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					Financial Exam Report         Affinity Insurance Group, Inc.
December 31, 1996                                              1




                        COLORADO DIVISION OF INSURANCE

                            REPORT OF EXAMINATION

                                        OF



                        AFFINITY INSURANCE GROUP, INC.

                               64 Inverness Drive East
                               Englewood, CO 80112




                                       AS OF

                               DECEMBER 31, 1996
 Financial Exam Report                                          Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                                                2


TABLE OF CONTENTS
                                                                                                                                     PAGE
SALUTATION ........................................................................................................................... 3
SCOPE OF EXAMINATION ..................................................................................................... 4
  HISTORY AND CAPITAL..................................................................................................... 5
    History................................................................................................................................. 5
    Capital ................................................................................................................................. 6
    Dividends to Stockholders..................................................................................................... 6
    Surplus Debentures .............................................................................................................. 6
  AFFILIATED COMPANIES .................................................................................................. 7
    Parent, Subsidiaries and Affiliates ........................................................................................ 7
    Acquisitions, Mergers or Sales.............................................................................................. 7
    Holding Company Filings ..................................................................................................... 7
    Organization Chart............................................................................................................... 9
  MANAGEMENT AND CONTROL...................................................................................... 10
    Shareholder Meetings ......................................................................................................... 10
    Board of Directors.............................................................................................................. 10
    Officers.............................................................................................................................. 11
    Committees ........................................................................................................................ 12
    Conflict of Interest.............................................................................................................. 12
    Service and Management Agreements ................................................................................. 13
  CORPORATE RECORDS .................................................................................................... 13
  FIDELITY BOND AND OTHER INSURANCE................................................................... 13
  EMPLOYEE AND AGENTS WELFARE AND PENSION PLANS...................................... 14
  TERRITORY AND PLAN OF OPERATION ....................................................................... 15
    Territory ............................................................................................................................ 15
    Plan of Operation ............................................................................................................... 15
  MARKET CONDUCT ACTIVITIES.................................................................................... 15
    Policy Forms and Underwriting Practices............................................................................ 15
    Rating and Statistical Reporting.......................................................................................... 16
    Treatment of Policyholders ................................................................................................. 16
    Advertising and Sales Materials.......................................................................................... 17
  GROWTH OF COMPANY................................................................................................... 17
  PREMIUMS BY STATE ...................................................................................................... 17
  LOSS AND UNDERWRITING EXPERIENCE.................................................................... 18
  REINSURANCE................................................................................................................... 18
    Ceded................................................................................................................................. 18
  STATUTORY AND SPECIAL DEPOSITS .......................................................................... 20
  ACCOUNTS AND RECORDS ............................................................................................. 20
FINANCIAL STATEMENTS................................................................................................... 23
    Assets, Liabilities, Surplus and Other Funds ....................................................................... 23
    Statement of Income ........................................................................................................... 24
    Capital and Surplus Account .............................................................................................. 26
    Reconciliation of Capital and Surplus ................................................................................. 27
    Analysis of Examination Changes....................................................................................... 28
    Comparative Financial Statement........................................................................................ 29
NOTES TO THE FINANCIAL STATEMENT......................................................................... 30
SUMMARY ............................................................................................................................. 34
COMMENTS AND RECOMMENDATIONS .......................................................................... 35
CONCLUSION ........................................................................................................................ 39
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                            3

                                                                  Englewood, Colorado
                                                                  January 30, 1998
Honorable Jack Ehnes
Commissioner of Insurance
State of Colorado
1560 Broadway, Suite 850
Denver, CO 80202


Commissioner:

       Pursuant to your instructions and in compliance with the requirements of Section 10-1-201, et seq., C.R.S.,
an examination has been made of the financial condition and affairs of the:

                                     AFFINITY INSURANCE GROUP, INC.

                                               64 Inverness Drive East
                                               Englewood, CO 80112

and the report thereon is respectfully submitted.

         Affinity Insurance Group, Inc., hereinafter referred to as "Company" was last examined as of December
22, 1995 by the Division of Insurance, State of Colorado when an organizational examination was conducted. The
current examination was also conducted by the Division of Insurance, State of Colorado.

        No recommendations were made during the prior examination.
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                              4


                                          SCOPE OF EXAMINATION

        This examination covers the period from December 22, 1995 through December 31, 1996. During the
course of examination, assets were verified and valued and all known liabilities were established as of December
31, 1996. Accounting and other pertinent records were reviewed to the extent deemed appropriate. The work
performed was in accordance with statutory requirements and followed procedures proscribed in the Colorado
Examiners Handbook and the NAIC Examiners Handbook. The extent of review on any given account or activity
was based upon its relationship and importance to the total operation. External audit reports were not used, as they
were not required per Colorado Insurance Regulation 3-1-4 as of December 31, 1996 due to low premium volume
and the small number of policyholders.

         A general review was also made of the Company’s operations. Compliance with the insurance laws and
regulations of the State of Colorado was considered in all phases of the examination. Details of the examination
review findings are found under the appropriate heading in the following sections of this report.
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               5

HISTORY AND CAPITAL

History

        Affinity Insurance Group, Inc. was originally incorporated in Colorado as a captive insurance company on
November 16, 1977 under the name of Aspen Indemnity Corporation (AIC). AIC was placed in rehabilitation by
the Colorado Division of Insurance (DOI) on August 1, 1984 and declared insolvent and ordered liquidated by the
Denver District Court on September 6, 1984. On May 4, 1995 the district court, City and County of Denver, State
of Colorado, issued an order approving the sale of the corporate shell of Aspen Indemnity Corporation to Affinity
Group, Inc. pursuant to Section 10-3-533.5, C.R.S.

        Affinity Group, Inc. (AGI) acquired all issued and outstanding shares of common stock representing 100%
ownership in Aspen Indemnity Corporation on June 30, 1995. On September 6, 1995 an order issued by Colorado
DOI approved the proposed acquisition of control of AIC by Affinity Group, Inc. subject to certain conditions
including minimum capitalization requirements. AIC restated and amended its Articles of Incorporation and filed
them with the Secretary of State on November 13, 1995. The amended Articles included changing the name of the
Company from Aspen Indemnity Corporation to Affinity Insurance Group, Inc., which is the Company’s current
name.

         The Colorado DOI granted a certificate of authority to the Company on December 22, 1995. The
certificate authorizes the Company to sell general casualty, general property, and both motor vehicle property and
casualty lines of business.

       The order issued on September 6, 1995 by the Colorado DOI imposed the following as conditions of the
approval granted for Affinity Group, Inc. to purchase the Company:

1. AGI shall cause the Company to have a minimum capitalization of $3,500,000 in securities, which are
   admissible under Colorado insurance law.
2. AGI will cause the Company to limit the gross direct premiums written to $3,000,000 in calendar year 1996,
   $7,000,000 in calendar year 1997 and $9,000,000 in calendar year 1998 and thereafter.
3. AGI shall provide a complete annual audited financial report of its operations.
4. The Company shall not declare and/or pay dividends or distribute any asset or equity of its own without
   approval of the Commissioner.
5. The Company will not enter into any transactions, other than the placement of insurance contracts, with AGI or
   any of its affiliates, subsidiaries or parent, without the approval of the Commissioner.
6. The Company shall not enter into any reinsurance transaction that has not been approved by the Insurance
   Commissioner.
7. The Company and AGI acknowledge and agree that the authority of the Company will be limited to the
   business of general casualty and motor vehicle insurance.

        The order further states that the above conditions will remain in effect until removed or changed by a
written order of the Insurance Commissioner.

          The Company began writing business on January 1, 1996.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                 6


          The restated and amended Articles of Incorporation state that the Company’s purpose is to:

1. Engage in all types and forms of insurance and reinsurance allowed by law on all risks, hazards, and liabilities;
2. Acquire, own, use, lease as lessor or lessee, convey and deal in and with real and personal property and any
   interest therein; and
3. Carry on any business or activity related to the first two purposes listed above that is permitted by law as a
   corporation and an insurance company established according to Colorado Corporate Code and Colorado
   Insurance Code.

Capital

        As part of the acquisition and purchase agreement by and between the receiver of Aspen Indemnity
Corporation and AGI, AGI acquired all 9,000 outstanding shares of common stock of Aspen Indemnity
Corporation. These shares had a par value of $175 per share. On August 1, 1995, based on a recommendation of
the board of directors, the sole shareholder agreed to a plan of recapitalization. Under the plan, a reverse stock split
was effected whereby every nine shares of common stock outstanding were combined into one share of common
stock with a par value of $175. As a result, Affinity Group, Inc. was issued 1,000 shares of common stock, in
exchange for 9,000 shares of Aspen Indemnity Corporation.

         At the time the Articles of Incorporation were refiled and amended, the par value for Affinity Insurance
Group, Inc. common stock was changed to $1 per share. The Articles also state that the Company is authorized to
issue 2,000 shares of voting common stock including the 1,000 shares held by Affinity Group, Inc. Each share of
stock outstanding has one vote. There are no other classes of stock authorized.

Dividends to Stockholders

        As part of the order authorizing acquisition and control of the Company, by Affinity Group Inc., the
Company is prohibited from declaring and/or paying dividends or distributing any asset or equity of its own without
the approval of the Commissioner of Insurance. No stockholder dividends were declared or paid during the
examination period.

Surplus Debentures

         Section 10-3-239, C.R.S. requires that surplus debenture agreements be submitted to and approved by the
Commissioner of Insurance prior to their issuance. The Colorado Division of Insurance has approved the issuance
of three surplus debentures by the Company to its parent, Affinity Group, Inc. during the period under examination.
However, the balance reported for surplus notes in the annual statement exceeds the amount approved by the
Colorado Division of Insurance by $87,500. In addition, note number 00002 was never executed. As a result,
$87,500 of the surplus note balance will be reclassified to the liability “Payable to Parent, Subsidiaries and
Affiliates” since monetary benefit was received from the parent in this amount.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                7


          Note Number   Approval Date                    Issue Date          Amount
         00001        Dec. 21, 1995                 Dec. 22, 1995            593,800.00
         00002        Mar. 10, 1996                 never executed            29,704.25
         00003        Feb. 20, 1997                 Mar. 10, 1997            424,568.99
         amount not         NONE                    no note executed          87,500.00
         approved                                   for this amount
               TOTAL                                                        1,135,573.24

RECOMMENDATION:

No. 1

It is recommended that the Company comply with Section 10-3-239, C.R.S., which requires prior approval for all
surplus notes that are issued. It is recommended that the Company execute note number 00002 in the amount
approved by the Division and file an executed copy with the Colorado Division of Insurance.

AFFILIATED COMPANIES

Parent, Subsidiaries and Affiliates

         The Company is a wholly owned subsidiary of Affinity Group Inc. (AGI), a Delaware Corporation whose
ultimate control resides with its primary shareholder, Stephen Adams. Affinity Group, Inc. owns eleven other
subsidiaries in addition to the Company – two of which have their own wholly owned subsidiaries. Affinity Group,
Inc. is primarily a membership-based direct marketing company which sells club memberships, products, services
and publications including magazines, directories and books to select groups, including its own subsidiaries.

        As part of the order authorizing acquisition and control of the Company by Affinity Group, Inc., the
company is prohibited from entering into any transactions, other than the placement of insurance contracts, with
Affinity Group, Inc., or any of its affiliates or subsidiaries, without the approval of the Commissioner of Insurance.

Acquisitions, Mergers or Sales

       No acquisitions, mergers or sales occurred during the period under examination except for the purchase of
the Company by Affinity Group, Inc.

Holding Company Filings

         The Company is a member of an insurance holding company system and as such is subject to the
registration requirements of Section 10-3-804, C.R.S. and Colorado Insurance Regulation 3-4-1. During the
examination period, the Company made the required Form B and Form C filings.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             8


         The ultimate controlling person of the holding company system as defined pursuant to Section 10-3-801(3),
C.R.S. and Colorado Insurance Regulation 3-4-1(III), is Stephen Adams of California who owns 97.75% of AGI
Holding Corporation. The Company’s registration statement filed for 1996 identified the Company’s direct parent,
Affinity Group, Inc. as the ultimate controlling person. The Company made this determination because there are
certain restrictive conditions in effect which limit Mr. Adam’s ability to exercise full control over the Company.
These conditions include:

1. Restrictive covenants contained in certain debt instruments issued by upper tier affiliates.

2. Conditions placed on the Company by order of the DOI dated September 6, 1995.

3. The boards of various upper tier affiliates include outside/non-employee members.

Section 10-3-801 (3), C.R.S. provides that control is presumed to exist if any party “…owns, controls … ten
percent or more of the voting securities of any other person.” However, this presumption may be rebutted by filing
a disclaimer of control in accordance with Section 10-3-804 (9), C.R.S. To date no such filing has been made with
the DOI. As such, Mr. Adams has been determined to be the ultimate controlling person of the holding company
system through his 97.75% ownership of AGI Holding Corporation.

RECOMMENDATION

No. 2

It is therefore recommended that the Company identify the ultimate controlling person as Stephen Adams in its
annual registration statement in accordance with the definitions stated in both Section 10-3-801(3), C.R.S. and
Colorado Insurance Regulation 3-4-1(III) or file a disclaimer of control for consideration by the DOI in accordance
with Section 10-3-804 (9), C.R.S.
 Financial Exam Report                     Affinity Insurance Group, Inc.
 December 31, 1996                                                                                          9

Organization Chart

        The following organizational chart depicts the Company’s relationship within the holding company system
as of December 31, 1996:




                                       Stephen Adams


                                         (California)


                                                97.75%

                                     AGI Holding Corp.


                                         (Delaware)


                                                100%

                                        Affinity Group
                                         Holding, Inc.

                                          (Delaware)


                                                100%

                                      Affinity Group, Inc.


                                          (Delaware)


                                                100%


                                       Affinity Insurance
                                          Group, Inc.

                                          (Colorado)
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               10

MANAGEMENT AND CONTROL

Shareholders Meetings

         The bylaws, as restated and amended, provide that the annual meeting of shareholder(s) shall be held on the
second Monday in April each year for the purpose of electing a Board of Directors and to transact such other
business as may properly be brought before the meeting. The meeting will be held in such place as stated in the
notice of the meeting.

       Special meetings of shareholder(s) may be called for any purpose by the Chairman, the President, the
Board of Directors or the holders of not less than one tenth of all shares entitled to vote.

        A majority of the shares of the Company, represented in person or by proxy, shall constitute a quorum at
any meeting of the shareholders. Any actions required to be taken at a meeting of the shareholders may be taken
without a meeting, if a consent in writing setting forth the actions so taken is signed by the shareholders in
accordance with Colorado law.

        During the period under examination, no formal shareholder meetings were held including the annual
meeting of shareholders, as evidenced by the lack of any shareholder minutes for this time period. In addition, no
documentation was found supporting the election of members of the board of directors including the election of a
chairman for the period April, 1996 to April, 1997 by the shareholder(s). The same lack of documentation was
noted regarding the election of the board of directors and chairman to serve for the period from April, 1997 to
April, 1998. The lack of annual shareholder meetings and elections are both violations of the Company’s bylaws.

RECOMMENDATION

No. 3

It is recommended that an annual shareholder meeting be held every year and that the minutes of the meeting be
formally documented. It is also recommended that a formal election of board members and the chairman be held
and documented at the time of the annual shareholder meeting.

Board of Directors

         The amended and restated articles of incorporation and the bylaws both provide that the business and
affairs of the Company shall be managed by a board of directors. The Board is to consist of not less than three but
no more than five individuals. The Board is charged with determining the exact number of directors at each annual
meeting.

        The bylaws specify that the annual meeting of the Board shall be held immediately following the annual
meeting of shareholders on the second Monday in April. Directors shall be elected by the shareholder(s) at the
annual meeting of shareholders and serve until the next annual meeting of shareholders and thereafter until a
successor shall have been elected and qualified. Directors need not be shareholders of the Company.
 Financial Exam Report                          Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                  11


        A majority of the total number of directors then in office constitutes a quorum for the transaction of
business.

        During the period under review, the board held three regular meetings. No annual meeting was held in
April, 1996 or 1997.

           Directors duly elected in 1995 and still serving at December 31, 1996 with their business affiliation are as
follows:

      Director                                       Business Affiliation

      Wayne A. Boysen                                Affinity Group, Inc. – Director;
      Edina, MN                                      Affinity Ins. Grp., Inc. – Chairman
                                                     of the Board

      James R. Parkinson                             Affinity Ins. Grp., Inc. – Director,
      Aurora, CO                                     President, CEO

      Joe B. McAdams                                 Affinity Group, Inc. – President,
      Westlake Village, CA                           CEO, Director; Affinity Ins. Grp., Inc. –
                                                     Director

      Mark J. Boggess                                Affinity Group, Inc. – Senior Vice
      Aurora, CO                                     President, CFO; Affinity Ins. Grp.,
                                                     Inc. – Secretary, Treasurer

           The directors listed above are all currently serving on the board.

Officers

         The bylaws state that the officers of the Company shall consist of a president, a treasurer, a secretary and
such other officers, including a chairman, vice-presidents, assistant treasurers or assistant secretaries as the board
of directors may elect or appoint. Officers shall be elected and the annual Board meeting following the annual
shareholders meeting. Such elections did not occur in April, 1996 or April, 1997.

         The bylaws state that the Chairman of the Board shall be the Chief Executive Officer (CEO) if a chairman
is elected, otherwise, the president shall hold this office. The Board has a chairman but he is not the CEO – the
president is the CEO. The bylaws also state that the president shall be the Chief Operating Officer but no one held
that office as of December 31, 1996. No evidence in the board minutes was found regarding the formal election of
a chairman. The president, secretary and treasurer have not been formally reelected since their original
appointments made of September 5, 1995.

         According to the bylaws, the secretary is charged with keeping the minutes of the meetings of the
shareholders, the board of directors and of any committees thereof. None of the minutes of the annual or regular
meetings were signed or attested to by the secretary. Based on these facts, the Company is not in compliance with
its bylaws.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             12



RECOMMENDATION

No. 4

It is recommended that the Company comply with its bylaws regarding who may serve as CEO and Chief Operating
Officer and regarding the Secretary’s responsibility for keeping of minutes of shareholder, board and committee
meetings.

        Officers serving at December 31, 1996 are as follows:

        Name                                       Title

        James R. Parkinson                         President and CEO

        Mark J. Boggess                            Secretary and Treasurer

        Robert A Enna                              Senior Vice President – Underwriting

        Joseph C. Palumbo                          Senior Vice President – Claims

        The Officers listed above are all currently serving as officers of the Company.

Committees

          There were no committees formally established during the period under examination.

Conflict of Interest

         For the period under examination, the Company answered in the affirmative to the annual statement general
interrogatory regarding an established procedure for disclosure of conflicts of interest on the part of directors,
officers, trustees and key employees to the board of directors. A review of conflict of interest statements for the
period under examination revealed that three of the directors, two of whom are also officers, did not complete the
statements. No conflicts of interest were identified in the statements that were completed.

RECOMMENDATION

No. 5

It is recommended that the Company establish a conflict of interest policy and procedures necessary to ensure that
conflict of interest statements are completed annually by all directors, officers, trustees and key employees.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               13

Service and Management Agreements

         During the period under examination, the Company contracted with Crawford and Company (Crawford)
for the purpose of handling all aspects of the claims processing for automobile, homeowners and umbrella claims
made to the Company. The contract calls for flat rate pricing for each type of service provided. The flat fee
schedule does not include allocated expenses, which are paid for separately. If certain performance goals are
exceeded, a bonus will be paid. If performance goals are below established criteria, a portion of the fee owed to
Crawford will be forfeited and retained by the Company. In addition to providing comprehensive claim processing
services, Crawford is also responsible for establishing initial reserves based on information gathered from the loss
report or from the initial claim activity.

         The Company participates in a tax sharing arrangement with all of the Affinity Group, Inc. affiliates
whereby a consolidated tax return is filed by Affinity Group, Inc. As a result, the Company’s operating losses from
1995 and 1996 were passed on to Affinity Group, Inc. and no tax effects were reported on the financial statements
of the Company. Beginning in 1998, the Company will file a stand-alone tax return. The overall effect of the
agreement is that the Company has given up net operating losses that it may have been able to use as an offset
against future net operating gains. This agreement violates the September 6, 1995 order issued by the Colorado
Division of Insurance. The Company has transferred tax benefits to its parent in the form of net operating losses
and is party to an agreement with the parent for purposes other than the issuance of insurance.

         The Company receives certain benefits from the parent company such as the use of office space, use of at
least one employee on a full-time basis, accounting services, cash handling services, computer support services,
payroll services, business insurance and other risk management services and entitlement to participate in the parent
company’s employee benefit plans. There is no charge for any of these benefits and there is no written management
or service agreement that addresses them.

RECOMMENDATION

No. 6

It is recommended that the Company no longer enter into any transactions with the parent company or its affiliates
that violate the order issued by the Commissioner of Insurance on September 6, 1995.

CORPORATE RECORDS

        The articles of incorporation, bylaws, and the minutes of the meetings of the board of directors were
reviewed for the period under examination. The Company did not amend its articles of incorporation during the
period under examination.

         As described above in the sections entitled “Officers” and “Committees”, the Company is not in compliance
with its bylaws regarding the holding of its annual shareholders and board of directors meetings, election of a board
of directors, election of officers, the duties of the secretary and the creation of an executive committee.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               14


         The Company’s investment guidelines state that the Board of Directors is responsible for advance written
approval of investments. There is no evidence in the board minutes to show that this is being done. In fact,
investments are being approved by the secretary and treasurer. However, there is no evidence in the board minutes
that the secretary and treasurer was appointed by the board to approve investments. In addition, no permanent
written record of the transactions occurring during the period under examination was found in the board of directors
minutes. The Company does not comply with the provisions of Section 10-3-234, C.R.S., regarding the method of
securing advance approval of investments or maintaining a permanent written record of investments.

RECOMMENDATION

No. 7

It is recommended that the Company implement procedures to ensure that prior written approval is obtained by the
board of directors or a committee or individual so authorized for all investment transactions as required by Section
10-3-234, C.R.S. It is also recommended that a permanent written record of all investment transactions be
maintained in the board minutes.

FIDELITY BOND AND OTHER INSURANCE

         The Company maintains fidelity coverage that meets the requirements of Colorado Insurance Regulation 3-
1-1, including the usage of the Colorado Rider, and requiring that 30 day advance notice be given to the
Commissioner of Insurance in the event of termination of the bond. A carrier, licensed in the State of Colorado,
provides the coverage. Based on the Company’s admitted asset base and its gross revenues, coverage in the range
of $50,000 - $75,000 should be in place. The current coverage is in the amount of $175,000 for any one loss and
in aggregate with a $5,000 deductible. Coverage includes losses through computer systems fraud.

        The Company is also covered under an errors and omissions insurance policy. The Companies writing the
primary and excess coverages for the errors and omissions insurance are approved by the Colorado Division of
Insurance as surplus lines insurers. All other insurance related to the business operations of the Company is in the
name of Affinity Group, Inc. and each policy covers many of the entities in the holding company system. The
coverages include commercial general liability, business automobile, multi-peril property and workers’
compensation and employer’s liability.

EMPLOYEE AND AGENTS’ WELFARE AND PENSION PLANS

        The Company provides its employees and their dependents with a basic benefit package that includes short-
term and long-term disability and group term life/accidental death and dismemberment insurance on a non-
contributory basis and health and dental insurance on a contributory basis. Eligible employees may participate in a
401(k) plan sponsored by the Company’s parent, Affinity Group, Inc., which provides for partial matching of
employee
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                            15

contributions. Affinity Group, Inc.’s costs for the benefits provided to the Company’s employees are allocated
back to the Company. No other retirement benefits, stock ownership plans or employment contracts are provided
for employees. All required liabilities are established on the books and records of the parent company, Affinity
Group, Inc.

TERRITORY AND PLAN OF OPERATION

Territory

       The Company was granted a multiple line license to operate in the State of Colorado on December 22,
1995. Currently, licenses are being sought in other states but none have been acquired as of December 31, 1997.

Plan of Operation

         The Company markets and underwrites its own personal insurance products including automobile,
homeowners and personal umbrella coverages. The products are offered as part of voluntary benefits packages
sponsored by employers who participate in the Company’s program. Employer groups are enrolled through
relationships established directly by Company personnel or through relationships with employee benefits brokers.
A small amount of direct mail marketing was also used to produce business in 1996.

         As of December 31, 1996, the Company was also selling automobile insurance products that compliment
its own products, but are underwritten by another property and casualty company. The Company is paid a fee for
this service. The Company does not employ a producer force for the purposes of selling its products.

MARKET CONDUCT ACTIVITIES

        The following areas were reviewed as part of the market conduct evaluation of the Company:

Policy Forms and Underwriting Practices

        The Company offers three basic types of personal insurance coverage as outlined below:

                  Coverage Type               Minimum             Maximum
            Personal Automobile           $25,000/$50,000/   $300,000/$500,000/
                                          $15,000            $100,000
            Homeowner
               100% insurance to value $85,000               $400,000
                80% insurance to value $50,000               $400,000
            General Liability (100%    $1,000,000            $1,000,000
            ceded)
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               16


         Various endorsements are also offered in order to modify and customize coverage to the customer’s specific
needs. The Company also has on file a plan approved by the Colorado Division of Insurance for the issuance of
dwelling/fire insurance to protect rented dwellings from various hazards. However, this plan has not yet been
offered to consumers.

        Underwriting guidelines and rating manuals are provided to the Company’s insurance counselors who
perform the underwriting review and evaluation under the direction of the senior vice president of underwriting.
Each risk is underwritten individually, based on the specific factors involved for the coverage under consideration.
A computer system is currently under development that will perform most of the underwriting function
automatically based on the particular risk being evaluated.

         As discussed in more detail below in the section on reinsurance, the Company does not retain any risk that
is greater than $25,000.

         Records maintained by the Company regarding policy filings indicate that policy forms listings have been
filed as required by Section 10-4-725, C.R.S.

Rating and Statistical Reporting

        The Company has made rate filings with the Colorado Division of Insurance as required by Sections 10-4-
401, C.R.S. et. seq. as evidenced by a review of the Company’s filing records.

        Since the Company is newly formed, it does not have a loss experience database from which to develop
rates. The Company has chosen to base its automobile insurance rates on the experience of another large
automobile insurer that targets its sales efforts at “affinity” groups – groups that have a common interest or other
defining characteristic – in the same way that the Company does.

        The Company is a member of and uses loss cost data obtained by the Insurance Services Office as a basis
for developing homeowner insurance rates. Loading and adjustments to adapt the data to the specific circumstances
under which the Company is providing coverage are added to derive the rate to be charged.

         Umbrella coverage is 100% reinsured by Swiss Reinsurance America Corporation who also provides the
rating structure to be used for this line of business.

Treatment of Policyholders

       Claims settlement practices were reviewed by examining a sample of physical and computer claims files.
No exceptions indicating unacceptable claims settlement practices were noted.

        The Company has established a complaint register in the format required by Colorado Insurance
Regulation 6-2-1. The register did not contain any complaints for the period under examination. The Colorado
Division of Insurance does not have a record of any complaints having been filed for this time period either.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                          17


Advertising and Sales Materials

         A cursory review of the Company’s written advertising and sales materials was made with no exceptions
identified.

GROWTH OF THE COMPANY

        The growth of the company for selected years is presented in the following schedule:

                     Admitted                                            Surplus
          Year        Assets         Liabilities        Capital           Funds

          1995       $3,616,141           $      0           $1,000      $3,615,141
          1996        2,806,751            248,040            1,000       2,557,711

       The 1995 amounts were compiled from a filed annual statement. For 1996, the amounts were determined
by examination.

        A summary of direct premiums written, reinsurance activity, net premiums written and net premiums
earned is presented as follows:

                                   Reinsurance Premiums
                    Direct                                           Net          Net
                  Premiums                                        Premiums     Premiums
        Year       Written        Assumed            Ceded         Written      Earned

        1995               0                 0             0               0             0
        1996         148,500                 0        93,443          55,057       (8,466)

         No premiums were written in 1995. Negative net premiums earned were reported as a result of premiums
paid on reinsurance ceded and the recording of an unearned premium liability. The above amounts were compiled
from filed annual statements. For 1996 the amounts were determined by examination.

PREMIUMS BY STATE

                                                        Direct Premiums
                                  State                     Written

                    Colorado                                      $148,500

                         Total Direct Business                    $148,500

As of December 31, 1996, the Company was only authorized to write business in Colorado.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                               18


LOSS AND UNDERWRITING EXPERIENCE

                              Loss and Loss     Underwriting
            Net Premiums        Expense           Expense        Loss and Loss     Underwriting
 Year          Earned           Incurred          Incurred       Expense Ratio        Ratio

   1995                 $0                $0               $0            0.00%            0.00%
   1996            (8,466)            60,635        1,263,765         -716.22%         -14,928%

        No business was written in 1995. The amounts for 1996 were determined by examination. The loss and
loss expense ratios are extremely high and negative due to the fact that net premiums earned were both small and
negative in 1996. As the Company continues to write more business, these ratios should become more meaningful.

REINSURANCE

Ceded

         The Company has arranged for reinsurance coverage on all of its lines of business. Three contracts were in
effect at December 31, 1996 to provide three layers of casualty excess of loss coverage, property per risk excess of
loss coverage and property catastrophe excess of loss coverage. The Company’s retention on any one risk is
$25,000. A low level of retention has been established largely due to the fact that the Company began writing
business on January 1, 1996. This retention level is well within the limitations regarding any one risk or hazard
retained by a company per Section 10-3-102(3), C.R.S.

          Casualty Excess of Loss

         The casualty excess of loss agreement went into effect on January 1, 1996 and is effective until termination
as defined in the agreement except for the third excess layer, which is renewable annually. The first two layers
have no annual limitation for loss recovery. An unlimited number of loss occurrences in excess of $25,000 up to a
limit of $1,500,000 may be recovered. The third excess layer allows for two total losses of $1,500,000 or as many
partial losses that are greater than $1,500,000, that in the aggregate, do not to exceed $3,000,000 on an
annual/accident year basis.

        The umbrella coverage is only addressed as part of the second and third excess layers which is when the
coverage would be activated. Umbrella coverage provides an additional $1,000,000 in coverage only and is 100%
reinsured. The casualty contract also provides for a contingent commission payable to the Company of up to
33.33% of the profit realized by the reinsurer as defined in the agreement. The coverages are as follows:
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                19


               Covers: Auto Liability,       Initial      First Excess      Second
               Section II Homeowners        Retention      Layer (per       Excess
                Liability and Personal                    Occurrence)     Layer (per
                 Umbrella Liability                                       Occurrence)

               Company’s Retention              25,000          25,000         200,000
               Amount of Reinsurance                 0         175,000       1,300,000
               Cumulative Total                 25,000         200,000       1,500,000
               Coverage

Note: Each layer of coverage by the reinsurer is in addition to and separate from coverages provided by the
reinsurer in the other layers.

        Property per Risk Excess of Loss

          This agreement became effective January 1, 1996 and is in effect until terminated. The Company retains
the first $25,000 in event of a loss and the reinsurer covers the ultimate net losses in excess of Company’s retention
not to exceed $775,000 each risk for any one loss occurrence but shall not exceed $1,000,000 from all risks in each
loss occurrence. Coverage is for the following lines: fire, allied lines, auto physical damage, inland marine and
homeowners (section 1 only).

        Property Catastrophe Excess of Loss

        This agreement went into effect on January 1, 1996 and expired on December 31, 1996. It was renewed
for 1997. Coverage is for fire, allied lines, auto physical damage (not to include collision coverage), inland marine
and homeowners (section one only). The policy only attaches if two or more risks are involved in the same loss
occurrence. The policy may be reinstated by payment of additional premium for that portion of the coverage that
was exhausted due to a claim having been paid by the reinsurer.

       This coverage works together with the property per risk excess of loss policy discussed above in cases
where two or more losses are the result of a single loss occurrence. When more than $100,000 is paid by the
Company on the per risk excess of loss policy, the reinsurer will pay 95% of additional losses up to the limits noted
below:

                                                  Affinity Insurance      Reinsured by
                                                     Group, Inc.             Swiss
                      Description                     Retention           Reinsurance
        Initial Retention                        100,000
        Reinsurance                              5%                      95%
        Limit per Any One Loss Occurrence                                95% of
                                                                         $1,000,000
        Limit in Total During Term of                                    95% of
        Agreement                                                        $2,000,000
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             20


Assumed

          The Company did not assume any reinsurance during the period under examination.

STATUTORY AND SPECIAL DEPOSITS

        The Company maintained the following deposit on December 31, 1996 for the protection of all
policyholders.

                                                                     Statement       Market
        Location             Type of Security          Par Value       Value         Value

State of Colorado      FNMA Medium Term Note          $2,000,000     $2,010,997    $1,988,740

         As a multiple line company, Affinity Insurance Group, Inc. is required by Section 10-3-201, C.R.S. to
maintain a statutory deposit with the State of Colorado in the amount of $2,000,000. Additionally, Colorado
Insurance Regulation 3-2-3 requires that if the market value of the security falls below the statutory minimum, the
deposit must be immediately increased to eliminate the deficiency. At December 31, 1996, the market value, as
reported in the Company’s quarterly filing was deficient in the amount of $11,260. At the direction of the Colorado
Division of Insurance, the Company deposited additional security with a par value of $100,000 on March 17, 1997
to eliminate the deficiency.

RECOMMENDATION

No. 8

It is recommended that when the market value of the statutory deposit drops below the statutory minimum, the
Company increase the deposit immediately as required by Colorado Insurance Regulation 3-2-3.

        The statutory deposit was found to be in compliance with the provisions of Section 10-3-206 and 210,
C.R.S. as well as Colorado Insurance Regulation 3-1-2 at December 31, 1996.

ACCOUNTS AND RECORDS

         The accounts and records of the Company are maintained on a computerized accounting system that
utilizes Sequel to Platinum software. Only the general ledger and accounts payable subsystems of this software are
used by the Company. Another group of systems created by Programming Resources Corp. used to maintain data
relating to the issuance of policies, policy billing and claims is still under development. These systems currently
have only limited reporting capability, requiring some information, such as claims payment data to be tracked
“manually” in computer spreadsheets in addition to tracking within the system in order to obtain amounts used for
statutory reporting purposes. In two cases, amounts reported in the annual statement could not be supported at all
because no report was currently available to extract the required data from the computer software systems. In one
case, the balance was nonadmitted; in the other case, alternate methods were used to verify the balance reported in
the annual statement. See notes 3 and 5 of the “Notes to the Financial Statements”.

RECOMMENDATION

No. 9
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                              21



It is recommended that the Company enhance its automated reporting capability to enable the extraction of data
such that reports from the policy, billing and claims systems can be generated. These reports and other supporting
detail are required to support the final totals that are reported on the Company’s annual statement.

         The accounting system and procedures used by the Company generally conform to insurance accounting
standard practices and procedures. However, the Company is not reporting loss adjustment expenses other than
those related to outside claims adjustment services in Column 1 of the Underwriting and Investment Exhibit, Part 4
as required by the NAIC Annual Statement Instructions. Improper allocation of loss adjustment expenses affects
the results of loss ratio and expense ratio calculations.

RECOMMENDATION

No. 10

It is recommended that the Company allocate expenses in the Underwriting and Investment Exhibit, Part 4 of the
annual statement according to the methodology proscribed in the NAIC Annual Statement Instructions.

        A review of the Company’s internal controls was performed in conjunction with the examination of each
account. However, substantive testing was emphasized as the Company’s staff is small thereby not allowing for
segregation of duties in all cases and written practices and procedures for most accounting functions and some other
departmental functions are not yet in place. Written practices and procedures aid in the examination in that they
can be used in the determination of whether or not the Company is following the policies and procedures it has
authorized.

RECOMMENDATION

No. 11

It is recommended that written practices and procedures be developed for all major accounting functions and for
other departmental functions for which they do not exist.

        A trial balance was extracted from the general ledger for the year ending December 31, 1996 and traced to
the appropriate assets, liabilities, income and expense exhibits of the annual statement. There were several expense
amounts reported in the Underwriting and Investment Exhibit, Part 4 that could not be traced back to specific
general ledger balances or to supporting workpapers prepared by the Company. However, the net unreconciled
differences could be explained.
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             22


         The Company’s trial balance for 1995 was also reviewed and the asset and liability amounts traced to the
respective annual statement lines. A review of receipts and disbursements and other postings to the general ledger
was made for selected periods under examination. Test checks of postings from original documents to the general
ledger revealed no material differences.

RECOMMENDATION

No. 12

It is recommended that the Company maintain detailed workpapers, including actual adjusting entries made, to
support all amounts reported in the annual statement.

        An audit by an independent accounting firm was not performed in 1995 or 1996 as it was not required by
Colorado Insurance Regulation 3-1-4. An audit is necessary only if the Company has more than $1,000,000 in
direct written premium and more than 1,000 policyholders. The Company does not have and internal audit
department.

        The Company has filed its 1995 and 1996 actuarial opinions in accordance with Colorado Insurance
Regulation 3-1-3.

          The Company had two custodial accounts open at December 31, 1996. The related custodial agreements
were reviewed for compliance with Colorado Insurance Regulation 3-1-6. While the custodial agreement for the
Company’s statutory deposit was found to comply with the referenced regulation, it was noted that the custodial
agreement for the Company’s general account assets did not contain several provisions required by the regulation;
i.e. the agreement did not address the provisions contained in Section IV, B, 1, 2, 6, 7, 9, 13 and 14 of the
regulation.

RECOMMENDATION

No. 13

It is therefore recommended that the Company amend its custodial agreement for general account assets in order to
bring it into full compliance with the requirements of Colorado Insurance Regulation 3-1-6.
 Financial Exam Report                     Affinity Insurance Group, Inc.
 December 31, 1996                                                                                           23

                                         FINANCIAL STATEMENTS

         The following pages present a Statement of Assets, Liabilities, Surplus and Other Funds as of December
31, 1996 as determined by this examination. This statement is followed by supporting statements and
reconciliations presented in the following order:

Statement of Assets, Liabilities, Surplus and Other Funds, December 31, 1996



                                                              Non-            Assets             Net
                                           Ledger            Ledger            Not             Admitted
                                           Assets            Assets          Admitted           Assets

Bonds (Note 1)                            $2,010,997                                            $2,010,997
Cash on Deposit (Note 2)                     224,000                                               224,000
Short-Term Investments                       499,125                                               499,125
 Premiums in Course of Collection             37,037                             37,037                  0
                         (Note 3)
           EDP Equipment (Note 4)            226,149                            173,987             52,162
Interest, Dividends and Real Estate                             20,467                              20,467
           Income Due and Accrued

                      Total Assets        $2,997,308           $20,467         $211,024         $2,806,751




                            Underwriting Income:

Premiums Earned                                                                    ($8,466)
                  Deductions:
                       Losses Incurred (Note 13)                                    53,376
                         Loss Expenses Incurred                                      7,259
 Other Underwriting Expenses                                                     1,263,765
                  Total Underwriting Deductions                                 $1,324,400

                           Net Underwriting Loss                              ($1,332,866)

               Investment Income:

Net Investment Income Earned                                                      $168,455
                       Net Realized Capital Loss                                   (11,594)
                            Net Investment Gain                                   $156,861

                  Other Income:
 Financial Exam Report                    Affinity Insurance Group, Inc.
 December 31, 1996                                                                    24



Finance and Service Charges not Included in                                   $600
Premiums
                              Total Other Income                              $600


Net Income Before Dividends to Policyholders and                       ($1,175,405)
        Before Federal and Foreign Income Taxes

                       Dividends to Policyholders                                 0
Federal Income Taxes Incurred                                                     0
                                     Net Income                        ($1,175,405)
 Financial Exam Report                    Affinity Insurance Group, Inc.
 December 31, 1996                                                                                    25

Summary of Operations, Year 1996



                                                                           1995          1996

Surplus as Regards Policyholders, December 31 Prior Year                          $0    $3,616,141

                                                    Net Income         ($677,988)      ($1,175,405)

                                  Change in Nonadmitted Assets                           (211,024)

                                                 Capital Paid In              1,000

                                                 Surplus Paid In           3,582,125

             Aggregate Write-Ins for Gains and Losses in Surplus
                                             Surplus Note Issued            711,004        424,569
                                       Examination Adjustments                             (95,571)

        Changes in Surplus as Regards Policyholders for the Year       $3,616,141      ($1,057,431)

Surplus as Regards Policyholders, December 31, Current Year            $3,616,141       $2,558,710
 Financial Exam Report                    Affinity Insurance Group, Inc.
 December 31, 1996                                                                       26


Capital and Surplus Account, Year 1996

  Surplus as Regards Policyholders December 31,                            $3,616,141
                                   Previous Year

                                     Net Income                            (1,175,405)
                Change in Non-Admitted Assets                                (211,024)
     Aggregate Write-Ins for Gains and Losses in
                                        Surplus
                             Surplus Note Issued                             424,569
                         Examination Adjustments                             (95,571)

Net Change in Surplus as Regards Policholders for                      ($1,057,431)
                                        the Year

 Surplus as Regards Policyholders December 31,                             $2,558,710
                                         1996
 Financial Exam Report                    Affinity Insurance Group, Inc.
 December 31, 1996                                                                                     27

Reconciliation of Capital and Surplus, December 31, 1989 to December 31, 1996


                                                                           1995           1996

Surplus as Regards Policyholders, December 31 Prior Year                          $0     $3,616,141

                                                    Net Income          ($677,988)      ($1,175,405)

                                  Change in Nonadmitted Assets                            (211,024)

                                                 Capital Paid In                1,000

                                                Surplus Paid In            3,582,125

            Aggregate Write-Ins for Gains and Losses in Surplus
                                            Surplus Note Issued             711,004         424,569
                                      Examination Adjustments                               (95,571)

        Changes in Surplus as Regards Policyholders for the Year        $3,616,141      ($1,057,431)

Surplus as Regards Policyholders, December 31, Current Year             $3,616,141       $2,558,710
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                  28

Analysis of Examination Changes, December 31, 1996


                                                        Per Company        Per           Surplus
                                                                        Examination     Increase
                                                                                       (Decrease)


                 Admitted Assets:

Premiums and Agents' Balances in Course of                   37,037               0       (37,037)
Collection

Electronic Data Processing Equipment                       $226,149          $52,162    ($173,987)

                    Liabilities:

                                              Losses         (7,704)          21,933      (29,637)

                                     Other Expenses          24,399           50,719      (26,320)

Amounts Withheld or Retained by Company for                  38,209           11,889        26,320
Account of Others

       Payable to Parent, Subsidiaries and Affiliates             0           87,500      (87,500)

Aggregate Write-In For Liabilities - Reinsurance                  0            8,071       (8,071)
Payable

                       Net Change per Examination                                       ($336,232)



                      Surplus Per Annual Statement                                      $2,894,942
                       Net Change per Examination                                        (336,232)
                           Surplus Per Examination                                      $2,558,710
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                    29


Comparative Financial Statement, December 31, 1989 and December 31, 1996

                                                                        ASSETS

                                                                        December      December 31, *
                                                                           31,
                                                                          1995           1996

                                                Bonds                  $2,014,903       $2,010,997
                       Cash On Hand and On Deposit                                         224,000
                               Short Term Investments                   1,513,594          499,125
     Aggregate Write-ins for Invested Assets - Accrued                     53,906                0
                                    Interest Purchased
Premiums and Agent's Balances in Course of Collection                             0              0
EDP Equipment                                                                18,829         52,162
    Interest, Dividends and Real Estate Income Due or                        14,909         20,467
                                             Accrued

                                           Total Assets                $3,616,141       $2,806,751

                                  LIABILITIES, SURPLUS AND OTHER FUNDS

                                                 Losses                         $0         $21,933
Loss Adjustment Expenses                                                         0           4,406
                                     Other Expenses                              0          50,719
                                 Unearned Premiums                               0          63,523
        Amounts Withheld or Retained by Company for                              0          11,889
                                   Account of Others
          Payable to Parent, Subsidiaries and Affiliates                         0          87,500
                    Aggregate Write-Ins for Liabilities                          0           8,071

                                       Total Liabilities                        $0        $248,041

                                 Common Capital Stock                      $1,000            $1,000
                                          Surplus Notes                   711,004         1,048,073
                  Gross Paid in and Contributed Surplus                 3,582,125         3,582,125
                             Unassigned Funds (Surplus)                 (677,988)       (2,072,488)
Surplus as Regards Policyholders                                       $3,616,141       $2,558,710
   Total Liabilities, Capital
     and Surplus                                                       $3,616,141       $2,806,751


                                     * per examination
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             30

                                NOTES TO THE FINANCIAL STATEMENT
Note 1 - Bonds

As stated in the Notes to the Financial Statements of the Annual Statement and verified through examination, the
Company is amortizing premium and discount on bond purchases using the straight line method. Section 10-3-231,
C.R.S., which addresses the valuation of investments with a fixed term and rate requires that the effective interest
method be used. No change was made to the balance reported in the annual statement as the overall adjustment was
determined to be immaterial.

RECOMMENDATION

No. 14

It is recommended that the Company value investments with a fixed term and rate in compliance with Section 10-3-
231, C.R.S.

Note 2 – Cash and Short-Term Investments

The Company does not maintain a listing of outstanding checks on its main disbursement account. The Company
determines the outstanding check balance by adding to the prior balance the amount of checks issued during the
period and subtracting the total amount of checks cleared. However, the balance cannot be supported by a detailed
listing of checks as this information is not maintained. Alternative methods used to verify the reliability of the
amount reported for checks outstanding at December, 31, 1996 were inconclusive regarding the accuracy of the
amount reported by the Company.

RECOMMENDATION

No. 15

It is recommended that the Company develop procedures to account for outstanding checks on a detailed, check by
check basis.

Note 3 – Premiums and Agents’ Balances in Course of Collection

Due to deficiencies in the database reporting system noted above in the section entitled “Accounts and Records”, the
Company could not provide a policy by policy listing of amounts making up the balance reported in this account.
The amount reported of $37,037 consists of premiums due in the amount of $45,108 and a reinsurance balance
payable of $8,071. The premiums due amount is being nonadmitted since it cannot be verified. The reinsurance
balance payable is being reclassified to an aggregate write-in liability since all of the debit amounts for premiums
due are being nonadmitted.

The premiums due balance reported by the Company represents balances not yet due at December 31, 1996.
Therefore they should have been classified as “Premiums, Agents’
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                 31

Balances and Installments Booked but Deferred and Not Yet Due” if not for the fact that the balance is being
nonadmitted as noted above. See also note 8 below.

RECOMMENDATION

No. 16

It is recommended that balances for premiums not yet due at the balance sheet date be reported as Premiums,
Agents’ Balances and Installments Booked but Deferred and Not Yet Due rather than Premiums and Agents’
Balances in the Course of Collection as required in the NAIC Annual Statement Instructions and Accounting
Practices and Procedures.

Note 4 – Electronic Data Processing Equipment

This account is being reduced from $226,149 to $52,162. Section 10-1-102(1.5)(p), C.R.S. permits a company to
report value for electronic or mechanical equipment constituting a data processing or accounting system, including
any additions purchased for use in connection with the business of the insurer, if the cost of such system is at least
twenty-five thousand dollars, … The Company has included in this account items valued at $173,987 that do no
meet this definition. Most the nonadmitted amount is related to different operating software and a telephone
system.

Note 5 - Losses

Loss reserves reported by the Company at December 31, 1996 were a negative $7,704 due to the fact that only four
claims were open and a large subrogation payment was expected to be received. Development of these claims and
the reporting of one other claim that was incurred prior to the reporting date but not reported until 1997 resulted in
a liability balance determined by examination of $21,933. Therefore, loss reserves are being increased by $29,637.

As noted above in the section entitled “Accounts and Records” certain reports from the different database systems
are not yet available. One of the reports that is not available is for claims payment and reserving data. Although a
spreadsheet is maintained and updated daily to reflect claims payments on a cumulative basis by claim, the
information as of December 31, 1996 was not saved and therefore only bulk data was available. This limits the
type of testing and verification work that can be performed during the examination.

RECOMMENDATION

No. 17

It is recommended that the Company be able to provide claims payment and reserving data at the policy level that
supports amounts reported in all statutory financial statements prepared and filed with the Colorado Division of
Insurance.

As of December 31, 1996, the Company was not establishing a reserve for incurred but not reported (IBNR)
physical damage claims. It was establishing such a reserve for liability claims.
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             32



RECOMMENDATION

No. 18

It is recommended that the Company establish an IBNR reserve for property claims that is reasonable and that it be
able to support the methodology used to establish the reserve.

Note 6 – Loss Adjustment Expenses

The Company does not currently establish any type of loss reserves for unallocated loss adjustment expenses
(ULAE) and as of September, 1997, it no longer establishes an IBNR reserve for allocated loss adjustment
expenses (ALAE). The adjustment under consideration was immaterial to the financial statements and therefore,
was not made.

RECOMMENDATION

No. 19

It is recommended that the Company begin establishing a ULAE reserve and resume establishing an ALAE reserve
as appropriate.

Note 7 – Other Expenses

The Company incorrectly reported $26,320 of general expense accruals in the annual statement account - Amounts
Withheld or Retained by the Company for the Account of Others (Amounts Withheld). This amount is being
reclassified from Amounts Withheld to Other Expenses in order to more correctly portray the nature of the
underlying liabilities that existed at December 31, 1996. As a result, the account balance is being increased from
$24,399 to $50,719.

RECOMMENDATION

No. 20

It is recommended that the Company report expenses in accordance with the requirements of the NAIC Annual
Statement Instructions and Accounting Practices and Procedures.

Note 8 – Unearned Premiums

Currently, all premium payments received by the Company are applied against the Agents’ Balances or Uncollected
Premiums asset. However, testing of premium payments shows that some of the payments are for policies not yet
in effect at the examination date. Therefore, the payments should be reported as unearned premiums at December
31, 1996. Due to this incorrect accounting treatment, the uncollected premiums asset and the unearned premiums
liability are both understated. The exact amount of the understatement has not been determined due to the fact that
the Company’s systems have limited reporting capabilities and a report does not currently exist to extract this
information from the policy database.
 Financial Exam Report                       Affinity Insurance Group, Inc.
 December 31, 1996                                                                                                33



RECOMMENDATION

No. 21

It is recommended that premium payments received prior to a reporting period, related to a policy with an effective
date after the reporting period, be reported as unearned premiums.

Note 9 – Amounts Withheld or Retained by Company for Account of Others

The Company incorrectly reported $26,319 of general expense accruals in the annual statement account Amounts
Withheld or Retained by the Company for the Account of Others (Amounts Withheld). This amount is being
reclassified from Amounts Withheld to Other Expenses in order to more correctly portray the nature of the
underlying liabilities that existed at December 31, 1996. As a result, the balance in this account is being reduced
from $38,209 to $11,889. (See also Note 7.)

Note 10 – Payable to Parent, Subsidiaries and Affiliates

As noted in the section above entitled “Surplus Debentures”, the Company is reporting a balance that is $87,500
greater than amounts authorized by the Colorado Division of Insurance. Therefore, this amount is being
reclassified to the liability account – Payable to Parent, Subsidiaries and Affiliates – from the Surplus Note account
since the parent paid for expenses in this amount on behalf of the Company.

Note 11 – Aggregate Write-Ins for Liabilities

The balance in this account of $8,071 is due to an examination reclassification, as discussed in Note 3 above, from
the Premiums and Agents’ Balances in the Course of Collection account. Normally, debit balances exist for
premiums due and amounts owed to reinsurers are netted against the debit balance. However, since the all debit
balances are being nonadmitted, the liability to reinsurers is being reclassified so that a credit balance will not be
reported for an asset account.

Note 12 – Surplus Notes

As noted in the section above entitled “Surplus Debentures”, the Company is reporting a balance that is $87,500
greater than amounts authorized by the Colorado Division of Insurance. Therefore this amount is being reclassified
to the liability account – Payable to Parent, Subsidiaries and Affiliates – since the parent paid for expenses in this
amount on behalf of the Company. The reclassification reduces the surplus note account balance from $1,135,573
to $1,048,073. (See also note 10.)

Note 13 – Losses Incurred

The losses incurred expense is being increased by $29,637 from $23,739 to $53,376. This increase is based on an
analysis of the development of 1996 incurred losses which shows that adequate loss reserves were not established at
December 31, 1996. See also Note 5 above.
 Financial Exam Report                      Affinity Insurance Group, Inc.
 December 31, 1996                                                                                             34

                                                   SUMMARY

        Based upon the results of this examination, as of December 31, 1996 the Company had admitted assets of
$2,806,751, liabilities of $248,041, capital stock of $1,000, surplus notes of $1,048,073, paid in and contributed
surplus of $3,582,125, and unassigned funds of ($2,072,488). This examination resulted in a decrease to the
Company’s surplus as regards policyholders of $336,232. The Company’s revised capital and surplus is
$2,558,710. A schedule of changes to the Company’s surplus per this examination is included on page 27 of this
report. The admitted value of securities owned by the Company exceeded their market value by $22,257 as of
December 31, 1996.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                         35

                                              RECOMMENDATIONS

                                                   Rec.   Page
                     Issue                          No.    No.              Recommendation
The value reported for surplus notes in the        1      5      It is recommended that the Company
annual statement exceeds the amount                              comply with Section 10-3-239,
authorized by the Colorado Division of                           C.R.S., which requires prior
Insurance and therefore a violation of Section                   approval for all surplus notes that
10-3-239, C.R.S. exists. In addition, note                       are issued. It is recommended that
number 00002 has not been executed.                              the Company execute note number
                                                                 00002 in the amount approved by
                                                                 the Division and file an executed
                                                                 copy with the DOI.
The Company did not identify the correct           2      6      It is therefore recommended that the
ultimate controlling person in its 1996                          Company identify the ultimate
registration statement as defined in Section 10-                 controlling person as Stephen
3-801(3), C.R.S. and Colorado Insurance                          Adams in its annual registration
Regulation 3-4-1(III).                                           statement in accordance with the
                                                                 definitions stated in both Section 10-
                                                                 3-801(3), C.R.S. and Colorado
                                                                 Insurance Regulation 3-4-1(III) or
                                                                 file a disclaimer of control for
                                                                 consideration by the DOI in
                                                                 accordance with Section 10-3-804
                                                                 (9), C.R.S.
Annual shareholder meetings are not being held 3          8      It is recommended that an annual
and shareholder meetings are not being                           shareholder meeting be held every
formally documented as evidenced by the lack                     year and that the minutes of the
of minutes for meetings. Due to the lack of                      meeting be formally documented. It
annual meetings, no formal elections of board                    is also recommended that a formal
members or the chairman of the board have                        election of the board members and
been held since the Company began operating                      the chairman be held and
in 1995.                                                         documented at the time of the annual
                                                                 shareholder meeting.
The Company is not in compliance with its          4      10     It is recommended that the Company
bylaws regarding who may serve as CEO and                        comply with its bylaws regarding
chief operating officer and regarding the                        who may serve as CEO and chief
secretary’s responsibility for keeping minutes                   operating officer and regarding the
of shareholder, board and committee meetings.                    secretary’s responsibility for
                                                                 keeping of minutes of shareholder,
                                                                 board and committee meetings.
A review of conflict of interest statements for    5      10     It is recommended that the Company
the period under examination revealed that                       establish a conflict of interest policy
three of the directors, two of whom are also                     and procedures necessary to ensure
officers, did not complete the statements.                       that conflict of interest statements
                                                                 are completed annually by all
                                                                 directors, officers, trustees and key
                                                                 employees.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                       36



                                                  Rec.   Page
                        Issue                      No.    No.              Recommendation
The Company is receiving numerous benefits        6      11     It is recommended that the Company
from the parent Company for which no                            no longer enter into any transactions
payment is made and no management or                            with the parent company or its
service agreement exists. The Company is                        affiliates that violate the order
prohibited by an Order dated September 6,                       issued by the Commissioner of
1995 from entering into any transaction with                    Insurance on September 6, 1995.
its parent or affiliates other than for the
placement of insurance contracts.
Per the Company’s investment guidelines, the      7      12     It is recommended that the Company
Board of Directors is responsible for advance                   implement procedures to ensure that
written approval of investments. The board                      prior written approval is obtained by
minutes do not show that advance approval by                    the board of directors or a
the board is being made or that a permanent                     committee or individual so
written record of investment transactions is                    authorized for all investment
being maintained in the board minutes.                          transactions as required by Section
                                                                10-3-234, C.R.S. and that a
                                                                permanent written record of all
                                                                investment transactions be
                                                                maintained.
At December 31, 1996, the market value, as        8      18     It is recommended that when the
reported in the Company’s quarterly filing was                  market value of the statutory deposit
deficient in the amount of $11,260. The                         drops below the statutory minimum,
deficiency was only corrected when the                          the Company increase the deposit
Colorado Division of Insurance notified the                     immediately as required by
Company that there was a problem.                               Colorado Insurance Regulation 3-2-
                                                                3.
The Company’s policy, billing and claims          9      19     It s recommended that the Company
systems currently have only limited reporting                   enhance it s automated reporting
capabilities. As a result, data is being                        capability to enable the extraction of
compiled “manually”, in some cases, on                          data such that reports from the
computer spreadsheets which increases the                       policy billing and claims systems
possibility of incorrect data being reported in                 can be generated. These reports and
the financial statements.                                       other supporting detail are required
                                                                to support the final totals that are
                                                                reported on the Company’s annual
                                                                statement.
 Financial Exam Report                         Affinity Insurance Group, Inc.
 December 31, 1996                                                                                      37



                                                   Rec.   Page
                     Issue                          No.    No.              Recommendation
The Company is not reporting loss adjustment       10     19     It is recommended that the Company
expenses other than those related to outside                     allocate expenses in the
claims adjustment services in Column 1 of the                    Underwriting and Investment
Underwriting and Investment Exhibit, Part 4,                     Exhibit, Part 4 of the annual
as required by the NAIC Annual Statement                         statement according to the
Instructions.                                                    methodology proscribed in the
                                                                 NAIC Annual Statement
                                                                 Instructions.
Written practices and procedures for most          11     19     It is recommended that written
accounting functions and some other                              practices and procedures be
departmental functions are not yet in place.                     developed for all major accounting
                                                                 functions and for other departmental
                                                                 functions for which they do not
                                                                 exist.
There were several expense amounts reported        12     20     It is recommended that the Company
in the Underwriting and Investment Exhibit,                      maintain detailed workpapers,
Part 4 that could not be traced back to specific                 including actual adjusting entries
general ledger balances or to supporting                         made, to support all amounts
workpapers by the Company.                                       reported in the annual statement.
It was noted that the Company’s custodial          13     20     It is therefore recommended that the
agreement for general account assets did not                     Company amend its custodial
contain several provisions required by                           agreement for general account assets
Colorado Insurance Regulation 3-1-6.                             in order to bring it into full
                                                                 compliance with the requirements of
                                                                 Colorado Insurance Regulation 3-1-
                                                                 6.
The Company is amortizing premium and              14     29     It is recommended that the Company
discount on bond purchases using the straight                    value investments with a fixed term
line method. Section 10-3-231, C.R.S., which                     and rate in compliance with Section
addresses the valuation of investments with a                    10-3-231, C.R.S.
fixed term and rate requires that the effective
interest method be used for amortization.
The Company does not maintain a listing of         15     29     It is recommended that the Company
outstanding checks on it main disbursement                       develop procedures to account for
account.                                                         outstanding checks on a detailed,
                                                                 check by check basis.
 Financial Exam Report                        Affinity Insurance Group, Inc.
 December 31, 1996                                                                                         38



                                                    Rec.   Page
                     Issue                           No.    No.             Recommendation
The premiums due balance reported represents        16     30     It is recommended that the balances
balances not yet due at December 31, 1996. It                     for premiums not yet due at the
was incorrectly reported as Premiums and                          balance sheet date be reported as
Agents’ Balances in the Course of Collection.                     Premiums, Agents’ Balances and
                                                                  Installments Booked but Deferred
                                                                  and not Yet Due rather than
                                                                  Premiums and Agents’ Balances in
                                                                  the Course of Collection as required
                                                                  in the NAIC Annual Statement
                                                                  Instructions and Accounting
                                                                  Practices and Procedures.
The Company could not provide reserving and         17     30     It is recommended that the Company
loss payment data on a claim by claim basis to                    be able to provide claims payment
support amounts reported in the quarterly and                     and reserving data at the policy level
annual statement filings provided to the                          that supports amounts reported in all
Colorado Division of Insurance.                                   statutory financial statements
                                                                  prepared and filed with the Colorado
                                                                  Division of Insurance.
As of December 31, 1996, the Company was            18     31     It is recommended that the Company
not establishing a reserve for incurred but not                   establish an IBNR reserve for
reported (IBNR) property claims.                                  property claims that is reasonable
                                                                  and that it be able to support the
                                                                  methodology used to establish the
                                                                  reserve.
The Company does not currently establish any        19     31     It is recommended that the Company
type of loss reserves for unallocated loss                        begin establishing a ULAE reserve
adjustment expenses (ULAE) and as of                              and resume establishing an ALAE
September, 1997, it no longer establishes an                      reserve as appropriate.
IBNR reserve for allocated loss adjustment
expense (ALAE).
The Company is misclassifying general               20     31     It is recommended that the Company
expense accruals as part of Amounts Withheld                      report expenses in accordance with
or Retained by the Company for the Account                        the requirements of the NAIC
of Others.                                                        Annual Statement Instructions and
                                                                  Accounting Practices and
                                                                  Procedures.
Some payments received for policies not yet in      21     32     It is recommended that premium
effect at the reporting date are being applied to                 payments received prior to a
reduce Premiums Due rather than being                             reporting period, related to a policy
reported as unearned premium.                                     with an effective date after the
                                                                  reporting period, be reported as
                                                                  unearned premiums.
 Financial Exam Report                     Affinity Insurance Group, Inc.
 December 31, 1996                                                                                          39


                                               CONCLUSION

        The courtesy, assistance and cooperation extended by the officers and employees of the Company during
the course of this examination is greatly appreciated.

        In addition to the undersigned, Mr. Terry Breckenridge and Mr. Matthew Knieriem, Insurance Examiners,
Division of Insurance, State of Colorado, also participated in the examination.




                                                        Respectfully submitted,



                                                     ______________________________
                                                       Debbie Seiden
                                                       Senior Insurance Examiner
                                                       Division of Insurance
                                                       State of Colorado

				
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