notice is a "notice of default". In the event that the Agent receives such a notice, the Agent shall give prompt notice thereof to the Lenders. 10.10. RIGHTS AS A LENDER. In the event the Agent is a Lender, the Agent shall have the same rights and powers hereunder and under any other Loan Document as any Lender, including, without limitation, pursuant to Article XII hereof, and may exercise the same as though it were not the Agent, and the term "Lender" or "Lenders" shall, at any time when the Agent is a Lender, unless -52- the context otherwise indicates, include the Agent in its individual capacity. The Agent may accept deposits from, lend money to, and generally engage in any kind of trust, debt, equity or other transaction, in addition to those contemplated by this Agreement or any other Loan Document, with the Borrower or any of its Subsidiaries in which the Borrower or such Subsidiary is not restricted hereby from engaging with any other Person. 10.11. LENDER CREDIT DECISION. Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender and based on the financial statements prepared by the Borrower and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement and the other Loan Documents. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement and the other Loan Documents. 10.12. SUCCESSOR AGENT. The Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower, such resignation to be effective upon the appointment of a successor Agent or, if no successor Agent has been appointed, forty-five (45) days after the retiring Agent gives notice of its intention to resign. Upon any such resignation, the Required Lenders shall have the right to appoint, on behalf of the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If no successor Agent shall have been so appointed by the Required Lenders and shall have accepted such appointment within thirty (30) days after the resigning Agent's giving notice of its intention to resign, then the resigning Agent may appoint, on behalf of the Borrower and the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If the Agent has resigned and no successor Agent has been appointed, the Lenders may perform all the duties of the Agent hereunder and the Borrower shall make all payments in respect of the Obligations to the applicable Lender and for all other purposes shall deal directly with the Lenders. No successor Agent shall be deemed to be appointed hereunder until such successor Agent has accepted the appointment. Any such successor Agent shall be a commercial bank having capital and retained earnings of at least $50,000,000 and with a Lending Installation in the United States of America. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the resigning Agent. Upon the effectiveness of the resignation of the Agent, the resigning Agent shall be discharged from its duties and obligations hereunder and under the Loan Documents. After the effectiveness of the resignation of an Agent, the provisions of this ARTICLE X shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent hereunder and under the other Loan Documents. -53- ARTICLE XI SETOFF; RATABLE PAYMENTS 11.1. SETOFF. In addition to, and without limitation of, any rights of the Lenders under applicable law, if the Borrower becomes insolvent, however evidenced, or any Default or Unmatured Default occurs, any and all deposits (including all account balances, whether provisional or final and whether or not collected or available) and any other Indebtedness at any time held or owing by any Lender to or for the credit or account of the Borrower may be offset and applied toward the payment of the Obligations owing to such Lender, whether or not the Obligations, or any part hereof, shall then be due. 11.2. RATABLE PAYMENTS. If any Lender, whether by setoff or otherwise, has payment made to it upon its Loans (other than payments received pursuant to SECTIONS 2.18, 3.1, 3.2 or 3.4) in a greater proportion than its pro-rata share of such Loans, such Lender agrees, promptly upon demand, to purchase a portion of the Loans held by the other Lenders so that after such purchase each Lender will hold its ratable proportion of Loans. If any Lender, whether in connection with setoff or amounts which might be subject to setoff or otherwise, receives collateral or other protection for its Obligations or such amounts which may be subject to setoff, such Lender agrees, promptly upon demand, to take such action necessary such that all Lenders share in the benefits of such collateral ratably in proportion to their Loans. In case any such payment is disturbed by legal process, or otherwise, appropriate further adjustments shall be made. If an amount to be setoff is to be applied to Indebtedness of the Borrower to a Lender, other than Indebtedness evidenced by any of the Notes held by such Lender, such amount shall be applied ratably to such other Indebtedness and to the Indebtedness evidenced by such Notes. -54- ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS 12.1. SUCCESSORS AND ASSIGNS. The terms and provisions of the Loan Documents shall be binding upon and inure to the benefit of the Borrower and the Lenders and their respective successors and assigns, except that (a) the Borrower shall not have the right to assign its rights or obligations under the Loan Documents, and (b) any assignment by any Lender must be made in compliance with SECTION 12.3. Notwithstanding CLAUSE (b) of the preceding sentence, any Lender may at any time, without the consent of the Borrower or the Agent, assign all or any portion of its rights under this Agreement and its Notes to a Federal Reserve Bank; PROVIDED, HOWEVER, that no such assignment to a Federal Reserve Bank shall release the transferor Lender from its obligations hereunder. The Agent may treat the payee of any Note as the owner thereof for all purposes hereof unless and until such payee complies with SECTION 12.3 in the case of an assignment thereof or, in the case of any other transfer, a written notice of the transfer is filed with the Agent. Any assignee or transferee of a Note agrees by acceptance thereof to be bound by all the terms and provisions of the Loan Documents. Any request, authority or consent of any Person, who at the time of making such request or giving such authority or consent is the holder of any Note, shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note or Notes issued in exchange therefor. 12.2. PARTICIPATIONS. 12.2.1. PERMITTED PARTICIPANTS; EFFECT. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks or other entities ("PARTICIPANTS") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender under the Loan Documents. In the event of any such sale by a Lender of participating interests to a Participant, such Lender's obligations under the Loan Documents shall remain unchanged, such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, such Lender shall remain the holder of any such Note for all purposes under the Loan Documents, all amounts payable by the Borrower under this Agreement shall be determined as if such Lender had not sold such participating interests, and the Borrower and the Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Loan Documents. 12.2.2. VOTING RIGHTS. Each Lender shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the Loan Documents other than any amendment, modification or waiver which effects any of the modifications referenced in clauses (a) through (f) of SECTION 8.2. 12.2.3. BENEFIT OF SETOFF. The Borrower agrees that each Participant shall be deemed to have the right of setoff provided in SECTION 11.1 in respect of its participating interest in amounts -55- owing under the Loan Documents to the same extent as if the amount of its participating interest were owing directly to it as a Lender under the Loan Documents; PROVIDED, that each Lender shall retain the right of setoff provided in SECTION 11.1 with respect to the amount of participating interests sold to each Participant. The Lenders agree to share with each Participant, and each Participant, by exercising the right of setoff provided in SECTION 11.1, agrees to share with each Lender, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with SECTION 11.2 as if each Participant were a Lender. 12.3. ASSIGNMENTS. 12.3.1. PERMITTED ASSIGNMENTS. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more banks or other entities ("PURCHASERS") all or any part of its rights and obligations under the Loan Documents; provided, however, that in the case of an assignment to an entity which is not a Lender or an Affiliate of a Lender, such assignment shall be in a minimum amount (when added to the amount of the assignment of such Lender's obligations under the Valley Credit Agreement) of $5,000,000 (or, if less, the entire amount of such Lender's Commitment). Such assignment shall be substantially in the form of EXHIBIT C hereto or in such other form as may be agreed to by the parties thereto. The consent of the Agent and, so long as no Default under SECTIONS 7.2, 7.6 or 7.7 is continuing, the Borrower, shall be required prior to an assignment becoming effective with respect to a Purchaser which is not a Lender or an Affiliate thereof. Such consent shall not be unreasonably withheld. Notwithstanding anything to the contrary contained herein, any assignment by a Lender of its rights and obligations under the Loan Documents shall be accompanied by an assignment to the same assignee of the same ratable share of the rights and obligations of such Lender under the Valley Credit Agreement in respect of its obligations thereunder. 12.3.2. EFFECT; EFFECTIVE DATE. Upon (a) delivery to the Agent of a notice of assignment, substantially in the form attached as Exhibit I to EXHIBIT C hereto (a "NOTICE OF ASSIGNMENT"), together with any consents required by SECTION 12.3.1, and (b) payment of a $3,000 fee to the Agent for processing such assignment, such assignment shall become effective on the effective date specified in such Notice of Assignment. On and after the effective date of such assignment, (a) such Purchaser shall for all purposes be a Lender party to this Agreement and any other Loan Document executed by the Lenders and shall have all the rights and obligations of a Lender under the Loan Documents, to the same extent as if it were an original party hereto, and (b) the transferor Lender shall be released with respect to the percentage of the Aggregate Commitment and Loans assigned to such Purchaser without any further consent or action by the Borrower, the Lenders or the Agent. Upon the consummation of any assignment to a Purchaser pursuant to this SECTION 12.3.2, the transferor Lender, the Agent and the Borrower shall make appropriate arrangements so that replacement Notes are issued to such transferor Lender and new Notes or, as appropriate, replacement Notes, are issued to such Purchaser, in each case in principal amounts reflecting their Commitment, as adjusted pursuant to such assignment. 12.4. DISSEMINATION OF INFORMATION. Subject to SECTION 9.17(b), the Borrower authorizes each Lender to disclose to any Participant or Purchaser or any other Person acquiring an interest in -56- the Loan Documents by operation of law (each a "TRANSFEREE") and any prospective Transferee any and all information in such Lender's possession concerning the creditworthiness of the Borrower and its Subsidiaries. 12.5. TAX TREATMENT. If any interest in any Loan Document is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the transferor Lender shall cause such Transferee, concurrently with the effectiveness of such transfer, to comply with the provisions of SECTION 2.18. ARTICLE XIII NOTICES 13.1. GIVING NOTICE. All notices and other communications provided to any party hereto under this Agreement or any other Loan Document shall be in writing, by facsimile, first class U.S. mail or overnight courier and addressed or delivered to such party at its address set forth below its signature hereto or at such other address as may be designated by such party in a notice to the other parties. Any notice, if mailed and properly addressed with first class postage prepaid, return receipt requested, shall be deemed given three (3) Business Days after deposit in the U.S. mail; any notice, if transmitted by facsimile, shall be deemed given when transmitted; and any notice given by overnight courier shall be deemed given when received by the addressee. 13.2. CHANGE OF ADDRESS. The Borrower, the Agent and any Lender may each change the address for service of notice upon it by a notice in writing to the other parties hereto. ARTICLE XIV AMENDMENT AND RESTATEMENT 14.1. (a) This Agreement amends and restates in its entirety the Existing Credit Agreement and, upon the Restatement Effective Date, the terms and provisions of the Existing Credit Agreement shall, subject to this ARTICLE XIV, be superseded hereby and thereby. Prior to the Restatement Effective Date, the Existing Credit Agreement shall continue to govern the making of any Loans and any outstanding Loans and Obligations. (b) Notwithstanding the amendment and restatement of the Existing Credit Agreement by this Agreement, the Loans under, and as defined in, the Existing Credit Agreement ("Continuing Loans") and all accrued interest, fees and expenses owing to First Chicago and Fleet National Bank by the Borrower shall remain outstanding as of the Restatement Effective Date and constitute continuing Obligations under this Agreement. The Continuing Loans shall in all respects be continuing, and this Agreement shall not be deemed to evidence or result in a novation or -57- repayment and re-borrowing of the Continuing Loans. In furtherance of and without limiting the foregoing (i) all interest, fees and expenses which have arisen under the Existing Credit Agreement shall be paid on the applicable due date therefor specified in this Agreement and (ii) from and after the Restatement Effective Date, the terms, conditions and covenants governing the Continuing Loans shall be solely as set forth in this Agreement, which shall supersede the Prior Credit Agreement to the extent provided in this ARTICLE XIV. [signature pages to follow] -58- IN WITNESS WHEREOF, the Borrower, the Lenders and the Agent have executed this Agreement as of the date first above written. WHITE MOUNTAINS HOLDINGS, INC. By: ----------------------------------------- Print Name: --------------------------------- Title: -------------------------------------- Address: 80 South Main Street Hanover, New Hampshire 03755 Attn: Reid T. Campbell Vice President and Director of Finance Fax No.: (603) 640-2203 Tel. No.: (603) 643-4562 -59- COMMITMENTS THE FIRST NATIONAL BANK OF CHICAGO, Commitment $27,307,692.31 Individually and as Agent -------------- By: ----------------------------------------- Print Name: --------------------------------- Title: -------------------------------------- Address: 153 West 51st Street New York, NY 10019 Attn: Samuel W. Bridges First Vice President Fax No.: (212) 373-1393 Tel. No.: (212) 373-1142 $22,692,307.69 FLEET NATIONAL BANK -------------- By: ----------------------------------------- Print Name: --------------------------------- Title: -------------------------------------- Address: One Federal Street-MAOFD06H Boston, MA 02110-2010 Attn: David A. Bosselait --------------- Fax No.: (617) 346-5825 Tel. No.: (617) 346-5823 Aggregate Initial Commitment $50,000,000 ----------- -----------
-60- SCHEDULE 1 TO CREDIT AGREEMENT MARGINS "Applicable Eurodollar Margin" and "Applicable Facility Fee Margin" means, for any period, the applicable of the following percentages in effect with such period based on the Leverage Ratio and the Fixed Charges Coverage Ratio as follows:
I II III IV Greater than Greater than Leverage Ratio is: Less than 25% or equal to 25% Less than 25% or equal to 25% - ------------------ ------------- ---------------- ------------- --------------- If Fixed Charges Less than or Less than or Coverage Ratio is: Greater than 2:1 Greater than 2:1 equal to 2:1 equal to 2:1 - ------------------ ------------- ---------------- ------------- --------------- The applicable margin will be: - ------------------ ------------- ---------------- ------------- --------------- Applicable Facility .150% .175% .175% .200% Fee Margin - ------------------ ------------- ---------------- ------------- --------------- Applicable .350% .450% .450% .550% Eurodollar Margin - ------------------ ------------- ---------------- ------------- ---------------
The Leverage Ratio and Fixed Charges Coverage Ratio shall be calculated by the Borrower as of the end of each of its Fiscal Quarters commencing September 30, 1998 and shall be reported to the Agent pursuant to a certificate executed by an authorized officer of the Borrower and delivered in accordance with SECTION 6.1(g) of the Agreement. The foregoing margins shall be adjusted, if necessary, quarterly as of the fifth (5th) day after the delivery of the certificate provided for above; PROVIDED that if such certificate, together with the financial statements to which such certificate relates, are not delivered by the fifth (5th) day after the due date therefor specified in SECTION 6.1(g), then until the fifth (5th) day after such delivery, each of the margins specified above shall be as set forth in Column IV above. Until adjusted as described above after September 30, 1998, the Applicable Eurodollar Margin and Applicable Facility Fee Margin, as the case may be, shall be as specified in Column II above.




                                                                   EXHIBIT 10.C

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
                                   $15,000,000


                           SECOND AMENDED AND RESTATED

                                CREDIT AGREEMENT


                                      AMONG


                               VALLEY GROUP, INC.,

                                  as Borrower,

                         WHITE MOUNTAINS HOLDINGS, INC.,

                                  as Guarantor,

                            THE LENDERS NAMED HEREIN


                                       and



                       THE FIRST NATIONAL BANK OF CHICAGO,

                                    as Agent


                                   DATED AS OF


                                 August 14, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------






                                TABLE OF CONTENTS

                                                                                                             
ARTICLE I DEFINITIONS............................................................................................   1

ARTICLE II THE CREDITS...........................................................................................  16
         2.1.       ADVANCES.....................................................................................  16
         2.2.       RATABLE LOANS................................................................................  16
         2.3.       TYPES OF ADVANCES............................................................................  16
         2.4.       FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT.............................................  17
         2.5.       MINIMUM AMOUNT OF EACH ADVANCE...............................................................  17
         2.6.       OPTIONAL PRINCIPAL PAYMENTS..................................................................  17
         2.7.       MANDATORY COMMITMENT REDUCTIONS..............................................................  17
         2.8.       METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR NEW ADVANCES..............................  18
         2.9.       CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES..........................................  19
         2.10.      CHANGES IN INTEREST RATE, ETC................................................................  19
         2.11.      RATES APPLICABLE AFTER DEFAULT...............................................................  19
         2.12.      METHOD OF PAYMENT............................................................................  20
         2.13.      NOTES........................................................................................  20
         2.14.      INTEREST PAYMENT DATES; INTEREST AND FEE BASIS...............................................  20
         2.15.      NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS AND COMMITMENT
                    REDUCTIONS...................................................................................  20
         2.16.      LENDING INSTALLATIONS........................................................................  21
         2.17.      NON-RECEIPT OF FUNDS BY THE AGENT............................................................  21
         2.18.      TAXES........................................................................................  21
         2.19.      AGENT'S FEES.................................................................................  22

ARTICLE III CHANGE IN CIRCUMSTANCES..............................................................................  22
         3.1.       YIELD PROTECTION.............................................................................  22
         3.2.       CHANGES IN CAPITAL ADEQUACY REGULATIONS......................................................  23
         3.3.       AVAILABILITY OF TYPES OF ADVANCES............................................................  24
         3.4.       FUNDING INDEMNIFICATION......................................................................  24
         3.5.       LENDER STATEMENTS; SURVIVAL OF INDEMNITY.....................................................  24

ARTICLE IV CONDITIONS PRECEDENT..................................................................................  24
         4.1.       EFFECTIVENESS................................................................................  24
         4.2.       EACH FUTURE ADVANCE..........................................................................  26

ARTICLE V REPRESENTATIONS AND WARRANTIES.........................................................................  27
         5.1.       CORPORATE EXISTENCE AND STANDING.............................................................  27
         5.2.       AUTHORIZATION AND VALIDITY...................................................................  27
         5.3.       COMPLIANCE WITH LAWS AND CONTRACTS...........................................................  27

-i- 5.4. GOVERNMENTAL CONSENTS........................................................................ 28 5.5. FINANCIAL STATEMENTS......................................................................... 28 5.6. MATERIAL ADVERSE CHANGE...................................................................... 28 5.7. TAXES........................................................................................ 28 5.8. LITIGATION AND CONTINGENT OBLIGATIONS........................................................ 29 5.9. CAPITALIZATION............................................................................... 29 5.10. ERISA........................................................................................ 29 5.11. DEFAULTS..................................................................................... 30 5.12. FEDERAL RESERVE REGULATIONS.................................................................. 30 5.13. INVESTMENT COMPANY........................................................................... 30 5.14. CERTAIN FEES................................................................................. 30 5.15. SOLVENCY..................................................................................... 30 5.16. INDEBTEDNESS................................................................................. 31 5.17. INSURANCE LICENSES........................................................................... 31 5.18. MATERIAL AGREEMENTS.......................................................................... 31 5.19. ENVIRONMENTAL LAWS........................................................................... 31 5.20. INSURANCE.................................................................................... 32 5.21. DISCLOSURE................................................................................... 32 5.22. YEAR 2000.................................................................................... 32 ARTICLE VI COVENANTS............................................................................................. 32 6.1. FINANCIAL REPORTING.......................................................................... 32 6.2. USE OF PROCEEDS.............................................................................. 35 6.3. NOTICE OF DEFAULT............................................................................ 35 6.4. CONDUCT OF BUSINESS.......................................................................... 35 6.5. TAXES........................................................................................ 36 6.6. INSURANCE.................................................................................... 36 6.7. COMPLIANCE WITH LAWS......................................................................... 36 6.8. MAINTENANCE OF PROPERTIES.................................................................... 36 6.9. INSPECTION................................................................................... 36 6.10. DIVIDENDS.................................................................................... 36 6.11. INDEBTEDNESS................................................................................. 37 6.12. MERGER....................................................................................... 38 6.13. INVESTMENTS AND PURCHASES.................................................................... 38 6.14. CONTINGENT OBLIGATIONS....................................................................... 39 6.15. LIENS........................................................................................ 40 6.16. AFFILIATES................................................................................... 41 6.17. ENVIRONMENTAL MATTERS........................................................................ 41 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR................................................... 41 6.19. INCONSISTENT AGREEMENTS...................................................................... 41 6.20. FINANCIAL COVENANTS.......................................................................... 42 6.20.2. LEVERAGE RATIO...................................................................... 42 6.20.3. FIXED CHARGES COVERAGE RATIO........................................................ 42
-ii- 6.20.4. STATUTORY SURPLUS................................................................... 42 6.21. TAX CONSOLIDATION............................................................................ 42 6.22. ERISA COMPLIANCE............................................................................. 42 6.23. YEAR 2000.................................................................................... 43 ARTICLE VII DEFAULTS............................................................................................. 43 ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES...................................................... 45 8.1. ACCELERATION................................................................................. 45 8.2. AMENDMENTS................................................................................... 46 8.3. PRESERVATION OF RIGHTS....................................................................... 46 ARTICLE IX GENERAL PROVISIONS.................................................................................... 47 9.1. SURVIVAL OF REPRESENTATIONS.................................................................. 47 9.2. GOVERNMENTAL REGULATION...................................................................... 47 9.3. TAXES........................................................................................ 47 9.4. HEADINGS..................................................................................... 47 9.5. ENTIRE AGREEMENT............................................................................. 47 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT.............................................. 47 9.7. EXPENSES; INDEMNIFICATION.................................................................... 47 9.8. NUMBERS OF DOCUMENTS......................................................................... 48 9.9. ACCOUNTING................................................................................... 48 9.10. SEVERABILITY OF PROVISIONS................................................................... 48 9.11. NONLIABILITY OF LENDERS...................................................................... 48 9.12. CHOICE OF LAW................................................................................ 49 9.13. CONSENT TO JURISDICTION...................................................................... 49 9.14. WAIVER OF JURY TRIAL......................................................................... 49 9.15. DISCLOSURE................................................................................... 49 9.16. COUNTERPARTS................................................................................. 49 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY............................................ 50 ARTICLE X THE AGENT.............................................................................................. 50 10.1. APPOINTMENT.................................................................................. 50 10.2. POWERS....................................................................................... 50 10.3. GENERAL IMMUNITY............................................................................. 51 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC................................................... 51 10.5. ACTION ON INSTRUCTIONS OF LENDERS............................................................ 51 10.6. EMPLOYMENT OF AGENTS AND COUNSEL............................................................. 51 10.7. RELIANCE ON DOCUMENTS; COUNSEL............................................................... 51 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION.................................................... 52 10.9. NOTICE OF DEFAULT............................................................................ 52 10.10. RIGHTS AS A LENDER........................................................................... 52 10.11. LENDER CREDIT DECISION....................................................................... 52
-iii- 10.12. SUCCESSOR AGENT.............................................................................. 52 ARTICLE XI SETOFF; RATABLE PAYMENTS.............................................................................. 53 11.1. SETOFF....................................................................................... 53 11.2. RATABLE PAYMENTS............................................................................. 53 ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS 12.1. SUCCESSORS AND ASSIGNS....................................................................... 54 12.2. PARTICIPATIONS............................................................................... 54 12.2.1. PERMITTED PARTICIPANTS; EFFECT. ................................................... 54 12.2.2. VOTING RIGHTS....................................................................... 54 12.2.3. BENEFIT OF SETOFF................................................................... 55 12.3. ASSIGNMENTS.................................................................................. 55 12.3.1. PERMITTED ASSIGNMENTS............................................................... 55 12.3.2. EFFECT; EFFECTIVE DATE.............................................................. 55 12.4. DISSEMINATION OF INFORMATION................................................................. 56 12.5. TAX TREATMENT................................................................................ 56 ARTICLE XIII NOTICES............................................................................................. 56 13.1. GIVING NOTICE................................................................................ 56 13.2. CHANGE OF ADDRESS............................................................................ 56 ARTICLE XIV GUARANTY............................................................................................ 56 ARTICLE XV AMENDMENT AND RESTATEMENT............................................................................ 60
-iv- EXHIBITS Exhibit A (Article 1) Note Exhibit B (Section 6.1(g)) Compliance Certificate Exhibit C (Section 12.3.1) Assignment Agreement
SCHEDULES Schedule 1 -- Margins Schedule 5.3 -- Approvals and Consents Schedule 5.9 -- Capitalization and Subsidiaries Schedule 5.10 -- ERISA Schedule 5.16 -- Indebtedness Schedule 5.17 -- Insurance Licenses Schedule 5.18 -- Material Restrictions Schedule 6.13 -- Investment Commitments Schedule 6.15 -- Liens
-v- SECOND AMENDED AND RESTATED CREDIT AGREEMENT This Second Amended and Restated Credit Agreement, dated as of August 14, 1998, is among VALLEY GROUP, INC., an Oregon corporation, WHITE MOUNTAINS HOLDINGS, INC., a Delaware corporation, the Lenders and THE FIRST NATIONAL BANK OF CHICAGO, individually and as Agent. R E C I T A L S: A. The Borrower, the Lenders and the Agent are party to that certain $15,000,000 amended and restated credit agreement, dated as of July 30, 1997 (the "Existing Credit Agreement"). B. The Borrower has requested that the Existing Credit Agreement be amended and restated in order to make certain amendments to the Existing Credit Agreement. C. The Borrower, the Lenders and the Agent desire to amend and restate the Existing Credit Agreement on the terms and conditions set forth below to accomplish such amendments. NOW, THEREFORE, in consideration of the mutual covenants and undertakings herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, each Loan Party, the Lenders and the Agent hereby agree as follows: ARTICLE I DEFINITIONS As used in this Agreement: "ABR Advance" means an Advance which bears interest at the Alternate Base Rate. "Adjusted Net Worth" means, with respect to Parent, Net Worth of Parent (on a consolidated basis) on the date of determination (without duplication for amounts already excluded), MINUS the aggregate book value of Parent's equity interest in SOMSC at such time, MINUS any intercompany loans or receivables owing from Holdings that are assets of Parent or its Subsidiaries at such time. "Advance" means a borrowing pursuant to SECTION 2.1 consisting of the aggregate amount of the several Loans made on the same Borrowing Date by the Lenders to the Borrower of the same Type and, in the case of Eurodollar Advances, for the same Interest Period. "Affiliate" of any Person means any other Person directly or indirectly controlling, controlled by or under common control with such Person. A Person shall be deemed to control another Person if the controlling Person owns 20% or more of any class of voting securities (or other ownership interests) of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management or policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Agent" means First Chicago in its capacity as agent for the Lenders pursuant to ARTICLE X, and not in its individual capacity as a Lender, and any successor Agent appointed pursuant to ARTICLE X. "Aggregate Commitment" means the aggregate of the Commitments of all the Lenders hereunder. The initial Aggregate Commitment is $15,000,000. "Agreement" means this Second Amended and Restated Credit Agreement, as it may be amended, modified or restated and in effect from time to time. "Agreement Accounting Principles" means generally accepted accounting principles as in effect from time to time; PROVIDED, HOWEVER, that if any changes in accounting principles from those in effect on the date of this Agreement are adopted which result in a material change in the method of calculation of any of the financial covenants, standards or terms in this Agreement, the parties agree to enter into negotiations to determine whether such provisions require amendment and, if so, the terms of such amendment so as to equitably reflect such changes. Until a resolution thereof is reached, all calculations made for the purposes of determining compliance with the terms of this Agreement shall be made by application of generally accepted accounting principles in effect on the date of this Agreement applied, to the extent applicable, on a basis consistent with that used in the preparation of the Financial Statements furnished to the Lenders pursuant to SECTION 5.5 hereof. "Alternate Base Rate" means, for any day, a rate of interest per annum equal to the higher of (a) the Corporate Base Rate for such day, and (b) the sum of the Federal Funds Effective Rate for such day plus 1/2% per annum, in each case changing when and as the Corporate Base Rate and the Federal Funds Effective Rate, as the case may be, changes. "Annual Statement" means the annual statutory financial statement of any Insurance Subsidiary required to be filed with the insurance commissioner (or similar authority) of its jurisdiction of incorporation, which statement shall be in the form required by such Insurance Subsidiary's jurisdiction of incorporation or, if no specific form is so required, in the form of financial statements permitted by such insurance commissioner (or such similar authority) to be used for filing annual statutory financial statements and shall contain the type of information permitted by such insurance commissioner (or such similar authority) to be disclosed therein, together with all exhibits or schedules filed therewith. "Applicable Eurodollar Margin" has the meaning ascribed to it by, and shall be determined in accordance with, SCHEDULE 1. "Applicable Facility Fee Margin" has the meaning ascribed to it by, and shall be determined in accordance with, SCHEDULE 1. -2- "Article" means an article of this Agreement unless another document is specifically referenced. "Asset Disposition" means any sale, transfer or other disposition (outside the ordinary course of business) of any material asset of the Borrower in a single transaction or in a series of related transactions (other than the sale of a Money Market Investment, the net proceeds of which are utilized within one hundred eighty (180) days to pay dividends permitted by SECTION 6.10), including any such sale, transfer or disposition by means of a transaction permitted by SECTION 6.12. "Authorized Officer" means, with respect to either Loan Party, any of the chief executive officer, president, chief financial officer, treasurer or controller of such Loan Party, acting singly. "Bankruptcy Code" means Title 11, United States Code, sections 1 ET SEQ., as the same may be amended from time to time, and any successor thereto or replacement therefor which may be hereafter enacted. "Benefit Plan" means any deferred benefit plan for the benefit of present, future or former employees, whether or not such benefit plan is a Plan. "Borrower" means Valley Group, Inc., an Oregon corporation, and its successors and assigns. "Borrowing Date" means a date on which an Advance is made hereunder. "Borrowing Notice" is defined in SECTION 2.8. "Business Day" means (a) with respect to any borrowing, payment or rate selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities and on which dealings in United States dollars are carried on in the London interbank market, and (b) for all other purposes, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities. "Capitalized Lease" of a Person means any lease of Property by such Person as lessee which would be capitalized on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. "Capitalized Lease Obligations" of a Person means the amount of the obligations of such Person under Capitalized Leases which would be shown as a liability on a balance sheet of such Person prepared in accordance with Agreement Accounting Principles. "Change" is defined in SECTION 3.2. -3- "Change in Control" means (a) the acquisition by any "person" or "group" (as such terms are used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) (other than Holdings, any Wholly-Owned Subsidiary of Holdings, John J. Byrne or any Plan or any Benefit Plan of Holdings, Parent, the Borrower or any of their Subsidiaries), including without limitation any acquisition effected by means of any transaction contemplated by SECTION 6.12, of beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended) of 25% or more of the outstanding shares of voting stock of the Borrower; or (b) during any period of twelve (12) consecutive calendar months, commencing on the date of the Agreement, the ceasing of those individuals (the "CONTINUING DIRECTORS") who (i) were directors of the Borrower on the first day of each such period or (ii) subsequently became directors of the Borrower and whose initial election or initial nomination for election subsequent to that date was approved by a majority of the Continuing Directors then on the board of directors of the Borrower to constitute a majority of the board of directors of the Borrower; or (c) during any period of twelve (12) consecutive calendar months, commencing on the date of this Agreement, the ceasing of individuals who hold an office possessing the title Senior Vice President or such title that ranks senior to a Senior Vice President (collectively, "Senior Management") of the Borrower on the first day of each such period to constitute a majority of the Senior Management of the Borrower. "Code" means the Internal Revenue Code of 1986, as amended, reformed or otherwise modified from time to time. "Commitment" means, for each Lender, the obligation of such Lender to make Loans not exceeding the amount set forth opposite its signature below and as set forth in any Notice of Assignment relating to any assignment which has become effective pursuant to SECTION 12.3.2, as such amount may be modified from time to time pursuant to the terms hereof. "Consolidated" or "consolidated", when used in connection with any calculation, means a calculation to be determined on a consolidated basis for a Person and its Subsidiaries in accordance with Agreement Accounting Principles. "Consolidated Person" means, for the taxable year of reference, each Person which is a member of the affiliated group of Parent if Consolidated returns are or shall be filed for such affiliated group for federal income tax purposes or any combined or unitary group of which Parent is a member for state income tax purposes. "Contingent Obligation" of a Person means any agreement, undertaking or arrangement by which such Person assumes, guarantees, endorses, contingently agrees to purchase or provide funds for the payment of, or otherwise becomes or is contingently liable upon, the obligation or liability of any other Person, or agrees to maintain the net worth or working capital or other financial condition of any other Person, or otherwise assures any creditor of such other Person against loss, including, without limitation, any comfort letter, operating agreement or take-or-pay contract or application for a Letter of Credit, excluding however (a) insurance policies and insurance contracts issued in the ordinary course of business and (b) any financial guarantees issued by FSA. -4- "Controlled Group" means all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with either Loan Party or any of their Subsidiaries, are treated as a single employer under Section 414 of the Code. "Conversion/Continuation Notice" is defined in SECTION 2.9. "Corporate Base Rate" means a rate per annum equal to the corporate base rate of interest publicly announced by First Chicago from time to time, changing when and as said corporate base rate changes. The Corporate Base Rate is a reference rate and does not necessarily represent the lowest or best rate of interest actually charged to any customer. First Chicago may make commercial loans or other loans at rates of interest at, above or below the Corporate Base Rate. "Default" means an event described in ARTICLE VII. "Environmental Laws" is defined in SECTION 5.19. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "Eurodollar Advance" means an Advance which bears interest at the Eurodollar Rate. "Eurodollar Base Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the rate determined by the Agent to be the rate at which deposits in U.S. dollars are offered by First Chicago to first-class banks in the London interbank market at approximately 11 a.m. (London time) two (2) Business Days prior to the first day of such Interest Period, in the approximate amount of First Chicago's relevant Eurodollar Advance and having a maturity approximately equal to such Interest Period. "Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the sum of (a) the quotient of (i) the Eurodollar Base Rate applicable to such Interest Period, divided by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to such Interest Period, plus the Applicable Eurodollar Margin. The Eurodollar Rate shall be rounded to the next higher multiple of 1/100 of 1% if the rate is not such a multiple. "Existing Credit Agreement" is defined in the recitals to this Agreement. "Facility Fee" is defined in Section 2.4(a). "Facility Termination Date" means July 30, 2002. "FAE" means Fund American Enterprises, Inc. (f/k/a Fund American Enterprises II, Inc.), a Delaware corporation and direct Wholly-Owned Subsidiary of Parent. -5- "Federal Funds Effective Rate" means, for any day, an interest 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 for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10 a.m. (Chicago time) on such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent in its sole discretion. "Financial Statements" is defined in SECTION 5.5. "First Chicago" means The First National Bank of Chicago in its individual capacity, and its successors. "First-Tier Insurance Subsidiary" means any Insurance Subsidiary that is either (a) a direct Wholly-Owned Subsidiary of Parent or (b) a Wholly-Owned Subsidiary of a Subsidiary of Parent and there exists no Insurance Subsidiary in the chain of ownership between Parent and such Insurance Subsidiary. "Fiscal Quarter" means one of the four three-month accounting periods comprising a Fiscal Year. "Fiscal Year" means the twelve-month accounting period ending December 31 of each year. "Fixed Charges Coverage Ratio" means, as of the end of any Fiscal Quarter, the ratio of: (a) the sum, without duplication, of, (i) investments of Parent, the Borrower, FAE, Charter Group, Inc., Charter General Agency, Inc., NCM Management Corporation and Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of Parent) in cash and Money Market Investments as of the end of such Fiscal Quarter, PLUS (ii) an amount equal to the maximum amount of dividends and intercompany fees available to be paid to Parent, the Borrower, FAE and Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of Parent) without approval of any Governmental Authority by each present and future Wholly- Owned Subsidiary of Parent that is a First-Tier Insurance Subsidiary of either Parent or any of its Subsidiaries that is not an Insurance Subsidiary pursuant to applicable insurance statutes, rules and regulations of the applicable Governmental Authority during the succeeding four Fiscal Quarters, to (b) Fixed Charges. -6- "Fixed Charges" means, with respect to Holdings, Parent and the Borrower, as of the end of any Fiscal Quarter, the sum, without duplication and after giving effect to consolidation, of (a) the sum of all interest expense on outstanding Indebtedness (determined by adjusting the principal amount of such Indebtedness for scheduled amortization payments and assuming that the applicable interest rate in effect as of the date of determination would remain constant during the succeeding four Fiscal Quarter period) payable by Holdings, Parent, the Borrower and any of Parent's Wholly- Owned Subsidiaries (other than any Unrestricted Subsidiary), (b) dividends payable on preferred stock by Holdings, Parent, the Borrower and any of Parent's Wholly-Owned Subsidiaries (other than any Unrestricted Subsidiary), (c) Indebtedness payable pursuant to the scheduled amortization of such Indebtedness by Holdings, Parent, the Borrower and any of Parent's Wholly-Owned Subsidiaries (other than any Unrestricted Subsidiary), (d) Loans payable pursuant to SECTION 2.1(b) as a result of reductions in the Aggregate Commitment occurring in any such period pursuant to SECTION 2.7(a) (subject to the last sentence of this definition with respect to the July 30, 2002 reduction), and Loans (as defined in the White Mountains Credit Agreement) payable pursuant to Section 2.1(b) of the White Mountains Credit Agreement as a result of reductions in the Aggregate Commitment (as determined in the White Mountains Credit Agreement) occurring in any such period pursuant to Section 2.7(a) of the White Mountains Credit Agreement (subject to the last sentence of this definition with respect to the July 30, 2002 reduction), in each case for the period of four Fiscal Quarters immediately following the date of determination. Solely for purposes of computing Fixed Charges under the preceding CLAUSE (c), the scheduled principal payment of approximately $56,000,000 due on or before March 31, 1999 under the Folksamerica Loan Agreement shall not be included. Solely for purposes of computing Fixed Charges under the preceding CLAUSE (d) for any period on or after June 30, 2001, the "Reduction Amount" on July 30, 2002 stated in SECTION 2.7(a) shall be deemed to be $2,000,000 and the "Reduction Amount" on July 30, 2002 stated in Section 2.7(a) of the White Mountains Credit Agreement shall be deemed to be $4,000,000. "Folksamerica" means Folksamerica Holding Company, Inc., a New York corporation. "Folksamerica Loan Agreement means that certain $70,000,000 loan agreement between Folksamerica and Swedbank (Sparbanken Sverige AB (publ), New York Branch, dated as of November 12, 1991, as amended. "Folksamerica Transaction" means that certain transaction by which (a) Parent and/or FAE acquires all of the outstanding capital stock of Folksamerica not already owned by Parent and (b) Holdings assumes the obligations of each of Folksam Omsesidig Sakforsakring (Sweden) and Samvirke Skadeforsikring AS (Norway) (collectively, the "Folksamerica Guarantors") to guarantee the obligations of Folksamerica (the "Folksamerica Guaranty") under the Folksamerica Loan Agreement and (c) Holdings indemnifies the Folksamerica Guarantors and their respective affiliates, successors and assigns with respect to various matters relating to the Folksamerica Guaranty. "FSA" means Financial Security Assurance Holdings Ltd., a New York corporation. -7- "FSA Amount" means an amount equal to that immediately utilized by SOMSC to exercise certain options, in existence on the date hereof, on the capital stock of FSA, such amount not to exceed $18,000,000. "Funded Indebtedness" means Indebtedness of the type described in clauses (a), (d), (e) and (h) of the definition "Indebtedness". "Governmental Authority" means any government (foreign or domestic) or any state or other political subdivision thereof or any governmental body, agency, authority, department or commission (including without limitation any board of insurance, insurance department or insurance commissioner and any taxing authority or political subdivision) or any instrumentality or officer thereof (including without limitation any court or tribunal) exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government and any corporation, partnership or other entity directly or indirectly owned or controlled by or subject to the control of any of the foregoing. "Guaranty" means the Guaranty of Parent pursuant to ARTICLE XIV. "Hazardous Materials" is defined in SECTION 5.19. "Holdings" means Fund American Enterprises Holdings, Inc., a Delaware corporation. "Indebtedness" of a Person means such Person's (a) obligations for borrowed money, (b) obligations representing the deferred purchase price of Property or services (other than accounts payable arising in the ordinary course of such Person's business payable on terms customary in the trade), (c) obligations, whether or not assumed, secured by Liens or payable out of the proceeds or production from Property now or hereafter owned or acquired by such Person, (d) obligations which are evidenced by notes, acceptances, or similar instruments, (e) Capitalized Lease Obligations, (f) Rate Hedging Obligations, (g) Contingent Obligations, (h) obligations for which such Person is obligated pursuant to or in respect of a Letter of Credit and (i) repurchase obligations or liabilities of such Person with respect to accounts or notes receivable sold by such Person. "Insurance Subsidiary" means any Subsidiary which is engaged in the insurance business as an issuer or underwriter of insurance policies and/or insurance contracts. "Interest Period" means, with respect to a Eurodollar Advance, a period of one, two, three or six months commencing on a Business Day selected by the Borrower pursuant to this Agreement. Such Interest Period shall end on (but exclude) the day which corresponds numerically to such date one, two, three or six months thereafter; PROVIDED, HOWEVER, that if there is no such numerically corresponding day in such next, second, third or sixth succeeding month, such Interest Period shall end on the last Business Day of such next, second, third or sixth succeeding month. If an Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall end on the next succeeding Business Day; PROVIDED, HOWEVER, that if said next succeeding Business Day -8- falls in a new calendar month, such Interest Period shall end on the immediately preceding Business Day. "Investment" of a Person means any loan, advance (other than commission, travel and similar advances to officers and employees made in the ordinary course of business), extension of credit (other than accounts receivable arising in the ordinary course of business on terms customary in the trade), deposit account or contribution of capital by such Person to any other Person or any investment in, or purchase or other acquisition of, the stock, partnership interests, notes, debentures or other securities of any other Person made by such Person. "Lenders" means the lending institutions listed on the signature pages of this Agreement and their respective successors and assigns. "Lending Installation" means, with respect to a Lender or the Agent, any office, branch, subsidiary or affiliate of such Lender or the Agent. "Letter of Credit" of a Person means a letter of credit or similar instrument which is issued upon the application of such Person or upon which such Person is an account party or for which such Person is in any way liable. "Leverage Ratio" means, at any time, the ratio of (a) the consolidated Funded Indebtedness of Holdings (excluding SOMSC) at such time to (b) the sum of the consolidated Funded Indebtedness of Parent and its Subsidiaries, other than SOMSC, at such time PLUS Adjusted Net Worth at such time, in all cases determined in accordance with Agreement Accounting Principles. "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 business. "Lien" means any security interest, lien (statutory or other), mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance or preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever (including, without limitation, the interest of a vendor or lessor under any conditional sale, Capitalized Lease or other title retention agreement), save in respect of liabilities and obligations arising out of the underwriting of insurance policies and contracts of insurance. "Loan" means, with respect to a Lender, such Lender's portion of any Advance and "Loans" means, with respect to the Lenders, the aggregate of all Advances. "Loan Documents" means this Agreement, the Notes and the other documents and agreements contemplated hereby and executed by either Loan Party in favor of the Agent or any Lender. "Loan Party" means each and either of the Borrower or Parent. -9- "Margin Stock" has the meaning assigned to that term under Regulation U. "Material Adverse Effect" means a material adverse effect on (a) the business, Property, condition (financial or other), performance, results of operations, or prospects of Parent and its Subsidiaries taken as a whole, (b) the ability of Parent, the Borrower or any Subsidiary of Parent or the Borrower to perform its obligations under the Loan Documents, or (c) the validity or enforceability of any of the Loan Documents or the rights or remedies of the Agent or the Lenders thereunder. "Money Market Investments" means (a) direct obligations of the United States of America, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States of America, or of any agency thereof, in either case maturing not more than one year from the date of acquisition thereof; (b) certificates of deposit issued by any bank or trust company organized under the laws of the United States of America or any state thereof and having capital, surplus and undivided profits of at least $500,000,000, maturing not more than ninety (90) days from the date of acquisition thereof; (c) commercial paper rated A-1 or better P-1 or better by Standard & Poor's Ratings Group or Moody's Investors Services, Inc., respectively, maturing not more than ninety (90) days from the date of acquisition thereof; and (d) shares in an open-end management investment company with U.S. dollar denominated investments in fixed income obligations, including repurchase agreements, fixed time deposits and other obligations, with a dollar weighted average maturity of not more than one year, and for the calculation of this dollar weighted average maturity, certain instruments which have a variable rate of interest readjusted no less frequently than annually are deemed to have a maturity equal to the period remaining until the next readjustment of the interest rate. "Multiemployer Plan" means a Plan maintained pursuant to a collective bargaining agreement or any other arrangement to which either Loan Party or any member of the Controlled Group is a party to which more than one employer is obligated to make contributions. "NAIC" means the National Association of Insurance Commissioners or any successor thereto, or in lieu thereof, any other association, agency or other organization performing advisory, coordination or other like functions among insurance departments, insurance commissioners and similar Governmental Authorities of the various states of the United States toward the promotion of uniformity in the practices of such Governmental Authorities. "Net Available Proceeds" means (a) with respect to any Asset Disposition, the sum of cash or readily marketable cash equivalents received (including by way of a cash generating sale or discounting of a note or account receivable) therefrom, whether at the time of such disposition or subsequent thereto, in excess in the case of any Asset Disposition of any amounts derived from such sale used (and permitted by this Agreement to be used) within one hundred eighty (180) days after such sale to make a Permitted Reinvestment, or (b) with respect to any sale or issuance of equity securities of the Borrower, cash or readily marketable cash equivalents received therefrom, whether at the time of such sale or issuance or subsequent thereto, net, in the case of either CLAUSE (a) or -10- CLAUSE (b), of all legal, title and recording tax expenses, commissions and other fees and all costs and expenses incurred, including, without limitation, incremental income taxes resulting from such transaction. "Net Worth" means, with respect to any Person, at any date the consolidated shareholders' equity of such Person and its Consolidated Subsidiaries determined in accordance with Agreement Accounting Principles (but excluding the effect of Statement of Financial Accounting Standards No. 115). "Non-Excluded Taxes" is defined in SECTION 2.18(a). "Note" means a promissory note in substantially the form of EXHIBIT A hereto, with appropriate insertions, duly executed and delivered to the Agent by the Borrower and payable to the order of a Lender in the amount of its Commitment, including any amendment, modification, renewal or replacement of such promissory note. "Notice of Assignment" is defined in SECTION 12.3.2. "Obligations" means all unpaid principal of and accrued and unpaid interest on the Notes, all accrued and unpaid fees and all expenses, reimbursements, indemnities and other obligations of each Loan Party to the Lenders or to any Lender, the Agent or any indemnified party hereunder arising under any of the Loan Documents. "Parent" means White Mountains Holdings, Inc., a Delaware corporation, formerly known as Fund American Enterprises, Inc. and the survivor of a merger with White Mountains Holdings, Inc., a Hew Hampshire corporation. "Participants" is defined in SECTION 12.2.1. "Payment Date" means the last day of each March, June, September and December. "PBGC" means the Pension Benefit Guaranty Corporation or any successor thereto. "Permitted Reinvestment" means an Investment in Subsidiaries (other than any Unrestricted Subsidiary) in existence on the date hereof, an Investment in Main Street America Holdings, Inc., or any other Investment approved by the Required Lenders. "Person" means any natural person, corporation, firm, joint venture, partnership, association, enterprise, trust or other entity or organization, or any government or political subdivision or any agency, department or instrumentality thereof. "Plan" means an employee pension benefit plan, as defined in Section 3(2) of ERISA, as to which either Loan Party or any member of the Controlled Group may have any liability. -11- "Proceeding" is defined in SECTION 5.19. "Property" of a Person means any and all property, whether real, personal, tangible, intangible, or mixed, of such Person, or other assets owned, leased or operated by such Person. "pro-rata" means, when used with respect to a Lender, and any described aggregate or total amount, an amount equal to such Lender's pro-rata share or portion based on its percentage of the Aggregate Commitment or if the Aggregate Commitment has been terminated, its percentage of the aggregate principal amount of outstanding Advances. "Purchase" means any transaction, or any series of related transactions, consummated on or after the date of this Agreement, by which either Loan Party or any of their Subsidiaries (a) acquiresany going business or all or substantially all of the assets of any firm, corporation or division or line of business thereof, whether through purchase of assets, merger or otherwise, or (b) directly or indirectly acquires (in one transaction or as the most recent transaction in a series of transactions) at least a majority (in number of votes) of the securities of a corporation which have ordinary voting power for the election of directors (other than securities having such power only by reason of the happening of a contingency) or a majority (by percentage or voting power) of the outstanding partnership interests of a partnership. "Purchasers" is defined in SECTION 12.3.1. "Quarterly Statement" means the quarterly statutory financial statement of any Insurance Subsidiary required to be filed with the insurance commissioner (or similar authority) of its jurisdiction of incorporation or, if no specific form is so required, in the form of financial statements permitted by such insurance commissioner (or such similar authority) to be used for filing quarterly statutory financial statements and shall contain the type of financial information permitted by such insurance commissioner (or such similar authority) to be disclosed therein, together with all exhibits or schedules filed therewith. "Rate Hedging Obligations" of a Person means any and all obligations of such Person, whether absolute or contingent and howsoever and whensoever created, arising, evidenced or acquired (including all renewals, extensions and modifications thereof and substitutions therefor), under (a) any and all agreements, devices or arrangements designed to protect at least one of the parties thereto from the fluctuations of interest rates, exchange rates or forward rates applicable to such party's assets, liabilities or exchange transactions, including, but not limited to, dollar-denominated or cross-currency interest rate exchange agreements, forward currency exchange agreements, interest rate cap or collar protection agreements, forward rate currency or interest rate options, puts and warrants, and (b) any and all cancellations, buy backs, reversals, terminations or assignments of any of the foregoing. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor thereto or other regulation or official -12- interpretation of said Board of Governors relating to reserve requirements applicable to depositary institutions. "Regulation T" means Regulation T of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of such Board of Governors relating to the extension of credit by securities brokers and dealers for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by banks for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Regulation X" means Regulation X of the Board of Governors of the Federal Reserve System as from time to time in effect and shall include any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by the specified lenders for the purpose of purchasing or carrying margin stocks applicable to such Persons. "Release" is defined in the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. 39601 ET SEQ. "Reportable Event" means a reportable event as defined in Section 4043 of ERISA and the regulations issued under such section, with respect to a Plan, excluding, however, such events as to which the PBGC has by regulation waived the requirement of Section 4043(a) of ERISA that it be notified within thirty (30) days of the occurrence of such event; PROVIDED, that a failure to meet the minimum funding standard of Section 412 of the Code and of Section 302 of ERISA shall be a Reportable Event regardless of the issuance of any such waiver of the notice requirement in accordance with either Section 4043(a) of ERISA or Section 412(d) of the Code. "Required Lenders" means Lenders in the aggregate having at least 66-2/3% of the Aggregate Commitment or, if the Aggregate Commitment has been terminated, Lenders in the aggregate holding at least 66-2/3% of the aggregate unpaid principal amount of the outstanding Loans. "Reserve Requirement" means, with respect to an Interest Period, the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed under Regulation D on Eurocurrency liabilities. "Restatement Effective Date" means the date on which all conditions precedent set forth in SECTION 4.1 are satisfied or waived by all of the Lenders. "Risk-Based Capital Guidelines" is defined in SECTION 3.2. -13- "SAP" means, with respect to any Insurance Subsidiary, the statutory accounting practices prescribed or permitted by the insurance commissioner (or other similar authority) in the jurisdiction of such Person for the preparation of annual statements and other financial reports by insurance companies of the same type as such Person in effect from time to time; PROVIDED, HOWEVER, that if any changes in statutory accounting practices from those in effect on the date of this Agreement are adopted which result in a material change in the method of calculation of any of the financial covenants, standards or terms in this Agreement, the parties agree to enter into negotiations to determine whether such provisions require amendment and, if so, the terms of such amendment so as to equitably reflect such changes. Until a resolution thereof is reached, all calculations made for the purposes of determining compliance with the terms of this Agreement shall be made by application of statutory accounting practices in effect on the date of this Agreement applied, to the extent applicable, on a basis consistent with that used in the preparation of the Financial Statements furnished to the Lenders pursuant to SECTION 5.5(j) AND (k) hereof. "Section" means a numbered section of this Agreement, unless another document is specifically referenced. "Significant Subsidiary" shall mean and include, at any time, each Subsidiary of the Borrower to the extent that the Net Worth of such Subsidiary is equal to or greater than $5,000,000. "Single Employer Plan" means a Plan subject to Title IV of ERISA maintained by either Loan Party or any member of the Controlled Group for employees of either Loan Party or any member of the Controlled Group, other than a Multiemployer Plan. "Solvent" means, when used with respect to a Person, that (a) the fair saleable value of the assets of such Person is in excess of the total amount of the present value of its liabilities (including for purposes of this definition all liabilities (including loss reserves as determined by such Person), whether or not reflected on a balance sheet prepared in accordance with Agreement Accounting Principles and whether direct or indirect, fixed or contingent, secured or unsecured, disputed or undisputed), (b) such Person is able to pay its debts or obligations in the ordinary course as they mature and (c) such Person does not have unreasonably small capital to carry out its business as conducted and as proposed to be conducted. "Solvency" shall have a correlative meaning. "SOMSC" means Source One Mortgage Services Corporation, a Delaware corporation. "SOMSC Credit Agreements" means the credit agreement or credit agreements from time to time in effect among SOMSC, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented, restated, replaced or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "Statutory Surplus" means, with respect to any Insurance Subsidiary at any time, the statutory capital and surplus of such Insurance Subsidiary at such time, as determined in accordance -14- with SAP ("Liabilities, Surplus and Other Funds" statement, page 3, line 25 of the Annual Statement for the 1995 Fiscal Year entitled "Surplus as Regards Policyholders"). "Subsidiary" of a Person means (a) any corporation more than 50% of the outstanding securities having ordinary voting power of which shall at the time be owned or controlled, directly or indirectly, by such Person or by one or more of its Subsidiaries or by such Person and one or more of its Subsidiaries, or (b) any partnership, association, joint venture, limited liability company or similar business organization more than 50% of the ownership interests having ordinary voting power of which shall at the time be so owned or controlled. Unless otherwise expressly provided, all references herein to a "Subsidiary" shall mean a Subsidiary of the Borrower. "Termination Event" means, with respect to a Plan which is subject to Title IV of ERISA, (a) a Reportable Event, (b) the withdrawal of either Loan Party or any other member of the Controlled Group from such Plan during a plan year in which either Loan Party or any other member of the Controlled Group was a "substantial employer" as defined in Section 4001(a)(2) of ERISA or was deemed such under Section 4068(f) of ERISA, (c) the termination of such Plan, the filing of a notice of intent to terminate such Plan or the treatment of an amendment of such Plan as a termination under Section 4041 of ERISA, (d) the institution by the PBGC of proceedings to terminate such Plan or (e) any event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or appointment of a trustee to administer, such Plan. "Transferee" is defined in SECTION 12.4. "Type" means, with respect to any Advance, its nature as an ABR Advance or Eurodollar Advance. "Unfunded Liability" means the amount (if any) by which the present value of all vested and unvested accrued benefits under a Single Employer Plan exceeds the fair market value of assets allocable to such benefits, all determined as of the then most recent valuation date for such Plans using PBGC actuarial assumptions for single employer plan terminations. "Unmatured Default" means an event which but for the lapse of time or the giving of notice, or both, would constitute a Default. "Unrestricted Subsidiary" means SOMSC and its Subsidiaries. "White Mountains Credit Agreement" means the Second Amended and Restated Credit Agreement, dated as of August 14, 1998, among Parent, the financial institutions from time to time party thereto and First Chicago, as agent, as the same may be amended, supplemented or otherwise modified from time to time (and, subsequent to the termination thereof, as in effect on the date of such termination). "Wholly-Owned Subsidiary" of a Person means (a) any Subsidiary all of the outstanding voting securities of which (other than directors' qualifying or similar shares) shall at the time be -15- owned or controlled, directly or indirectly, by such Person or one or more Wholly-Owned Subsidiaries of such Person, or by such Person and one or more Wholly-Owned Subsidiaries of such Person, or (b) any partnership, association, joint venture, limited liability company or similar business organization 100% of the ownership interests having ordinary voting power of which (other than directors' qualifying or similar shares) shall at the time be so owned or controlled. "Year 2000 Issues" means anticipated costs, problems and uncertainties associated with the inability of certain computer applications and hardware to effectively function on and after January 1, 2000, as such inability affects the business, operations and financial condition of either Loan Party and their Subsidiaries and of either Loan Party's and their Subsidiaries' material customers, suppliers and vendors. "Year 2000 Program" is defined in SECTION 5.22. The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms. References herein to particular columns, lines or sections of any Person's Annual Statement shall be deemed, where appropriate, to be references to the corresponding column, line or section of such Person's Quarterly Statement, or if no such corresponding column, line or section exists or if any report form changes, then to the corresponding item referenced thereby. In the event that the columns, lines or sections of the Annual Statement referenced herein are changed or renumbered, all such references shall be deemed references to such column, line or section as so renumbered or changed. Each accounting term used herein which is not otherwise defined herein shall be defined in accordance with Agreement Accounting Principles or SAP, as applicable, unless otherwise specified. ARTICLE II THE CREDITS 2.1. ADVANCES. (a) From and including the date hereof to but excluding the Facility Termination Date, each Lender severally (and not jointly) agrees, on the terms and conditions set forth in this Agreement, to make Advances to the Borrower from time to time in amounts not to exceed in the aggregate at any one time outstanding the amount of its pro-rata share of the Aggregate Commitment existing at such time. Subject to the terms of this Agreement, the Borrower may borrow, repay and reborrow Advances at any time prior to the Facility Termination Date. (b) The Borrower hereby agrees that if at any time, as a result of reductions in the Aggregate Commitment pursuant to SECTION 2.7 or otherwise, the aggregate balance of the Loans exceeds the Aggregate Commitment, the Borrower shall repay immediately its then outstanding Loans in such amount as may be necessary to eliminate such excess. (c) The Borrower's obligation to pay the principal of, and interest on, the Loans shall be evidenced by the Notes. Although the Notes shall be dated the date of this Agreement, -16- interest in respect thereof shall be payable only for the periods during which the Loans evidenced thereby are outstanding and, although the stated amount of each Note shall be equal to the applicable Lender's Commitment, each Note shall be enforceable, with respect to the Borrower's obligation to pay the principal amount thereof, only to the extent of the unpaid principal amount of the Loans at the time evidenced thereby. (d) All Advances and all Loans shall mature, and the principal amount thereof and the unpaid accrued interest thereon shall be due and payable, on the Facility Termination Date. 2.2. RATABLE LOANS. Each Advance hereunder shall consist of Loans made from the several Lenders ratably in proportion to the ratio that their respective Commitments bear to the Aggregate Commitment. 2.3. TYPES OF ADVANCES. The Advances may be ABR Advances or Eurodollar Advances, or a combination thereof, selected by the Borrower in accordance with SECTIONS 2.8 and 2.9. 2.4. FACILITY FEE; REDUCTIONS IN AGGREGATE COMMITMENT. (a) The Borrower agrees to pay to the Agent for the account of each Lender a facility fee ("Facility Fee") in an amount equal to the Applicable Facility Fee Margin per annum times the daily average Commitment of such Lender from the date hereof to and including the Facility Termination Date, payable on each Payment Date hereafter and on the Facility Termination Date. All accrued Facility Fees shall be payable on the effective date of any termination of the obligations of the Lenders to make Loans hereunder. (b) The Borrower may permanently reduce the Aggregate Commitment in whole, or in part ratably among the Lenders in a minimum aggregate amount of $1,000,000 upon at least three (3) Business Days' written notice to the Agent, which notice shall specify the amount of any such reduction; PROVIDED, HOWEVER, that the amount of the Aggregate Commitment may not be reduced below the aggregate principal amount of the outstanding Advances. Such reductions shall be in addition to reductions occurring pursuant to SECTION 2.7(b). Voluntary commitment reductions pursuant to this SECTION 2.4(b) shall be applied to the mandatory commitment reductions required to be made pursuant to SECTION 2.7(a) in direct order of maturity. 2.5. MINIMUM AMOUNT OF EACH ADVANCE. Each Advance shall be in the minimum amount of $1,000,000 (and in integral multiples of $500,000 if in excess thereof); PROVIDED, HOWEVER, that (a) any ABR Advance may be in the amount of the unused Aggregate Commitment and (b) in no event shall more than six (6) Eurodollar Advances be permitted to be outstanding at any time. 2.6. OPTIONAL PRINCIPAL PAYMENTS. The Borrower may from time to time pay, without penalty or premium, all outstanding ABR Advances, or, in a minimum aggregate amount of $1,000,000 any portion of the outstanding ABR Advances upon two (2) Business Days' prior notice to the Agent. Subject to SECTION 3.4 and upon like notice, a Eurodollar Advance may be paid prior -17- to the last day of the applicable Interest Period in a minimum amount of $1,000,000 or an integral multiple of $500,000 in excess thereof. 2.7. MANDATORY COMMITMENT REDUCTIONS. (a) The Aggregate Commitment shall be automatically and permanently reduced by the following amounts (or such lesser amount as a result of reductions pursuant to SECTION 2.7(c)) on the following dates:
DATE REDUCTION AMOUNT ---- ---------------- June 30, 1999 $ 1,000,000 June 30, 2000 $ 2,000,000 June 30, 2001 $ 2,000,000 July 30, 2002 $10,000,000
(b) The Aggregate Commitment shall also be automatically and permanently reduced in the amounts and at the times set forth below: (i) within one hundred eighty (180) days after the receipt in the form of cash or cash equivalents thereof by the Borrower, 100% of the aggregate Net Available Proceeds in excess of $1,000,000 realized upon all Asset Dispositions in any Fiscal Year of the Borrower; and (ii) within five (5) Business Days after the receipt in the form of cash or cash equivalents thereof by the Borrower, 85% of the Net Available Proceeds realized upon the sale by the Borrower of any equity securities issued by it or equity contributed to it after the date of this Agreement in excess of an aggregate amount of $1,000,000 (other than a sale of common stock of the Borrower to Parent). (c) Mandatory commitment reductions under SECTION 2.7(b) shall be cumulative and in addition to reductions occurring pursuant to SECTION 2.4(b). Any mandatory commitment reductions under SECTION 2.7(b) shall be applied to the mandatory commitment reductions required to be made pursuant to SECTION 2.7(a) in the inverse order of maturity. (d) Any reduction in the Aggregate Commitment pursuant to this SECTION 2.7 or otherwise shall ratably reduce the Commitment of each Lender. 2.8. METHOD OF SELECTING TYPES AND INTEREST PERIODS FOR NEW ADVANCES. The Borrower shall select the Type of Advance and, in the case of each Eurodollar Advance, the Interest Period applicable to each Advance from time to time; PROVIDED, HOWEVER, that in the event Loans are incurred on the date of this Agreement, all Loans incurred on such date shall be ABR Advances. The Borrower shall give the Agent irrevocable notice (a "BORROWING NOTICE") not later than 10:00 a.m. (Chicago time) on the Borrowing Date of each ABR Advance and at least three (3) Business Days before the Borrowing Date for each Eurodollar Advance, specifying: -18- (a) the Borrowing Date of such Advance, which shall be a Business Day; (b) the aggregate amount of such Advance; (c) the Type of Advance selected; (d) in the case of each Eurodollar Advance, the Interest Period applicable thereto, which shall end on or prior to the Facility Termination Date; and (e) any changes to money transfer instructions previously delivered to the Agent. Not later than noon (Chicago time) on each Borrowing Date, each Lender shall make available its Loan or Loans, in funds immediately available in Chicago, to the Agent at its address specified pursuant to ARTICLE XIII. The Agent will make the funds so received from the Lenders available to the Borrower at the Agent's aforesaid address or at such account at such other institution in the United States of America as the Borrower may indicate in the Borrowing Notice. 2.9. CONVERSION AND CONTINUATION OF OUTSTANDING ADVANCES. ABR Advances shall continue as ABR Advances unless and until such ABR Advances are converted into Eurodollar Advances. Each Eurodollar Advance shall continue as a Eurodollar Advance until the end of the then applicable Interest Period therefor, at which time such Eurodollar Advance shall be automatically converted into an ABR Advance unless the Borrower shall have given the Agent a Conversion/Continuation Notice requesting that, at the end of such Interest Period, such Eurodollar Advance continue as a Eurodollar Advance for the same or another Interest Period. Subject to the terms of SECTION 2.5, the Borrower may elect from time to time to convert all or any part of an Advance of any Type into any other Type or Types of Advances; PROVIDED, HOWEVER, that any conversion of any Eurodollar Advance shall be made on, and only on, the last day of the Interest Period applicable thereto. The Borrower shall give the Agent irrevocable notice (a "CONVERSION/ CONTINUATION NOTICE") of each conversion of an ABR Advance or continuation of a Eurodollar Advance not later than 10:00 a.m. (Chicago time) on the conversion date, in the case of a conversion into an ABR Advance, or at least three (3) Business Days, in the case of a conversion into or continuation of a Eurodollar Advance, prior to the date of the requested conversion or continuation, specifying: (a) the requested date of such conversion or continuation, which shall be a Business Day; (b) the aggregate amount and Type of the Advance which is to be converted or continued; and (c) the amount and Type(s) of Advance(s) into which such Advance is to be converted or continued and, in the case of a conversion into or continuation of a Eurodollar Advance, the duration of the Interest Period applicable thereto, which shall end on or prior to the Facility Termination Date. 2.10. CHANGES IN INTEREST RATE, ETC. Each ABR Advance shall bear interest at the Alternate Base Rate from and including the date of such Advance or the date on which such Advance -19- was converted into an ABR Advance to (but not including) the date on which such ABR Advance is paid or converted to a Eurodollar Advance. Changes in the rate of interest on that portion of any Advance maintained as an ABR Advance will take effect simultaneously with each change in the Alternate Base Rate. Each Eurodollar Advance shall bear interest from and including the first day of the Interest Period applicable thereto to, but not including, the last day of such Interest Period at the Eurodollar Rate determined as applicable to such Eurodollar Advance plus the Applicable Eurodollar Margin. No Interest Period may end after the Facility Termination Date. The Borrower shall select Interest Periods so that it is not necessary to repay any portion of a Eurodollar Advance prior to the last day of the applicable Interest Period in order to make a mandatory repayment required pursuant to SECTION 2.7(A). 2.11. RATES APPLICABLE AFTER DEFAULT. Notwithstanding anything to the contrary contained in SECTIONS 2.8 or 2.9, no Advance may be made as, converted into or continued as a Eurodollar Advance (except with the consent of the Agent and the Required Lenders) when any Default or Unmatured Default has occurred and is continuing. During the continuance of a Default the Required Lenders may, at their option, by notice to the Borrower (which notice may be revoked at the option of the Required Lenders notwithstanding any provision of SECTION 8.2 requiring unanimous consent of the Lenders to changes in interest rates), declare that each Eurodollar Advance and ABR Advance shall bear interest (for the remainder of the applicable Interest Period in the case of Eurodollar Advances) at a rate per annum equal to the rate otherwise applicable plus two percent (2%) per annum; PROVIDED, HOWEVER, that such increased rate shall automatically and without action of any kind by the Lenders become and remain applicable until revoked by the Required Lenders in the event of a Default described in SECTIONS 7.6 or 7.7. 2.12. METHOD OF PAYMENT. All payments of the Obligations hereunder shall be made, without setoff, deduction or counterclaim, in immediately available funds to the Agent at the Agent's address specified pursuant to ARTICLE XIII, or at any other Lending Installation of the Agent specified in writing by the Agent to the Borrower (at least two (2) Business Days in advance) by noon (Chicago time) on the date when due and shall be applied ratably by the Agent among the Lenders. Each payment delivered to the Agent for the account of any Lender shall be delivered promptly by the Agent to such Lender in the same type of funds that the Agent received at its address specified pursuant to ARTICLE XIII or at any Lending Installation specified in a notice received by the Agent from such Lender. The Agent is hereby authorized to charge the account of the Borrower maintained with the Agent for each payment of principal, interest and fees as it becomes due hereunder. 2.13. NOTES. Each Lender is hereby authorized to record the principal amount of each of its Loans and each repayment on the schedule attached to its Note; PROVIDED, HOWEVER, that neither the failure to so record nor any error in such recordation shall affect the Borrower's obligations under such Note. 2.14. INTEREST PAYMENT DATES; INTEREST AND FEE BASIS. Interest accrued on each ABR Advance shall be payable on each Payment Date, commencing with the first such date to occur after the date hereof, on any date on which an ABR Advance is prepaid, whether due to acceleration or otherwise, and at maturity. Interest accrued on that portion of the outstanding principal amount of -20- any ABR Advance converted into a Eurodollar Advance on a day other than a Payment Date shall be payable on the date of conversion. Interest accrued on each Eurodollar Advance shall be payable on the last day of its applicable Interest Period, on any date on which the Eurodollar Advance is prepaid, whether by acceleration or otherwise, and at maturity. Interest accrued on each Eurodollar Advance having an Interest Period longer than three (3) months shall also be payable on the last day of each three-month interval during such Interest Period. Interest and commitment fees shall be calculated for actual days elapsed on the basis of a 360-day year. Interest shall be payable for the day an Advance is made but not for the day of any payment on the amount paid if payment is received prior to noon (Chicago time) at the place of payment. If any payment of principal of or interest on an Advance shall become due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day and, in the case of a principal payment, such extension of time shall be included in computing interest in connection with such payment. 2.15. NOTIFICATION OF ADVANCES, INTEREST RATES, PREPAYMENTS AND COMMITMENT REDUCTIONS. Promptly after receipt thereof, the Agent will notify each Lender of the contents of each Aggregate Commitment reduction notice, Borrowing Notice, Conversion/Continuation Notice, and repayment notice received by it hereunder. The Agent will notify each Lender of the interest rate applicable to each Eurodollar Advance promptly upon determination of such interest rate and will give each Lender prompt notice of each change in the Alternate Base Rate. 2.16. LENDING INSTALLATIONS. Each Lender may book its Loans at any Lending Installation selected by such Lender and may change its Lending Installation from time to time. All terms of this Agreement shall apply to any such Lending Installation and the Notes shall be deemed held by each Lender for the benefit of such Lending Installation. Each Lender may, by written or telex notice to the Agent and the Borrower, designate a Lending Installation through which Loans will be made by it and for whose account Loan payments are to be made. 2.17. NON-RECEIPT OF FUNDS BY THE AGENT. Unless the Borrower or a Lender, as the case may be, notifies the Agent prior to the date on which it is scheduled to make payment to the Agent of (a) in the case of a Lender, the proceeds of a Loan, or (b) in the case of the Borrower, a payment of principal, interest or fees to the Agent for the account of the Lenders, that it does not intend to make such payment, the Agent may assume that such payment has been made. The Agent may, but shall not be obligated to, make the amount of such payment available to the intended recipient in reliance upon such assumption. If the Borrower has not in fact made such payment to the Agent, the Lenders shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to the Federal Funds Effective Rate for such day. If any Lender has not in fact made such payment to the Agent, such Lender or the Borrower shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to (a) in the case of payment by a Lender, the Federal Funds Effective Rate for such day, or (b) in the case of payment by the Borrower, the interest rate applicable to the relevant Loan. -21- 2.18. TAXES. (a) Any payments made by either Loan Party under this Agreement or any other Loan Document shall be made free and clear of, and without deduction or withholding for or on account of, any present or future income, stamp or other taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed by any Governmental Authority, excluding net income taxes and franchise taxes or any other tax based upon any income imposed on the Agent or any Lender by the jurisdiction in which the Agent or such Lender is incorporated or has its principal place of business or maintains its Lending Installation. If any such non-excluded taxes, levies, imposts, duties, charges, fees, deductions or withholdings ("Non-Excluded Taxes") are required to be withheld from any amounts payable to the Agent or any Lender hereunder, the amounts so payable to the Agent or such Lender shall be increased to the extent necessary to yield to the Agent or such Lender (after payment of all Non- Excluded Taxes) interest or any such other amounts payable hereunder at the rates or in the amounts specified in or pursuant to this Agreement; PROVIDED, HOWEVER, that no Loan Party shall be required to increase any such amounts payable to any Lender that is not organized under the laws of the U.S. or a state thereof if such Lender fails to comply with the requirements of paragraph (b) of this SECTION 2.18. Whenever any Non-Excluded Taxes are payable by either Loan Party, as promptly as practicable thereafter such Loan Party shall send to the Agent for its own account or for the account of such Lender, as the case may be, a certified copy of an original official receipt received by such Loan Party showing payment thereof. If either Loan Party fails to pay any Non-Excluded Taxes when due to the appropriate taxing authority or fails to remit to the Agent the required receipts or other required documentary evidence, each Loan Party shall indemnify the Agent and the Lenders for any incremental taxes, interest or penalties that may become payable by any Agent or any Lender as a result of any such failure. The agreements in this SECTION 2.18 shall survive the termination of this Agreement and the payment of all other amounts payable hereunder. (b) At least five (5) Business Days prior to the first date on which interest or fees are payable hereunder for the account of any Lender, each Lender that is not incorporated under the laws of the United States of America, or a state thereof, agrees that it will deliver to each of the Borrower and the Agent two (2) duly completed and properly executed copies of United States Internal Revenue Service Form 1001 or 4224 (or a successor form), certifying in either case that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes. Each Lender which so delivers a Form 1001 or 4224 (or a successor form) further undertakes to deliver to each of the Borrower and the Agent two (2) additional duly completed and properly executed copies of such form (or a successor form) on or before the date that such form expires (currently, three (3) successive calendar years for Form 1001 and each tax year for Form 4224) or becomes obsolete or after the occurrence of any event requiring a change in the most recent forms so delivered by it, and such amendments thereto or extensions or renewals thereof as may be reasonably requested by the Borrower or the Agent, in each case certifying that such Lender is entitled to receive payments under this Agreement and the Notes without deduction or withholding of any United States federal income taxes, unless an event (including, without limitation, any change in treaty, law or regulation) has occurred prior to the date on which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Lender from duly completing and delivering any such form with -22- respect to it and such Lender advises the Borrower and the Agent that it is not capable of receiving payments without any deduction or withholding of United States federal income tax. 2.19. AGENT'S FEES. The Borrower shall pay to the Agent those fees, in addition to the Facility Fees referenced in SECTION 2.4(a), in the amounts and at the times separately agreed to between the Agent and the Borrower. ARTICLE III CHANGE IN CIRCUMSTANCES 3.1. YIELD PROTECTION. If, after the date hereof, the adoption of or any change in any law or any governmental or quasi-governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any new interpretation thereof, or the compliance of any Lender with such adoption, change or interpretation, (a) subjects any Lender or any applicable Lending Installation to any tax, duty, charge or withholding on or from payments due from the Borrower (excluding taxation of the overall net income of any Lender or applicable Lending Installation imposed by the jurisdiction in which such Lender or Lending Installation is incorporated or has its principal place of business), or changes the basis of taxation of principal, interest or any other payments to any Lender or Lending Installation in respect of its Loans or other amounts due it hereunder, or (b) imposes or increases or deems applicable any reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender or any applicable Lending Installation (other than reserves and assessments taken into account in determining the interest rate applicable to Eurodollar Advances), or (c) imposes any other condition the result of which is to increase the cost to any Lender or any applicable Lending Installation of making, funding or maintaining Loans or reduces any amount receivable by any Lender or any applicable Lending Installation in connection with any Loans, or requires any Lender or any applicable Lending Installation to make any payment calculated by reference to the amount of Loans held, or interest received by it, by an amount deemed material by such Lender, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender that portion of such increased expense incurred or resulting in an amount received which such Lender determines is attributable to making, funding and maintaining its Loans and its Commitment. 3.2. CHANGES IN CAPITAL ADEQUACY REGULATIONS. If a Lender determines the amount of capital required or expected to be maintained by such Lender, any Lending Installation of such -23- Lender or any corporation controlling such Lender is increased as a result of a Change, then, within fifteen (15) days of demand by such Lender, the Borrower shall pay such Lender the amount necessary to compensate for any shortfall in the rate of return on the portion of such increased capital which such Lender determines is attributable to this Agreement, its Loans or its obligation to make Loans hereunder (after taking into account such Lender's policies as to capital adequacy). "CHANGE" means (a) any change after the date of this Agreement in the Risk-Based Capital Guidelines, or (b) any adoption of or change in any other law, governmental or quasi-governmental rule, regulation, policy, guideline, interpretation, or directive (whether or not having the force of law) after the date of this Agreement which affects the amount of capital required or expected to be maintained by any Lender or any Lending Installation or any corporation controlling any Lender. "RISK-BASED CAPITAL GUIDELINES" means (a) the risk-based capital guidelines in effect in the United States on the date of this Agreement and (b) the corresponding capital regulations promulgated by regulatory authorities outside the United States implementing the July 1988 report of the Basle Committee on Banking Regulation and Supervisory Practices entitled "International Convergence of Capital Measurements and Capital Standards" and any amendments to such regulations adopted prior to the date of this Agreement. 3.3. AVAILABILITY OF TYPES OF ADVANCES. If any Lender determines that maintenance of its Eurodollar Loans at a suitable Lending Installation would violate any applicable law, rule, regulation, or directive, whether or not having the force of law, or if the Required Lenders determine that (a) deposits of a type and maturity appropriate to match fund Eurodollar Advances are not available, or (b) the interest rate applicable to a Eurodollar Advance does not accurately or fairly reflect the cost of making or maintaining such Advance, then the Agent shall suspend the availability of the Eurodollar Advances until such circumstance no longer exists and require any Eurodollar Advances to be repaid. 3.4. FUNDING INDEMNIFICATION. If any payment of a Eurodollar Advance occurs on a date which is not the last day of the applicable Interest Period, whether because of acceleration, prepayment or otherwise, or a Eurodollar Advance is not made on the date specified by the Borrower for any reason other than default by the Lenders, the Borrower will indemnify the Agent and each Lender for any loss or cost incurred by it resulting therefrom, including, without limitation, any loss or cost in liquidating or employing deposits acquired to fund or maintain the Eurodollar Advance. 3.5. LENDER STATEMENTS; SURVIVAL OF INDEMNITY. To the extent reasonably possible, each Lender shall designate an alternate Lending Installation with respect to its Eurodollar Advances to reduce any liability of the Borrower to such Lender under SECTIONS 2.18, 3.1 and 3.2 or to avoid the unavailability of a Type of Advance under SECTION 3.3, so long as such designation is not disadvantageous to such Lender. Each Lender shall deliver a written statement of such Lender to the Borrower (with a copy to the Agent) as to the amount due, if any, under SECTIONS 3.1, 3.2 or 3.4. Such written statement shall set forth in reasonable detail the calculations upon which such Lender determined such amount and shall be final, conclusive and binding on the Borrower in the absence of manifest error. Determination of amounts payable under such Sections in connection with a Eurodollar Advance shall be calculated as though each Lender funded its Eurodollar Advances through the purchase of a deposit of the type and maturity corresponding to the deposit used as a -24- reference in determining the Eurodollar Rate applicable to such Loan, whether in fact that is the case or not. Unless otherwise provided herein, the amount specified in the written statement of any Lender shall be payable on demand after receipt by the Borrower of the written statement. The obligations of the Borrower under SECTIONS 3.1, 3.2 and 3.4 shall survive payment of the Obligations and termination of this Agreement. ARTICLE IV CONDITIONS PRECEDENT 4.1. EFFECTIVENESS. The Lenders shall not be required to make the initial Advance hereunder unless and until each Loan Party has furnished the following to the Agent with sufficient copies for the Lenders and the other conditions set forth below have been satisfied: (a) CHARTER DOCUMENTS; GOOD STANDING CERTIFICATES. Copies of the certificate of incorporation of each Loan Party, together with all amendments thereto, both certified by the appropriate governmental officer in its jurisdiction of incorporation, together with a good standing certificate issued by the Secretary of State of the jurisdiction of its incorporation and such other jurisdictions as shall be reasonably requested by the Agent. (b) BY-LAWS AND RESOLUTIONS. Copies, certified by the Secretary or Assistant Secretary of the relevant Loan Party, of its by-laws and of its Board of Directors' resolutions authorizing the execution, delivery and performance of the Loan Documents to which it is a party. (c) SECRETARY'S CERTIFICATE. An incumbency certificate, executed by the Secretary or Assistant Secretary of the relevant Loan Party, which shall identify by name and title and bear the signature of the officers of such Loan Party authorized to sign the Loan Documents and, in the case of the Borrower, to make borrowings hereunder, upon which certificate the Agent and the Lenders shall be entitled to rely until informed of any change in writing by the Borrower. (d) OFFICER'S CERTIFICATE. A certificate signed by an Authorized Officer of the Borrower, in form and substance satisfactory to the Agent, to the effect that on the Restatement Effective Date (both before and after giving effect to the consummation of the transactions contemplated hereby and the making of the Loans hereunder, if any, being made on such date): (i) no Default or Unmatured Default has occurred and is continuing; (ii) no injunction or temporary restraining order which would prohibit the making of any Loans or other litigation which could reasonably be expected to have a Material Adverse Effect is pending or, to the best of such Person's knowledge, threatened; (iii) all orders, consents, approvals, licenses, authorizations, or validations of, or filings, recordings or registrations with, or exemptions by, any Governmental Authority required in connection with the execution, delivery and performance of this Agreement have been or, prior to the time -25- required, will have been, obtained, given, filed or taken and are or will be in full force and effect (or the relevant Loan Party has obtained effective judicial relief with respect to the application thereof) and all applicable waiting periods have expired; (iv) each of the representations and warranties set forth in ARTICLE V of this Agreement is true and correct on and as of the Restatement Effective Date; and (v) since December 31, 1997, no event or change has occurred that has caused or evidences a Material Adverse Effect. (e) LEGAL OPINION. A written opinion of Brobeck, Phleger & Harrison LLP., counsel to each Loan Party, addressed to the Agent and the Lenders in form and substance acceptable to the Agent and its counsel. (f) NOTES. Notes payable to the order of each of the Lenders duly executed by the Borrower. (g) LOAN DOCUMENTS. Executed originals of this Agreement and each of the Loan Documents, which shall be in full force and effect, together with all schedules, exhibits, certificates, instruments, opinions, documents and financial statements required to be delivered pursuant hereto and thereto. (h) LETTERS OF DIRECTION. Written money transfer instructions with respect to the initial Advances and to future Advances in form and substance acceptable to the Agent and its counsel addressed to the Agent and signed by an Authorized Officer, together with such other related money transfer authorizations as the Agent may have reasonably requested. (i) SOLVENCY CERTIFICATE. A written solvency certificate from the chief financial officer of the relevant Loan Party in form and content satisfactory to the Agent with respect to the value, Solvency and other factual information, or relating to, as the case may be, of such Loan Party on a consolidated basis. (j) REGULATORY MATTERS. Receipt of any required regulatory approvals from any Governmental Authority. (k) INVESTMENT POLICY GUIDELINES. Certified copy of the investment policy guidelines adopted by the finance committee of the board of directors of Parent and the board of directors of the Borrower. (l) PAYMENT OF FEES. The Borrower shall have paid all fees due to First Chicago. (m) FOLKSAMERICA LOAN AGREEMENT. A copy of the Folksamerica Loan Agreement, including all amendments thereto. (n) OTHER. Such other documents as the Agent, any Lender or their counsel may have reasonably requested. -26- 4.2. EACH FUTURE ADVANCE. The Lenders shall not be required to make any Advance unless on the applicable Borrowing Date: (a) There exists no Default or Unmatured Default and none would result from such Advance; (b) The representations and warranties contained in ARTICLE V are true and correct as of such Borrowing Date (except to the extent such representations and warranties are expressly made as of a specified date, in which event such representations and warranties shall be true and correct as of such specified date); (c) A Borrowing Notice shall have been properly submitted; and (d) All legal matters incident to the making of such Advance shall be satisfactory to the Lenders and their counsel. Each Borrowing Notice with respect to each such Advance shall constitute a representation and warranty by each Loan Party that the conditions contained in SECTIONS 4.2(a), (b) AND (c) have been satisfied. Any Lender may require a duly completed compliance certificate in substantially the form of EXHIBIT B hereto as a condition to making an Advance. ARTICLE V REPRESENTATIONS AND WARRANTIES Each Loan Party represents and warrants to the Lenders that: 5.1. CORPORATE EXISTENCE AND STANDING. Each Loan Party and each of its Subsidiaries is a corporation duly incorporated, validly existing and in good standing under the laws of its respective jurisdiction of incorporation and is duly qualified and in good standing as a foreign corporation and is duly authorized to conduct its business in each jurisdiction in which its business is conducted or proposed to be conducted, except where the failure to be so qualified could not reasonably be expected to have a Material Adverse Effect. 5.2. AUTHORIZATION AND VALIDITY. Each Loan Party has all requisite power and authority (corporate and otherwise) and legal right to execute and deliver each of the Loan Documents to which it is a party and to perform its obligations thereunder. The execution and delivery by each Loan Party of the Loan Documents to which it is a party and the performance of its obligations thereunder have been duly authorized by proper corporate proceedings and the Loan Documents constitute legal, valid and binding obligations of such Loan Party enforceable against it in accordance with their terms, except as enforceability may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally. 5.3. COMPLIANCE WITH LAWS AND CONTRACTS. Each Loan Party and each of its Subsidiaries have complied in all material respects with all applicable statutes, rules, regulations, orders and -27- restrictions of any domestic or foreign government or any instrumentality or agency thereof, having jurisdiction over the conduct of their respective businesses or the ownership of their respective properties, except where the failure to so comply could not reasonably be expected to have a Material Adverse Effect. Neither the execution and delivery by either Loan Party of the Loan Documents to which it is party, the application of the proceeds of the Loans or the consummation of the transactions contemplated in the Loan Documents, nor compliance with the provisions of the Loan Documents will, or at the relevant time did, (a) violate any law, rule, regulation (including Regulations T, U and X), order, writ, judgment, injunction, decree or award binding on such Loan Party or any of its Subsidiaries or the charter, articles or certificate of incorporation or by-laws of such Loan Party or any of its Subsidiaries, (b) violate the provisions of or require the approval or consent of any party to any indenture, instrument or agreement to which such Loan Party or any of its Subsidiaries is a party or is subject, or by which it, or its property, is bound, or conflict with or constitute a default thereunder, or result in the creation or imposition of any Lien (other than Liens permitted by, the Loan Documents) in, of or on the property of such Loan Party or any of its Subsidiaries pursuant to the terms of any such indenture, instrument or agreement, or (c) require any consent of the stockholders of any Person, except for approvals or consents which will be obtained on or before the initial Advance and are disclosed on SCHEDULE 5.3, except for any violation of, or failure to obtain an approval or consent required under, any such indenture, instrument or agreement that could not reasonably be expected to have a Material Adverse Effect. 5.4. GOVERNMENTAL CONSENTS. No order, consent, approval, qualification, license, authorization, or validation of, or filing, recording or registration with, or exemption by, or other action in respect of, any court, governmental or public body or authority, or any subdivision thereof, any securities exchange or other Person is or at the relevant time was required to authorize, or is or at the relevant time was required in connection with the execution, delivery, consummation or performance of, or the legality, validity, binding effect or enforceability of, any of the Loan Documents or the application of the proceeds of the Loans or any other transaction contemplated in the Loan Documents. No Loan Party nor any of its Subsidiaries is in default under or in violation of any foreign, federal, state or local law, rule, regulation, order, writ, judgment, injunction, decree or award binding upon or applicable to such Loan Party or such Subsidiary, in each case the consequences of which default or violation could reasonably be expected to have a Material Adverse Effect. 5.5. FINANCIAL STATEMENTS. The Loan Parties have heretofore furnished to each of the Lenders (a) the December 31, 1997 audited consolidated financial statements of Parent and its Subsidiaries, (b) the unaudited consolidated financial statements of Parent and its Subsidiaries as of March 31, 1998, (c) the December 31, 1997 audited financial statements of Charter Group, Inc. and its Subsidiaries, (d) the December 31, 1997 audited financial statements of Valley Insurance Co. and its Subsidiaries, (e) the December 31, 1997 audited consolidated financial statements of the Borrower and its Subsidiaries, (f) the December 31, 1997 audited financial statements of SOMSC and its Subsidiaries , (g) the December 31, 1997 audited financial statements of Holdings and its Subsidiaries, (h) the December 31, 1997 audited financial statements of Folksamerica and its Subsidiaries, (i) the December 31, 1997 audited financial statements of Main Street America Holdings, Inc. and its Subsidiaries, (j) the March 31, 1998 unaudited balance sheets and income -28- statements of Holdings, Parent, the Borrower , SOMSC, Folksamerica and Main Street America Holdings, Inc., (k) the December 31, 1997 Annual Statement of each Insurance Subsidiary of Parent and the Borrower and Folksamerica Reinsurance Company and (l) the March 31, 1998 Quarterly Statement of each Insurance Subsidiary of Parent and the Borrower and Folksamerica Reinsurance Company (collectively, the "FINANCIAL STATEMENTS"). Each of the Financial Statements (other than as described in CLAUSE (j)) was prepared in accordance with Agreement Accounting Principles or SAP, as applicable, and fairly presents the consolidated financial condition and operations of the Person which is the subject of such Financial Statements at such dates and the consolidated results of their operations for the respective periods then ended (except, in the case of such unaudited statements, for normal year-end audit adjustments). 5.6. MATERIAL ADVERSE CHANGE. No material adverse change in the business, Property, condition (financial or otherwise), performance, prospects or results of operations of either Loan Party and its Subsidiaries has occurred since December 31, 1997, except as specifically disclosed in the Financial Statements. 5.7. TAXES. Neither Loan Party nor any of its Subsidiaries is required to file United States federal, foreign, state or local tax returns. As of the date hereof, the United States income tax returns of Holdings on a consolidated basis have been audited by the Internal Revenue Service through its fiscal period ending December 31, 1988, and all tax years beginning on or after January 1, 1989 are currently being audited or are subject to audit. No tax liens have been filed and no claims are being asserted with respect to any taxes of Holdings which could reasonably be expected to have a Material Adverse Effect. The charges, accruals and reserves on the books of Holdings in respect of any taxes or other governmental charges of Holdings are in accordance with Agreement Accounting Principles. 5.8. LITIGATION AND CONTINGENT OBLIGATIONS. There is no litigation, arbitration, proceeding, inquiry or governmental investigation pending or, to the knowledge of any of their officers, threatened against or affecting either Loan Party or any of its Subsidiaries or any of their respective properties which could reasonably be expected to have a Material Adverse Effect or to prevent, enjoin or unduly delay the making of the Loans under this Agreement. No Loan Party nor any of its Subsidiaries has any material contingent obligations incurred outside of the ordinary course of its business except as set forth on SCHEDULE 5.16 or disclosed in the Financial Statements or in the financial statements required to be delivered under SECTIONS 6.1(a) and (b) and as permitted under this Agreement. 5.9. CAPITALIZATION. SCHEDULE 5.9 hereto contains (a) an accurate description of each Loan Party's capitalization as of March 31, 1998 and (b) an accurate list of all of the existing Subsidiaries of each Loan Party as of the date of this Agreement, setting forth their respective jurisdictions of incorporation and the percentage of their capital stock owned by such Loan Party or its other Subsidiaries. All of the issued and outstanding shares of capital stock of each Loan Party and of each Subsidiary of such Loan Party have been duly authorized and validly issued, are fully paid and non-assessable, and are free and clear of all Liens. No authorized but unissued or treasury shares of capital stock of each Loan Party or any of its Subsidiaries are subject to any option, -29- warrant, right to call or commitment of any kind or character. Except as set forth on SCHEDULE 5.9 or pursuant to management incentive plans implemented after the date of this Agreement, no Loan Party nor any of its Subsidiaries has any outstanding stock or securities convertible into or exchangeable for any shares of its capital stock, or any right issued to any Person (either preemptive or other) to subscribe for or to purchase, or any options for the purchase of, or any agreements providing for the issuance (contingent or otherwise) of, or any calls, commitments or claims of any character relating to any of its capital stock or any stock or securities convertible into or exchangeable for any of its capital stock other than as expressly set forth in the certificate or articles of incorporation of such Loan Party or such Subsidiary. No Loan Party nor any of its Subsidiaries is subject to any obligation (contingent or otherwise) to repurchase or otherwise acquire or retire any shares of its capital stock or any convertible securities, rights or options of the type described in the preceding sentence except as otherwise set forth on SCHEDULE 5.9 or pursuant to management incentive plans implemented after the date of this Agreement. 5.10. ERISA. Except as disclosed on SCHEDULE 5.10, no Loan Party nor any other member of the Controlled Group maintains any Single Employer Plans, and no Single Employer Plan has any Unfunded Liability. No Loan Party nor any other member of the Controlled Group maintains, or is obligated to contribute to, any Multiemployer Plan or has incurred, or is reasonably expected to incur, any withdrawal liability to any Multiemployer Plan. Each Plan complies in all material respects with all applicable requirements of law and regulations other than any such failure to comply which could not reasonably be expected to have a Material Adverse Effect. No Loan Party nor any member of the Controlled Group has, with respect to any Plan, failed to make any contribution or pay any amount required under Section 412 of the Code or Section 302 of ERISA or the terms of such Plan. There are no pending or, to the knowledge of either Loan Party, threatened claims, actions, investigations or lawsuits against any Plan, any fiduciary thereof, or either Loan Party or any member of the Controlled Group with respect to a Plan. No Loan Party nor any member of the Controlled Group has engaged in any prohibited transaction (as defined in Section 4975 of the Code or Section 406 of ERISA) in connection with any Plan which would subject such Person to any material liability. Within the last five (5) years no Loan Party nor any member of the Controlled Group has engaged in a transaction which resulted in a Single Employer Plan with an Unfunded Liability being transferred out of the Controlled Group which could reasonably be expected to have a Material Adverse Effect. No Termination Event has occurred or is reasonably expected to occur with respect to any Plan which is subject to Title IV of ERISA which could reasonably be expected to have a Material Adverse Effect. 5.11. DEFAULTS. No Default or Unmatured Default has occurred and is continuing. 5.12. FEDERAL RESERVE REGULATIONS. No Loan Party nor any of its Subsidiaries is engaged, directly or indirectly, principally, or as one of its important activities, in the business of extending, or arranging for the extension of, credit for the purpose of purchasing or carrying Margin Stock. No part of the proceeds of any Loan will be used in a manner which would violate, or result in a violation of, Regulation T, Regulation U or Regulation X. Neither the making of any Advance hereunder nor the use of the proceeds thereof will violate or be inconsistent with the provisions of Regulation T, Regulation U or Regulation X. -30- 5.13. INVESTMENT COMPANY. No Loan Party nor any of its Subsidiaries is, or after giving effect to any Advance will be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 5.14. CERTAIN FEES. No broker's or finder's fee or commission was, is or will be payable by either Loan Party or any of its Subsidiaries with respect to any of the transactions contemplated by this Agreement, except as described in SECTION 9.5. Each Loan Party hereby agrees to indemnify the Agent and the Lenders against and agrees that it will hold each of them harmless from any claim, demand or liability for broker's or finder's fees or commissions alleged to have been incurred by either Loan Party in connection with any of the transactions contemplated by this Agreement and any expenses (including, without limitation, attorneys' fees and time charges of attorneys for the Agent or any Lender, which attorneys may be employees of the Agent or any Lender) arising in connection with any such claim, demand or liability. No other similar fee or commissions will be payable by either Loan Party or any of its Subsidiaries for any other services rendered to such Loan Party or such Subsidiary ancillary to any of the transactions contemplated by this Agreement. 5.15. SOLVENCY. As of the date hereof, after giving effect to the consummation of the transactions contemplated by the Loan Documents and the payment of all fees, costs and expenses payable by each Loan Party or any of its Subsidiaries with respect to the transactions contemplated by the Loan Documents and the application of the proceeds of Loans incurred by the Borrower on the initial Borrowing Date, each Loan Party and each of its Subsidiaries is Solvent. 5.16. INDEBTEDNESS. Attached hereto as SCHEDULE 5.16 is a complete and correct list of all Indebtedness of each Loan Party and each of its Subsidiaries outstanding on the date of this Agreement (other than Indebtedness in a principal amount not exceeding $100,000 for a single item of Indebtedness and $1,000,000 in the aggregate for all such Indebtedness listed, it being understood and agreed that any such Indebtedness shall be permitted to exist pursuant to SECTION 6.11(b) notwithstanding the absence thereof on SCHEDULE 5.16), showing the aggregate principal amount which was outstanding on such date after giving effect to the application of the proceeds of Loans incurred by the Borrower on the initial Borrowing Date. 5.17. INSURANCE LICENSES. SCHEDULE 5.17 hereto lists all of the jurisdictions in which any Insurance Subsidiary holds a License and is authorized to and does transact insurance business as of the date of this Agreement. No such License, the loss of which could reasonably be expected to have a Material Adverse Effect, is the subject of a proceeding for suspension or revocation. To each Loan Party's knowledge, there is no sustainable basis for such suspension or revocation, and no such suspension or revocation has been threatened by any Governmental Authority. 5.18. MATERIAL AGREEMENTS. Except as set forth in SCHEDULE 5.18 and except for agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries, no Loan Party nor any of its Subsidiaries is a party to any agreement or instrument or subject to any charter or other corporate restriction which could reasonably be expected to have a Material Adverse Effect or which restricts or imposes conditions upon the ability of any Subsidiary of a Loan Party (other -31- than an Unrestricted Subsidiary) to (a) pay dividends or make other distributions on its capital stock (b) make loans or advances to either Loan Party, (c) repay loans or advances from either Loan Party or (d) grant Liens to the Agent to secure the Obligations. No Loan Party nor any of its Subsidiaries is in default in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any agreement to which it is a party, which default could reasonably be expected to have a Material Adverse Effect. 5.19. ENVIRONMENTAL LAWS. There are no claims, investigations, litigation, administrative proceedings, notices, requests for information (each a "PROCEEDING"), whether pending or threatened, or judgments or orders asserting violations of applicable federal, state and local environmental, health and safety statutes, regulations, ordinances, codes, rules, orders, decrees, directives and standards ("ENVIRONMENTAL LAWS") or relating to any toxic or hazardous waste, substance or chemical or any pollutant, contaminant, chemical or other substance defined or regulated pursuant to any Environmental Law, including, without limitation, asbestos, petroleum, crude oil or any fraction thereof ("HAZARDOUS MATERIALS") asserted against either Loan Party or any of its Subsidiaries, other than in connection with an insurance policy issued in the ordinary course of business to any Person (other than Holdings or any Subsidiary of Holdings), which, in any case, could reasonably be expected to have a Material Adverse Effect. As of the date hereof, Parent and its Subsidiaries do not have liabilities exceeding $100,000 in the aggregate for all of them with respect to compliance with applicable Environmental Laws or related to the generation, treatment, storage, disposal, release, investigation or cleanup of Hazardous Materials, and no facts or circumstances exist which could give rise to such liabilities with respect to compliance with applicable Environmental Laws and the generation, treatment, storage, disposal, release, investigation or cleanup of Hazardous Materials. 5.20. INSURANCE. Each Loan Party and each of its Subsidiaries maintain with financially sound and reputable insurance companies insurance on their Property in such amounts and covering such risks as is consistent with sound business practice. 5.21. DISCLOSURE. No information, exhibit or report furnished by either Loan Party or any of its Subsidiaries to the Agent or to any Lender in connection with the negotiation of, or compliance with, the Loan Documents contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statements contained therein not materially misleading. There is no fact known to either Loan Party (other than matters of a general economic or political nature) that has had or could reasonably be expected to have a Material Adverse Effect and that has not been disclosed herein or in such other documents, certificates and statements furnished to the Lenders for use in connection with the transactions contemplated by this Agreement. 5.22. YEAR 2000. Each Loan Party has made a reasonable assessment of the Year 2000 Issues and has a realistic and achievable program for remediating the Year 2000 Issues on a timely basis (the "Year 2000 Program"). Based on such assessment and on the Year 2000 Program each Loan Party does not reasonably anticipate that Year 2000 Issues will have a Material Adverse Effect. -32- ARTICLE VI COVENANTS During the term of this Agreement, unless the Required Lenders shall otherwise consent in writing: 6.1. FINANCIAL REPORTING. Parent will maintain, for itself and each of its Subsidiaries, a system of accounting established and administered in accordance with generally accepted accounting principles, consistently applied, and furnish to the Lenders: (a) As soon as practicable and in any event within 100 days after the close of each of its Fiscal Years, an unqualified audit report certified by independent certified public accountants, acceptable to the Lenders, prepared in accordance with Agreement Accounting Principles on a consolidated and consolidating basis (consolidating statements need not be certified by such accountants) for itself and its Subsidiaries, including balance sheets as of the end of such period and related statements of income, retained earnings and cash flows accompanied by a certificate of said accountants that, in the course of the examination necessary for their certification of the foregoing, they have obtained no knowledge of any Default or Unmatured Default, or if, in the opinion of such accountants, any Default or Unmatured Default shall exist, stating the nature and status thereof. (b) As soon as practicable and in any event within sixty (60) days after the close of each of the first three Fiscal Quarters of each of its Fiscal Years, for itself and its Subsidiaries, consolidated and consolidating unaudited balance sheets as at the close of each such period and consolidated and consolidating statements of income, retained earnings and cash flows for the period from the beginning of such Fiscal Year to the end of such quarter, all certified by its chief financial officer. (c) (i) Upon the earlier of (A) fifteen (15) days after the regulatory filing date or (B) seventy-five (75) days after the close of each fiscal year of each Insurance Subsidiary of the Parent, copies of the unaudited Annual Statement of such Insurance Subsidiary, certified by the chief financial officer or the treasurer of such Insurance Subsidiary, all such statements to be prepared in accordance with SAP and (ii) no later than each June 15, copies of financial statements prepared in accordance with SAP, or generally accepted accounting principles with a reconciliation to SAP, and certified by independent certified public accountants of recognized national standing. (d) Upon the earlier of (i) ten (10) days after the regulatory filing date or (ii) sixty (60) days after the close of each of the first three (3) fiscal quarters of each fiscal year of each Insurance Subsidiary of the Parent, copies of the unaudited Quarterly Statement of each of the Insurance Subsidiaries of the Parent, certified by the chief financial officer or the treasurer of such Insurance Subsidiary, all such statements to be prepared in accordance with SAP. -33- (e) Promptly and in any event within ten (10) days after (i) learning thereof, notification of any changes after the date of this Agreement in the rating given by A.M. Best & Co. in respect of any Insurance Subsidiary of the Parent and (ii) receipt thereof, copies of any ratings analysis by A.M. Best & Co. relating to any Insurance Subsidiary of the Parent. (f) Copies of any outside actuarial reports prepared with respect to any valuation or appraisal of any Insurance Subsidiary of the Parent, promptly after the receipt thereof. (g) Together with the financial statements required by CLAUSES (a) and (b) above, a compliance certificate in substantially the form of EXHIBIT B hereto signed by the Borrower's chief financial officer showing the calculations necessary to determine compliance with this Agreement and stating that no Default or Unmatured Default exists, or if any Default or Unmatured Default exists, stating the nature and status thereof. (h) Promptly after the same becomes available after the close of each Fiscal Year, a statement of the Unfunded Liabilities of each Single Employer Plan, certified as correct by an actuary enrolled under ERISA. (i) As soon as possible and in any event within ten (10) days after such Loan Party knows that any Termination Event has occurred with respect to any Plan, a statement, signed by the chief financial officer of such Loan Party, describing said Termination Event and the action which such Loan Party proposes to take with respect thereto. (j) As soon as possible and in any event within ten (10) days after receipt by such Loan Party, a copy of (i) any notice, claim, complaint or order to the effect that such Loan Party or any of its Subsidiaries is or may be liable to any Person as a result of the release by such Loan Party or any of its Subsidiaries of any Hazardous Materials into the environment or requiring that action be taken to respond to or clean up a Release of Hazardous Materials into the environment, and (ii) any notice, complaint or citation alleging any violation of any Environmental Law or Environmental Permit by such Loan Party or any of its Subsidiaries. Within ten (10) days of such Loan Party or any of its Subsidiaries having knowledge of the enactment or promulgation of any Environmental Law which could reasonably be expected to have a Material Adverse Effect, such Loan Party shall provide the Agent with written notice thereof. (k) Promptly upon the furnishing thereof to the shareholders of such Loan Party, copies of all financial statements, reports and proxy statements so furnished. (l) Promptly upon the filing thereof, copies of all registration statements and annual, quarterly, monthly or other regular reports which such Loan Party or any of its Subsidiaries files with the Securities and Exchange Commission, the National Association of Securities Dealers, any securities exchange, the NAIC or any insurance commission -34- or department or analogous Governmental Authority (including any filing made by such Loan Party or any of its Subsidiaries pursuant to any insurance holding company act or related rules or regulations), but excluding routine or non-material filings with the NAIC, any insurance commissioner or department or analogous Governmental Authority. (m) Promptly and in any event within ten (10) days after learning thereof, notification of (i) any material tax assessment, demand, notice of proposed deficiency or notice of deficiency received by Holdings or any other Consolidated Person or (ii) the filing of any tax Lien or commencement of any judicial proceeding by or against any such Consolidated Person, if any such assessment, demand, notice, Lien or judicial proceeding relates to tax liabilities in excess of ten percent (10%) of the net worth (determined according to generally accepted accounting standards and without reduction for any reserve for such liabilities) of such Loan Party and its Subsidiaries taken as a whole. (n) Promptly after available, any management letter prepared by the accountants conducting the audit of the financial statements delivered pursuant to Section 6.1(a). (o) Promptly after reviewed by the relevant board of directors, a copy of the Borrower's and Parent's investment policy compliance report. (p) Such other information (including, without limitation, the annual Best's Advance Report Service report prepared with respect to each Insurance Subsidiary of the Parent rated by A.M. Best & Co. and non-financial information) as the Agent or any Lender may from time to time reasonably request. 6.2. USE OF PROCEEDS. The Borrower will, and will cause each of its Subsidiaries to, use the proceeds of the Advances to meet the working capital and general corporate needs of the Borrower and its Subsidiaries, including, but not limited to, the making of any Investments permitted by SECTION 6.13. The Borrower will not, nor will it permit any of its Subsidiaries to, use any of the proceeds of the Advances in any manner which would violate, or result in the violation of, Regulation T, Regulation U or Regulation X or to finance the Purchase of any Person which has not been approved and recommended by the board of directors (or functional equivalent thereof) of such Person. 6.3. NOTICE OF DEFAULT. The Borrower will give prompt notice in writing to the Lenders of the occurrence of (a) any Default or Unmatured Default, (b) of any other event or development, financial or other, relating specifically to either Loan Party or any of their Subsidiaries (and not of a general economic or political nature) which could reasonably be expected to have a Material Adverse Effect, (c) receipt by either Loan Party or any of their Subsidiaries of any notice from any Governmental Authority of the expiration without renewal, revocation or suspension of, or the institution of any proceedings to revoke or suspend, any License now or hereafter held by any Insurance Subsidiary of the Parent which is required to conduct insurance business in compliance with all applicable laws and regulations and the expiration, revocation or suspension of which could reasonably be expected to have a Material Adverse Effect, (d) receipt by either Loan Party or any of their Subsidiaries of any notice from any Governmental Authority of the institution of any disciplinary proceedings against or in respect of any Insurance Subsidiary of the Parent, or the issuance of any order, the taking of any action or any request for an extraordinary audit for cause by -35- any Governmental Authority which, if adversely determined, could reasonably be expected to have a Material Adverse Effect, (e) any material judicial or administrative order of which either Loan Party or any of their Subsidiaries are aware limiting or controlling the insurance business of any Insurance Subsidiary (and not the insurance industry generally) which has been issued or adopted or (f) the commencement of any litigation of which either Loan Party or any of their Subsidiaries are aware which could reasonably be expected to create a Material Adverse Effect. 6.4. CONDUCT OF BUSINESS. Each Loan Party will, and will cause each of its Subsidiaries to, (a) carry on and conduct its business in substantially the same manner as it is presently conducted, (b) not conduct any significant business except for financial services, (c) do all things necessary to remain duly incorporated, validly existing and in good standing as a domestic corporation in its jurisdiction of incorporation and maintain all requisite authority to conduct its business in each jurisdiction in which its business is conducted except where the failure to maintain such authority could not reasonably be expected to have a Material Adverse Effect and (d) do all things necessary to renew, extend and continue in effect all Licenses which may at any time and from time to time be necessary for any Insurance Subsidiary of the Parent to operate its insurance business in compliance with all applicable laws and regulations except for any License the loss of which could not reasonably be expected to have a Material Adverse Effect; PROVIDED, that any Insurance Subsidiary of the Parent may withdraw from one or more states (other than its state of domicile) as an admitted insurer if such withdrawal is determined by such Loan Party's Board of Directors to be in the best interest of such Loan Party and could not reasonably be expected to have a Material Adverse Effect. The Parent shall cause Folksamerica to remain a Wholly-Owned Subsidiary of the Parent (but only after it becomes a Wholly-Owned Subsidiary of the Parent) until the Borrower shall have repaid all outstanding Advances and other Obligations and the Lenders' Commitments hereunder have terminated. 6.5. TAXES. At any time on and after the date Parent or any of its Subsidiaries are required to do so, each Loan Party will, and will cause each of its Subsidiaries to, timely file complete and correct United States federal and applicable foreign, state and local tax returns required by applicable law and pay when due all taxes, assessments and governmental charges and levies upon it or its income, profits or Property, except those which are being contested in good faith by appropriate proceedings and with respect to which adequate reserves have been set aside in accordance with generally accepted accounting principles or SAP, as applicable. 6.6. INSURANCE. Each Loan Party will, and will cause each of its Subsidiaries to, maintain with financially sound and reputable insurance companies insurance on all their Property in such amounts and covering such risks as is consistent with sound business practice, and the Borrower will furnish to the Agent and any Lender upon request full information as to the insurance carried. 6.7. COMPLIANCE WITH LAWS. Each Loan Party will, and will cause each of its Subsidiaries to, comply with all laws, rules, regulations, orders, writs, judgments, injunctions, decrees or awards to which it may be subject, the failure to comply with which could reasonably be expected to have a Material Adverse Effect. -36- 6.8. MAINTENANCE OF PROPERTIES. Each Loan Party will, and will cause each of its Subsidiaries to, do all things necessary to maintain, preserve, protect and keep its Property in good repair, working order and condition, and make all necessary and proper repairs, renewals and replacements so that its business carried on in connection therewith may be properly conducted at all times. 6.9. INSPECTION. Each Loan Party will, and will cause each of its Subsidiaries to, at reasonable times during normal business hours and upon reasonable notice, permit the Agent and the Lenders, by their respective representatives and agents, to inspect any of the Property, corporate books and financial records of such Loan Party and such Subsidiary, to examine and make copies of the books of accounts and other financial records of such Loan Party and such Subsidiary, and to discuss the affairs, finances and accounts of such Loan Party and such Subsidiary with, and to be advised as to the same by, their respective officers at such reasonable times and intervals as the Lenders may designate. Each Loan Party will keep or cause to be kept, and cause each of its Subsidiaries to keep or cause to be kept, appropriate records and books of account in which complete entries are to be made reflecting its and their business and financial transactions, such entries to be made in accordance with Agreement Accounting Principles or SAP, as applicable. 6.10. DIVIDENDS. The Borrower may declare and pay dividends or make distributions to Parent. Parent will not declare or pay any dividends or make any distributions on its capital stock (other than dividends payable in its own capital stock) or redeem, repurchase or otherwise acquire or retire any of its capital stock or any options or other rights in respect thereof at any time outstanding, except that so long as no Default or Unmatured Default exists before or after giving effect to the declaration or payment of such dividends or distributions or repurchase or redemption of such stock or other transaction, (a) Parent may declare and pay dividends, and make distributions, on its common stock and repurchase and redeem and otherwise acquire or retire its common stock and any options or other rights thereof in an aggregate amount not to exceed, when aggregated with the principal amount of loans (exclusive of loans described in SECTION 6.13(e)(II)) made during such Fiscal Year from Parent or its Subsidiaries to Holdings, (i) during Parent's 1998 Fiscal Year, 2% of Adjusted Net Worth as of December 31, 1997, and (ii) during any Fiscal Year thereafter, 3% of Adjusted Net Worth as of the end of the Fiscal Year preceding the Fiscal Year during which such transaction is consummated and (b) in addition to any dividends, distributions, repurchases, redemptions, acquisitions or retirements which may be declared, paid or made pursuant to the preceding CLAUSE (a), Parent may declare and pay dividends, and make distributions, on its common stock and repurchase and redeem and otherwise acquire or retire its common stock, and any options or rights thereof, (x) in an amount equal to (1) the net proceeds received by Parent from dividends, sales, transfers or other dispositions of its equity interests in SOMSC or FAE's equity interest in San Juan Basin Trust, MINUS (2) the amount of loans made pursuant to SECTION 6.13(e)(II), PROVIDED, that such dividend is paid within one hundred eighty (180) days of receipt of such net proceeds, (y) its equity interests in SOMSC and (z) in an amount equal to that immediately utilized by Holdings to repay all or a portion of a certain $40,000,000 loan from FAE to Holdings. -37- 6.11. INDEBTEDNESS. No Loan Party will, nor will it permit any of its Subsidiaries (other than an Unrestricted Subsidiary) to, create, incur or suffer to exist any Indebtedness, except: (a) the Loans; (b) Indebtedness existing on the date hereof and described in SCHEDULE 5.16 hereto and any renewals, extensions, refundings or refinancings of such Indebtedness; PROVIDED that the amount thereof is not increased and the maturity or scheduled amortization of principal thereof is not shortened (unless to a maturity or scheduled amortization occurring after the Facility Termination Date); (c) Indebtedness owing by (x) either Loan Party to any Wholly-Owned Subsidiary of a Loan Party and (y) any Wholly-Owned Subsidiary of a Loan Party to a Wholly-Owned Subsidiary of a Loan Party or either Loan Party; (d) Indebtedness permitted under the White Mountains Credit Agreement; (e) Indebtedness of Folksamerica or its Subsidiaries in existence at the time of the Folksamerica Transaction; PROVIDED, HOWEVER, such Indebtedness of Folksamerica or its Subsidiaries may not be renewed, extended, refunded or refinanced by Folksamerica without the prior written consent of the Required Lenders; (f) Indebtedness of the Parent, the proceeds of which are used directly or indirectly to refund or refinance the Indebtedness described in SECTION 6.11 (e); PROVIDED, HOWEVER, that the amount thereof is not increased, the maturity or scheduled amortization of principal thereof is not set to a maturity or weighted average maturity occurring before the Facility Termination Date hereunder and the terms of the proposed Indebtedness are not otherwise, in the reasonable judgment of the Required Lenders, disadvantageous (relative to the terms of the Indebtedness refunded or refinanced) to the interests of the Lenders hereunder; (g) Indebtedness secured by Liens permitted pursuant to SECTION 6.15(f); (h) Contingent Obligations permitted under SECTION 6.14; and (i) other Indebtedness of either Loan Party or any of their Subsidiaries to the extent not otherwise included in subparagraphs (a) through (h) of this SECTION 6.11 or in SECTION 6.14, in an aggregate amount outstanding at any one time not to exceed $5,000,000. 6.12. MERGER. No Loan Party will, nor will it permit any Significant Subsidiary to, merge or consolidate with or into any other Person, except that: (a) a Wholly-Owned Subsidiary (other than any Unrestricted Subsidiary) may merge with (i) either Loan Party, (ii) any Wholly-Owned Subsidiary of either Loan Party or -38- (iii) any other Person so long as no Default or Unmatured Default shall have occurred or be continuing before and after giving effect to such merger and the surviving entity of such merger is either Loan Party or a Wholly-Owned Subsidiary of either Loan Party; (b) a Significant Subsidiary (other than the Borrower) may merge or consolidate with any Person so long as neither Parent, the Borrower, nor any of their Subsidiaries shall hold any capital stock of such Significant Subsidiary after giving effect to such merger or consolidation; and (c) either Loan Party may merge into any Person so long as (i) such Loan Party is the surviving entity of such merger, (ii) no Default or Unmatured Default shall have occurred or be continuing before and after giving effect to such merger and (iii) the covenants contained in SECTION 6.20 shall be complied with on a PRO FORMA basis on the date of, and after giving effect to, such merger. 6.13. INVESTMENTS AND PURCHASES. No Loan Party will, and will not permit any of its Subsidiaries (other than an Unrestricted Subsidiary) to, make or suffer to exist any Investments (including, without limitation, loans and advances to, and other Investments in, Holdings or Subsidiaries of either Loan Party), or commitments therefor, or create any Subsidiary or become or remain a partner in any partnership or joint venture, or make any Purchases, except: (a) Investments or commitments therefor (such commitments being set forth on SCHEDULE 6.13) in existence on the date hereof (including a certain $40,000,000 loan from FAE to Holdings); (b) loans and advances to employees in the ordinary course of business and consistent with past practices; (c) Investments made in Subsidiaries (other than any Unrestricted Subsidiary) and Main Street America Holdings, Inc.; (d) Purchases of or Investments in businesses or entities engaged in the insurance and/or insurance services business or businesses reasonably incident thereto (including holding companies, the Subsidiaries of which on a consolidated basis are primarily engaged in such businesses) which do not constitute hostile takeovers (including the creation of Subsidiaries in connection therewith) so long as no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Purchase or Investment; (e) Investments by Parent made on or before May 13, 1999 directly in SOMSC in an amount equal to the FSA Amount so long as at the time of such Investment no Default or Unmatured Default has occurred and is continuing or would occur after giving effect to such Investment; PROVIDED, however, that any Investments pursuant to this CLAUSE (e) are made from net proceeds traceable to dividends, sales, transfers or other distributions of equity interests in SOMSC after the date hereof; -39- (f) loans made by Parent or its Subsidiaries to Holdings, (i) so long as at all times, after giving effect to the aggregate outstanding principal amount of such loans, Parent would be permitted to pay at least $1.00 in incremental dividends pursuant to SECTION 6.10(a) or (ii) that are made out or the net proceeds described in SECTION 6.10(b)(x) in lieu of utilizing such net proceeds to pay a dividend; (g) other Investments (other than any direct or indirect Investments in Holdings), so long as any such Investment is materially consistent with such Loan Party's investment policy guidelines as approved from time to time by the finance committee of the board of directors of Parent and the board of directors of the Borrower (a copy of the current version of such guidelines having been delivered to each Lender); provided that any change from the guidelines previously submitted to the Lenders shall not materially adversely affect the Lenders; and (h) other Investments (other than any direct or indirect Investments in Holdings) by Folksamerica (but only after it becomes a Wholly-Owned Subsidiary of Parent) at any time prior to March 31, 1999, so long as any such Investment is permitted under the insurance laws of the State of New York and is materially consistent with Folksamerica's investment policy guidelines as approved from time to time by the board of directors of Folksamerica (a copy of the current version of such guidelines having been delivered to each Lender); provided that any change from the guidelines previously submitted to the Lenders shall not materially adversely affect the Lenders. 6.14. CONTINGENT OBLIGATIONS. No Loan Party will, nor will it permit any of its Subsidiaries (other than an Unrestricted Subsidiary) to, make or suffer to exist any Contingent Obligation (including, without limitation, any Contingent Obligation with respect to the obligations of a Subsidiary of either Loan Party), except (a) the issuance of financial guarantees in the ordinary course of business, (b) by endorsement of instruments for deposit or collection in the ordinary course of business, (c) for insurance policies issued in the ordinary course of business, (d) the issuance of intercompany guarantees so long as the primary obligation is permitted under this Agreement and (e) issuance of financial guarantees to the holders of seller notes issued by ML (Bermuda) Holdings Ltd. or any of its Subsidiaries, provided that the aggregate principal amount of all such financial guarantees shall not at any time exceed 6,500,000 British Pounds. 6.15. LIENS. No Loan Party will, nor will it permit any of its Subsidiaries (other than an Unrestricted Subsidiary) to, create, incur, or suffer to exist any Lien in, of or on the Property (other than Margin Stock) of such Loan Party or any of its Subsidiaries (other than an Unrestricted Subsidiary), except: (a) Liens for taxes, assessments or governmental charges or levies on its Property if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being contested in good faith and by appropriate proceedings and for which adequate -40- reserves in accordance with generally accepted principles of accounting shall have been set aside on its books; (b) Liens imposed by law, such as carriers', warehousemen's and mechanics' liens and other similar liens arising in the ordinary course of business which secure the payment of obligations not more than sixty (60) days past due or which are being contested in good faith by appropriate proceedings and for which adequate reserves shall have been set aside on its books; (c) Liens arising out of pledges or deposits under worker's compensation laws, unemployment insurance, old age pensions, or other social security or retirement benefits, or similar legislation; (d) Utility easements, building restrictions and such other encumbrances or charges against real property as are of a nature generally existing with respect to properties of a similar character and which do not in any material way affect the marketability of the same or interfere with the use thereof in the business of such Loan Party or any of its Subsidiaries; (e) Liens existing on the date hereof and described in SCHEDULE 6.15 hereto; (f) Liens in, of or on Property acquired after the date of this Agreement (by purchase, construction or otherwise) by either Loan Party or any of their Subsidiaries, each of which Liens either (1) existed on such Property before the time of its acquisition and was not created in anticipation thereof, or (2) was created solely for the purpose of securing Indebtedness representing, or incurred to finance, refinance or refund, the cost (including the cost of construction) of such Property; PROVIDED that no such Lien shall extend to or cover any Property of such Loan Party or such Subsidiary other than the Property so acquired and improvements thereon; and PROVIDED, FURTHER, that the principal amount of Indebtedness secured by any such Lien shall at the time the Lien is incurred not exceed 75% of the fair market value (as determined in good faith by a financial officer of such Loan Party and, in the case of any Property having a fair market value in excess of $500,000, certified by such officer to the Agent, with a copy for each Lender) of the Property at the time it was so acquired; (g) Liens on assets securing letters of credit issued on behalf of Insurance Subsidiaries in the ordinary course of business; and (h) Liens not otherwise permitted by the foregoing clauses (a) through (g) securing any Indebtedness of either Loan Party, PROVIDED that the aggregate principal amount of Indebtedness secured by Liens permitted by this clause (h) shall not exceed $3,000,000 at any time. 6.16. AFFILIATES. No Loan Party will, and will not permit any of its Subsidiaries to, enter into any material transaction (including, without limitation, the purchase or sale of any Property or service) with, or make any payment or transfer to, any Affiliates (other than a Wholly-Owned Subsidiary of either Loan Party), except in the ordinary course of business and pursuant to the -41- reasonable requirements of such Loan Party's or such Subsidiary's business and upon fair and reasonable terms no less favorable to such Loan Party or such Subsidiary than such Loan Party or such Subsidiary would obtain in a comparable arms-length transactions, except that any Unrestricted Subsidiary may make loans to Holdings. 6.17. ENVIRONMENTAL MATTERS. Each Loan Party shall and shall cause each of its Subsidiaries to (a) at all times comply in all material respects with all applicable Environmental Laws and (b) promptly take any and all necessary remedial actions in response to the presence, storage, use, disposal, transportation or Release of any Hazardous Materials on, under or about any real property owned, leased or operated by such Loan Party or any of its Subsidiaries. 6.18. CHANGE IN CORPORATE STRUCTURE; FISCAL YEAR. No Loan Party shall, nor shall it permit any of its Subsidiaries to, (a) permit any amendment or modification to be made to its certificate or articles of incorporation or by-laws which is materially adverse to the interests of the Lenders or (b) change its Fiscal Year to end on any date other than December 31 of each year. 6.19. INCONSISTENT AGREEMENTS. No Loan Party shall, nor shall it permit any of its Subsidiaries (other than an Unrestricted Subsidiary) to, enter into any indenture, agreement, instrument or other arrangement which by its terms (a) other than pursuant to the White Mountains Credit Agreement or pursuant to agreements or arrangements with regulatory agencies with regard to Insurance Subsidiaries, directly or indirectly contractually prohibits or restrains, or has the effect of contractually prohibiting or restraining, or contractually imposes materially adverse conditions upon, the incurrence of the Obligations, the granting of Liens to secure the Obligations, the amending of the Loan Documents or the ability of any Subsidiary to (i) pay dividends or make other distributions on its capital stock, (ii) make loans or advances to such Loan Party or (iii) repay loans or advances from such Loan Party or (b) contains any provision which would be violated or breached by the making of Advances or by the performance by such Loan Party or any of its Subsidiaries of any of its obligations under any Loan Document. 6.20. FINANCIAL COVENANTS. Parent shall (or, in the case of Section 6.20.4, shall cause its Insurance Subsidiaries to): 6.20.1 MINIMUM ADJUSTED NET WORTH. At all times after the date hereof, maintain a minimum Adjusted Net Worth at least equal to the sum of, without duplication, (a) $465,000,000, PLUS (b) an amount equal to 85% of the cash and non-cash proceeds of any equity securities issued or capital contributions received by Parent after June 30, 1998, PLUS (c) an amount equal to 50% of Parent's positive consolidated net income (excluding from such calculation (i) SOMSC and its Subsidiaries, (ii) any net realized gain from the sale of Parent's equity interests in White River Corp. or Travelers Property Casualty Corp. and (iii) any net income directly arising out of the consummation of the Folksamerica Transaction) after June 30, 1998, PLUS (d) an amount equal to 85% of the proceeds of any sale of the Parent's equity interest in SOMSC to the extent such proceeds are not paid out by Parent as dividends within one hundred eighty (180) days after receipt thereof. -42- 6.20.2. LEVERAGE RATIO. At all times after the date hereof, maintain a Leverage Ratio of (a) not greater than 45% through and including December 31, 2000 and (b) not greater than 30% at all times thereafter. 6.20.3. FIXED CHARGES COVERAGE RATIO. As of the end of each Fiscal Quarter maintain a Fixed Charges Coverage Ratio of not less than 1.5:1.0. 6.20.4. STATUTORY SURPLUS. At all times, maintain Statutory Surplus for each First-Tier Insurance Subsidiary in an amount not less than an amount equal to (a) 85% of the Statutory Surplus of each such First-Tier Insurance Subsidiary, in existence on the date hereof, as of March 31, 1998 (or, in the case of any First-Tier Insurance Subsidiary acquired after the date hereof, 85% of the Statutory Surplus of each such acquired First-Tier Insurance Subsidiary as of the most recently ended Fiscal Quarter preceding such acquisition), PLUS (b) 85% of all subsequent capital contributions to each such First-tier Insurance Subsidiary, MINUS (c) in the event such First-Tier Insurance Subsidiary dividends or otherwise distributes to its parent all the capital stock of a Wholly-Owned Insurance Subsidiary, 100% of the book value (calculated in accordance with SAP) of such Wholly-Owned Insurance Subsidiary at the time of such dividend or distribution. 6.21. TAX CONSOLIDATION. No Loan Party will and will not permit any of its Subsidiaries to (a) file or consent to the filing of any consolidated, combined or unitary income tax return with any Person other than Holdings and its Subsidiaries or (b) amend, terminate or fail to enforce any existing tax sharing agreement or similar arrangement if such action would cause a Material Adverse Effect. 6.22. ERISA COMPLIANCE. With respect to any Plan, no Loan Party nor any of its Subsidiaries shall: (a) engage in any "prohibited transaction" (as such term is defined in Section 406 of ERISA or Section 4975 of the Code) for which a civil penalty pursuant to Section 502(i) of ERISA or a tax pursuant to Section 4975 of the Code in excess of $100,000 could be imposed; (b) incur any "accumulated funding deficiency" (as such term is defined in Section 302 of ERISA) in excess of $100,000, whether or not waived, or permit any Unfunded Liability to exceed $100,000; (c) permit the occurrence of any Termination Event which could result in a liability to either Loan Party or any other member of the Controlled Group in excess of $100,000; -43- (d) be an "employer" (as such term is defined in Section 3(5) of ERISA) required to contribute to any Multiemployer Plan or a "substantial employer" (as such term in defined in Section 4001(a)(2) of ERISA) required to contribute to any Multiple Employer Plan; or (e) permit the establishment or amendment of any Plan or fail to comply with the applicable provisions of ERISA and the Code with respect to any Plan which could result in liability to either Loan Party or any other member of the Controlled Group which, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect. 6.23. YEAR 2000. Each Loan Party will take and will cause each of its Subsidiaries to take all such actions as are reasonably necessary to successfully implement its Year 2000 Program and to assure that Year 2000 Issues will not have a Material Adverse Effect. At the request of the Agent or any Lender, each Loan Party will provide a description of its Year 2000 Program, together with any updates or progress reports with respect thereto. ARTICLE VII DEFAULTS The occurrence of any one or more of the following events shall constitute a Default: 7.1. Any representation or warranty made or deemed made by or on behalf of either Loan Party or any of its Subsidiaries to the Lenders or the Agent under or in connection with this Agreement, any other Loan Document, any Loan, or any certificate or information delivered in connection with this Agreement or any other Loan Document shall be false in any material respect on the date as of which made. 7.2. Nonpayment of (a) any principal of any Note when due, or (b) any interest upon any Note or any commitment fee or other fee or obligations under any of the Loan Documents within five (5) days after the same becomes due. 7.3. The breach by either Loan Party of any of the terms or provisions of SECTION 6.2, SECTION 6.3(A) or SECTIONS 6.10 through 6.16 or SECTIONS 6.18 through 6.22. 7.4. The breach by either Loan Party (other than a breach which constitutes a Default under SECTIONS 7.1, 7.2 or 7.3) of any of the terms or provisions of this Agreement which is not remedied within twenty (20) days after written notice from the Agent or any Lender. 7.5. The default by either Loan Party or any of its Subsidiaries (or, at any time Parent is a Subsidiary of Holdings, by Holdings) in the performance of any term, provision or condition contained in any agreement or agreements under which any Funded Indebtedness aggregating in excess of $2,000,000 ($10,000,000 in the case of Holdings and $20,000,000, or such lower cross- default threshold amount as is provided in the SOMSC Credit Agreements, in the case of SOMSC) -44- was created or is governed, or the occurrence of any other event or existence of any other condition, the effect of any of which is to cause, or to permit the holder or holders of such Funded Indebtedness to cause, such Funded Indebtedness to become due prior to its stated maturity; or any such Funded Indebtedness of either Loan Party or any of its Subsidiaries or Holdings shall be declared to be due and payable or required to be prepaid (other than by a regularly scheduled payment) prior to the stated maturity thereof. 7.6. Either Loan Party or any of its Significant Subsidiaries shall (a) have an order for relief entered with respect to it under the Federal bankruptcy laws as now or hereafter in effect, (b) make an assignment for the benefit of creditors, (c) apply for, seek, consent to, or acquiesce in, the appointment of a receiver, custodian, trustee, examiner, liquidator or similar official for it or any substantial portion of its Property, (d) institute any proceeding seeking an order for relief under the Federal bankruptcy laws as now or hereafter in effect or seeking to adjudicate it a bankrupt or insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors or fail to file an answer or other pleading denying the material allegations of any such proceeding filed against it, (e) take any corporate action to authorize or effect any of the foregoing actions set forth in this SECTION 7.6, (f) fail to contest in good faith any appointment or proceeding described in SECTION 7.7 or (g) become unable to pay, not pay, or admit in writing its inability to pay, its debts generally as they become due. 7.7. Without the application, approval or consent of the relevant Loan Party or any of its Significant Subsidiaries, a receiver, trustee, examiner, liquidator or similar official shall be appointed for either Loan Party or any of its Significant Subsidiaries or any substantial portion of its Property, or a proceeding described in SECTION 7.6(d) shall be instituted against either Loan Party or any of its Significant Subsidiaries and such appointment continues undischarged or such proceeding continues undismissed or unstayed for a period of sixty (60) consecutive days. 7.8. Either Loan Party or any of its Subsidiaries shall fail within thirty (30) days to pay, bond or otherwise discharge any judgment or order for the payment of money in excess of $1,000,000 (or multiple judgments or orders for the payment of an aggregate amount in excess of $5,000,000), which is not stayed on appeal or otherwise being appropriately contested in good faith and as to which no enforcement actions have been commenced. 7.9. Any Change in Control shall occur. 7.10. The occurrence of any "default", as defined in any Loan Document (other than this Agreement or the Notes) or the breach of any of the terms or provisions of any Loan Document (other than this Agreement or the Notes), which default or breach continues beyond any period of grace therein provided. 7.11. Any License of any Insurance Subsidiary of Parent (a) shall be revoked by the Governmental Authority which issued such License, or any action (administrative or judicial) to revoke such License shall have been commenced against such Insurance Subsidiary and shall not have been dismissed within thirty (30) days after the commencement thereof, (b) shall be suspended -45- by such Governmental Authority for a period in excess of thirty (30) days or (c) shall not be reissued or renewed by such Governmental Authority upon the expiration thereof following application for such reissuance or renewal of such Insurance Subsidiary, which, in any case, could reasonably be expected to have a Material Adverse Effect. 7.12. Any Insurance Subsidiary of Parent shall be the subject of a final non-appealable order imposing a fine by or at the request of any state insurance regulatory agency as a result of the violation by such Insurance Subsidiary of such state's applicable insurance laws or the regulations promulgated in connection therewith which could reasonably be expected to have a Material Adverse Effect. 7.13. Any Insurance Subsidiary of Parent shall become subject to any conservation, rehabilitation or liquidation order, directive or mandate issued by any Governmental Authority or any Insurance Subsidiary shall become subject to any other directive or mandate issued by any Governmental Authority in either case which could reasonably be expected to have a Material Adverse Effect and which is not stayed within thirty (30) days. 7.14. The Guaranty shall fail to remain in full force or effect or any action shall be taken to discontinue or to assert the invalidity or unenforceability of the Guaranty, or Parent shall fail to comply with any of the terms or provisions of the Guaranty, or shall deny, or give notice to such effect, that it has any further liability under the Guaranty. ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES 8.1. ACCELERATION. If any Default described in SECTIONS 7.6 or 7.7 occurs with respect to the Borrower, the obligations of the Lenders to make Loans hereunder shall automatically terminate and the Obligations shall immediately become due and payable without any election or action on the part of the Agent or any Lender. If any other Default occurs, the Required Lenders (or the Agent with the consent of the Required Lenders) may terminate or suspend the obligations of the Lenders to make Loans hereunder, or declare the Obligations to be due and payable, or both, whereupon the Obligations shall become immediately due and payable, without presentment, demand, protest or notice of any kind, all of which the Borrower hereby expressly waives. If, within ten (10) Business Days after acceleration of the maturity of the Obligations or termination of the obligations of the Lenders to make Loans hereunder as a result of any Default (other than any Default as described in SECTIONS 7.6 or 7.7 with respect to the Borrower) and before any judgment or decree for the payment of the Obligations due shall have been obtained or entered, the Required Lenders (in their sole discretion) shall so direct, the Agent shall, by notice to the Borrower, rescind and annul such acceleration and/or termination. -46- 8.2. AMENDMENTS. Subject to the provisions of this ARTICLE VIII, the Required Lenders (or the Agent with the consent in writing of the Required Lenders) and the Loan Parties may enter into agreements supplemental hereto for the purpose of adding or modifying any provisions to the Loan Documents or changing in any manner the rights of the Lenders or either Loan Party hereunder or waiving any Default hereunder; PROVIDED, HOWEVER, that no such supplemental agreement shall, without the consent of each Lender: (a) Extend the final maturity of any Loan or Note or reduce the principal amount thereof, or, subject to Section 2.11, reduce the rate or extend the time of payment of interest or fees thereon; (b) Reduce the percentage specified in the definition of Required Lenders; (c) Reduce the amount of or extend the date for the mandatory payments and commitment reductions required under SECTIONS 2.1(b) or 2.7, or increase the amount of the Commitment of any Lender hereunder; (d) Extend the Facility Termination Date or reduce the amount or extend the time of any mandatory commitment reduction required by SECTION 2.7; (e) Amend this SECTION 8.2; (f) Release Parent from the Guaranty; or (g) Permit any assignment by either Loan Party of its Obligations or its rights hereunder. No amendment of any provision of this Agreement relating to the Agent shall be effective without the written consent of the Agent. The Agent may waive payment of the fee required under SECTION 12.3.2 without obtaining the consent of any other party to this Agreement. 8.3. PRESERVATION OF RIGHTS. No delay or omission of the Lenders or the Agent to exercise any right under the Loan Documents shall impair such right or be construed to be a waiver of any Default or an acquiescence therein, and the making of a Loan notwithstanding the existence of a Default or the inability of either Loan Party to satisfy the conditions precedent to such Loan shall not constitute any waiver or acquiescence. Any single or partial exercise of any such right shall not preclude other or further exercise thereof or the exercise of any other right, and no waiver, amendment or other variation of the terms, conditions or provisions of the Loan Documents whatsoever shall be valid unless in writing signed by the Lenders required pursuant to SECTION 8.2, and then only to the extent in such writing specifically set forth. All remedies contained in the Loan Documents or by law afforded shall be cumulative and all shall be available to the Agent and the Lenders until the Obligations have been paid in full. -47- ARTICLE IX GENERAL PROVISIONS 9.1. SURVIVAL OF REPRESENTATIONS. All representations and warranties of each Loan Party contained in this Agreement or either Loan Party or any of their Subsidiaries contained in any Loan Document shall survive delivery of the Notes and the making of the Loans herein contemplated. 9.2. GOVERNMENTAL REGULATION. Anything contained in this Agreement to the contrary notwithstanding, no Lender shall be obligated to extend credit to the Borrower in violation of any limitation or prohibition provided by any applicable statute or regulation. 9.3. TAXES. Any stamp, documentary or similar taxes, assessments or charges payable or ruled payable by any governmental authority in respect of the Loan Documents shall be paid by the Borrower, together with interest and penalties, if any. 9.4. HEADINGS. Section headings in the Loan Documents are for convenience of reference only, and shall not govern the interpretation of any of the provisions of the Loan Documents. 9.5. ENTIRE AGREEMENT. The Loan Documents embody the entire agreement and understanding among each Loan Party, the Agent and the Lenders and supersede all prior agreements and understandings among each Loan Party, the Agent and the Lenders relating to the subject matter thereof other than the fee letter, dated August 14, 1998, in favor of First Chicago. 9.6. SEVERAL OBLIGATIONS; BENEFITS OF THIS AGREEMENT. The respective obligations of the Lenders hereunder are several and not joint and no Lender shall be the partner or agent of any other (except to the extent to which the Agent is authorized to act as such). The failure of any Lender to perform any of its obligations hereunder shall not relieve any other Lender from any of its obligations hereunder. This Agreement shall not be construed so as to confer any right or benefit upon any Person other than the parties to this Agreement and their respective successors and assigns. 9.7. EXPENSES; INDEMNIFICATION. Each Loan Party agrees to reimburse the Agent for any costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent) paid or incurred by the Agent in connection with the preparation, negotiation, execution, delivery, review, actual or proposed amendment, modification, and administration of the Loan Documents. Each Loan Party also agrees to reimburse the Agent and the Lenders for any reasonable costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent and the Lenders, which attorneys may be employees of the Agent or the Lenders) paid or incurred by the Agent or any Lender in connection with the collection and enforcement of the Loan Documents. Each Loan Party further agrees to indemnify the Agent and each Lender, its directors, officers and employees against all losses, claims, damages, penalties, judgments, liabilities and expenses (including, without limitation, all expenses of litigation or preparation therefor whether or not the Agent or any Lender is a party thereto) which any of them may pay or incur arising out of or relating -48- to this Agreement, the other Loan Documents, the transactions contemplated hereby or thereby or the direct or indirect application or proposed application of the proceeds of any Loan hereunder arising from claims or assertions by third parties except to the extent that they arise out of the gross negligence or willful misconduct of the party seeking indemnification. The obligations of each Loan Party under this Section shall survive the termination of this Agreement. 9.8. NUMBERS OF DOCUMENTS. All statements, notices, closing documents, and requests hereunder shall be furnished to the Agent with sufficient counterparts so that the Agent may furnish one to each of the Lenders. 9.9. ACCOUNTING. Except as provided to the contrary herein, all accounting terms used herein shall be interpreted and all accounting determinations hereunder shall be made in accordance with Agreement Accounting Principles. 9.10. SEVERABILITY OF PROVISIONS. Any provision in any Loan Document that is held to be inoperative, unenforceable, or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability, or validity of that provision in any other jurisdiction, and to this end the provisions of all Loan Documents are declared to be severable. 9.11. NONLIABILITY OF LENDERS. The relationship between the Borrower and the Lenders and the Agent shall be solely that of borrower and lender. Neither the Agent nor any Lender shall have any fiduciary responsibilities to either Loan Party. Neither the Agent nor any Lender undertakes any responsibility to either Loan Party to review or inform either Loan Party of any matter in connection with any phase of either Loan Party's business or operations. Each Loan Party shall rely entirely upon its own judgment with respect to its business, and any review, inspection or supervision of, or information supplied to either Loan Party by the Agent or the Lenders is for the protection of the Agent and the Lenders and no Loan Party nor any other Person is entitled to rely thereon. Whether or not such damages are related to a claim that is subject to the waiver effected above and whether or not such waiver is effective, neither the Agent nor any Lender shall have any liability with respect to, and each Loan Party hereby waives, releases and agrees not to sue for, any special, indirect or consequential damages suffered by either Loan Party in connection with, arising out of, or in any way related to the Loan Documents or the transactions contemplated thereby or the relationship established by the Loan Documents, or any act, omission or event occurring in connection therewith. 9.12. CHOICE OF LAW. THE LOAN DOCUMENTS (OTHER THAN THOSE CONTAINING A CONTRARY EXPRESS CHOICE OF LAW PROVISION) SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS, WITHOUT REGARD TO CONFLICT OF LAWS PROVISIONS, OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 9.13. CONSENT TO JURISDICTION. EACH LOAN PARTY HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED -49- STATES FEDERAL OR ILLINOIS STATE COURT SITTING IN CHICAGO IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY LOAN DOCUMENTS AND EACH LOAN PARTY HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT AND IRREVOCABLY WAIVES ANY OBJECTION IT MAY NOW OR HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN SUCH A COURT OR THAT SUCH COURT IS AN INCONVENIENT FORUM. NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR ANY LENDER TO BRING PROCEEDINGS AGAINST EITHER LOAN PARTY IN THE COURTS OF ANY OTHER JURISDICTION. ANY JUDICIAL PROCEEDING BY EITHER LOAN PARTY AGAINST THE AGENT OR ANY LENDER OR ANY AFFILIATE OF THE AGENT OR ANY LENDER INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT SHALL BE BROUGHT ONLY IN A COURT IN CHICAGO, ILLINOIS; PROVIDED, THAT SUCH PROCEEDINGS MAY BE BROUGHT IN OTHER COURTS IF JURISDICTION MAY NOT BE OBTAINED IN A COURT IN CHICAGO, ILLINOIS. 9.14. WAIVER OF JURY TRIAL. EACH LOAN PARTY, THE AGENT AND EACH LENDER HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT OR THE RELATIONSHIP ESTABLISHED THEREUNDER. 9.15. DISCLOSURE. Each Loan Party and each Lender hereby (a) acknowledge and agree that First Chicago and/or its Affiliates from time to time may hold other investments in, make other loans to or have other relationships with either Loan Party, including, without limitation, in connection with any interest rate hedging instruments or agreements or swap transactions, and (b) waive any liability of First Chicago or such Affiliate to either Loan Party or any Lender, respectively, arising out of or resulting from such investments, loans or relationships other than liabilities arising out of the gross negligence or willful misconduct of First Chicago or its Affiliates to the extent that such liability would not have arisen but for First Chicago's status as Agent hereunder. 9.16. COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. This Agreement shall be effective when it has been executed by each Loan Party, the Agent and the Lenders and each party has notified the Agent that it has taken such action. 9.17. TREATMENT OF CERTAIN INFORMATION: CONFIDENTIALITY. (a) Each Loan Party acknowledges that (i) services may be offered or provided to it (in connection with this Agreement or otherwise) by each Lender or by one or more subsidiaries or affiliates of such Lender and (ii) information delivered to each Lender by such Loan Party and its -50- Subsidiaries may be provided to each such Subsidiary and Affiliate, it being understood that any such Subsidiary or Affiliate receiving such information shall be bound by the provisions of clause (b) below as if it were a Lender hereunder. (b) Each Lender and the Agent agrees (on behalf of itself and each of its affiliates, directors, officers, employees and representatives) to use reasonable precautions to keep confidential, in accordance with their customary procedures for handling confidential information of this nature and in accordance with safe and sound banking practices, any non-public information supplied to it by either Loan Party pursuant to this Agreement, provided that nothing herein shall limit the disclosure of any such information (i) to the extent required by statue, rule, regulation or judicial process, (ii) to counsel for any of the Lenders or the Agent, (iii) to bank examiners, auditors or accountants, (iv) to the Agent or any other Lender (or to First Chicago Capital Markets, Inc.), (v) in connection with any litigation to which any one or more of the Lenders or the Agent is a party, (vi) to a subsidiary or affiliate of such Lender as provided in clause (a) above, (vii) to any assignee or participant (or prospective assignee or participant) so long as such assignee or participant (or prospective assignee or participant) agrees with the respective Lender to keep such information confidential on substantially the terms set forth in this SECTION 9.17(b), (viii) to any other Person as may be reasonably required in the course of the enforcement of any Lender's rights or remedies hereunder or under any of such Lender's Note, or (ix) to any other creditor of either Loan Party or any of their Subsidiaries at any time during the continuance of a Default; PROVIDED that in no event shall any Lender or the Agent be obligated or required to return any materials furnished by either Loan Party. ARTICLE X THE AGENT 10.1. APPOINTMENT. First Chicago is hereby appointed Agent hereunder and under each other Loan Document, and each of the Lenders authorizes the Agent to act as the agent of such Lender. The Agent agrees to act as such upon the express conditions contained in this ARTICLE X. The Agent shall not have a fiduciary relationship in respect of either Loan Party or any Lender by reason of this Agreement. 10.2. POWERS. The Agent shall have and may exercise such powers under the Loan Documents as are specifically delegated to the Agent by the terms of each thereof, together with such powers as are reasonably incidental thereto. The Agent shall have no implied duties to the Lenders, or any obligation to the Lenders to take any action thereunder, except any action specifically provided by the Loan Documents to be taken by the Agent. 10.3. GENERAL IMMUNITY. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to either Loan Party or any Lender for any action taken or omitted to be taken by it or them hereunder or under any other Loan Document or in connection herewith or therewith except for its or their own gross negligence or willful misconduct. -51- 10.4. NO RESPONSIBILITY FOR LOANS, RECITALS, ETC. Neither the Agent nor any of its directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into, or verify (a) any statement, warranty or representation made in connection with any Loan Document or any borrowing hereunder, (b) the performance or observance of any of the covenants or agreements of any obligor under any Loan Document, including, without limitation, any agreement by an obligor to furnish information directly to each Lender; (c) the satisfaction of any condition specified in ARTICLE IV, except receipt of items required to be delivered to the Agent and not waived at closing, or (d) the validity, effectiveness, sufficiency, enforceability or genuineness of any Loan Document or any other instrument or writing furnished in connection therewith. The Agent shall have no duty to disclose to the Lenders information that is not required to be furnished by either Loan Party to the Agent at such time, but is voluntarily furnished by either Loan Party to the Agent (either in its capacity as Agent or in its individual capacity). 10.5. ACTION ON INSTRUCTIONS OF LENDERS. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder and under any other Loan Document in accordance with written instructions signed by the Required Lenders (or, to the extent required by SECTION 8.2, all Lenders), and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Lenders and on all holders of Notes. The Agent shall be fully justified in failing or refusing to take any action hereunder and under any other Loan Document unless it shall first be indemnified to its satisfaction by the Lenders pro rata against any and all liability, cost and expense that it may incur by reason of taking or continuing to take any such action. 10.6. EMPLOYMENT OF AGENTS AND COUNSEL. The Agent may execute any of its duties as Agent hereunder and under any other Loan Document by or through employees, agents and attorneys-in-fact and shall not be answerable to the Lenders, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. The Agent shall be entitled to advice of counsel concerning all matters pertaining to the agency hereby created and its duties hereunder and under any other Loan Document. 10.7. RELIANCE ON DOCUMENTS; COUNSEL. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of counsel selected by the Agent, which counsel may be employees of the Agent. 10.8. AGENT'S REIMBURSEMENT AND INDEMNIFICATION. The Lenders agree to reimburse and indemnify the Agent ratably in proportion to their respective Commitments (or, if the Commitments have been terminated, in proportion to their Commitments immediately prior to such termination) (a) for any amounts not reimbursed by either Loan Party for which the Agent is entitled to reimbursement by such Loan Party under the Loan Documents, (b) for any other expenses incurred by the Agent on behalf of the Lenders, in connection with the preparation, execution, delivery, administration and enforcement of the Loan Documents, and (c) for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind -52- and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of the Loan Documents or any other document delivered in connection therewith or the transactions contemplated thereby, or the enforcement of any of the terms thereof or of any such other documents; PROVIDED, that no Lender shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the Agent. The obligations of the Lenders under this SECTION 10.8 shall survive payment of the Obligations and termination of this Agreement. 10.9. NOTICE OF DEFAULT. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Unmatured Default hereunder unless the Agent has received written notice from a Lender or the Borrower referring to this Agreement describing such Default or Unmatured Default and stating that such notice is a "notice of default". In the event that the Agent receives such a notice, the Agent shall give prompt notice thereof to the Lenders. 10.10. RIGHTS AS A LENDER. In the event the Agent is a Lender, the Agent shall have the same rights and powers hereunder and under any other Loan Document as any Lender, including, without limitation, pursuant to Article XII hereof, and may exercise the same as though it were not the Agent, and the term "Lender" or "Lenders" shall, at any time when the Agent is a Lender, unless the context otherwise indicates, include the Agent in its individual capacity. The Agent may accept deposits from, lend money to, and generally engage in any kind of trust, debt, equity or other transaction, in addition to those contemplated by this Agreement or any other Loan Document, with either Loan Party or any of their Subsidiaries in which such Loan Party or such Subsidiary is not restricted hereby from engaging with any other Person. 10.11. LENDER CREDIT DECISION. Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender and based on the financial statements prepared by each Loan Party and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement and the other Loan Documents. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement and the other Loan Documents. 10.12. SUCCESSOR AGENT. The Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower, such resignation to be effective upon the appointment of a successor Agent or, if no successor Agent has been appointed, forty-five (45) days after the retiring Agent gives notice of its intention to resign. Upon any such resignation, the Required Lenders shall have the right to appoint, on behalf of the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If no successor Agent shall have been so appointed by the Required Lenders and shall have accepted such appointment within thirty (30) days after the resigning Agent's giving notice of its intention to resign, then the resigning Agent may appoint, on behalf of the Borrower and the Lenders, a successor Agent, which successor Agent, so long as no Default is continuing, shall be reasonably acceptable to the Borrower. If the Agent has resigned and no successor Agent has been appointed, the Lenders -53- may perform all the duties of the Agent hereunder and the Borrower shall make all payments in respect of the Obligations to the applicable Lender and for all other purposes shall deal directly with the Lenders. No successor Agent shall be deemed to be appointed hereunder until such successor Agent has accepted the appointment. Any such successor Agent shall be a commercial bank having capital and retained earnings of at least $50,000,000 and with a Lending Installation in the United States of America. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the resigning Agent. Upon the effectiveness of the resignation of the Agent, the resigning Agent shall be discharged from its duties and obligations hereunder and under the Loan Documents. After the effectiveness of the resignation of an Agent, the provisions of this ARTICLE X shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent hereunder and under the other Loan Documents. ARTICLE XI SETOFF; RATABLE PAYMENTS 11.1. SETOFF. In addition to, and without limitation of, any rights of the Lenders under applicable law, if the Borrower becomes insolvent, however evidenced, or any Default or Unmatured Default occurs, any and all deposits (including all account balances, whether provisional or final and whether or not collected or available) and any other Indebtedness at any time held or owing by any Lender to or for the credit or account of the Borrower may be offset and applied toward the payment of the Obligations owing to such Lender, whether or not the Obligations, or any part hereof, shall then be due. 11.2. RATABLE PAYMENTS. If any Lender, whether by setoff or otherwise, has payment made to it upon its Loans (other than payments received pursuant to SECTIONS 2.18, 3.1, 3.2 or 3.4) in a greater proportion than its pro-rata share of such Loans, such Lender agrees, promptly upon demand, to purchase a portion of the Loans held by the other Lenders so that after such purchase each Lender will hold its ratable proportion of Loans. If any Lender, whether in connection with setoff or amounts which might be subject to setoff or otherwise, receives collateral or other protection for its Obligations or such amounts which may be subject to setoff, such Lender agrees, promptly upon demand, to take such action necessary such that all Lenders share in the benefits of such collateral ratably in proportion to their Loans. In case any such payment is disturbed by legal process, or otherwise, appropriate further adjustments shall be made. If an amount to be setoff is to be applied to Indebtedness of the Borrower to a Lender, other than Indebtedness evidenced by any of the Notes held by such Lender, such amount shall be applied ratably to such other Indebtedness and to the Indebtedness evidenced by such Notes. -54- ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS 12.1. SUCCESSORS AND ASSIGNS. The terms and provisions of the Loan Documents shall be binding upon and inure to the benefit of each Loan Party and the Lenders and their respective successors and assigns, except that (a) no Loan Party shall have the right to assign their rights or obligations under the Loan Documents, and (b) any assignment by any Lender must be made in compliance with SECTION 12.3. Notwithstanding CLAUSE (b) of the preceding sentence, any Lender may at any time, without the consent of either Loan Party or the Agent, assign all or any portion of its rights under this Agreement and its Notes to a Federal Reserve Bank; PROVIDED, HOWEVER, that no such assignment to a Federal Reserve Bank shall release the transferor Lender from its obligations hereunder. The Agent may treat the payee of any Note as the owner thereof for all purposes hereof unless and until such payee complies with SECTION 12.3 in the case of an assignment thereof or, in the case of any other transfer, a written notice of the transfer is filed with the Agent. Any assignee or transferee of a Note agrees by acceptance thereof to be bound by all the terms and provisions of the Loan Documents. Any request, authority or consent of any Person, who at the time of making such request or giving such authority or consent is the holder of any Note, shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note or Notes issued in exchange therefor. 12.2. PARTICIPATIONS. 12.2.1. PERMITTED PARTICIPANTS; EFFECT. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks or other entities ("PARTICIPANTS") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender under the Loan Documents. In the event of any such sale by a Lender of participating interests to a Participant, such Lender's obligations under the Loan Documents shall remain unchanged, such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, such Lender shall remain the holder of any such Note for all purposes under the Loan Documents, all amounts payable by the Borrower under this Agreement shall be determined as if such Lender had not sold such participating interests, and each Loan Party and the Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Loan Documents. 12.2.2. VOTING RIGHTS. Each Lender shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the Loan Documents other than any amendment, modification or waiver which effects any of the modifications referenced in clauses (a) through (f) of SECTION 8.2. 12.2.3. BENEFIT OF SETOFF. The Borrower agrees that each Participant shall be deemed to have the right of setoff provided in SECTION 11.1 in respect of its participating interest -55- in amounts owing under the Loan Documents to the same extent as if the amount of its participating interest were owing directly to it as a Lender under the Loan Documents; PROVIDED, that each Lender shall retain the right of setoff provided in SECTION 11.1 with respect to the amount of participating interests sold to each Participant. The Lenders agree to share with each Participant, and each Participant, by exercising the right of setoff provided in SECTION 11.1, agrees to share with each Lender, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with SECTION 11.2 as if each Participant were a Lender. 12.3. ASSIGNMENTS. 12.3.1. PERMITTED ASSIGNMENTS. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more banks or other entities ("PURCHASERS") all or any part of its rights and obligations under the Loan Documents; provided, however, that in the case of an assignment to an entity which is not a Lender or an Affiliate of a Lender, such assignment shall be in a minimum amount (when added to the amount of the assignment of such Lender's obligations under the White Mountains Credit Agreement) of $5,000,000 (or, if less, the entire amount of such Lender's Commitment). Such assignment shall be substantially in the form of EXHIBIT C hereto or in such other form as may be agreed to by the parties thereto. The consent of the Agent and, so long as no Default under SECTIONS 7.2, 7.6 or 7.7 is continuing, the Borrower, shall be required prior to an assignment becoming effective with respect to a Purchaser which is not a Lender or an Affiliate thereof. Such consent shall not be unreasonably withheld. Notwithstanding anything to the contrary contained herein, any assignment by a Lender of its rights and obligations under the Loan Documents shall be accompanied by an assignment to the same assignee of the same ratable share of the rights and obligations of such Lender under the White Mountains Credit Agreement in respect of its obligations thereunder. 12.3.2. EFFECT; EFFECTIVE DATE. Upon (a) delivery to the Agent of a notice of assignment, substantially in the form attached as Exhibit I to EXHIBIT C hereto (a "NOTICE OF ASSIGNMENT"), together with any consents required by SECTION 12.3.1, and (b) payment of a $3,000 fee to the Agent for processing such assignment, such assignment shall become effective on the effective date specified in such Notice of Assignment. On and after the effective date of such assignment, (a) such Purchaser shall for all purposes be a Lender party to this Agreement and any other Loan Document executed by the Lenders and shall have all the rights and obligations of a Lender under the Loan Documents, to the same extent as if it were an original party hereto, and (b) the transferor Lender shall be released with respect to the percentage of the Aggregate Commitment and Loans assigned to such Purchaser without any further consent or action by the Borrower, the Lenders or the Agent. Upon the consummation of any assignment to a Purchaser pursuant to this SECTION 12.3.2, the transferor Lender, the Agent and the Borrower shall make appropriate arrangements so that replacement Notes are issued to such transferor Lender and new Notes or, as appropriate, replacement Notes, are issued to such Purchaser, in each case in principal amounts reflecting their Commitment, as adjusted pursuant to such assignment. 12.4. DISSEMINATION OF INFORMATION. Subject to SECTION 9.17(b), each Loan Party authorizes each Lender to disclose to any Participant or Purchaser or any other Person acquiring an interest in the Loan Documents by operation of law (each a "TRANSFEREE") and any prospective Transferee any -56- and all information in such Lender's possession concerning the creditworthiness of such Loan Party and its Subsidiaries. 12.5. TAX TREATMENT. If any interest in any Loan Document is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the transferor Lender shall cause such Transferee, concurrently with the effectiveness of such transfer, to comply with the provisions of SECTION 2.18. ARTICLE XIII NOTICES 13.1. GIVING NOTICE. All notices and other communications provided to any party hereto under this Agreement or any other Loan Document shall be in writing, by facsimile, first class U.S. mail or overnight courier and addressed or delivered to such party at its address set forth below its signature hereto or at such other address as may be designated by such party in a notice to the other parties. Any notice, if mailed and properly addressed with first class postage prepaid, return receipt requested, shall be deemed given three (3) Business Days after deposit in the U.S. mail; any notice, if transmitted by facsimile, shall be deemed given when transmitted; and any notice given by overnight courier shall be deemed given when received by the addressee. 13.2. CHANGE OF ADDRESS. Either Loan Party, the Agent and any Lender may each change the address for service of notice upon it by a notice in writing to the other parties hereto. ARTICLE XIV GUARANTY 14.1. Parent hereby absolutely, irrevocably and unconditionally guarantees prompt, full and complete payment when due, whether at stated maturity, upon acceleration or otherwise, and at all times thereafter, of (a) the principal of and interest on the Advances made by the Lenders to, and the Notes held by the Lenders of, the Borrower and (b) all other amounts from time to time owing to the Lenders by the Borrower under this Agreement, the Notes and the other Loan Documents, including without limitation all Obligations of the Borrower (solely for purposes of this ARTICLE XIV, collectively referred to as the "Guaranteed Debt"). This is a guaranty of payment, not a guaranty of collection. 14.2. Parent waives notice of the acceptance of this ARTICLE XIV (solely for purposes of this ARTICLE XIV, referred to as the "Guaranty") and of the extension or incurrence of the Guaranteed Debt or any part thereof. Parent further waives all setoffs and counterclaims and presentment, protest, notice, filing of claims with a court in the event of receivership, bankruptcy or reorganization of the Borrower, demand or action on delinquency in respect of the Guaranteed Debt or any part thereof, including any right to require the Agent or any Lender to sue the Borrower, or any other person obligated with respect to the Guaranteed Debt or any part -57- thereof, or otherwise to enforce payment thereof against any collateral securing the Guaranteed Debt or any part thereof. 14.3. Parent hereby agrees that, to the fullest extent permitted by law, its obligations hereunder shall be continuing, absolute and unconditional under any and all circumstances and not subject to any reduction, limitation, impairment, termination, defense (other than indefeasible payment in full), setoff, counterclaim or recoupment whatsoever (all of which are hereby expressly waived by it to the fullest extent permitted by law), whether by reason of any claim of any character whatsoever, including, without limitation, any claim of waiver, release, surrender, alteration or compromise. The validity and enforceability of this Guaranty shall not be impaired or affected by any of the following: (a) any extension, modification or renewal of, or indulgence with respect to, or substitution for, the Guaranteed Debt or any part thereof or any agreement relating thereto at any time; (b) any failure or omission to perfect or maintain any lien on, or preserve rights to, any security or collateral or to enforce any right, power or remedy with respect to the Guaranteed Debt or any part thereof or any agreement relating thereto, or any collateral securing the Guaranteed Debt or any part thereof; (c) any waiver of any right, power or remedy or of any default with respect to the Guaranteed Debt or any part thereof or any agreement relating thereto or with respect to any collateral securing the Guaranteed Debt or any part thereof; (d) any release, surrender, compromise, settlement, waiver, subordination or modification, with or without consideration, of any collateral securing the Guaranteed Debt or any part thereof, any other guaranties with respect to the Guaranteed Debt or any part thereof, or any other obligations of any person or entity with respect to the Guaranteed Debt or any part thereof; (e) the enforceability or validity of the Guaranteed Debt or any part thereof or the genuineness, enforceability or validity of any agreement relating thereto or with respect to any collateral securing the Guaranteed Debt or any part thereof; (f) the application of payments received from any source to the payment of indebtedness other than the Guaranteed Debt, any part thereof or amounts which are not covered by this Guaranty even though the Agent or any Lender might lawfully have elected to apply such payments to any part or all of the Guaranteed Debt or to amounts which are not covered by this Guaranty; (g) any change of ownership of the Borrower or the insolvency, bankruptcy or any other change in the legal status of the Borrower; (h) any change in, or the imposition of, any law, decree, regulation or other governmental act which does or might impair, delay or in any way affect the validity, enforceability or the payment when due of the Guaranteed Debt; (i) the failure of the Borrower to maintain in full force, validity or effect or to obtain or renew when required all governmental and other approvals, licenses or consents required in connection with the Guaranteed Debt or this Guaranty, or to take any other action required in connection with the performance of all obligations pursuant to the Guaranteed Debt or this Guaranty; (j) the existence of any claim, setoff or other rights which Parent may have at any time against the Borrower in connection herewith or with any unrelated transaction; (k) the Agent's or any Lender's election, in any case or proceeding instituted under chapter 11 of the Bankruptcy Code, of the application of section 1111(b)(2) of the Bankruptcy Code; (l) any borrowing, use of cash collateral, or grant of a security interest by the Borrower, as debtor in possession, under section 363 or 364 of the United States Bankruptcy Code; (m) the disallowance of all or any portion of the Lender's claims for repayment of the Guaranteed Debt under section 502 or 506 of the United States Bankruptcy Code; or (n) any other fact or circumstance which might -58- otherwise constitute grounds at law or equity for the discharge or release of Parent from its obligations hereunder, all whether or not Parent shall have had notice or knowledge of any act or omission referred to in the foregoing CLAUSES (a) THROUGH (n) of this paragraph. It is agreed that Parent's liability hereunder is independent of any other guaranties or other obligations at any time in effect with respect to the Guaranteed Debt or any part thereof and that Parent's liability hereunder may be enforced regardless of the existence, validity, enforcement or non-enforcement of any such other guaranties or other obligations or any provision of any applicable law or regulation purporting to prohibit payment by the Borrower of the Guaranteed Debt in the manner agreed upon between the Agent, the Lenders and the Borrower. 14.4. Credit may be granted or continued from time to time by the Agent and/or any Lender to the Borrower without notice to or authorization from Parent regardless of the Borrower's financial or other condition at the time of any such grant or continuation. Neither the Agent nor any Lender shall have any obligation to disclose or discuss with Parent its assessment of the financial condition of the Borrower. 14.5. Until the irrevocable payment in full of the Obligations and termination of all commitments which could give rise to any Obligation, Parent shall have no right of subrogation with respect to the Guaranteed Debt and hereby waives any right to enforce any remedy which the Agent and/or the Lenders now has or may hereafter have against the Borrower, any endorser or any other guarantor of all or any part of the Guaranteed Debt, and Parent hereby waives any benefit of, and any right to participate in, any security or collateral given to the Agent and/or the Lenders to secure payment of the Guaranteed Debt or any part thereof or any other liability of the Borrower to the Agent and/or the Lenders. 14.6. Parent authorizes the Agent and the Lenders to take any action or exercise any remedy with respect to any collateral from time to time securing the Guaranteed Debt, which the Agent and the Lenders in their sole discretion (but subject, as applicable, to the terms of this Agreement and of any documentation pursuant to which a Lien in such collateral is granted) shall determine, without notice to Parent. Notwithstanding any reference herein to any collateral securing any of the Guaranteed Debt, it is acknowledged that, on the date hereof, neither Parent nor any of its Subsidiaries has granted, or has any obligation to grant, any security interest in or other lien on any of its property as security for the Guaranteed Debt. 14.7. In the event the Agent and the Lenders in their sole discretion elect to give notice of any action with respect to any collateral securing the Guaranteed Debt or any part thereof, ten (10) days' written notice mailed to Parent by ordinary mail at the address shown hereon shall be deemed reasonable notice of any matters contained in such notice. Parent consents and agrees that neither the Agent nor any Lender shall be under any obligation to marshall any assets in favor of Parent or against or in payment of any or all of the Guaranteed Debt. 14.8. In the event that acceleration of the time for payment of any of the Guaranteed Debt is stayed upon the insolvency, bankruptcy or reorganization of the Borrower, or otherwise, all such amounts shall nonetheless be payable by Parent forthwith upon demand by the Agent. Parent further -59- agrees that, to the extent that the Borrower makes a payment or payments to the Agent or any Lender on the Guaranteed Debt, or the Agent or any Lender receives any proceeds of collateral securing the Guaranteed Debt, which payment or receipt of proceeds or any part thereof is subsequently invalidated, declared to be fraudulent or preferential, set aside or required to be returned or repaid to the Borrower, its estate, trustee, receiver, debtor in possession or any other party, including, without limitation, Parent, under any insolvency or bankruptcy law, state or federal law, common law or equitable cause, then to the extent of such payment, return or repayment, the obligation or part thereof which has been paid, reduced or satisfied by such amount shall be reinstated and continued in full force and effect as of the date when such initial payment, reduction or satisfaction occurred. 14.9. No delay on the part of the Agent or any Lender in the exercise of any right, power or remedy shall operate as a waiver thereof, and no single or partial exercise by the Agent or any Lender of any right, power or remedy shall preclude any further exercise thereof; nor shall any amendment, supplement, modification or waiver of any of the terms or provisions of this Guaranty be binding upon the Agent or any Lender, except as expressly set forth in a writing duly signed and delivered by the Agent and the Lenders. The failure by the Agent or any Lender at any time or times hereafter to require strict performance by the Borrower or Parent of any of the provisions, warranties, terms and conditions contained in any promissory note, security agreement, agreement, guaranty, instrument or document now or at any time or times hereafter executed pursuant to the terms of, or in connection with, this Agreement by the Borrower or Parent and delivered to the Agent or any Lender shall not waive, affect or diminish any right of the Agent or any Lender at any time or times hereafter to demand strict performance thereof, and such right shall not be deemed to have been waived by any act or knowledge of the Agent or any Lender, its agents, officers or employees, unless such waiver is contained in an instrument in writing duly signed and delivered by the Agent or such Lender. No waiver by the Agent or any Lender of any default shall operate as a waiver of any other default or the same default on a future occasion, and no action by the Agent or any Lender permitted hereunder shall in any way affect or impair the Agent's or such Lender's rights or powers, or the obligations of Parent under this Guaranty. Any determination by a court of competent jurisdiction of the amount of any Guaranteed Debt owing by the Borrower to the Agent and the Lender shall be conclusive and binding on Parent irrespective of whether Parent was a party to the suit or action in which such determination was made. 14.10. Subject to the provisions of SECTION 14.8, this guaranty shall continue in effect until this Agreement has terminated, the Guaranteed Debt has been paid in full and the other conditions of this guaranty have been satisfied. ARTICLE XV AMENDMENT AND RESTATEMENT 15.1. (a) This Agreement amends and restates in its entirety the Existing Credit Agreement and, upon the Restatement Effective Date, the terms and provisions of the Existing Credit Agreement -60- shall, subject to this ARTICLE XV, be superseded hereby and thereby. Prior to the Restatement Effective Date, the Existing Credit Agreement shall continue to govern the making of any Loans and any outstanding Loans and Obligations. (b) Notwithstanding the amendment and restatement of the Existing Credit Agreement by this Agreement, the Loans under, and as defined in, the Existing Credit Agreement ("Continuing Loans") and all accrued interest, fees and expenses owing to First Chicago and Fleet National Bank by the Borrower shall remain outstanding as of the Restatement Effective Date and constitute continuing Obligations under this Agreement. The Continuing Loans shall in all respects be continuing, and this Agreement shall not be deemed to evidence or result in a novation or repayment and re-borrowing of the Continuing Loans. In furtherance of and without limiting the foregoing (i) all interest, fees and expenses which have arisen under the Existing Credit Agreement shall be paid on the applicable due date therefor specified in this Agreement and (ii) from and after the Restatement Effective Date, the terms, conditions and covenants governing the Continuing Loans shall be solely as set forth in this Agreement, which shall supersede the Prior Credit Agreement to the extent provided in this ARTICLE XV. [signature pages to follow] -61- IN WITNESS WHEREOF, each Loan Party, the Lenders and the Agent have executed this Agreement as of the date first above written. VALLEY GROUP, INC. By: -------------------------------------------- Print Name: ------------------------------------ Title: ----------------------------------------- Address: 80 South Main Street Hanover, New Hampshire 03755 Attn: ----------------------------- Fax No.: ------------------------------------ Tel. No.: ----------------------------------- WHITE MOUNTAINS HOLDINGS, INC.