MAINE BONDING & CASUALTY COMPANY

REPORT OF EXAMINATION
AS OF
DECEMBER 31, 2003

TABLE OF CONTENTS

SCOPE OF EXAMINATION
DESCRIPTION OF COMPANY

HISTORY
CAPITAL STOCK
MANAGEMENT AND CONTROL
CONFLICT OF INTEREST
CORPORATE RECORD
TERRITORY AND PLAN OF OPERATION

ORGANIZATIONAL CHART (ABBREVIATED – NORTH AMERICA)
INTER-COMPANY AGREEMENTS
INSURANCE COVERAGES
LITIGATION
INFORMATION SYSTEMS
SUBSEQUENT EVENTS
FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS
COMMENTS & RECOMMENDATIONS
CONCLUSION

June 6, 2005

Honorable Alessandro A. Iuppa
Superintendent of Insurance
Maine Bureau of Insurance
34 State House Station
Augusta, ME 04333

Dear Sir:

Pursuant to the requirements of statute and in accordance with your instructions, a financial examination has been made of the

MAINE BONDING AND CASUALTY COMPANY

at its administrative office, 1400 American Lane, Schaumburg, Illinois. The following report is respectfully submitted.

SCOPE OF EXAMINATION

The Maine Bonding and Casualty Company (the “Company”) was last examined as of December 31, 2001. This examination covers the period from January 1, 2002 through December 31, 2003 including any material transactions and/or events noted occurring subsequent to December 31, 2003.

The examination consisted of a survey of the Company’s business policies, a review of corporate minutes, a verification of assets and a determination of liabilities at December 31, 2003 in conformity with statutory accounting practices, NAIC guidelines and the laws, rules and regulations prescribed by the Maine Bureau of Insurance.

The Company conducts and retains all business records at its parent’s operations in Schaumburg, Illinois, which was approved by the Bureau of Insurance in July 1999.

Certain scope limitations were inherent in the examination due to the full scope examination of the Zurich Reinsurance Pool. The Company’s business is conducted entirely by Zurich American Insurance Company (ZAIC) and has no employees. ZAIC performs all of the underwriting, investments and claim functions for the Company. The balance sheet and income statement balances are separately identifiable and were verified in accordance with the above standards.

Our examination was coordinated with the Maryland Insurance Administration, which conducted an examination of the financial condition and activities of Maryland Casualty Company (MCC), the Company’s parent. The Maryland Insurance Administration coordinated their examination with the New York Insurance Department, which conducted an examination of the financial condition and activities of ZAIC, MCC’s parent.

Business procedures and controls performed by ZAIC on behalf of MCC were reviewed by the Maryland Insurance Administration during their examination of MCC as of December 31, 2003. Examiners reviewed the workpapers prepared by the pool and were able to rely on their testing in the premium, loss, cash receipt, cash disbursement, reinsurance areas, management control and financial reporting.

For purposes of this report, comments on various balance sheet items may be limited to matters involving a departure from laws, regulation or rules, or where an explanation, comment and/or recommendation is warranted.

DESCRIPTION OF COMPANY

History

The Company was incorporated on August 29, 1939 under the provisions of Sections 55 to 56 inclusive, of Chapter 60 of the Revised Statutes of 1930 of the State of Maine as amended, and commenced business on September 1, 1939. The Company was organized as the result of the merger of the Union Safe Deposit and Trust Company of Delaware and the Maine Casualty Company of Delaware.

The Company is a wholly-owned subsidiary of MCC. MCC, in turn, is a wholly-owned subsidiary of ZAIC. The Company’s ultimate parent is Zurich Financial Services, Zurich, Switzerland.

Capital Stock

At December 31, 2003, the Company had outstanding capital stock of $3,500,000 consisting of 350,000 shares of $10.00 par value, all of which were held by its parent company, MCC.

Management and Control

Management of the Company is vested in not less than seven or more than twenty-one members. The following are the duly elected members of the Board of Directors and the Officers serving as of December 31, 2003:

Directors
John J. Amore	Chairman
David A. Bowers	Executive Vice and Corporate Secretary
James P. Connors	Executive Vice President
Barry J. Gilway	Executive Vice President
Donald J. Hurzeler	Executive Vice President
John A. Kelm	Executive Vice President
James W. March	Director
Michael D. Markman	Executive Vice President
John J. McCartney	President
Nancy D. Mueller	Executive Vice President
Juliet G. Nash	Executive Vice President
Frank A. Patalano	Executive Vice President
Raymond C. Thomas III	Executive Vice President

Officers
John J. Amore	Chairman and Chief Executive Officer
John J. McCartney	President
David A. Bowers	Vice President and Corporate Secretary
David A. Levinson	Executive Vice President and Treasurer
Earl R. Clouser	Executive Vice President
J. Peter Connors	Executive Vice President
James D. Engel	Executive Vice President
Robert M. Fishman	Executive Vice President
Craig J. Fundum	Executive Vice President
Barry J. Gilway	Executive Vice President
Donald J. Hurzeler	Executive Vice President
John A. Kelm	Executive Vice President
Michael D. Markman	Executive Vice President
Nancy D. Mueller	Executive Vice President
Frank A. Patalano	Executive Vice President
Steven P. Rand	Executive Vice President
David J. Saul	Executive Vice President
Diana J. Whidden	Executive Vice President

Conflict of Interest

Title 24-A M.R.S.A. § 3413 requires that each Director and Officer of the Company complete a Conflict of Interest Statement annually to disclose any material interest or affiliations which are likely to be in conflict with his/her official duties and responsibilities to the Company. The Conflict of Interest Statements for the period under review and the Company is substantially in compliance with Maine State Statute.

Corporate Records

The Articles of Incorporation, Bylaws, and the Minutes of the Board of Directors’ meetings held during the period under examination were reviewed. During the review of Board of Directors’ meetings, it was noted the Board minutes did not contain documentation authorizing the custodial agreement with the Bank of New York. It was further noted that the Company’s Board of Directors did not approve the Company’s investments which is in violation Title 24-A M.R.S.A. Chapter 13 § 1104. (See Comments and Recommendations #1 and #2)

Territory and Plan of Operation

The Company is licensed to write business in fourteen (14) states and the District of Columbia. The Company is owned directly by MCC and ultimately by Zurich Financial Services. The Company’s business is conducted entirely by ZAIC, including systems, management, taxes, underwriting and claim processing.

ORGANIZATIONAL CHART (Abbreviated – North America)

INTER-COMPANY AGREEMENTS

Amended Inter-Company Pooling Agreement

A pooling agreement, effective January 1, 1999, exists by and between ZAIC and certain of its affiliates, including the Company and its parent, MCC. The agreement provides that ZAIC assumes one hundred percent (100%) of all underwriting income and losses (net of applicable reinsurance) as well as all underwriting assets, liabilities and expenses of the pool participants.

Tax-sharing Agreement

The Company’s federal income tax returns are filed on a consolidated basis with those of its indirect parent, Zurich Holding Company of America, Inc. The agreement is dated December 15, 1981. On May 25, 1989, the agreement was amended to add several parties, including the Company, to the agreement. The method of tax allocation between the indirect parent and its subsidiaries is based upon separate tax return calculations with no immediate benefit for losses used in the current year consolidated tax returns.

INSURANCE COVERAGES

The Company is included as a subsidiary of MCC, which is specifically named on the fidelity bond issued to the ZAIC. The required minimum amount was calculated on a consolidated basis and the value maintained meets the requirement of the NAIC for a company of this size.

LITIGATION

A review of the letter furnished by general legal counsel from ZAIC revealed that the Company is not involved in any actual, pending or threatened litigation at this time that would result in a material judgment against the Company.

INFORMATION SYSTEMS

The Company uses an electronic data processing system to process the majority of its critical applications (e.g., general ledger, premium processing, claims processing). These critical applications were processed by the Company’s ultimate parent, ZAIC. Our examination was conducted in conjunction and coordination with the New York Insurance Department’s examination of the financial condition and activities at ZAIC.

This review of the procedures and controls over the electronic data processing system disclosed several weaknesses relating to ZAIC’s data processing system. These conditions were reported in the Information Systems Controls Evaluation Review report (“IS Review Report”) of ZAIC, which was issued under separate cover.

SUBSEQUENT EVENTS

Adverse Loss Development:

ZAIC’s liabilities for losses and LAE increased on a net basis by $2.01 billion and $866.2 million during 2004 and 2003, respectively, primarily due to adverse loss development relating to prior accident years in several casualty lines of business, including general liability, workers’ comp, medical malpractice and asbestos and environmental liability.

Subsequent Capital Contributions and Surplus Notes

During 2004, ZAIC’s combined statutory surplus increased by $1.2 billion from $3.7 billion as of December 31, 2003 to $4.9 billion as of December 31, 2004.

In this regard, to offset the adverse reserve development that emerged in 2004, a surplus note for $1 billion was issued to Zurich Insurance Company on December 31, 2004, minus a $38.7 million repayment of another surplus note. Also, prior to the filing of the 2004 Annual Statement, ZAIC received additional capital funding in the form of capital contributions. In conformity with the NAIC Accounting Practices and Procedures Manual, Statutory Accounting Principle No. 72 (“SSAP No. 72”), “Surplus and Quasi-reorganizations”, ZAIC accrued the receipt of cash proceeds and the related impact of capital and surplus of a $1.3 billion capital contribution from its parent, Zurich Holding Company of America. This amount was received on February 22, 2005 and was treated as a Type I subsequent event as the proceeds were received prior to the filing of ZAIC’s Annual Statement and the transaction was approved by the New York Department of Insurance (domiciliary state).

In summary, the 2004 Annual Statement of ZAIC reflected additional capital contributions and surplus notes, totaling $2.3 billion. As of June 30, 2005, ZAIC’s surplus as regards policyholders totaled $5.4 billion.

FINANCIAL STATEMENTS

The following financial statements show the results of the Company’s financial condition for the year ended December 31, 2003 as determined by this examination.

BALANCE SHEET

DECEMBER 31, 2003

ASSETS
Bonds (Note 1)	$ 21,694,508
Cash and short-term investments (Note 2)	96,627
Investment income due and accrued	203,116
Total Assets	$ 21,994,251
LIABILITIES AND SURPLUS
Other expenses	$ 6,286
Current federal and foreign income taxes	31,642
Net deferred tax liability	1,255
Payable to parent, subsidiaries and affiliates	6,305
Total Liabilities	$ 45,488
Common capital stock	$ 3,500,000
Gross paid-in and contributed surplus	1,000,000
Unassigned funds (surplus)	17,448,763
Total Surplus	$ 21,948,763
Total Liabilities and Surplus	$ 21,994,251

INCOME STATEMENT

DECEMBER 31, 2003

Net investment earned	$ 907,508
Net realized capital gain/(loss)	514,724
Net investment gain/(loss)	$ 1,422,232
Net income before taxes	$ 1,422,232
Federal and foreign income tax incurred	23,061
Net Income	$ 1,399,171
CAPITAL & SURPLUS ACCOUNT
Surplus as regards to policyholders at 12/31/02	$ 20,553,452
Net income	$ 1,399,171
Change in net deferred income tax	(3,860)
Change in surplus as regards to policyholders	$ 1,395,311
Surplus as regards to policyholders at 12/31/03	$ 21,948,763

NOTES TO FINANCIAL STATEMENTS

Note 1 – Bonds

$21,694,508

 

	Cost	Par Value	Market Value	Amortized Value
Governments:
United States	$ 11,271,729	$ 10,699,927	$ 11,365,828	$ 11,180,620
Special Revenue
United States	1,095,634	1,047,165	1,089,273	1,089,273
Industrial and Misc.
United States	9,485,848	8,855,782	9,368,284	9,424,615
TOTALS	$ 21,853,211	$ 20,602,874	$ 21,823,385	$ 21,694,508

As required by Title 24-A M.R.S.A. § 412, the Company has maintained the required security deposit with the Treasurer of Maine. Ownership of the bonds was confirmed by obtaining confirmations from depositories for those securities held under a custodial arrangement. Amortized values were tested and no material exceptions were noted. Market values for securities were tested for compliance with the NAIC Valuations of Securities without exception. Purchases and sales of securities were verified to appropriate supporting documentation.

It was noted during the review of the Company’s custodial agreement that it was absent a provision to notify the Superintendent in the event of termination or 100% of the assets being withdrawn. (See Comments and Recommendations #3)

Note 2 – Cash

$96,627

Certifications confirming bank balances were received through correspondence with the various depositories and reconciled to the Company’s book balances without exception.

Note 3 – Subsequent Events

As indicated in the "Scope" section of this Report, our examination was performed in conjunction and in coordination with the New York Insurance Department's examination of ZAIC. The Report on Examination of ZAIC will be issued under separate cover by the New York Insurance Department. As a result of the examination of ZAIC, adjustments could be made to the financial statements of ZAIC which could have an impact on the financial statements of the Company. Specifically, adjustments to the "Losses" and "Loss adjustment expenses" reserves reported by ZAIC as of December 31, 2003 could impact the Company's gross loss reserves related to business ceded to ZAIC. In addition, to the extent that other findings or adjustments related to New York's examination of ZAIC could affect ZAIC's ability to meet its obligations to thJanuary 2, 2008uld be responsible for any defaulted amounts. Because New York's examination of ZAIC has not been finalized as of the date of this Report, we cannot accurately conclude regarding the adequacy of ZAIC's "losses" and "loss adjustment expenses" reserves or its financial condition as of December 31, 2003.

COMMENTS & RECOMMENDATIONS

1. As discussed in the Corporate Records section, the Board of Directors review did not contain documentation approving the custodial agreement with the Bank of New York as required by the NAIC Financial Condition Examiners Handbook, Part 1, Section IV, J Paragraph 1. It is recommended the Company’s Board of Directors authorize custodial agreements.
2. As discussed on the Corporate Records section, the Board of Directors did not approve the Company’s investments in 2002. It is recommended the Board of Directors approve the Company’s investments to be in compliance with Maine Statute.
3. As discussed in Note 1 to the Financial Statements, the Company’s custodial agreement with the Bank of New York is absent a provision to notify the Superintendent in the event of termination or 100% withdrawal of the assets. The Company should amend the agreement to include the required provision per the NAIC Financial Condition Examiners Handbook, Part 1, Section J, paragraph 3.

CONCLUSION

The Company's financial condition, as disclosed by this examination, is reflected in statements and supporting exhibits contained in this report. The basis of preparation of such statements conforms to laws, rules and regulations prescribed and/or permitted by the Maine Bureau of Insurance.

Acknowledgment of cooperation and assistance extended to the examiners by all Company personnel is hereby expressed.

STATE OF MAINE
COUNTY OF KENNEBEC, SS

James C. Williams, CPA, CFE being duly sworn according to law, deposes and says that, in accordance with the authority vested in him by Alessandro A. Iuppa, Superintendent of Insurance, pursuant to the Insurance Laws of the State of Maine, he has made an examination of the conditions and affairs of the

MAINE BONDING AND CASUALTY COMPANY

of Portland, Maine as of December 31, 2003, and that the foregoing report on examination, subscribed to by him is true to the best of his knowledge and belief.

_________________________
James C. Williams, CPA, CFE
Director of Financial Affairs & Solvency

Subscribed and sworn to before me
this ____ day of ____________, 2005

_____________________________
Notary Public

My Commission Expires:

I hereby certify that the attached report of examination dated June 6, 2005 shows the condition and affairs of Maine Bonding and Casualty Company of Portland, Maine as of December 31, 2003 and has been filed in the Bureau of Insurance as a public document.

This report has been reviewed. _______________________ Eric A. Cioppa Deputy Superintendent

This ____ day of ____________, 2005

 

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