UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
FORM 10-K
_________________
Annual Report Pursuant to Section 13
or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004 | Commission file number 1-15731 |
EVEREST RE GROUP, LTD.
(Exact
name of registrant as specified in its charter)
Bermuda | 98-0365432 | ||
(State or other jurisdiction | (I.R.S. Employer | ||
of incorporation or organization) | Identification No.) |
Wessex House 2
nd Floor
45 Reid Street
PO Box HM 845
Hamilton HM DX, Bermuda
441-295-0006
(Address, including zip code, and
telephone number, including area code,
of registrants principal executive office)
_________________
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange | |||
Title of Each Class | on Which Registered | ||
Common Shares, $.01 par value per share | New York Stock Exchange |
___________________
Securities registered pursuant to
Section 12(g) of the Act: None
___________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Yes X No___
The aggregate market value on June 30, 2004, the last business day of the registrants most recently completed second quarter, of the voting stock held by non-affiliates of the registrant was $4,505.3 million.
At March 1, 2005, the number of shares outstanding of the registrants common shares was 56,246,539.
Certain information required by Items 10, 11, 12, 13 and 14 of Form 10-K is incorporated by reference into Part III hereof from the registrants proxy statement for the 2005 Annual General Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days of the close of the registrants fiscal year ended December 31, 2004.
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TABLE OF CONTENTS
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Item | Page | |
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PART I |
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1. |
Business |
1 |
2. | Properties | 30 |
3. | Legal Proceedings | 30 |
4. | Submission of Matters to a Vote of Security Holders | 31 |
PART II |
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5. |
Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities |
31 |
6. | Selected Financial Data | 33 |
7. | Managements Discussion and Analysis of Financial Condition and Results of Operation | 34 |
7A. | Quantitative and Qualitative Disclosures About Market Risk | 93 |
8. | Financial Statements and Supplementary Data | 93 |
9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 93 |
9A. | Controls and Procedures | 94 |
9B. | Other Information | 94 |
PART III |
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10. |
Directors and Executive Officers of the Registrant |
95 |
11. | Executive Compensation | 95 |
12. |
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder
Matters |
95 |
13. | Certain Relationships and Related Transactions | 95 |
14. | Principal Accountant Fees and Services | 95 |
PART IV |
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15. |
Exhibits and Financial Statement Schedules |
95 |
3
PART I
Unless otherwise indicated, all financial data in this document have been prepared using generally accepted accounting principles (GAAP) in the United States of America. As used in this document, Group means Everest Re Group, Ltd. (formerly Everest Reinsurance Group, Ltd.); Holdings means Everest Reinsurance Holdings, Inc.; Everest Re means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the Company means Everest Re Group, Ltd. and its subsidiaries, except when referring to periods prior to February 24, 2000, when it means Holdings and its subsidiaries.
ITEM 1. Business
The Company
Group, a Bermuda
company, was established in 1999 as a wholly-owned subsidiary of Holdings. On February
24, 2000, a corporate restructuring was completed and Group became the new parent holding
company of Holdings, which remains the holding company for the Companys U.S. based
operations. Holders of shares of common stock of Holdings automatically became holders of
the same number of common shares of Group. Prior to the restructuring, Group had no
significant assets or capitalization and had not engaged in any business or prior
activities other than in connection with the restructuring. The Company had gross written
premiums in 2004 of $4.7 billion and shareholders equity at December 31, 2004 of
$3.7 billion.
In connection with the restructuring, Group established a Bermuda-based reinsurance subsidiary, Everest Reinsurance (Bermuda), Ltd. (Bermuda Re), which commenced business in the second half of 2000. Group also formed Everest Global Services, Inc., a Delaware subsidiary, to perform administrative and back-office functions for Group and its U.S. based and non-U.S. based subsidiaries.
Holdings, a Delaware corporation, was established in 1993 to serve as the parent holding company of Everest Re, a Delaware property and casualty reinsurer formed in 1973. Until October 6, 1995, Holdings was an indirect wholly-owned subsidiary of The Prudential Insurance Company of America (The Prudential). On October 6, 1995, The Prudential sold its entire interest in the shares of common stock of Holdings in an initial public offering (the IPO).
The Companys principal business, conducted through its operating subsidiaries, is the underwriting of reinsurance and insurance in the U.S., Bermuda and international markets. The Company underwrites reinsurance both through brokers and directly with ceding companies, giving it the flexibility to pursue business regardless of the ceding companys preferred reinsurance purchasing method. The Company underwrites insurance principally through general agent relationships and surplus lines brokers. Groups operating subsidiaries, excluding Mt. McKinley Insurance Company (Mt. McKinley), which is in run-off, are each rated A+ (Superior) by A.M. Best Company (A.M. Best), an independent insurance industry rating organization that rates insurance companies on factors of concern to policyholders.
Following is a summary of the Companys principal operating subsidiaries:
o | Bermuda Re, a Bermuda insurance company and a direct subsidiary of Group, is registered in Bermuda as a Class 4 insurer and long-term insurer and is authorized to write property and casualty business and life and annuity business. Bermuda Re commenced business in the second half of 2000. On January 1, 2004 Bermuda Re purchased the UK branch of Everest Re. Bermuda Res UK branch provides property and casualty reinsurance to the United Kingdom and European markets. Bermuda Re had shareholdersequity at December 31, 2004 of $1.7 billion based on U.S. GAAP. |
1
o | Everest International Reinsurance, Ltd. (Everest International), a Bermuda insurance company and a direct subsidiary of Group, is registered in Bermuda as a Class 4 insurer and is authorized to write property and casualty business. All of Everest Internationals business during 2004, related to quota share reinsurance of Everest Re and the UK branch of Bermuda Re. Everest International had shareholders equity at December 31, 2004 of $142 million based on U.S. GAAP. |
o | Everest Re, a Delaware insurance company and a direct subsidiary of Holdings, is a licensed property and casualty insurer and/or reinsurer in all states (except Nevada and Wyoming), the District of Columbia and Puerto Rico and is authorized to conduct reinsurance business in the United Kingdom (through July 12, 2004), Canada and Singapore. Everest Re underwrites property and casualty reinsurance for insurance and reinsurance companies in the U.S. and international markets. Everest Re had statutory surplus at December 31, 2004 of $2.1 billion. |
o | Everest National Insurance Company (Everest National), an Arizona insurance company and a direct subsidiary of Everest Re, is licensed in 47 states and the District of Columbia and is authorized to write property and casualty insurance in the jurisdictions in which it is licensed. This is called writing insurance on an admitted basis. The majority of Everest Nationals business is reinsured by its parent, Everest Re. |
o | Everest Indemnity Insurance Company (Everest Indemnity), a Delaware insurance company and a direct subsidiary of Everest Re, engages in the excess and surplus lines insurance business in the U.S. Excess and surplus lines insurance is specialty property and liability coverage that an insurer not licensed to write insurance in a particular jurisdiction is permitted to provide to insureds when the specific specialty coverage is unavailable from admitted insurers. This is called writing insurance on a non-admitted basis. Everest Indemnity is licensed in Delaware and is eligible to write business on a non-admitted basis in 49 states, the District of Columbia and Puerto Rico. The majority of Everest Indemnitys business is reinsured by its parent, Everest Re. |
o | Everest Security Insurance Company (Everest Security), formerly Southeastern Security Insurance Company, a Georgia insurance company and a direct subsidiary of Everest Re, was acquired in January 2000 and writes property and casualty insurance on an admitted basis in Georgia and Alabama. The majority of Everest Securitys business is reinsured by its parent, Everest Re. |
o | Mt. McKinley (f/k/a Gibraltar Casualty Company, Gibraltar), a Delaware insurance company and a direct subsidiary of Holdings, was acquired by Holdings in September 2000 from The Prudential. Mt. McKinley was formed by Everest Re in 1978 to engage in the excess and surplus lines insurance business in the U.S. In 1985, Mt. McKinley ceased writing new and renewal insurance and now its ongoing operations relate to servicing claims arising from its previously written business. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arms-length consideration, all of its net insurance exposures and reserves to Bermuda Re. |
o | Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a direct subsidiary of Everest Re, was formed in 1998 and owned Everest Re Ltd., a United Kingdom company that was dissolved after its reinsurance operations were converted into branch operations of Everest Re. Everest Ltd. holds $79 million of investments and cash, the management of which constitutes its principal operations. |
Reinsurance Industry Overview
Reinsurance
is an arrangement in which an insurance company, the reinsurer, agrees to indemnify
another insurance company, the ceding company, against all or a portion of the insurance
risks underwritten by the ceding company under one or more insurance contracts.
Reinsurance can provide a ceding company with
2
several benefits, including a reduction in net liability on individual risks or classes of risks, catastrophe protection from large or multiple losses and assistance in maintaining acceptable financial ratios. Reinsurance also provides a ceding company with additional underwriting capacity by permitting it to accept larger risks and write more business than would be possible without a concomitant increase in capital and surplus. Reinsurance, however, does not discharge the ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative reinsurance. In treaty reinsurance, the ceding company is obligated to cede and the reinsurer is obligated to assume a specified portion of a type or category of risks insured by the ceding company. Treaty reinsurers do not separately evaluate each of the individual risks assumed under their treaties and, consequently, after a review of the ceding companys underwriting practices, are largely dependent on the original risk underwriting decisions made by the ceding company. In facultative reinsurance, the ceding company cedes and the reinsurer assumes all or part of the risk under a single insurance contract. Facultative reinsurance is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance normally is purchased by ceding companies for individual risks not covered by their reinsurance treaties, for amounts in excess of the dollar limits of their reinsurance treaties or for unusual risks.
Both treaty and facultative reinsurance can be written on either a pro rata basis or an excess of loss basis. Under pro rata reinsurance, the ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies the ceding company against all or a specified portion of losses and expenses in excess of a specified dollar amount, known as the ceding companys retention or reinsurers attachment point, generally subject to a negotiated reinsurance contract limit.
In pro rata reinsurance, the reinsurer generally pays the ceding company a ceding commission. The ceding commission generally is based on the ceding companys cost of acquiring the business being reinsured (commissions, premium taxes, assessments and miscellaneous administrative expense). Premiums paid by the ceding company to a reinsurer for excess of loss reinsurance are not directly proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk. There is usually no ceding commission on excess of loss reinsurance.
Reinsurers may purchase reinsurance to cover their own risk exposure. Reinsurance of a reinsurers business is called a retrocession. Reinsurance companies cede risks under retrocessional agreements to other reinsurers, known as retrocessionaires, for reasons similar to those that cause insurers to purchase reinsurance: to reduce net liability on individual or classes of risks, protect against catastrophic losses, stabilize financial ratios and obtain additional underwriting capacity.
Reinsurance can be written through intermediaries, generally professional reinsurance brokers, or directly with ceding companies. From a ceding companys perspective, both the broker and the direct distribution channels have advantages and disadvantages. A ceding companys decision to select one distribution channel over the other will be influenced by its perception of such advantages and disadvantages relative to the reinsurance coverage being placed.
Business Strategy
The Companys underwriting
strategies seek to capitalize on its financial strength and capacity, its employee
expertise and its flexibility to offer multiple products through multiple distribution
channels. The Companys strategies include effective management of the property and
casualty underwriting cycle, which refers to the tendency of insurance premiums, profits
and the demand for and availability of coverage to rise and fall over time. The Company
also seeks to manage its catastrophe exposures and retrocessional costs. Efforts to
control expenses and to operate in a cost-efficient manner are also a continuing focus for
the Company.
3
The Companys products include: (1) the full range of property and casualty reinsurance and insurance coverages, including marine, aviation, surety, errors and omissions liability (E&O), directors and officers liability (D&O), medical malpractice, other specialty lines, accident and health (A&H), workers compensation and (2) reinsurance of life and annuity business. The Companys product distribution includes direct and broker reinsurance channels; U.S., Bermuda and international markets; treaty and facultative reinsurance and admitted and non-admitted insurance.
The Companys underwriting strategy emphasizes underwriting profitability rather than premium volume, writing specialized property and casualty risks and integration of underwriting expertise across all underwriting units. Key elements of this strategy are prudent risk selection, appropriate pricing through strict underwriting discipline and continuous adjustment of the Companys business mix to respond to changing market conditions. The Company focuses on reinsuring companies that effectively manage the underwriting cycle through proper analysis and pricing of underlying risks and whose underwriting guidelines and performance are compatible with its objectives.
The Companys underwriting strategy also emphasizes flexibility and responsiveness to changing market conditions, such as increased demand or favorable pricing trends. The Company believes that its existing strengths, including its broad underwriting expertise, U.S., Bermuda and international presence, strong financial ratings and substantial capital, facilitate adjustments to its mix of business geographically, by line of business and by type of coverage, allowing it to capitalize on those market opportunities that provide the greatest potential for underwriting profitability. The Companys insurance operations complement these strategies by allowing the Company access to business that would not likely be available to it on a reinsurance basis. The Company carefully monitors its mix of business across all operations to avoid inappropriate concentrations of geographic or other risk.
Marketing
The Company writes
business on a worldwide basis for many different customers and for many lines of
business, providing a broad array of coverages. The Company is not materially dependent
on any single customer, small group of customers, line of business or geographical area.
For the 2004 calendar year, no single customer (ceding company or insured) generated more
than 7.8% of the Companys gross written premiums. The Company does not believe that
a reduction of business from any one customer would have a material adverse effect on its
future financial condition or results of operations due to the Companys competitive
position in the marketplace and the continuing availability of other sources of business.
Approximately 60.0%, 13.1% and 26.9% of the Companys 2004 gross written premiums were written in the broker reinsurance, direct reinsurance and insurance markets, respectively. The Companys ability to write reinsurance both through brokers and directly with ceding companies gives it the flexibility to pursue business regardless of the ceding companys preferred reinsurance purchasing method.
The broker reinsurance market consists of several substantial national and international brokers and a number of smaller specialized brokers. Brokers do not have the authority to bind the Company with respect to reinsurance agreements, nor does the Company commit in advance to accept any portion of a brokers submitted business. Reinsurance business from any ceding company, whether new or renewal, is subject to acceptance by the Company. Brokerage fees are generally paid by reinsurers. The Companys ten largest brokers accounted for an aggregate of approximately 45.1% of gross written premiums in 2004, with the two largest brokers accounting for approximately 16.9% (Marsh & McLennan Companies, Inc.) and 8.3% (Aon Risk Services) of gross written premiums, respectively. The Company does not believe that a reduction of business assumed from any one broker would have a materially adverse effect on the Company due to its competitive position in the market place, relationships with ceding companies and the continuing availability of other sources of business.
4
The direct reinsurance market remains an important distribution channel for reinsurance business written by the Company. Direct placement of reinsurance enables the Company to access clients who prefer to place their reinsurance directly with reinsurers based upon the reinsurers in-depth understanding of the ceding companys needs.
The Companys insurance business is written principally through general agent relationships and surplus lines brokers. In 2004, the Companys largest agency relationship, American All-Risk Insurance Services, LLC, accounted for approximately 7.8% of gross written premiums, which consists of approximately 15,000 individual workers compensation policies. In June 2004, the Company received notification of termination with respect to its contract with American All-Risk Insurance Services, LLC. Under the terms of the contract, the agency continued to produce business exclusively for the Company through October 15, 2004. The business produced under this relationship will continue in force through the policy expiration dates or cancellation. The Company does not believe that the termination of this contract will have a material adverse effect on future Company operations.
The Company continually evaluates each business relationship, including the underwriting expertise and experience brought to bear through the involved distribution channel, performs analyses to evaluate financial security, monitors performance and adjusts underwriting decisions accordingly.
Segment Information
The
Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S.
Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance
operation writes property and casualty reinsurance, on both a treaty and facultative
basis, through reinsurance brokers, as well as directly with ceding companies within the
U.S. The U.S. Insurance operation writes property and casualty insurance primarily
through general agent relationships and surplus lines brokers within the U.S. The
Specialty Underwriting operation writes A&H, marine, aviation and surety business
within the U.S. and worldwide through brokers and directly with ceding companies. The
International operation writes property and casualty reinsurance through Everest Res
branches in Canada and Singapore, in addition to foreign business written through Everest
Res Miami and New Jersey offices. The Bermuda operation provides reinsurance and
insurance to worldwide property and casualty markets and reinsurance to life insurers
through brokers and directly with ceding companies from its Bermuda office and property
and casualty reinsurance to the United Kingdom and European markets through its UK
branch.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments based upon their underwriting gain (loss) or underwriting results. Underwriting results include earned premium less losses and loss adjustment expenses (LAE) incurred, commission and brokerage expenses and other underwriting expenses and are analyzed using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. The Company utilizes inter-affiliate reinsurance, but such reinsurance generally does not impact segment results, as business is generally reported within the segment in which the business was first produced. For selected financial information regarding these segments, see Note 18 of Notes to Consolidated Financial Statements.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Due to the sale and in accordance with Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (FAS 131), the Company restated the International and Bermuda segments for the years ended 2003 and 2002 to conform to December 31, 2004 segment reporting.
5
In 2003, Everest National, another subsidiary of the Company, opened a regional office in California to better serve its western U.S. Insurance business. The business produced through this additional office is included in the U.S. Insurance operation.
Underwriting Operations
The following table presents the
distribution of the Companys gross written premiums by its U.S. Reinsurance, U.S.
Insurance, Specialty Underwriting, International and Bermuda operations for the years
ended December 31, 2004, 2003, 2002, 2001, and 2000, classified according to whether the
premium is derived from property or casualty business and, for reinsurance business,
whether it represents pro rata or excess of loss business:
6
Gross Written Premiums by Operation
Years Ended December 31, |
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(Dollars in millions) | 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||||||||||||
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U.S. Reinsurance | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | $ | 339.7 | 7.2 | % | $ | 357.8 | 7.8 | % | $ | 148.7 | 5.2 | % | $ | 62.9 | 3.4 | % | $ | 60.2 | 4.3 | % | ||||||||||||
Excess | 208.8 | 4.4 | 241.0 | 5.3 | 177.8 | 6.2 | 104.0 | 5.5 | 75.6 | 5.5 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 702.8 | 14.9 | 625.7 | 13.7 | 219.2 | 7.7 | 191.2 | 10.2 | 151.1 | 10.9 | ||||||||||||||||||||||
Excess | 226.8 | 4.8 | 527.8 | 11.5 | 348.9 | 12.3 | 252.3 | 13.5 | 194.7 | 14.1 | ||||||||||||||||||||||
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Total (2) | 1,478.1 | 31.4 | 1,752.3 | 38.3 | 894.6 | 31.4 | 610.4 | 32.6 | 481.6 | 34.8 | ||||||||||||||||||||||
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U.S. Insurance | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 159.0 | 3.4 | 42.9 | 0.9 | 6.5 | 0.2 | 6.2 | 0.3 | 9.3 | 0.7 | ||||||||||||||||||||||
Excess | - | 0.0 | - | 0.0 | - | 0.0 | - | 0.0 | - | 0.0 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 1,008.8 | 21.4 | 1,026.6 | 22.5 | 815.0 | 28.6 | 496.1 | 26.5 | 241.2 | 17.4 | ||||||||||||||||||||||
Excess | - | 0.0 | - | 0.0 | - | 0.0 | - | 0.0 | - | 0.0 | ||||||||||||||||||||||
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Total (2) | 1,167.8 | 24.8 | 1,069.5 | 23.4 | 821.5 | 28.9 | 502.4 | 26.8 | 250.5 | 18.1 | ||||||||||||||||||||||
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Specialty Underwriting | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 374.8 | 8.0 | 396.7 | 8.7 | 397.5 | 14.0 | 356.3 | 19.0 | 274.0 | 19.8 | ||||||||||||||||||||||
Excess | 65.4 | 1.4 | 64.3 | 1.4 | 43.8 | 1.5 | 35.0 | 1.9 | 19.3 | 1.4 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 34.1 | 0.7 | 28.1 | 0.6 | 41.9 | 1.5 | 18.4 | 1.0 | 21.4 | 1.5 | ||||||||||||||||||||||
Excess | 12.8 | 0.3 | 13.8 | 0.3 | 5.3 | 0.2 | 4.3 | 0.2 | 3.6 | 0.3 | ||||||||||||||||||||||
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Total (2) | 487.1 | 10.4 | 502.9 | 11.0 | 488.5 | 17.2 | 414.0 | 22.1 | 318.3 | 23.0 | ||||||||||||||||||||||
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Total U.S. | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 873.5 | 18.6 | 797.4 | 17.4 | 552.7 | 19.4 | 425.5 | 22.7 | 343.4 | 24.8 | ||||||||||||||||||||||
Excess | 274.2 | 5.8 | 305.3 | 6.7 | 221.6 | 7.8 | 139.0 | 7.4 | 94.9 | 6.9 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 1,745.7 | 37.1 | 1,680.4 | 36.8 | 1,076.1 | 37.8 | 705.8 | 37.6 | 413.8 | 29.9 | ||||||||||||||||||||||
Excess | 239.6 | 5.1 | 541.6 | 11.8 | 354.2 | 12.4 | 256.7 | 13.7 | 198.3 | 14.3 | ||||||||||||||||||||||
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Total (2) | 3,133.0 | 66.6 | 3,324.7 | 72.7 | 2,204.6 | 77.4 | 1,526.8 | 81.4 | 1,050.4 | 75.9 | ||||||||||||||||||||||
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International (4) | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 426.0 | 9.1 | 328.5 | 7.2 | 229.4 | 8.1 | 126.9 | 6.8 | 96.1 | 6.9 | ||||||||||||||||||||||
Excess | 159.7 | 3.4 | 118.6 | 2.6 | 78.4 | 2.8 | 40.6 | 2.2 | 25.1 | 1.8 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 51.2 | 1.1 | 31.3 | 0.7 | 30.6 | 1.1 | 47.1 | 2.5 | 64.9 | 4.7 | ||||||||||||||||||||||
Excess | 50.8 | 1.1 | 42.4 | 0.9 | 26.1 | 0.9 | 20.3 | 1.1 | 29.0 | 2.1 | ||||||||||||||||||||||
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Total (2) | 687.7 | 14.6 | 520.8 | 11.4 | 364.5 | 12.8 | 234.9 | 12.5 | 215.1 | 15.6 | ||||||||||||||||||||||
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Bermuda Operations (4) | ||||||||||||||||||||||||||||||||
Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 309.7 | 6.6 | 230.0 | 5.0 | 136.1 | 4.8 | 50.3 | 2.7 | 47.3 | 3.4 | ||||||||||||||||||||||
Excess | 232.5 | 4.9 | 239.5 | 5.2 | 80.5 | 2.8 | 20.0 | 1.1 | 30.5 | 2.2 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 227.0 | 4.8 | 175.4 | 3.8 | 19.8 | 0.7 | 25.2 | 1.3 | 25.1 | 1.8 | ||||||||||||||||||||||
Excess | 114.2 | 2.4 | 83.3 | 1.8 | 41.0 | 1.4 | 17.3 | 0.9 | 17.2 | 1.2 | ||||||||||||||||||||||
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Total (2) (3) | 883.4 | 18.8 | 728.2 | 15.9 | 277.4 | 9.7 | 112.8 | 6.0 | 120.1 | 8.7 | ||||||||||||||||||||||
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Property | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 1,609.2 | 34.2 | 1,355.9 | 29.6 | 918.2 | 32.3 | 602.6 | 32.1 | 486.8 | 35.1 | ||||||||||||||||||||||
Excess | 666.4 | 14.2 | 663.4 | 14.5 | 380.5 | 13.4 | 199.6 | 10.6 | 150.5 | 10.9 | ||||||||||||||||||||||
Casualty | ||||||||||||||||||||||||||||||||
Pro Rata (1) | 2,023.9 | 43.0 | 1,887.2 | 41.3 | 1,126.5 | 39.6 | 778.1 | 41.5 | 503.8 | 36.4 | ||||||||||||||||||||||
Excess | 404.6 | 8.6 | 667.3 | 14.6 | 421.3 | 14.8 | 294.3 | 15.7 | 244.5 | 17.6 | ||||||||||||||||||||||
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Total (2) | $ | 4,704.1 | 100.0 | % | $ | 4,573.8 | 100.0 | % | $ | 2,846.5 | 100.0 | % | $ | 1,874.6 | 100.0 | % | $ | 1,385.6 | 100.0 | % | ||||||||||||
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____________________ (1) For purposes of the presentation above, pro rata includes reinsurance attaching to the first dollar of loss incurred by the ceding company and insurance. |
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(2) Certain totals and subtotals may not reconcile due to rounding. | ||||||||||||||||||||||||||||||||
(3) Includes immaterial amounts of life and annuity premium. | ||||||||||||||||||||||||||||||||
(4) International and Bermuda operations have been restated in accordance with FAS 131 due to the sale of the UK Branch. |
7
U.S. Reinsurance Operation. The Companys U.S. Reinsurance operation writes property and casualty reinsurance, both treaty and facultative, through reinsurance brokers as well as directly with ceding companies within the U.S. The Company targets certain brokers and, through the broker market, specialty companies and small to medium sized standard lines companies. On a direct basis, the Company targets companies that place their business predominantly in the direct market, including small to medium sized regional ceding companies, and seeks to develop long-term relationships with those companies. In addition, the U.S. Reinsurance operation writes portions of reinsurance programs for larger, national insurance companies.
In 2004, $452.1 million of gross written premiums were attributable to U.S. treaty property business, of which 24.9% was written on an excess of loss basis and 75.1% was written on a pro rata basis. The Companys property underwriters utilize sophisticated underwriting methods, which management believes are necessary to analyze and price property business, particularly that segment of the property market which has catastrophe exposure.
U.S. treaty casualty business accounted for $792.6 million of gross written premiums in 2004, of which 11.3% was written on an excess of loss basis and 88.7% was written on a pro rata basis. The treaty casualty portfolio consists of professional liability, D&O liability, workers compensation, excess and surplus lines and other liability coverages. As a result of the complex technical nature of most of these risks, the Companys casualty underwriters tend to specialize by line of business and work closely with the Companys pricing actuaries.
The Companys facultative unit conducts business both through brokers and directly with ceding companies, and consists of four underwriting units representing property, casualty, specialty and national brokerage lines of business. Business is written from a facultative headquarter office in New York and satellite offices in Chicago and Oakland. In 2004, $64.3 million, $115.3 million, $21.7 million and $32.1 million of gross written premiums were attributable to the property, casualty, specialty and national brokerage lines of business, respectively.
In 2004, 83.0%, 10.4% and 6.6% of the U.S. Reinsurance operations gross written premiums were written in the broker reinsurance, direct reinsurance and insurance markets, respectively.
U.S. Insurance Operation. In 2004, the Companys U.S. Insurance operation wrote $1,167.8 million of gross written premiums, of which 86.4% was casualty, predominantly workers compensation insurance, and 13.6% was property. Of the total business written, Everest National wrote $953.1 million and Everest Re wrote $10.6 million, with both principally targeting commercial property and casualty business written through general agency relationships with program administrators. Workers compensation business accounted for $686.4 million, or 58.8% of the total business written, including $371.7 million, or 54.2% of the total workers compensation business written as California workers compensation business and $481.4 million, or 41.2% of the total business written as non-workers compensation business. Everest Indemnity wrote $176.6 million, principally targeting excess and surplus lines insurance business written through surplus lines brokers. Everest Security wrote $27.5 million, principally targeting non-standard auto business written through retail agency relationships. With respect to insurance written through general agents and surplus lines brokers, the Company supplements the initial underwriting process with periodic claims, underwriting and operational reviews and ongoing monitoring.
Specialty Underwriting Operation. The Companys Specialty Underwriting operation writes A&H, marine, aviation and surety reinsurance. The A&H unit primarily focuses on health reinsurance of traditional indemnity plans, self-insured health plans, accident coverages and specialty medical plans. The marine and aviation unit focuses on ceding companies with a particular expertise in marine and aviation business. The marine and aviation business is written primarily through brokers and contains a significant international component written primarily in the London market. Surety business underwritten by the Company consists mainly of reinsurance of contract surety bonds.
8
Gross written premiums of the A&H unit in 2004 totaled $281.9 million, of which 63.8% was written through the broker market and 36.2% was written through the direct market.
Gross written premiums of the marine and aviation unit in 2004 totaled $100.1 million, substantially all of which was written on a treaty basis and sourced through reinsurance brokers. Marine treaties represented 53.1% of marine and aviation gross written premiums in 2004 and consisted mainly of hull and liability coverage. Approximately 43.3% of the marine unit premiums in 2004 were written on a pro rata basis and 56.7% as excess of loss. Aviation premiums accounted for 46.9% of marine and aviation gross written premiums in 2004 and included reinsurance for airlines and general aviation. Approximately 72.6% of the aviation units premiums in 2004 were written on a pro rata basis and 27.4% as excess of loss.
In 2004, gross written premiums of the surety unit totaled $105.1 million. Approximately 93.9% of the surety unit premiums in 2004 were written on a pro rata basis and 6.1% on an excess of loss basis. Most of the portfolio is reinsurance of contract surety bonds written directly with ceding companies, with the remainder being credit reinsurance, mostly in international markets.
International Operation. The Companys International operation aims to capitalize on the growth opportunities in the international reinsurance markets. The Company targets several international markets, including: Canada, with a branch in Toronto; Asia, with a branch in Singapore; and Latin America, Africa and the Middle East, which business is serviced from Everest Res Miami and New Jersey offices. The Company also writes home-foreign business, which provides reinsurance on the international portfolios of U.S. insurers, from New Jersey. Approximately 85.2% of the gross written premiums by the Companys international underwriters in 2004 represented property business, while 14.8% represented casualty business. As with its U.S. operations, the Companys International operation focuses on financially sound companies that have strong management and underwriting discipline and expertise. Approximately 66.1% of the Companys international business was written through brokers, with 33.9% written directly with ceding companies.
Gross written premiums of the Companys Canadian branch totaled $140.5 million in 2004 and consisted of pro rata property (42.1%), excess property (24.4%), pro rata casualty (6.0%) and excess casualty (27.5%). Approximately 72.2% of the Canadian premiums consisted of treaty reinsurance, while 27.8% was facultative reinsurance.
The Companys Singapore branch covers the Asian markets and accounted for $112.1 million of gross written premiums in 2004. This business consisted of pro rata property (58.1%), excess property (37.0%), pro rata casualty (4.2%) and excess casualty (0.7%).
International business written out of Everest Res Miami and New Jersey offices accounted for $435.1 million of gross written premiums in 2004 and consisted of pro rata treaty property (69.7%), pro rata treaty casualty (8.3%), excess treaty property (9.6%), excess treaty casualty (2.4%) and excess facultative property and casualty (10.0%). Of this international business, 60.6% was sourced from Latin America, 25.7% was sourced from the Middle East, 10.4% was sourced from Africa and 3.3% was home-foreign business.
Bermuda Operation. The Companys Bermuda operation writes property, casualty, life and annuity business through Bermuda Re and property and casualty reinsurance through its UK branch. In 2004, the Bermuda operation continued to scale up and had gross property and casualty written premiums of $342.2 million accounting for virtually all of its business, of which $117.7 million or 34.4% was facultative reinsurance or individual risk insurance and $224.5 million or 65.6% was treaty reinsurance.
In 2004, the Companys gross written premiums by the UK branch of Bermuda Re totaled $541.2 million and consisted of pro rata property (34.1%), excess property (22.0%), pro rata casualty (27.2%) and excess casualty (16.7%). All of Londons gross written premiums related to treaty reinsurance.
9
Geographic Areas
The Company
conducts its business in Bermuda, the U.S. and a number of foreign countries. For select
financial information about geographic areas, see Note 18 of Notes to the Consolidated
Financial Statements. Risks attendant to the foreign operations of the Company parallel
those attendant to the U.S. operations of the Company, with the primary exception of
foreign exchange risks. For more information about the risks, see ITEM 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations Safe
Harbor Disclosure.
Underwriting Process
The
Company offers ceding companies full service capability, including actuarial, claims,
accounting and systems support, either directly or through the broker community. The
Companys capacity for both property and casualty risks allows it to underwrite
entire contracts or major portions thereof that might otherwise need to be syndicated
among several reinsurers. The Companys strategy is to act as lead reinsurer
in many of the reinsurance treaties it underwrites. The lead reinsurer on a treaty
generally accepts one of the largest percentage shares of the treaty and is in a stronger
position to negotiate price, terms and conditions than is a reinsurer that takes a
smaller position. Management believes this strategy enables it to more effectively
influence the terms and conditions of the treaties on which it participates. When the
Company does not lead the treaty, it may still suggest changes to any aspect of the
treaty. The Company may decline to participate in a treaty based upon its assessment of
all relevant factors.
The Companys treaty underwriting process emphasizes a team approach among the Companys underwriters, actuaries and claim staff. Treaties are reviewed for compliance with the Companys general underwriting standards and certain larger treaties are evaluated in part based upon actuarial analyses by the Company. The actuarial models used in such analyses are tailored in each case to the exposures and experience underlying the specific treaty and the loss experience for the risks covered by such treaties. The Company does not separately evaluate each of the individual risks assumed under its treaties. The Company does, however, generally evaluate the underwriting guidelines of its ceding companies to determine their adequacy prior to entering into a treaty. The Company, when appropriate, also conducts underwriting, operational and claim audits at the offices of ceding companies to ensure that the ceding companies operate within such guidelines. Underwriting audits focus on the quality of the underwriting staff, the selection and pricing of risks and the capability of monitoring price levels over time. Claim audits, when appropriate, are performed in order to evaluate the clients claims handling abilities and practices.
The Companys facultative underwriters operate within guidelines specifying acceptable types of risks, limits and maximum risk exposures. Specified classes of U.S. risks and large premium risks are referred to Everest Res New York facultative headquarters for specific review before premium quotations are given to clients. In addition, the Companys guidelines require certain types of risks to be submitted for review because of their aggregate limits, complexity or volatility, regardless of premium amount on the underlying contract. Non-U.S. risks exhibiting similar characteristics are reviewed by senior managers within the involved operations.
The Companys insurance operations principally write property and casualty coverages for homogeneous risks through select program managers. These programs are evaluated based upon actuarial analysis and the program managers capabilities. The Companys rates, forms and underwriting guidelines are tailored to specific risk types. The Companys underwriting, actuarial, claim and financial functions work closely with its program managers to establish appropriate underwriting and processing guidelines as well as appropriate monitoring mechanisms.
Risk Management and Retrocession
Arrangements
The Company manages its risk of loss
through a combination of aggregate exposure limits, underwriting guidelines that take into
account risks, prices and coverage, and retrocessional arrangements.
10
The Company is exposed to multiple insured losses arising out of a single occurrence, whether a natural event, such as a hurricane or an earthquake, or other catastrophe, such as an explosion at a major factory. Any such catastrophic event could generate insured losses in one, several or many of the Companys treaties or lines of business, including property and/or casualty exposures. The Company employs various techniques, including licensed modeling software, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the probable maximum loss (PML). The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake, of such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Companys greatest catastrophe exposure world wide from any single event is to a U.S. earthquake affecting the west coast including workers compensation exposure where the Company estimates it has a pre-tax PML exposure of $427 million. The Company further estimates that its second largest exposure relates to a hurricane affecting the U.S. east coast with a pre-tax PML of $390 million. There can be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML.
The U.S. Terrorism Risk Insurance Act of 2002 was signed into law in November 2002. This legislation provides Federal reimbursement of 90% of insured losses, in excess of statutory retention levels, due to acts of terrorism carried out by foreign powers on U.S. soil or against U.S. air carriers, vessels or foreign missions. This coverage does not apply to reinsurance. Reinsurance contracts generally exclude losses arising from terrorist events, except where such coverage has been specifically included in the underwriting and pricing of the involved reinsurance. As the Terrorism Risk Insurance Act of 2002 is due to expire on December 31, 2005, the Company is generally excluding coverage for terrorism risks effective January 1, 2006 on its insurance business, where such exclusions have been approved by state regulators. These endorsements are conditional based on an extension or modification of the legislation. The Company does not believe that this legislation has had a significant impact on its operations.
Underwriting guidelines have been established for each business unit. These guidelines place dollar limits on the amount of business that can be written based on a variety of factors, including ceding company, line of business, geographical location and risk hazards. In each case, those guidelines permit limited exceptions, which must be authorized by the Companys senior management.
The Company employs a retrocessional approach under which the Company may purchase reinsurance to cover specific business written or exposure accumulations or as a corporate level retrocessional program covering the potential accumulation or aggregation of exposures across some or all of the Companys operations. All reinsurance purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost-effective protection. The level of reinsurance coverage varies over time, reflecting the underwriters and/or Companys view of the changing dynamics of both the underlying exposure and the reinsurance markets.
The Company does not typically purchase significant amounts of reinsurance to cover specific reinsurance business written, but it does from time to time purchase retrocessional protections where underwriting management deems it to be prudent and/or cost-effective to reinsure a portion of the specific risks being assumed. The Company purchased an excess property facultative retrocessional program in 2002 and 2001 as well as an excess workers compensation retrocessional program in 2001. In addition, the Company purchased an excess property catastrophe retrocessional program for losses incurred outside of the U.S. in 2002 and 2001. The 2002 program, which expired on June 5, 2003, was not renewed. The Company also participates in common account retrocessional arrangements for certain reinsurance treaties. Common account reinsurance arrangements are arrangements whereby the ceding company purchases reinsurance for the benefit of itself and
11
its reinsurers on one or more of its reinsurance treaties. Common account retrocessional arrangements reduce the effect of individual or aggregate losses to all participating companies, including the ceding company, with respect to the involved treaties.
The Company typically considers the purchase of reinsurance to cover insurance program exposures written by the U.S. Insurance operation. The type of reinsurance coverage considered is dependent upon individual risk exposures, individual program exposures, aggregate exposures by line of business, overall segment exposures and the cost effectiveness of available reinsurance. Facultative reinsurance will typically be considered for individual accounts with large exposure and quota share reinsurance will generally be considered for individual programs of business. In evaluating the purchase of reinsurance for a line of business, the Company generally seeks to limit exposure to individual claim severity as opposed to frequency. For workers compensation, the Companys predominant business line at the time, the Company purchased in 1998, for policies incepting during and after November 1998, a workers compensation reinsurance program that provided for statutory limits coverage in excess of $75,000 of losses per occurrence on the Companys workers compensation insurance business written prior to November 1, 2000. Effective November 2000, this primary workers compensation reinsurance program provided statutory limits coverage in excess of $250,000 of losses per occurrence for business written prior to December 31, 2001. The Company has not purchased such coverage for the period subsequent to December 31, 2001. The remaining net aggregate U.S Insurance segment exposures, after purchasing facultative reinsurance, quota share program reinsurance and/or aggregate line of business coverage, are considered in evaluating the purchase of corporate level retrocessional protection.
The Company considers purchasing corporate level retrocessional protection covering the potential accumulation of exposures. Such consideration includes balancing the underlying exposures against the availability of cost-effective retrocessional protection. For years ended December 31, 1999, 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage that provided up to $175 million of coverage for each year. These excess of loss policies provided coverage if Everest Res consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point for each year of coverage. The attachment point was net of inuring reinsurance and included adjustable premium provisions that effectively caused the Company to offset, on a pre-tax income basis, up to approximately 57% of such ceded losses. The maximum recovery for each year was $175 million before giving effect to the adjustable premium. As of December 31, 2004, the Company has ceded the maximum limits under all three contracts. The Company did not purchase similar coverage subsequent to December 31, 2001.
Although certain of the Companys catastrophe and aggregate excess of loss retrocessions have terms which provide for additional premiums to be paid to the retrocessionaire in the event that losses are ceded, all aspects of the Companys retrocessional program have been structured to permit these agreements to be accounted for as reinsurance under Statement of Financial Accounting Standards No. 113, Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts.
If a single catastrophe were to occur that resulted in $427 million of gross loss and LAE in 2005 (an amount equivalent to the Companys PML), management estimates that the effect on the Companys income would be approximately $427 million and $341 million before and after taxes, respectively. There can be no assurance that the Company will not experience one or more catastrophic events that could cause these estimates to be exceeded, perhaps by a substantial amount.
In connection with the Companys acquisition of Mt. McKinley in September 2000, the Company had coverage under an aggregate excess of loss reinsurance agreement provided by Prudential Property and Casualty Insurance Company of Indiana (Prupac), a wholly-owned subsidiary of The Prudential. On October 31, 2003, LM Property & Casualty Insurance Company (LM) completed its purchase of Prupac and its obligations from The Prudential. The Prudential continues to guarantee LMs obligation under this agreement. This agreement covers 80% or $160 million of the first $200 million of any adverse loss reserve development on the carried
12
reserves of Mt. McKinley at the date of acquisition and reimburses the Company as such losses are paid by the Company. Cessions under this reinsurance agreement exhausted the limit available under the contract at December 31, 2003.
As of December 31, 2004, the Company carried as an asset $1,210.8 million in reinsurance receivables with respect to losses ceded. Of this amount, $405.0 million, or 33.4%, was receivable from subsidiaries of London Reinsurance Group (London Life), $160.0 million, or 13.2%, was receivable from LM, $132.5 million, or 10.9%, was receivable from Transatlantic Reinsurance Company (Transatlantic) and $100.0 million, or 8.3%, was receivable from Continental Insurance Company (Continental). No other retrocessionaire accounted for more than 5% of the Companys receivables. See ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Financial Condition.
The Companys arrangements with both London Life and Continental are managed on a funds held basis, which means that the Company has not released premium payments to the retrocessionaire, but rather retains such payments to secure obligations of the retrocessionaire, records them as a liability, credits interest on the balances and reduces the liability account as payments become due. As of December 31, 2004, such funds had reduced the Companys net exposure to London Life to $184.1 million, effectively 100% of which has been secured by letters of credit, and its exposure to Continental to $43.7 million. LMs obligations are guaranteed by The Prudential.
No assurance can be given that the Company will seek or be able to obtain retrocessional coverage in the future similar to that in place currently or in the past. The Company continuously evaluates its exposures and risk capacities in the context of reinsurance market conditions, at both the specific and corporate level. Although management carefully selects its reinsurers, the Company is subject to credit risk with respect to its reinsurance because the ceding of risk to reinsurers does not relieve the Company of its liability to insureds or ceding companies.
Claims
Reinsurance claims are managed by the
Companys professional claims staff whose responsibilities include reviewing initial
loss reports and coverage issues, monitoring claims handling activities of ceding
companies, establishing and adjusting proper case reserves and approving payment of
claims. In addition to claims assessment, processing and payment, the claims staff
selectively conducts comprehensive claim audits of both specific claims and overall claim
procedures at the offices of selected ceding companies. Insurance claims, except those
relating to Mt. McKinleys business, are generally handled by third party claims
services providers who have limited authority and are subject to oversight by the
Companys professional claims staff.
The Company intensively manages its asbestos and environmental (A&E) exposures through dedicated, centrally managed claim staffs for Mt. McKinley and Everest Re. Both are staffed with experienced claim and legal professionals that specialize in the handling of such exposures. These units actively manage each individual insured and reinsured account, responding to claim developments with evaluations of the involved exposures and adjustment of reserves as appropriate. Specific or general claim developments that may have material implications for the Company are regularly communicated to senior management, actuarial, legal and financial areas. Meetings among these areas, claim management and senior management are held at least quarterly to review the Companys overall reserve positions and make changes, if appropriate. The Company continually reviews its internal processing, communications and analytics, seeking to enhance the management of its A&E exposures, in particular in the context of changes in the landscape of asbestos claims and litigation.
Reserves for Unpaid Property and
Casualty Losses and Loss Adjustment Expenses
Significant periods of time may elapse
between the occurrence of an insured loss, the reporting of the loss to the insurer and
the reinsurer and the payment of that loss by the insurer and subsequent payments to the
insurer by the reinsurer. To recognize liabilities for unpaid losses and LAE, insurers
and reinsurers establish reserves,
13
which are balance sheet liabilities representing estimates of future amounts needed to pay reported and unreported claims and related expenses on losses that have already occurred. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. To the extent reserves prove to be insufficient to cover actual losses and LAE after taking into account available reinsurance coverage, the Company would have to augment such reserves and incur a charge to earnings, which could be material in the period such augmentation takes place. See ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Loss and LAE Reserves.
While the reserving process is difficult and subjective for insurance companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer time between the date of an occurrence and the reporting of any attendant claims to the reinsurer, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future. As a result, actual losses and LAE may deviate, perhaps substantially, from estimates of reserves reflected in the Companys consolidated financial statements.
Like many other property and casualty insurance and reinsurance companies, the Company has experienced adverse loss development for prior accident years, which has led to adjustments in losses and LAE reserves. The increase in net reserves for prior accident years reduced net income for the periods in which the adjustments were made. There can be no assurance that adverse development from prior years will not continue in the future or that such adverse development will not have a material adverse effect on net income.
Changes in Historical Reserves
The following table shows changes in
historical loss reserves for the Company for 1994 and subsequent years. The table is
presented on a GAAP basis except that the Companys loss reserves for its Canadian
branch operations are presented in Canadian dollars, the impact of which is not material.
The top line of the table shows the estimated reserves for unpaid losses and LAE recorded
at each year end date. Each amount in the top line represents the estimated amount of
future payments for losses and LAE on claims occurring in that year and in all prior
years. The upper (paid) portion of the table presents the cumulative amounts paid through
each subsequent year on those claims for which reserves were carried as of each specific
year end. The lower (liability re-estimated) portion shows the re-estimated amount of the
previously recorded reserves based on experience as of the end of each succeeding year.
The reserve estimates change as more information becomes known about the actual claims for
which the initial reserves were carried. The cumulative redundancy/deficiency line
represents the cumulative change in estimates since the initial reserve was established.
It is equal to the initial reserve less the latest liability re-estimated amount.
Each amount other than the original reserves in the top half of the table below includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 1997 for $100,000, was first reserved in 1994 at $60,000 and remained unchanged until settlement, the $40,000 deficiency (actual loss minus original estimate) would be included in the cumulative redundancy (deficiency) in each of the years in the period 1994 through 1996 shown below. Conditions and trends that have affected development of liability in the past are not indicative of future developments. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table.
14
15
The most recent six years on the above table reflect cumulative deficiencies, also referred to as adverse development, with the largest indicated deficiency in 2001. Three active classes of business are the principal contributors to those deficiencies: professional liability reinsurance, general casualty reinsurance and workers compensation insurance. In addition to these active business classes, there continues to be adverse experience on A&E reserves.
In the professional liability reinsurance class, the late 1990s and early 2000s saw a proliferation of claims relating to bankruptcies and other corporate, financial and/or management improprieties. This resulted in an increase in the frequency and severity of claims on the professional liability policies reinsured by the Company. In the general casualty area, the Company continues to experience claim frequency and severity greater than expected in the Companys pricing and reserving assumptions, particularly for accident years 1999 and 2000. These losses reflect unfavorable trends in litigation and economic variability. With respect to both of these classes, another factor was the increasingly competitive conditions in insurance and reinsurance markets during this period. While the Company seeks to manage the impact of competitive condition changes on its results, it is generally unable to divorce itself entirely from the underlying industry cycles of its principal business. See ITEM 1, Business Competition.
In the workers compensation insurance class, the majority of which was written in California, the Company has experienced adverse development primarily for accident years 2001 and 2002. As a result of significant growth in this book of business in a challenging business environment, the Companys writings in this class were relatively more subject to variability than are some of its more established and/or stable lines of business. Although cumulative results through 2004 continue to be quite profitable for this book of business, there has been some deterioration in claim frequency and severity related to accident years 2001 and 2002.
With respect to active business classes, the Company actively manages the collection, auditing and analysis of loss data, and factors the resulting information into both its reserving processes and its prospective underwriting and pricing activities on as timely a basis as possible.
For years 1994 and prior, management believes that two factors had the most significant impact on loss development. First, through the 1980s, a number of industry and external factors, such as the propensity of courts to award large damage awards in liability cases, combined to increase loss frequency and severity to unexpectedly high levels. Second, contracts written prior to 1986 contained coverage terms which, for the Company and the industry in general, have been interpreted by courts to provide coverage for A&E exposures not contemplated by either the pricing or the initial reserving of the contracts. Legal developments during the 1980s, and continuing to date, have necessitated additional reserving for such exposures on both a case basis and an incurred but not reported (IBNR) basis. These factors were the primary reasons for the cumulative adverse development on the 1994 and prior calendar year reserves. See ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies Asbestos and Environmental Exposures.
The change between 1994 and 1995 reflects the impact of a stop loss reinsurance agreement with Mt. McKinley, which was then a subsidiary of The Prudential. This stop loss agreement commenced in 1995 when The Prudential sold the stock of the Company in an initial public offering and hence recoveries under this coverage are attributed to the 1995 accident year. As a result of this agreement, reserve development arising from claims incurred prior to July 1, 1995 (January 1, 1995 as respects catastrophe losses) was ceded under the agreement with no impact on net development, except for a modest retention, when the adverse development reflected for accident year 1994 and prior is considered in the context of the mitigating favorable development attributed to the 1995 accident year. This coverage became an inter-affiliate reinsurance transaction with the acquisition of Mt. McKinley in 2000, which eliminated any subsequent impact on net reserve development. See ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Financial Condition.
16
Management believes that adequate provision has been made for the Companys loss and LAE reserves. While there can be no assurance that reserves for and losses from these claims will not increase in the future, management believes that the Companys existing reserves, reserving methodologies and retrocessional arrangements lessen the probability that any such increases would have a material adverse effect on the Companys financial condition, results of operations or cash flows. These statements regarding the Companys loss reserves are forward looking statements within the meaning of the U.S. federal securities laws and are intended to be covered by the safe harbor provisions contained therein. See ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Safe Harbor Disclosure.
The following table is derived from the Ten Year GAAP Loss Development Table above and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations by accident year for the same ten year period ended December 31, 2004. Each column represents the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates for the indicated accident years.
The reserve development by accident year reflected in the above table was generally the result of the same factors discussed above that caused the deficiencies shown in the Ten Year GAAP Loss Development Table. Development in accident years 1994 and prior principally reflect the impact of the liability award inflation and A&E exposures discussed above. The favorable development experienced for the 1995 accident year is due to stop loss reinsurance provided to the Company at the time of its initial public offering, which, when established, was specifically intended to mitigate the impact of development on reserves at June 30, 1995. The adverse development experienced in the 1998 through 2001 accident years relates principally to casualty reinsurance, including professional liability classes and workers compensation insurance where, in retrospect, the Companys initial estimates of losses were underestimated principally as the result of unanticipated variability in the underlying exposures. The favorable development for accident years 2002 and 2003 relates primarily to favorable experience with respect to property reinsurance business.
17
The Companys loss reserving methodologies continuously monitor the emergence of loss and loss development trends, seeking, on a timely basis, to both adjust reserves for the impact of trend shifts and to factor the impact of such shifts into its underwriting and pricing on a prospective basis.
The following table presents a reconciliation of beginning and ending reserve balances for the years indicated on a GAAP basis:
Reconciliation of Reserves for Losses and LAE | |||||||||||||
Years Ended December 31, | |||||||||||||
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(Dollars in millions) | 2004 | 2003 | 2002 | ||||||||||
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|
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Reserves at beginning of period | $ | 6,361.2 | $ | 4,905 | .6 | $ | 4,278 | .3 | |||||
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Incurred related to: | |||||||||||||
Current year | 2,979.1 | 2,343 | .3 | 1,489 | .3 | ||||||||
Prior years | 312.0 | 256 | .9 | 140 | .1 | ||||||||
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|
|||||||||||
Total incurred losses | 3,291.1 | 2,600 | .2 | 1,629 | .4 | ||||||||
Paid related to: | |||||||||||||
Current year | 607.1 | 501 | .1 | 352 | .9 | ||||||||
Prior years | 1,141.7 | 902 | .6 | 892 | .7 | ||||||||
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Total paid losses | 1,748.8 | 1,403 | .7 | 1,245 | .6 | ||||||||
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Paid related to: | 78.9 | 86 | .7 | 38 | .4 | ||||||||
Change in reinsurance receivables on unpaid losses and LAE | (146.1 | ) | 172 | .5 | 205 | .1 | |||||||
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Reserves at end of period | $ | 7,836.3 | $ | 6,361 | .2 | $ | 4,905 | .6 | |||||
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Prior year incurred losses were $312.0 million in 2004 and $256.9 million in 2003. Such losses were the result of the reserve development noted above, as well as inherent uncertainty in establishing loss and LAE reserves.
Reserves for Asbestos and
Environmental Losses and Loss Adjustment Expenses
The Companys reserves include
an estimate of the Companys ultimate liability for A&E claims for which
ultimate value cannot be estimated using traditional reserving techniques. There are
significant uncertainties in estimating the amount of the Companys potential losses
from A&E claims. See ITEM 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations Asbestos and Environmental Exposures and
Note 3 of Notes to Consolidated Financial Statements.
Mt. McKinleys book of direct A&E exposed insurance is relatively small and homogenous. The book is based principally on excess liability policies; thus the claim/legal staff does not have to analyze exposure under many different policy forms, but rather can focus on a limited number of policies and policy forms. As a result of this focused structure, the Company believes that it is able to comprehensively analyze its exposures, allowing it to identify and analyze those claims on which it has unusual exposure, such as policies in which it may be exposed to pay expenses in addition to policy limits or non-products asbestos claims, for concentrated ongoing attention.
The Company aims to be actively engaged with every insured account posing significant potential asbestos exposure to Mt. McKinley. Such engagement can take the form of pursuing a final settlement, negotiation, litigation, or the monitoring of claim activity under Settlement in Place (SIP) agreements. SIP agreements generally condition an insurers payment upon the actual claim experience of the insured and may have annual payment caps or other measures to control the insurers payments. The Companys Mt. McKinley operation is currently managing nine SIP agreements, three of which were executed prior to the acquisition of Mt. McKinley
18
in 2000. The Companys preference with respect to coverage settlements is to execute settlements that call for a fixed schedule of payments, because such settlements eliminate future uncertainty.
The Company has significantly enhanced its classification of insureds by exposure characteristics over time, as well as its analysis by insured for those it considers to be more exposed or active. Those insureds identified as relatively less exposed or active are subject to less rigorous, but still active management, with an emphasis on monitoring those characteristics, which may indicate an increasing exposure or levels of activity. The Company continually focuses on further enhancement of the detailed estimation processes used to evaluate potential exposure of policyholders, including those that may not have reported significant A&E losses.
Everest Res book of assumed reinsurance is relatively concentrated within a modest number of A&E exposed relationships. Because the book of business is relatively concentrated and the Company has been managing the A&E exposures for many years, its claim staff is familiar with the ceding companies that have generated most of these liabilities in the past and which are therefore most likely to generate future liabilities. The Companys claim staff has developed familiarity both with the nature of the business written by its ceding companies and the claims handling and reserving practices of those companies. This level of familiarity enhances the quality of the Companys analysis of its exposure through those companies. As a result, the Company believes that it can identify those claims on which it has unusual exposure, such as non-products asbestos claims, for concentrated attention. However, in setting reserves for its reinsurance liabilities, the Company relies on claims data supplied by its ceding companies and brokers. This information is not always timely or accurate and can impact the accuracy and timeliness of ultimate loss projections.
The following table summarizes the composition of the Companys total reserves for A&E losses, gross and net of reinsurance, for the years ended December 31:
(Dollars in millions) | 200 | 4 | 200 | 3 | 200 | 2 | |||||
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|
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Case reserves reported by ceding companies | $ | 148 | .5 | $ | 123 | .1 | $ | 112 | .5 | ||
Additional reserves established by the Company (assumed reinsurance) (1) | 151 | .3 | 109 | .1 | 55 | .5 | |||||
Case reserves established by the Company | 272 | .1 | 251 | .3 | 262 | .1 | |||||
IBNR reserves | 156 | .4 | 281 | .8 | 237 | .8 | |||||
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Gross reserves | 728 | .3 | 765 | .3 | 667 | .9 | |||||
Reinsurance receivable | (221 | .6) | (230 | .9) | (140 | .4) | |||||
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Net reserves | $ | 506 | .7 | $ | 534 | .4 | $ | 527 | .5 | ||
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______________
(1) Additional reserves are case specific reserves determined by the Company to be needed over and above those reported by the ceding company. |
Additional losses, including those relating to latent injuries and other exposures, which are as yet unrecognized, the type or magnitude of which cannot be foreseen by either the Company or the industry, may emerge in the future. Such future emergence could have material adverse effects on the Companys future financial condition, results of operations and cash flows.
Future Policy Benefit
Reserves
Future policy benefit liabilities for
annuities are reported at the accumulated fund balance of these contracts. Reserves for
those liabilities include both mortality and morbidity provisions with respect to life and
annuity claims, both reported and unreported. Actual experience in a particular period may
be worse than assumed experience and, consequently, may adversely affect the
Companys operating results for the period. See Note 1F of Notes to Consolidated
Financial Statements.
19
Activity in the reserve for future policy benefits is summarized as follows:
Years Ended December 31, | |||||||||||
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|
|
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(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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Balance at beginning of year | $ | 205,275 | $ | 227,925 | $ | 238,753 | |||||
Liabilities assumed | 300 | 512 | 6,563 | ||||||||
Adjustments to reserves | 8,544 | 11,239 | 8,519 | ||||||||
Benefits paid in the current year | (19,543 | ) | (34,401 | ) | (25,910 | ) | |||||
Contract terminations | (42,397 | ) | - | - | |||||||
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Balance at end of year | $ | 152,179 | $ | 205,275 | $ | 227,925 | |||||
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Investments
The Companys
overall financial strength and results of operations are, in part, dependent on the
quality and performance of its investment portfolio. Net investment income and net
realized capital gains (losses) on the Companys invested assets constituted 11.7%,
8.9%, and 11.8% of the Companys revenues for the years ended December 31, 2004,
2003 and 2002, respectively. The Companys cash and invested assets totaled $11.5
billion at December 31, 2004, which consisted of 93.0% fixed maturities of which 95.5%
were investment grade, 5.6% equity securities and 1.4% other invested assets.
The Companys current investment strategy seeks to maximize after-tax income, through a high quality, diversified, taxable bond and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Companys mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Companys current and projected operating results, market conditions and tax position. Additionally, the Company invests in equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio.
The board of directors of each of the Companys operating subsidiaries is responsible for establishing investment policy and guidelines and, together with senior management, for overseeing their execution. The Companys investment portfolio is in compliance with the insurance laws of the jurisdictions in which its subsidiaries are regulated. Generally, an independent investment advisor is utilized to manage the Companys fixed income investment portfolio within the established guidelines and is required to report activities on a current basis and to meet with the Company periodically to review and discuss the portfolio structure, securities selection and performance results. The Company manages directly its investments in its equity and other invested asset portfolios.
The Companys investment guidelines include a general duration guideline of five to six years. The duration of an investment is based on the maturity of the security but also reflects the payment of interest and the possibility of early prepayment of such security. This investment duration guideline is established and periodically revised by management, which considers economic and business factors. An important factor considered by management is the Companys average duration of potential liabilities, which, at December 31, 2004, is estimated at approximately 4.5 years based on the estimated payouts of underwriting liabilities using standard duration calculations.
The duration of the fixed income portfolio at December 31, 2004 was 5.2 years. The Company made a decision to shorten duration during the second half of 2003 by purchasing interest only strips of mortgaged-back securities (interest only strips). The interest only strips give the holder the right to receive interest payments at a stated coupon rate on an underlying pool of mortgages. The interest payments on the outstanding mortgages are guaranteed by entities generally rated AAA. The ultimate cash flow from these investments is primarily dependent upon the average life of the underlying mortgage pool. Generally, as market interest rates and more
20
specifically market mortgage rates decline, mortgagees tend to refinance, which will decrease the average life of a mortgage pool and decrease expected cash flows. Conversely, as market interest rates and more specifically market mortgage rates rise, repayments will slow and the ultimate cash flows will tend to rise. Accordingly, the market value of these investments tends to increase as general interest rates rise and decline as general interest rates fall. These movements are generally counter to the impact of interest rate movements on the Companys other fixed income investments. As interest rates peaked during the second quarter of 2004 the Company liquidated its portfolio of interest only strips causing duration to rise back to the present levels. Such investments contributed to the 4.2 year duration at December 31, 2003.
For each currency in which the Company has established substantial reserves, the Company seeks to maintain invested assets denominated in such currency in an amount approximately comparable to the estimated liabilities. Approximately 8.5% of the Companys consolidated reserves for losses and LAE and unearned premiums represent estimated amounts payable in foreign currencies.
As of December 31, 2004, 93.0% of the Companys total investments and cash were comprised of fixed maturity investments or cash and 95.5% of the Companys fixed maturities consisted of investment grade securities. The average maturity of fixed maturities was 8.1 years at December 31, 2004, and their overall duration was 5.2 years. As of December 31, 2004, the Company did not have any investments in commercial real estate or direct commercial mortgages or any material holdings of derivative investments or securities of issuers that are experiencing cash flow difficulty to an extent that the Companys management believes could threaten the issuers ability to meet debt service payments, except where other than temporary impairments have been recognized.
As of December 31, 2004, the Companys common stock portfolio, which is comprised primarily of publicly traded equity index funds, had a market value of $650.9 million, comprising 5.6% of total investments and cash.
21
The following table reflects investment results for the Company for each of the five years ended December 31:
The following table summarizes fixed maturities as of December 31, 2004 and 2003:
(Dollars in millions) |
Amortized
Cost |
Unrealized
Appreciation |
Unrealized
Depreciation |
Market
Value |
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December 31, 2004: | ||||||||||||||
U.S. Treasury securities and obligations of U.S. | ||||||||||||||
government agencies and corporations | $ | 184 | .1 | $ | 2 | .1 | $ | 0 | .8 | $ | 185 | .4 | ||
Obligations of states and political subdivisions | 3,281 | .4 | 160 | .2 | 2 | .3 | 3,439 | .3 | ||||||
Corporate securities | 3,211 | .7 | 137 | .5 | 17 | .7 | 3,331 | .5 | ||||||
Mortgage-backed securities | 1,468 | .8 | 13 | .3 | 8 | .1 | 1,474 | .0 | ||||||
Foreign government securities | 921 | .5 | 31 | .2 | 0 | .6 | 952 | .1 | ||||||
Foreign corporate securities | 542 | .1 | 24 | .6 | 1 | .8 | 564 | .9 | ||||||
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Total | $ | 9,609 | .6 | $ | 368 | .9 | $ | 31 | .3 | $ | 9,947 | .2 | ||
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|
December 31, 2003: | ||||||||||||||
U.S. Treasury securities and obligations of U.S. | ||||||||||||||
government agencies and corporations | $ | 152 | .0 | $ | 6 | .0 | $ | 0 | .6 | $ | 157 | .4 | ||
Obligations of states and political subdivisions | 2,798 | .4 | 156 | .4 | 3 | .1 | 2,951 | .7 | ||||||
Corporate securities | 2,969 | .2 | 172 | .6 | 24 | .8 | 3,117 | .0 | ||||||
Mortgage-backed securities | 1,369 | .2 | 26 | .7 | 12 | .6 | 1,383 | .3 | ||||||
Foreign government securities | 708 | .1 | 24 | .6 | 2 | .1 | 730 | .6 | ||||||
Foreign corporate securities | 360 | .8 | 26 | .5 | 0 | .4 | 386 | .9 | ||||||
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|
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Total | $ | 8,357 | .7 | $ | 412 | .8 | $ | 43 | .6 | $ | 8,726 | .9 | ||
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|
|
22
The following table presents the credit quality distribution of the Companys fixed maturities as of December 31:
The following table summarizes fixed maturities by contractual maturity as of December 31, 2004:
23
Ratings
The following table
shows the financial strength ratings of the Companys operating subsidiaries as
reported by A.M. Best, Standard & Poors Rating Services (Standard &Poors)
and Moodys Investors Service, Inc. (Moodys). These ratings are
based upon factors of concern to policyholders and should not be considered an indication
of the degree or lack of risk involved in an equity investment in an insurance company.
Operating Subsidiary | A.M. Best | Standard & Poor's | Moody's | ||||||||
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|
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Everest Re | A+ (Superior) | AA- (Very Strong) | Aa3 (Excellent) | ||||||||
Bermuda Re | A+ (Superior) | AA- (Very Strong) | Aa3 (Excellent) | ||||||||
Everest International | A+ (Superior) | Not Rated | Not Rated | ||||||||
Everest National | A+ (Superior) | AA- (Very Strong) | Not Rated | ||||||||
Everest Indemnity | A+ (Superior) | Not Rated | Not Rated | ||||||||
Everest Security | A+ (Superior) | Not Rated | Not Rated | ||||||||
Mt. McKinley | Not Rated | Not Rated | Not Rated |
A.M. Best states that the A+ (Superior) rating is assigned to those companies which, in its opinion, have a superior ability to meet their ongoing obligations to policyholders based on A.M. Bests comprehensive quantitative and qualitative evaluation of a companys balance sheet strength, operating performance and business profile. The A+" (Superior) rating is the second highest of fifteen ratings assigned by A.M. Best, which range from A++ (Superior) to F (In Liquidation). Additionally, A.M. Best has five classifications within the Not Rated category. Standard & Poors states that the AA- rating is assigned to those insurance companies which, in its opinion, have very strong financial security characteristics with respect to their ability to pay under its insurance policies and contracts in accordance with their terms. The AA- rating is the fourth highest of nineteen ratings assigned by Standard & Poors, which range from AAA to R. Ratings from AA to CCC may be modified by the use of a plus or minus sign to show relative standing of the insurer within those rating categories. Moodys states that insurance companies rated Aa offer excellent financial security. Together with the Aaa rated companies, Aa rated companies constitute what are generally known as high-grade companies, with Aa rated companies generally having somewhat larger long-term risks. Moodys rating gradations are shown through the use of nine distinct symbols, each symbol representing a group of ratings in which the financial security is broadly the same. The Aa3 (Excellent) rating is the fourth highest of ratings assigned by Moodys, which range from Aaa (Exceptional) to C (Lowest). Moodys appends numerical modifiers 1, 2 and 3 to each generic rating classification from Aa through Caa. Numeric modifiers are used to refer to the ranking within a group with 1 being the highest and 3 being the lowest.
Subsidiaries other than Everest Re and Bermuda Re may not be rated by some or any rating agencies because such ratings are not considered essential by the individual subsidiarys customers or because of the limited nature of the subsidiarys operations. In particular, Mt. McKinley is not rated because it is in run-off status.
The following table shows the debt ratings by A.M. Best, Standard & Poors and Moodys of the Holdings senior notes due March 15, 2005, March 15, 2010 and October 15, 2014 and Everest Re Capital Trust (Capital Trust) and Everest Re Capital Trust IIs (Capital Trust II) trust preferred securities due November 15, 2032 and March 29, 2034, all of which are considered investment grade. Debt ratings are a current assessment of the credit worthiness of an obligor with respect to a specific obligation.
A.M. Best | Standard & Poor's | Moody's | |||||||||
|
|
|
|
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Senior Notes | a | A- | A3 | ||||||||
Trust Preferred Securities | a- | BBB | Baal |
24
A debt rating of a or a- is assigned by A.M. Best where the issuer, in A.M. Bests opinion, has a strong ability to meet the terms of the obligation. The a and a- ratings are the sixth and seventh highest of 19 ratings assigned by A.M. Best, which range from aaa to ccc. A debt rating of A- is assigned by Standard & Poors where the obligor has a strong capacity to meet its financial commitment on the obligation, although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rated categories. Standard & Poors assigns a debt rating of BBB to issues that exhibit adequate protection parameters although adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. The A- and BBB ratings from Standard & Poors are the seventh and ninth highest of 24 ratings assigned by Standard & Poors, which range from AAA to D. According to Moodys, a debt rating of A3 is assigned to issues that are considered upper-medium-grade obligations and subject to low credit risk. Obligations rated Baa1 are subject to moderate credit risk and are considered medium-grade and as such may possess certain speculative characteristics. The A3 and Baa1 ratings are the seventh and eighth highest of 21 ratings assigned by Moodys, which range from AAA to C.
All of the above-mentioned ratings are continually monitored and revised, if necessary, by each of the rating agencies.
The Company believes that its ratings, in general, have become increasingly important to its operations because they provide the Companys customers and investors with an independent assessment of the Companys underlying financial strength using a scale that provides for relative comparisons.
Competition
The worldwide
reinsurance and insurance businesses are highly competitive yet cyclical by product and
market. Competition with respect to the types of reinsurance and insurance business in
which the Company is engaged is based on many factors, including the perceived overall
financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by
A.M. Best and/or Standard & Poors, underwriting expertise, the jurisdictions
where the reinsurer or insurer is licensed or otherwise authorized, capacity and
coverages offered, premiums charged, other terms and conditions of the reinsurance and
insurance business offered, services offered, speed of claims payment and reputation and
experience in lines written. These factors operate at the individual market participant
level to varying degrees as applicable to the specific participants circumstances.
They also operate in aggregate across the reinsurance industry more generally
contributing, in combination with background economic conditions and variations in the
reinsurance buying practices of insurance companies, by participant and in the aggregate,
to cyclical movements in reinsurance rates, terms and conditions and ultimately
reinsurance industry aggregate financial results.
The Company competes in the U.S., Bermuda and international reinsurance and insurance markets with numerous international and domestic reinsurance and insurance companies. The Companys competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyds. Some of these competitors have greater financial resources than the Company and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. In addition, the potential for securitization of reinsurance and insurance risks through capital markets provides an additional source of potential reinsurance and insurance capacity and competition.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased, in part due to the relative profitability achieved by many reinsurers over 2002 and 2003 and the attendant buildup of capital in these participants. However, this profitability and capital buildup varied significantly by market participant, reflecting the fact that the industry
25
generally still remained exposed to fundamental issues that had negatively impacted its aggregate capacity in 2002 and 2003, including weak investment market conditions and adverse loss emergence. Both of these had tended to depress the industrys aggregate financial performance and perceptions of financial strength of industry participants over this period albeit with significant variation by individual market participant. The industry experienced a record level of catastrophe losses during 2004, particularly in the second half of the year, and it remains unclear whether the aggregate catastrophe losses experienced by the industry will reverse, stop or even moderate the trends toward market softening, particularly as respects property classes.
Through 2003, reinsurance and insurance markets had generally continued to firm, reflecting the continuing, although diminishing, implications of losses arising from the terrorist attacks of September 11, 2001, and more broadly, the impact of aggregate company reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which became apparent through excessive loss emergence, varied widely by company depending on product offerings, markets accessed, underwriting and operating practices, competitive strategies and business volumes. Across all market participants, however, the aggregate general effect was depressed financial results and erosion of the industry capital base. Coupled with deteriorating investment market conditions and results, and renewed concerns regarding longer-term industry specific issues, including legacy reserve issues and sub-par capital returns, these financial impacts introduced substantial, and in some cases extreme, pressure for the initiation and/or strengthening of corrective action by individual market participants. These pressures, aggregating across industry participants, reinforced the trend established in 2000 through 2003 toward firming prices, more restrictive terms and conditions, tightened coverage availability across most classes and markets and increasing concern with respect to the financial security of insurance and reinsurance providers, impacts which set the stage for the 2004 trends discussed above.
The Company has been somewhat disappointed by industry developments in 2004, which have generally operated to modestly weaken pricing. The Company can not predict with any reasonable certainty whether and to what extent these trends or conditions will persist and in particular whether the property catastrophe losses experienced by the industry in 2004 will lessen competitive pressures, particularly for the property classes of business. Notwithstanding these catastrophe losses, the continued growth of reinsurance capacity, particularly in Bermuda, changes in the Lloyds market, and the potential reemergence of a market share orientation among some industry participants, combined with improving and in some cases strong financial results, continues to contribute to uncertainty about the prospective level of competitive pressures.
Employees
As of March 1,
2005, the Company employed 606 persons. Management believes that its employee relations
are good. None of the Companys employees are subject to collective bargaining
agreements, and the Company is not aware of any current efforts to implement such
agreements.
Regulatory Matters
The Company
and its insurance subsidiaries are subject to regulation under the insurance statutes of
the various jurisdictions in which they conduct business, including essentially all
states of the U.S., Canada, Singapore, the United Kingdom and Bermuda. These regulations
vary from jurisdiction to jurisdiction and are generally designed to protect ceding
insurance companies and policyholders by regulating the Companys conduct of
business, financial integrity and ability to meet its obligations relating to its
business transactions and operations. Many of these regulations require reporting of
information designed to allow insurance regulators to closely monitor the Companys
performance.
Insurance Holding Company Regulation. Under applicable U.S. laws and regulations, no person, corporation or other entity may acquire a controlling interest in the Company, unless such person, corporation or entity has obtained the prior approval for such acquisition from the Insurance Commissioners of Delaware and the other states in which the Companys insurance subsidiaries are domiciled or deemed domiciled, currently Arizona,
26
California and Georgia. Under these laws, control is presumed when any person acquires, directly or indirectly, 10% or more of the voting securities of an insurance company. To obtain the approval of any change in control, the proposed acquirer must file an application with the relevant insurance commissioner disclosing, among other things, the background of the acquirer and that of its directors and officers, the acquirers financial condition and its proposed changes in the management and operations of the insurance company. U.S. state regulators also require prior notice or regulatory approval of material inter-affiliate transactions within the holding company structure. See Dividends.
The Insurance Companies Act of Canada also requires prior approval by the Minister of Finance of anyone acquiring a significant interest in an insurance company authorized to do business in Canada. In addition, the Company is subject to regulation by the insurance regulators of other states and foreign jurisdictions in which it is authorized to do business. Certain of these states and foreign jurisdictions impose regulations regulating the ability of any person to acquire control of an insurance company authorized to do business in that jurisdiction without appropriate regulatory approval similar to those described above.
Dividends. Under Bermuda law, Group is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities and its issued share capital and share premium (additional paid-in capital) accounts. Groups ability to pay dividends and its operating expenses is partially dependent upon dividends from its subsidiaries. The payment of dividends by insurance subsidiaries is limited under Bermuda law as well as the laws of the various U.S. states in which Groups insurance and reinsurance subsidiaries are domiciled or deemed domiciled. The limitations are generally based upon net income and compliance with applicable policyholders surplus or minimum solvency margin and liquidity ratio requirements as determined in accordance with the relevant statutory accounting practices. As Holdings has outstanding debt obligations, it is dependent upon dividends and other permissible payments from its operating subsidiaries to enable it to meet its debt and operating expense obligations and to pay dividends to Group.
Under Bermuda law, Bermuda Re is unable to declare or make payment of a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, exceeds its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Monetary Authority is required if Bermuda Res dividend payments would reduce its prior year end total statutory capital by 15.0% or more. At December 31, 2004, Bermuda Re and Everest International met their solvency and liquidity requirements by a significant margin.
The payment of dividends to Holdings by Everest Re is subject to limitations imposed by Delaware law. Generally, Everest Re may only pay dividends out of its statutory earned surplus, which was $1,368.4 million at December 31, 2004, and only after it has given 10 days prior notice to the Delaware Insurance Commissioner. During this 10-day period, the Commissioner may, by order, limit or disallow the payment of ordinary dividends if the Commissioner finds the insurer to be presently or potentially in financial distress. Further, the maximum amount of dividends that may be paid without the prior approval of the Delaware Insurance Commissioner in any twelve month period is the greater of (1) 10% of an insurers statutory surplus as of the end of the prior calendar year or (2) the insurers statutory net income, not including realized capital gains, for the prior calendar year. Under this definition, the maximum amount that will be available for the payment of dividends by Everest Re in 2005 without triggering the requirement for prior approval of regulatory authorities in connection with a dividend is $209.3 million.
Insurance Regulation. Neither Bermuda Re nor Everest International are admitted to do business in any jurisdiction in the U.S. Both conduct their insurance business from their offices in Bermuda, and in the case of Bermuda Re, its branch in the UK. In Bermuda, Bermuda Re and Everest International are regulated by the
27
Insurance Act 1978 (as amended) and related regulations (the Act). The Act establishes solvency and liquidity standards and auditing and reporting requirements and subjects Bermuda Re and Everest International to the supervision, investigation and intervention powers of the Bermuda Monetary Authority. Under the Act, Bermuda Re and Everest International, as Class 4 insurers, are each required to maintain a principal office in Bermuda, to maintain a minimum of $100 million in statutory capital and surplus, to have an independent auditor approved by the Bermuda Monetary Authority conduct an annual audit and report on their respective statutory financial statements and filings and to have an appointed loss reserve specialist (also approved by the Bermuda Monetary Authority) review and report on their respective loss reserves annually.
Bermuda Re is also registered under the Act as a long-term insurer and is thereby authorized to write life and annuity business. As a long-term insurer, Bermuda Re is required to maintain $250,000 in statutory capital separate from its Class 4 minimum statutory capital and surplus, to maintain a long-term business fund, to separately account for this business and to have an approved actuary prepare a certificate concerning its long-term business assets and liabilities to be filed annually.
U.S. domestic property and casualty insurers, including reinsurers, are subject to regulation by their state of domicile and by those states in which they are licensed. The regulation of reinsurers is typically related to the reinsurers financial condition, investments, management and operation. The rates and policy terms of reinsurance agreements are generally not subject to direct regulation by any governmental authority.
The operations of Everest Res foreign branch offices in Canada, and Singapore are subject to regulation by the insurance regulatory officials of those jurisdictions. Management believes that the Company is in material compliance with applicable laws and regulations pertaining to its business and operations. Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re, a Bermuda insurance company and direct subsidiary of Group. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Through this transaction, Bermuda Res operations in the United Kingdom and worldwide are subject to regulation by the Financial Services Authority (the FSA). The FSA imposes solvency, capital adequacy, audit, financial reporting and other regulatory requirements on insurers transacting business in the United Kingdom. Bermuda Re presently meets or exceeds all of the FSAs solvency and capital requirements.
Everest Indemnity, Everest National, Everest Security and Mt. McKinley are subject to regulations similar to the U.S. regulations applicable to Everest Re. In addition, Everest National and Everest Security must comply with substantial regulatory requirements in each state where they conduct business. These additional requirements include, but are not limited to, rate and policy form requirements, requirements with regard to licensing, agent appointments, participation in residual markets and claim handling procedures. These regulations are primarily designed for the protection of policyholders.
Licenses. Everest Re is a licensed property and casualty insurer and/or reinsurer in all states (except Nevada and Wyoming), the District of Columbia and Puerto Rico. In New Hampshire and Puerto Rico, Everest Re is licensed for reinsurance only. Such licensing enables U.S. domestic ceding company clients to take credit for reinsurance ceded to Everest Re.
Everest Re is licensed as a property and casualty reinsurer in Canada. It is also authorized to conduct reinsurance business in Singapore. Everest Re can also write reinsurance in other foreign countries. Because some jurisdictions require a reinsurer to register in order to be an acceptable market for local insurers, Everest Re is registered as a foreign insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile, Colombia, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Peru, Venezuela and the Philippines. Everest National is licensed in 47 states and the District of Columbia. Everest Indemnity is licensed in Delaware and is eligible to write insurance on a surplus lines basis in 49 states, the District of Columbia and Puerto Rico. Everest Security is licensed in Georgia and Alabama. Mt. McKinley is licensed in Delaware and California.
28
Bermuda Re and Everest International are registered as Class 4 insurers in Bermuda. Bermuda Re is also registered as a long-term insurer in Bermuda.
Periodic Examinations. Everest Re, Everest National, Everest Indemnity, Everest Security and Mt. McKinley are subject to periodic financial examination (usually every 3 years) of their affairs by the insurance departments of the states in which they are licensed, authorized or accredited. Everest Res, Everest Securitys, Everest Indemnitys and Mt. McKinleys last examination reports were as of December 31, 2000, while Everest Nationals last examination was as of December 31, 2001. None of these reports contained any material findings or recommendations. In addition, U.S. insurance companies are subject to examinations by the various state insurance departments where they are licensed concerning compliance with applicable conduct of business regulations.
NAIC Risk-Based Capital Requirements. The U.S. National Association of Insurance Commissioners (NAIC) employs a formula to measure the amount of capital appropriate for a property and casualty insurance company to support its overall business operations in light of its size and risk profile. The major categories of a companys risk profile are its asset risk, credit risk, and underwriting risk. The standards are an effort by the NAIC to prevent insolvencies, to ward off other financial difficulties of insurance companies and to establish uniform regulatory standards among state insurance departments.
Under the approved formula, a companys statutory surplus is compared to its risk based capital (RBC). If this ratio is above a minimum threshold, no action is necessary. Below this threshold are four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer as the ratio of surplus to RBC decreases. The mildest intervention requires the Company to submit a plan of appropriate corrective actions. The most severe action requires the Company to be rehabilitated or liquidated.
Based on their financial positions at December 31, 2004, Everest Re, Everest National, Everest Indemnity and Everest Security exceed the minimum thresholds. Since Mt. McKinley ceased writing new and renewal insurance in 1985, its domiciliary regulator, Delaware, has exempted Mt. McKinley from complying with RBC requirements. Various proposals to change the RBC formula arise from time to time. The Company is unable to predict whether any such proposal will be adopted, the form in which any such proposals would be adopted or the effect, if any, the adoption of any such proposal or change in the RBC calculations would have on the Company.
Tax Matters. The following summary of the taxation of the Company is based on current law. There can be no assurance that legislative, judicial, or administrative changes will not be enacted that materially affect this summary.
Bermuda. Under current Bermuda law, no income, withholding or capital gains taxes are imposed upon Group and its Bermuda subsidiaries. Group and its Bermuda subsidiaries have received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, Group and its Bermuda subsidiaries will be exempt from taxation in Bermuda until March 2016. Non-Bermuda branches of Bermuda subsidiaries are subject to local taxes in the jurisdictions in which they operate.
Barbados. Through December 31, 2004, Group, maintained its principal office in Barbados and was registered as an external company under the Companies Act, Cap. 308 of Barbados and was licensed as an international business company under the Barbados International Business Companies Act, 1991-24. As a result, Group was subject to a preferred rate of corporation tax on profits and gains in Barbados and was exempt from withholding tax on dividends, interest, royalties, management fees, fees or other income paid or deemed paid to a person who is not resident in Barbados or who, if so resident, carried on an international business. No tax was imposed on capital gains. Effective January 1, 2005, Groups principal office was relocated to Bermuda.
29
United States. Groups U.S. subsidiaries conduct business in and are subject to taxation in the U.S. Non-U.S. branches of U.S. subsidiaries are subject to local taxation in the jurisdictions in which they operate. Should the U.S. subsidiaries distribute current or accumulated earnings and profits in the form of dividends or otherwise to Group, the Company would be subject to withholding taxes. Group and its Bermuda subsidiaries believe that they have operated and will continue to operate their businesses in a manner that will not cause them to generate income treated as effectively connected with the conduct of a trade or business within the U.S. On this basis, Group does not expect that it and its Bermuda subsidiaries will be required to pay U.S. corporate income taxes other than withholding taxes on certain investment income and premium excise taxes. If Group or its Bermuda subsidiaries were subject to U.S. income tax; there could be a material adverse effect on the Companys financial condition, results of operations or cash flows.
United Kingdom. Bermuda Res UK branch conducts business in the UK and is subject to taxation in the UK. Bermuda Res Bermuda operations believe that they have operated and will continue to operate in a manner which will not cause them to be subject to UK taxation. If Bermuda Res Bermuda operations were subject to UK income tax there could be a material adverse impact on the Companys financial condition, results of operations or cash flow.
Available Information
The Companys Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements
and amendments to those reports are available free of charge through the Companys
internet website at http://www.everestre.com as soon as reasonably practicable after such
reports are electronically filed with the Securities and Exchange Commission (the
SEC).
ITEM 2. Properties
Everest Res corporate offices are located in approximately 115,000 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Res corporate offices are located in approximately 3,600 total square feet of leased office space in Hamilton, Bermuda. The Companys other twelve locations occupy a total of approximately 76,400 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
ITEM 3. Legal Proceedings
The Company does not believe that there are any material pending legal proceedings to which it or any of its subsidiaries is a party or of which any of their properties are subject.
In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Companys rights and obligations under insurance, reinsurance and other contractual agreements. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation and arbitration.
In all such matters, the Company believes that its positions are legally and commercially reasonable. The Company also regularly evaluates those positions and, where appropriate, establishes or adjusts insurance reserves to reflect its evaluation. The Companys aggregate reserves take into account the possibility that the Company may not ultimately prevail in each and every disputed matter. The Company believes its aggregate reserves reduce the potential that an adverse resolution of one or more of these matters, at any point in time, would have a material impact on the Companys financial condition or results of operations. However, there
30
can be no assurance that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on the Companys results of operations.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
PART II
ITEM 5.
Market for Registrants
Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information
The common
shares of Group trade on the New York Stock Exchange under the symbol, RE.
Quarterly high and low market prices of the Companys common shares in 2004 and 2003
were as follows:
High | Low | |||||||
|
|
|||||||
First Quarter 2004: | $ 88 | .7400 | $ 82 | .5000 | ||||
Second Quarter 2004: | 89 | .8500 | 77 | .9200 | ||||
Third Quarter 2004: | 80 | .9600 | 69 | .9900 | ||||
Fourth Quarter 2004: | 90 | .1300 | 74 | .1100 | ||||
First Quarter 2003: |
$ 57 | .4200 | $ 48 | .1400 | ||||
Second Quarter 2003: | 78 | .0700 | 57 | .3500 | ||||
Third Quarter 2003: | 77 | .8700 | 71 | .7400 | ||||
Fourth Quarter 2003: | 84 | .6000 | 76 | .5100 |
Number of Holders of Common Shares
The number of record holders of common shares as of March 1, 2005 was 79. That number
excludes the beneficial owners of shares held in street name or held through
participants in depositories, such as The Depository Trust Company.
Dividend History and Restrictions
In 1995, the Board of Directors of the Company established a policy of declaring regular
quarterly cash dividends and has paid a regular quarterly dividend in each quarter since
the fourth quarter of 1995. The Company declared and paid its regular quarterly cash
dividend of $0.10 per share for each quarter of 2004 and $0.09 per share for each quarter
of 2003. A committee of the Companys Board of Directors declared a dividend of
$0.11 per share, payable on or before March 25, 2005 to shareholders of record on March
7, 2005.
The declaration and payment of future dividends, if any, by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Companys earnings, financial condition, business needs and growth objectives, capital and surplus requirements of its operating subsidiaries, regulatory restrictions, rating agency considerations and other factors. As an insurance holding company, the Company is partially dependent on dividends and other permitted payments from its subsidiaries to pay cash dividends to its stockholders. The payment of dividends to Group by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by Bermuda Re will be subject to
31
Bermuda insurance regulatory restrictions. See Regulatory Matters Dividends and Note 14A of Notes to Consolidated Financial Statements.
Recent Sales of Unregistered
Securities
None.
Changes in Securities, Use of
Proceeds and Issuer Purchases of Equity Securities
None.
32
ITEM 6. Selected Financial Data
The following selected consolidated GAAP financial data of the Company as of and for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 were derived from the consolidated financial statements of the Company, which were audited by PricewaterhouseCoopers LLP. The following financial data should be read in conjunction with the Consolidated Financial Statements and accompanying notes.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Unless otherwise indicated, all financial data in this document have been prepared using generally accepted accounting principles (GAAP) in the United States of America. As used in this document, Group means Everest Re Group, Ltd. (formerly Everest Reinsurance Group, Ltd.); Holdings means Everest Reinsurance Holdings, Inc.; Everest Re means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the Company means Everest Re Group, Ltd. and its subsidiaries, except when referring to periods prior to February 24, 2000, when it means Holdings and its subsidiaries.
The following is a discussion of the results of operations and financial condition of the Company. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto presented under ITEM 8, Financial Statements and Supplementary Data.
RESTRUCTURING
On February 24, 2000, a corporate
restructuring was completed and Group became the new parent holding company of Holdings,
which remains the holding company for Groups U.S. operations. Effective January 1,
2005 the principal executive offices of Group were relocated from Barbados to Bermuda.
INDUSTRY CONDITIONS
The worldwide reinsurance and
insurance businesses are highly competitive yet cyclical by product and market.
Competition with respect to the types of reinsurance and insurance business in which the
Company is engaged is based on many factors, including the perceived overall financial
strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best
and/or Standard & Poors, underwriting expertise, the jurisdictions where the
reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered,
premiums charged, other terms and conditions of the reinsurance and insurance business
offered, services offered, speed of claims payment and reputation and experience in lines
written. These factors operate at the individual market participant level to varying
degrees as applicable to the specific participants circumstances. They also operate
in aggregate across the reinsurance industry more generally contributing, in combination
with background, economic conditions and variations in the reinsurance buying practices of
insurance companies, by participant and in the aggregate, to cyclical movements in
reinsurance rates, terms and conditions and ultimately reinsurance industry aggregate
financial results.
The Company competes in the U.S., Bermuda and international reinsurance and insurance markets with numerous international and domestic reinsurance and insurance companies. The Companys competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyds. Some of these competitors have greater financial resources than the Company and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. In addition, the potential for securitization of reinsurance and insurance risks through capital markets provides an additional source of potential reinsurance and insurance capacity and competition.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased, in part due to the relative profitability achieved by many reinsurers over 2002 and 2003 and the attendant buildup of capital in these participants. However, this profitability and capital buildup varied significantly by market participant, reflecting the fact that the industry generally still remained exposed to fundamental issues that had negatively impacted its aggregate capacity in 2002 and 2003, including weak investment market conditions and adverse loss emergence. Both of these had tended to depress the industrys aggregate financial performance and perceptions of financial strength of
34
industry participants over this period albeit with significant variation by individual market participant. The industry experienced a record level of catastrophe losses during 2004, particularly in the second half of the year, and it remains unclear whether the aggregate catastrophe losses experienced by the industry will reverse, stop or even moderate the trends toward market softening, particularly as respects property classes.
Through 2003, reinsurance and insurance markets had generally continued to firm, reflecting the continuing, although diminishing, implications of losses arising from the terrorist attacks of September 11, 2001, and more broadly, the impact of aggregate company reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which became apparent through excessive loss emergence, varied widely by company depending on product offerings, markets accessed, underwriting and operating practices, competitive strategies and business volumes. Across all market participants, however, the aggregate general effect was depressed financial results and erosion of the industry capital base. Coupled with deteriorating investment market conditions and results, and renewed concerns regarding longer-term industry specific issues, including asbestos exposure and sub-par capital returns, these financial impacts introduced substantial, and in some cases extreme, pressure for the initiation and/or strengthening of corrective action by individual market participants. These pressures, aggregating across industry participants, reinforced the trend established in 2000 through 2003 toward firming prices, more restrictive terms and conditions, tightened coverage availability across most classes and markets and increasing concern with respect to the financial security of insurance and reinsurance providers, impacts which set the stage for the 2004 trends discussed above.
The Company has been somewhat disappointed by industry developments in 2004, which have generally operated to modestly weaken pricing. The Company can not predict with any reasonable certainty whether and to what extent these trends or conditions will persist and in particular whether the property catastrophe losses experienced by the industry in 2004 will lessen competitive pressures, particularly for the property classes of business. Notwithstanding these catastrophe losses, the continued growth of reinsurance capacity, particularly in Bermuda, changes in the Lloyds market, and the potential reemergence of a market share orientation among some industry participants, combined with improving and in some cases strong financial results, continue to contribute to uncertainty about the prospective level of competitive pressures.
35
FINANCIAL SUMMARY
The Companys management
monitors and evaluates overall Company performance based upon financial results. The
following table displays a summary of the consolidated net income for the periods
indicated:
Years Ended December 31, | |||||||||||
|
|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 4,704,135 | $ | 4,573,802 | $ | 2,846,501 | |||||
Net written premiums | 4,531,488 | 4,315,389 | 2,637,620 | ||||||||
REVENUES: |
|||||||||||
Premiums earned | $ | 4,425,082 | $ | 3,737,851 | $ | 2,273,677 | |||||
Net investment income | 495,908 | 402,610 | 350,668 | ||||||||
Net realized capital gains (losses) | 89,614 | (38,026 | ) | (50,043 | ) | ||||||
Net derivative (expense) income | (2,660 | ) | 5,851 | (14,509 | ) | ||||||
Other income (expense) | 741 | (1,033 | ) | (2,091 | ) | ||||||
|
|
|
|||||||||
Total revenues | 5,008,685 | 4,107,253 | 2,557,702 | ||||||||
|
|
|
|||||||||
CLAIMS AND EXPENSES: |
|||||||||||
Incurred losses and loss adjustment expenses | 3,291,139 | 2,600,196 | 1,629,382 | ||||||||
Commission, brokerage, taxes and fees | 975,176 | 863,933 | 551,787 | ||||||||
Other underwriting expenses | 107,120 | 94,623 | 69,916 | ||||||||
Interest expense | 75,539 | 57,288 | 44,573 | ||||||||
|
|
|
|||||||||
Total claims and expenses | 4,448,974 | 3,616,040 | 2,295,658 | ||||||||
|
|
|
|||||||||
INCOME BEFORE TAXES |
559,711 | 491,213 | 262,044 | ||||||||
Income tax expense | 64,853 | 65,185 | 30,741 | ||||||||
|
|
|
|||||||||
NET INCOME | $ | 494,858 | $ | 426,028 | $ | 231,303 | |||||
|
|
|
As indicated in the preceding Industry Conditions section, the reinsurance and insurance industry generally experienced favorable market conditions from 2001 through 2003. These favorable market conditions, coupled with the Companys financial strength, strategic positioning and market and underwriting expertise, enabled the Company to increase its volume of business significantly over this period. With the change in competitive trend throughout 2004 and with little clarity regarding the impact of property catastrophe losses on prospective market conditions, the Company continued to adapt its operations to slow its rate of growth and even decrease writings for some classes of business and reemphasize its focus on profitability as opposed to volume.
Gross written premiums were $4.7 billion for the year ended December 31, 2004, an increase of 2.8% as compared with $4.6 billion for the year ended December 31, 2003, which had increased 60.7% compared with the year ended December 31, 2002. Gross written premiums were $2.8 billion for the year ended December 31, 2002, an increase of 51.8% compared with the year ended December 31, 2001.
Due to the nature of its businesses, the Company is unable to precisely differentiate between the effects of price changes as compared to the effects of changes in exposure. Similarly, because individual reinsurance arrangements often reflect revised coverages, structuring, pricing, terms and/or conditions from period to period, the Company is unable to differentiate between the premium volumes attributable to new business as compared to renewal business. Management believes, however, that on balance, the Companys growth has been reasonably balanced between growth in exposures underwritten and increased pricing and/or improved terms and conditions. Management believes further that market conditions, although changing, remain generally more
36
favorable for casualty business classes than for property business classes; however, management notes that it continues to see business opportunities in most product classes and markets. Although premium volumes on a year to date basis have increased, the Company continues to decline business that does not meet its objectives regarding underwriting profitability, a discipline which became more apparent over the second half of 2004 with quarterly volumes for the third and fourth quarters which reflected year over year declines in gross premiums written.
In June 2004, the Company received notification of termination with respect to its contract with American All-Risk Insurance Services, LLC, its single largest producer of California workers compensation insurance. In 2004, American AllRisk Insurance Services, LLC accounted for approximately 7.8% of total gross written premiums. Under the terms of the contract, the agency continued to produce business exclusively for the Company through October 15, 2004. The business produced under this relationship will continue in force through the policy expiration dates or cancellation. The Company does not believe that the termination of this contract will have a material adverse effect on future Company operations and believes the termination was not entirely inconsistent with its plan to moderate its writings in this market.
Net written premiums, comprised of gross written premiums less ceded premiums, were $4.5 billion for the year ended December 31, 2004, an increase of 5.0% compared with $4.3 billion for the year ended December 31, 2003, which had increased 63.6% compared with the year ended December 31, 2002. Net written premiums for the year ended December 31, 2002 were $2.6 billion, an increase of 69.1% compared with the year ended December 31, 2001. The increases in net written premium are in line with the increases in gross written premium, as ceded written premium over the period was relatively stable at $172.6 million, $258.4 million and $208.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. Ceded premiums relate primarily to specific reinsurance purchased by the U.S. Insurance operation and, to a lesser extent, adjustment premiums in 2003 and 2002 on loss cessions made to the Companys corporate level aggregate reinsurance coverages.
Premiums earned were $4.4 billion for the year ended December 31, 2004, an increase of 18.4% compared with $3.7 billion for the year ended December 31, 2003, which had increased 64.4% compared with the year ended December 31, 2002. Premiums earned for the year ended December 31, 2002 were $2.3 billion, an increase of 54.9% compared with the year ended December 31, 2001. These increases reflect period to period changes in net written premiums and business mix together with normal variability in earning patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. Changes in estimates related to unreported reinsurance activity also contribute.
Incurred losses and LAE for the year ended December 31, 2004 were $3.3 billion, an increase of 26.6% compared with $2.6 billion for the year ended December 31, 2003, which had increased 59.6% compared with the year ended December 31, 2002. Incurred losses and LAE for the year ended December 31, 2002 were $1.6 billion, an increase of 34.7% compared with the year ended December 31, 2001. The major contributing factor for the increases in 2004 was the increase in incurred losses and LAE due to property catastrophe net event losses of $403 million, arising principally from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, Edmonton hailstorms and the Asian tsunami. Other factors, including the level of incurred losses and LAE related to changes in volume as measured by earned premium, changes in rates, and terms and the effect of changes in prior period loss reserve estimates, also contributed. The increase in incurred losses and LAE relating to net adverse prior period reserve strengthening of $312.0 million, $256.9 million and $140.1 million for years ended December 31, 2004, 2003 and 2002, respectively, principally related to the Companys asbestos exposures, treaty casualty and workers compensation, partially offset in 2004 by a $33.4 million reduction in
37
reserves related to the World Trade Center events. See ITEM 1, Business Changes in Historical Reserves for additional details and explanation.
Commission, brokerage and tax expense for the years ended December 31, 2004, 2003 and 2002 were $975.2 million, $863.9 million and $551.8 million, respectively, increasing principally as a result of premium volume changes, as these expenses generally vary in direct proportion to premiums earned. However, the percentage increase in expenses was somewhat less than the change in premiums, primarily reflecting the impact of changes in the Companys business mix.
Net investment income was $495.9 million for the year ended December 31, 2004, an increase of 23.2% compared with $402.6 million for the year ended December 31, 2003, which had increased 14.8% compared with the year ended December 31, 2002. Net investment income for the year ended December 31, 2002 was $350.7 million, an increase of 3.0% compared with the year ended December 31, 2001. The year ended December 31, 2004 included a $32.7 million increase arising from an atypical increase in the value of one of the Companys limited partnership investments. Excluding this increase, the net investment income increase generally reflected growth in the Companys cash and invested assets. Premiums are generally collected over the first 12 to 15 months of the Companys reinsurance and insurance contract, while related losses are typically paid out over numerous years. This tends to increase cash flow from operations when premiums are increasing. The Companys cash flow from operations was $1,487.6 million, $1,653.8 million and $742.7 million for the years ended December 31, 2004, 2003 and 2002, respectively. Cash flow from operations was impacted in particular by increased loss payments relating to catastrophe losses and asbestos claim settlements in 2004. Coupled with common stock offerings and the issuance of junior subordinated debt securities, this contributed to the growth in the Companys total investments and cash to $11,530.2 million.
Net realized capital gains of $89.6 million for the year ended December 31, 2004 were primarily the result of gains on the sale of the Companys interest only strips investment portfolio. Net realized capital losses of $38.0 million and $50.0 million for the years ended December 31, 2003 and 2002, respectively, were primarily the result of valuation adjustments on the interest only strip portfolio in accordance with Emerging Issues Task Force No. 99-20, Recognition of Interest Income and Impairment on Purchases and Beneficial Interests in Securitized Financial Assets (EITF 99-20) and write-downs in the value of securities deemed to be impaired on an other than temporary basis, partially offset by realized gains.
The Companys income tax expense is primarily a function of the statutory tax rates and corresponding net income in the jurisdictions where the Company operates, coupled with the impact from tax preferenced investment income. Variations between years generally reflect changes in the relative levels of pre-tax income between jurisdictions with different tax rates. Additionally, in conjunction with the transfer of the Companys UK Branch to Bermuda Re, there were various tax issues giving rise to incremental net tax expenses in 2004. The Company incurred income tax expenses of $64.9 million, $65.2 million and $30.7 million for the years ended December 31, 2004, 2003 and 2002, respectively. The slight decrease in tax expense primarily reflected the impact of the catastrophe losses on 2004 underwriting results, which were partially offset by additional taxable net investment income, taxable realized capital gains and the expense associated with the transfer of the UK branch.
Net income for the years ended December 31, 2004, 2003 and 2002 was $494.9 million, $426.0 million and $231.3 million, respectively, generally reflecting improving underwriting and investment results and realized capital gains in 2004, partially offset by realized capital losses in 2003 and 2002 and, particularly in 2004, catastrophe and asbestos losses, all moderated by the impact of income taxes.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S.
Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance
operation writes property and casualty
38
reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the U.S. The Specialty Underwriting operation writes A&H, marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through Everest Res branches in Canada and Singapore, in addition to foreign business written through Everest Res Miami and New Jersey offices. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and property and casualty reinsurance to the United Kingdom and European markets through its UK branch.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting gain (loss) or underwriting results. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses and are analyzed using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. The Company utilizes inter-affiliate reinsurance but such reinsurance generally does not impact segment results, as business is generally reported within the segment in which the business was first produced. For selected financial information regarding these segments, see Note 18 of Notes to Consolidated Financial Statements.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Due to the sale and in accordance with FAS 131, the Company restated the International and Bermuda segments for the years ended December 31, 2003 and 2002 to conform to December 31, 2004 segment reporting.
In 2003, Everest National, another subsidiary of the Company, opened a regional office in California to better serve its western U.S. insurance business. The business produced through this additional office is included in the U.S. Insurance operation.
The following tables present the relevant underwriting results for the operating segments for the three years ended December 31:
U.S. Reinsurance | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 1,478,159 | $ | 1,752,302 | $ | 894,555 | |||||
Net written premiums | 1,468,466 | 1,687,333 | 834,234 | ||||||||
Premiums earned |
$ | 1,473,545 | $ | 1,423,841 | $ | 726,352 | |||||
Incurred losses and loss adjustment expenses | 1,168,563 | 1,059,087 | 535,950 | ||||||||
Commission and brokerage | 373,581 | 350,641 | 182,558 | ||||||||
Other underwriting expenses | 23,390 | 21,670 | 18,876 | ||||||||
|
|
|
|||||||||
Underwriting loss | $ | (91,989 | ) | $ | (7,557 | ) | $ | (11,032 | ) | ||
|
|
|
39
U.S. Insurance | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 1,167,808 | $ | 1,069,527 | $ | 821,442 | |||||
Net written premiums | 1,019,716 | 923,147 | 705,313 | ||||||||
Premiums earned |
$ | 937,576 | $ | 823,601 | $ | 573,081 | |||||
Incurred losses and loss adjustment expenses | 658,777 | 605,602 | 432,917 | ||||||||
Commission and brokerage | 130,380 | 146,782 | 122,806 | ||||||||
Other underwriting expenses | 44,834 | 38,569 | 25,802 | ||||||||
|
|
|
|||||||||
Underwriting gain (loss) | $ | 103,585 | $ | 32,648 | $ | (8,444 | ) | ||||
|
|
|
Specialty Underwriting |
|||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 487,072 | $ | 502,888 | $ | 488,583 | |||||
Net written premiums | 470,571 | 498,013 | 486,979 | ||||||||
Premiums earned |
$ | 459,284 | $ | 468,932 | $ | 459,973 | |||||
Incurred losses and loss adjustment expenses | 302,010 | 295,397 | 313,352 | ||||||||
Commission and brokerage | 129,209 | 133,531 | 130,552 | ||||||||
Other underwriting expenses | 7,068 | 6,475 | 6,363 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 20,997 | $ | 33,529 | $ | 9,706 | |||||
|
|
|
International |
|||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 687,657 | $ | 520,800 | $ | 364,476 | |||||
Net written premiums | 684,390 | 518,919 | 351,004 | ||||||||
Premiums earned |
$ | 655,694 | $ | 461,607 | $ | 318,207 | |||||
Incurred losses and loss adjustment expenses | 419,101 | 267,707 | 184,490 | ||||||||
Commission and brokerage | 161,106 | 113,091 | 80,853 | ||||||||
Other underwriting expenses | 11,298 | 9,734 | 9,256 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 64,189 | $ | 71,075 | $ | 43,608 | |||||
|
|
|
40
Bermuda | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 883,439 | $ | 728,285 | $ | 277,445 | |||||
Net written premiums | 888,345 | 687,977 | 260,090 | ||||||||
Premiums earned |
$ | 898,983 | $ | 559,870 | $ | 196,064 | |||||
Incurred losses and loss adjustment expenses | 742,688 | 372,403 | 162,673 | ||||||||
Commission and brokerage | 180,900 | 119,888 | 35,018 | ||||||||
Other underwriting expenses | 13,998 | 12,222 | 6,433 | ||||||||
|
|
|
|||||||||
Underwriting (loss) gain | $ | (38,603 | ) | $ | 55,357 | $ | (8,060 | ) | |||
|
|
|
The following table reconciles the underwriting results for the operating segments to income before tax as reported in the consolidated statements of operations and comprehensive income for the years ended December 31:
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 58,179 | $ | 185,052 | $ | 25,778 | |||||
Net investment income | 495,908 | 402,610 | 350,668 | ||||||||
Realized gain (loss) | 89,614 | (38,026 | ) | (50,043 | ) | ||||||
Net derivative (expense) income | (2,660 | ) | 5,851 | (14,509 | ) | ||||||
Corporate expenses | (6,532 | ) | (5,953 | ) | (3,186 | ) | |||||
Interest expense | (75,539 | ) | (57,288 | ) | (44,573 | ) | |||||
Other income (expense) | 741 | (1,033 | ) | (2,091 | ) | ||||||
|
|
|
|||||||||
Income before taxes | $ | 559,711 | $ | 491,213 | $ | 262,044 | |||||
|
|
|
CONSOLIDATED RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004
COMPARED TO YEAR ENDED DECEMBER 31, 2003
Premiums.
Gross written premiums increased 2.8% to $4,704.1 million in 2004 from
$4,573.8 million in 2003, as the Company took advantage of selected growth
opportunities, while continuing to maintain a disciplined underwriting approach.
Premium growth areas included a 32.0% ($166.9 million) increase in the
International operations, primarily due to a $97.7 million increase in
international business written through the Miami and New Jersey offices,
representing primarily Latin American business, and a $67.2 million increase in
Asian business. The Bermuda operation grew 21.3% ($155.2 million) reflecting an
emphasis on traditional business classes in Bermuda and the UK. The U.S.
Insurance operation grew 9.2% ($98.3 million), principally as a result of a
$193.8 million increase in program business other than workers
compensation, partially offset by a $95.5 million decrease in workers
compensation business. The Specialty Underwriting operation decreased 3.1%
($15.8 million), resulting primarily from a $70.4 million decrease in A&H
business, partially offset by an increase in surety business of $29.6 million
and an increase in marine and aviation business of $25.0 million. The U.S.
Reinsurance operation decreased 15.6% ($274.1 million), principally relating to
an $142.5 million decrease in treaty casualty business, a $74.9 million decrease
in facultative business, a $32.6 million decrease in treaty property business
and a $19.8 million decrease in treaty non-property business.
Ceded premiums decreased to $172.6 million in 2004 from $258.4 million in 2003, principally resulting from the inclusion in 2003 of $49.6 million in adjustment premiums relating to claims made under the 2000 accident year aggregate excess of loss element of the Companys corporate retrocessional programs, compared with no such adjustment premiums in 2004. Aside from the corporate retrocessional programs, ceded premiums
41
generally relate to specific reinsurance purchased by the U.S. Insurance operation and fluctuate based upon the level of premiums written in the applicable programs.
Net written premiums increased by 5.0% to $4,531.5 million in 2004 from $4,315.4 million in 2003, reflecting the increase in gross written premiums, combined with the decrease in ceded premiums.
Premium Revenues. Net premiums earned increased by 18.4% to $4,425.1 million in 2004 from $3,737.9 million in 2003. Contributing to this increase was a 60.6% ($339.1 million) increase in the Bermuda operation, a 42.0% ($194.1 million) increase in the International operation, a 13.8% ($114.0 million) increase in the U.S. Insurance operation and a 3.5% ($49.7 million) increase in the U.S. Reinsurance operation, partially offset by a 2.1% ($9.6 million) decrease in the Specialty Underwriting operation. All of these changes reflect period to period changes in net written premiums and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting, earnings, loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items. Changes in estimates related to unreported reinsurance activity also contribute.
Expenses. Incurred loss and LAE increased by 26.6% to $3,291.1 million in 2004 from $2,600.2 million in 2003. The increase in incurred losses and LAE was principally attributable to the provision for estimated catastrophe losses from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, the Asian tsunami and reserve adjustments for prior period losses, together with the mitigating effects of the increase in net premiums earned and the impact of favorable changes in the Companys underlying business mix and aggregate rates, terms and conditions.
The Companys loss and LAE reserves reflect estimates of ultimate claim liability. Such estimates are reevaluated on an ongoing basis, including re-estimates of prior period reserves, taking into consideration all available information and, in particular, newly reported loss and claim experience. The effect of such reevaluations impacts incurred losses for the current period. The Company notes that its analytical methods and processes operate at multiple levels, including individual contracts, groupings of like contracts, classes and lines of business, internal business units, segments, legal entities, and in the aggregate. The complexities of the Companys business and operations require analyses and adjustments, both qualitative and quantitative, at these various levels. Additionally, the attribution of reserves, changes in reserves and incurred losses between accident year and underwriting year requires adjustments and allocations, both qualitative and quantitative, at these various levels. All of these processes, methods and practices appropriately balance actuarial science, business expertise and management judgment in a manner intended to assure the accuracy, precision and consistency of the Companys reserving practices, which are fundamental to the Companys operation. The Company notes, however, that the underlying reserves remain estimates, which are subject to variation, and that the relative degree of variability is generally least when reserves are considered in the aggregate and generally increases as the focus shifts to more granular data levels.
Incurred losses and LAE in 2004 reflected ceded losses and LAE of $141.0 million compared to ceded losses and LAE in 2003 of $278.4 million. The decrease in ceded losses is primarily the result of the absence in 2004 of cessions under the corporate level aggregate reinsurance covers. The ceded losses and LAE in 2003 included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program and $81.1 million under the LM/Mt. McKinley reinsurance agreement.
42
Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and adverse development on prior period events and are net of reinsurance. Individual catastrophe losses are reported net of specific reinsurance, but before recoveries under corporate level reinsurance and potential IBNR reserve offsets. The Company defines a catastrophe as a property event with expected reported losses of at least $5.0 million before corporate level reinsurance and taxes. Catastrophe losses, net of contract specific cessions, were $403.0 million in 2004, relating principally to aggregate estimated losses of $428.8 million from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, Edmonton hailstorms and the Asian tsunami, which were partially offset by $33.4 million of reserve reductions related to the World Trade Center events. Catastrophe losses, net of contract specific cessions, were $36.8 million in 2003, relating principally to the May 2003 tornado and hailstorm events and hurricanes Fabian and Isabel.
(Dollars in millions) Segment Net Catastrophe Losses | |||||||||
|
|
|
|||||||
Segment | 2004 | 2003 | |||||||
|
|
|
|||||||
U.S. Reinsurance | $ | 250 | .7 | $ | 23 | .9 | |||
U.S. Insurance | 1 | .0 | 1 | .4 | |||||
Specialty Underwriting | 18 | .4 | 3 | .2 | |||||
International | 88 | .0 | 1 | .1 | |||||
Bermuda | 44 | .9 | 7 | .2 | |||||
|
|
|
|||||||
Total | $ | 403 | .0 | $ | 36 | .8 | |||
|
|
|
Net adverse prior period reserve adjustments for the year ended December 31, 2004 were $312.0 million compared to $256.9 million in 2003. For the year ended December 31, 2004, the adverse reserve adjustments included net adverse A&E adjustments of $159.4 million and net adverse non-A&E adjustments of approximately $186.0 million relating primarily to casualty reinsurance, partially offset by favorable development of $33.4 million relating to the reduction of reserves for the World Trade Center events. For the year ended December 31, 2003, net adverse prior period reserve adjustments for A&E exposures were $50.2 million and net adverse non-A&E adjustments were $206.7 million, which were net of a cession of $85 million under the 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program. It is important to note that adverse non-A&E accident year reserve development arises from the reevaluation of accident year results and that such reevaluations also impact premiums and commissions attributed by accident year, generally mitigating, in part, the impact of loss development and that such impacts are recorded as part of the overall reserve evaluation.
The U.S. Reinsurance segment accounted for $77.7 million of net adverse prior period reserve adjustments for the year ended December 31, 2004, which included $34.2 million of favorable development due to the reserve reduction related to the catastrophe losses from the World Trade Center events, as compared to net adverse prior period reserve adjustments of $150.9 million for the year ended December 31, 2003. Asbestos exposures accounted for $10.3 million and $16.8 million of adverse reserve adjustments for the years ended December 31, 2004 and 2003, respectively, with the remainder principally attributable to professional liability and casualty business classes. During the late 1990s and early 2000s, there had been a proliferation of claims relating to bankruptcies and other financial management improprieties. This increased number of claims, combined with larger claims, has significantly increased incurred losses on the professional liability policies. In the general casualty area, the Company continues to experience losses greater than historical trends for accident years 1998 through 2001. These losses are being driven by adverse trends in litigation and economic variability. In both the professional liability and general casualty reinsurance areas, the Company relies upon loss reports from ceding companies. Although the Company may record reserves at higher levels than those reported by ceding companies, actual reported results have exceeded the initial loss indications.
The U.S. Insurance segment reflected $43.3 million and $58.7 million of net adverse prior period reserve adjustments for the years ended December 31, 2004 and 2003, respectively. The adverse prior period reserve adjustments were principally due to accident years 2000 through 2002, where the Company strengthened its
43
reserves for California workers compensation insurance. This was a relatively new book of business and was written in a challenging political and economic environment. While management believes the cumulative results through 2004 remain quite positive, there has been some deterioration in claim frequency and severity related to accident years 2001 and 2002.
The Specialty Underwriting segment had $5.1 million of net adverse prior period reserve adjustments for the year ended December 31, 2004, principally related to net adverse prior period reserve adjustments in the surety and A&H business lines partially offset by favorable development from marine and aviation. The net favorable prior period reserve adjustments for the year ended December 31, 2003 were $23.9 million, primarily related to A&H business.
The International segment had $4.4 million of favorable net prior period reserve adjustments for the year ended December 31, 2004 and net adverse prior period reserve adjustments of $15.8 million for the year ended December 31, 2003. The favorable development in 2004 related primarily to 2003 Canadian property catastrophe, international and Asia business. The prior period reserve development for 2003 related primarily to general casualty business written in the U.S. and Canada on both a quota share and excess basis for accident years 1996 through 2002.
The Bermuda segment reflected $190.3 million of net adverse prior period reserve adjustments for the year ended December 31, 2004 and $55.4 million of net adverse prior reserve adjustments for the year ended December 31, 2003. The development in the year ended December 31, 2004 was primarily the result of $149.1 million of A&E reserve development. For the year ended December 31, 2003, reserve adjustments included $33.5 million related to A&E exposures. All of the development related to asbestos exposures that were assumed through the September 19, 2000 loss portfolio transfer from Mt. McKinley in 2000.
Aggregate reserve development related to A&E exposures was $159.4 million and $50.2 million for the years ended December 31, 2004 and 2003, respectively. The Company has A&E exposure related to contracts written by the Company prior to 1986 and to claim obligations acquired as part of the Mt. McKinley acquisition in September 2000. The reserve strengthening on business written by the Company, net of reinsurance, was $10.3 million and the net strengthening on the acquired business was $149.1 million in 2004. Substantially all of the Companys A&E exposures relate to insurance and reinsurance contracts with coverage periods prior to 1986. Given the uncertainties surrounding the settlement of A&E losses, management is unable to establish a meaningful range for these obligations.
(Dollars in millions) Segment Net Prior Period Reserve Adjustments | ||||||||||||
|
|
|
|
|||||||||
Segment | 2004 | 2003 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | $ | 77 | .7 | $ | 150 | .9 | ||||||
U.S. Insurance | 43 | .3 | 58 | .7 | ||||||||
Specialty Underwriting | 5 | .1 | (23 | .9 | ) | |||||||
International | (4 | .4 | ) | 15 | .8 | |||||||
Bermuda | 190 | .3 | 55 | .4 | ||||||||
|
|
|
|
|||||||||
Total | $ | 312 | .0 | $ | 256 | .9 | ||||||
|
|
|
|
In all cases, the prior period development, sometimes referred to as reserve strengthening, reflects managements judgment as to the implications of losses and claim information reported during the period on the Companys reserve balances.
The segment components of the increase in incurred losses and LAE in 2004 from 2003 were a 99.4% ($370.3 million) increase in the Bermuda operation, a 56.6% ($151.4 million) increase in the International operation, a 10.3% ($109.5 million) increase in the U.S Reinsurance operation, an 8.8% ($53.2 million) increase in the U.S.
44
Insurance operation and a 2.2% ($6.6 million) increase in the Specialty Underwriting operation. These changes reflect variability in premiums earned and changes in the loss expectation assumptions for business written, as well as the net prior period reserve development and catastrophe losses discussed above. Incurred losses and LAE for each operation were also impacted by generally improved pricing of the underlying business, as well as variability relating to changes in the mix of business by class and type, which in general reflected a more favorable mix.
The Companys loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, increased by 4.8 percentage points to 74.4% in 2004 from 69.6% in 2003, reflecting the impact of the changes in premiums earned and incurred losses and LAE discussed above, as well as favorable changes in the underlying business mix and aggregate rates, terms and conditions.
The following table shows the loss ratios for each of the Companys operating segments for 2004 and 2003. The loss ratios for all operations were impacted by the factors noted above.
Segment Loss Ratios | ||||||||||||
|
|
|
|
|||||||||
Segment | 2004 | 2003 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 79 | .3% | 74 | .4% | ||||||||
U.S. Insurance | 70 | .3% | 73 | .5% | ||||||||
Specialty Underwriting | 65 | .8% | 63 | .0% | ||||||||
International | 63 | .9% | 58 | .0% | ||||||||
Bermuda | 82 | .6% | 66 | .5% |
Segment underwriting expenses increased by 12.9% to $1,075.8 million in 2004 from $952.6 million in 2003. Commission, brokerage, taxes and fees increased by $111.2 million, principally reflecting increases in premium volume and changes in the mix of business. Segment other underwriting expenses increased by $11.9 million as the Company continues to expand operations to support its increased business volume. Contributing to the segment underwriting expense increases were a 47.5% ($62.8 million) increase in the Bermuda operation, a 40.4% ($49.6 million) increase in the International operation and a 6.6% ($24.7 million) increase in the U.S. Reinsurance operation, which were all partially offset by a 5.5% ($10.1 million) decrease in the U.S. Insurance operation and a 2.7% ($3.7 million) decrease in the Specialty Underwriting operation. The changes for each operations expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, changes in the use of specific reinsurance, as well as the underwriting performance of the underlying business. The Companys expense ratio, which is calculated by dividing underwriting expenses by net premiums earned, was 24.4% in 2004 compared to 25.6% in 2003.
Segment Expense Ratios | ||||||||||||
|
|
|
|
|||||||||
Segment | 2004 | 2003 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 26 | .9% | 26 | .1% | ||||||||
U.S. Insurance | 18 | .7% | 22 | .5% | ||||||||
Specialty Underwriting | 29 | .6% | 29 | .9% | ||||||||
International | 26 | .3% | 26 | .6% | ||||||||
Bermuda | 21 | .7% | 23 | .6% |
The Companys combined ratio, which is the sum of the loss and expense ratios, increased by 3.6 percentage points to 98.8% in 2004 compared to 95.2% in 2003.
45
The following table shows the combined ratios for each of the Companys operating segments in 2004 and 2003. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above.
Segment Combined Ratios | ||||||||||||
|
|
|
|
|||||||||
Segment | 2004 | 2003 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 106 | .2% | 100 | .5% | ||||||||
U.S. Insurance | 89 | .0% | 96 | .0% | ||||||||
Specialty Underwriting | 95 | .4% | 92 | .9% | ||||||||
International | 90 | .2% | 84 | .6% | ||||||||
Bermuda | 104 | .3% | 90 | .1% |
Investments. Net investment income increased 23.2% to $495.9 million in 2004 from $402.6 million in 2003, principally reflecting the effects of investing $1,487.6 million of cash flow from operations for the twelve months ended December 31, 2004, as well as $320.0 of net proceeds from the issuance of junior subordinated debt securities in March 2004 and $250.0 of net proceeds from the issuance of senior notes in October 2004. The increase also reflected $32.7 million representing an atypical increase in the carrying value of a limited partnership investment.
The following table shows a comparison of various investment yields for the periods indicated:
2004 | 2003 | |||||||||||
|
|
|
|
|||||||||
Imbedded pre-tax yield of cash and invested assets at December 31, 2004 and 2003 | 4 | .7% | 4 | .8% | ||||||||
Imbedded after-tax yield of cash and invested assets at December 31, 2004 and 2003 | 4 | .1% | 4 | .1% | ||||||||
Annualized pre-tax yield on average cash and invested assets for the twelve months
ended December 31, 2004 and 2003 |
5 | .0% | 5 | .1% | ||||||||
Annualized after-tax yield on average cash and invested assets for the twelve months
ended December 31, 2004 and 2003 |
4 | .2% | 4 | .4% |
The Company, because of its historical income orientation, has generally considered total return, the combination of income yield and capital appreciation/depreciation, to be relatively less important as a measure of performance than its overall income yield. With changes the Company perceives in overall investment market conditions, and more specifically the acquisition of $496.5 million of equity securities into the overall investment portfolio in 2004, the Company is reweighting its view of total return. The following table provides a comparison of the Companys total return by asset class to broadly accepted industry benchmarks for 2004 and 2003.
2004 | 2003 | |||||||||||
|
|
|
|
|||||||||
Fixed income portfolio total return | 6 | .5% | 6 | .2% | ||||||||
Lehman bond aggregate | 4 | .3% | 4 | .1% | ||||||||
Common equity portfolio total return | 21 | .9% | 17 | .0% | ||||||||
S&P 500 | 10 | .9% | 28 | .7% |
Net realized capital gains were $89.6 million in 2004, which reflected realized capital gains on the Companys investments of $164.3 million, including $118.2 million on the sale of interest only strip investments, partially offset by $74.7 million of realized capital losses, which included $65.0 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance with EITF 99-20, prior to liquidation of the interest only strip portfolio during the second quarter of 2004. Net realized capital losses of $38.0 million in 2003 reflected realized capital losses on the Companys investments of $88.7 million, which included $25.7 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis and $46.2 million related to the impairment on interest only strips,
46
partially offset by $50.7 million of realized capital gains, which included $16.8 million of realized capital gains on sales of the interest only strips.
The Company has one credit default swap, which it no longer writes, and five specialized equity put options in its product portfolio. These products meet the definition of a derivative under Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). Net derivative expense from these derivative transactions in 2004 was $2.7 million and net derivative income from these derivative transactions in 2003 was $5.9 million, with both periods principally reflecting changes in fair value for the specialized equity put options. See also Note 2 of Notes to the Consolidated Financial Statements.
Other income in 2004 was $0.7 million compared to other expense of $1.0 million in 2003. The decrease in net expense for 2004 was primarily due to variability in the impact of foreign exchange, partially offset by other miscellaneous expenses.
Corporate underwriting expenses not allocated to segments increased to $6.5 million for 2004 compared with $6.0 million for 2003 as the Company expanded its infrastructure to support increased business volume.
Interest expense in 2004 was $75.5 million compared to $57.3 million in 2003. Interest expense in 2004 included $42.0 million relating to the senior notes, $32.4 million relating to the junior subordinated debt securities and $1.2 million relating to borrowings under the Companys revolving credit facility. Interest expense in 2003 reflected $38.9 million relating to the issuance of the senior notes, $17.0 million relating to the junior subordinated debt securities and $1.4 million relating to borrowings under the Companys revolving credit facility. The increase in interest expense was due to the additional issuance of $320 million of junior subordinated debt securities in March 2004 and the issuance of $250 million of senior notes in October 2004.
Income Taxes. The Companys income tax expense is primarily a function of the statutory tax rates and corresponding net income in the jurisdictions where the Company operates, coupled with the impact from tax preferenced investment income. Variations between years generally reflect changes in the relative levels of pre-tax income between jurisdictions with different tax rates. Additionally, in conjunction with the transfer of the Companys UK Branch to Bermuda Re, there were various tax issues giving rise to net tax expenses. The Company recognized income tax expense of $64.9 million in 2004 compared to $65.2 million in 2003 .
Net Income. Net income was $494.9 million in 2004 compared to net income of $426.0 million in 2003, reflecting improved investment income and realized capital gains, partially offset by reduced underwriting profitability due to catastrophe losses.
YEAR ENDED DECEMBER 31, 2003
COMPARED TO YEAR ENDED DECEMBER 31, 2002
Premiums.
Gross
written premiums increased 60.7% to $4,573.8 million in 2003 from $2,846.5
million in 2002, as the Company took advantage of the general firming of rates,
terms and conditions and selected growth opportunities, while continuing to
maintain a disciplined underwriting approach. Premium growth areas included a
95.9% ($857.7 million) increase in the U.S. Reinsurance operation, principally
related to a $519.4 million increase in treaty casualty business, a $253.9
million increase in treaty property business and a $62.8 million increase in
facultative business. The International operation increased 42.9% ($156.3
million), primarily due to a $79.6 million increase in international business
written through the Miami and New Jersey offices representing primarily Latin
American business and a $67.4 million increase to Canadian business. The U.S.
Insurance operation grew 30.2% ($248.1 million), principally as a result of an
$89.5 million increase in workers compensation and a $73.2 million
increase in excess and surplus lines insurance. The Bermuda operation increased
$450.8 million, reflecting a $256.9 million increase in premiums from the UK
branch, and a shift toward more traditional business resulting from the rollout
of treaty, facultative and individual risk capabilities in Bermuda. The
Specialty Underwriting operation increased 2.9% ($14.3 million), resulting
primarily from a $38.0 million increase in A&H business and a $19.0 million
decrease in marine and aviation.
47
Ceded premiums increased to $258.4 million in 2003 from $208.9 million in 2002, principally reflecting growth in specific reinsurance of the Companys primary insurance business, which increased from $116.1 million to $146.4 million. In addition, ceded premiums for 2003 included $49.6 million in adjustment premiums relating to claims made under the 2000 accident year aggregate excess of loss element of the Companys corporate retrocessional programs, while ceded premiums for 2002 included $5.1 million and $49.4 million in adjustment premium relating to claims made under the 2001 and 2000 accident year aggregate excess of loss elements of the Companys corporate retrocessional programs, respectively.
Net written premiums increased by 63.6% to $4,315.4 million in 2003 from $2,637.6 million in 2002, reflecting the increase in gross written premiums, combined with the growth in ceded premiums.
Premium Revenues. Net premiums earned increased by 64.4% to $3,737.9 million in 2003 from $2,273.7 million in 2002. Contributing to this increase was a 96.0% ($697.5 million) increase in the U.S. Reinsurance operation, a 45.1% ($143.4 million) increase in the International operation, a 43.7% ($250.5 million) increase in the U.S. Insurance operation, a $363.8 million increase in the Bermuda operation and a 1.9% ($9.0 million) increase in the Specialty Underwriting operation. All of these changes reflect period to period changes in net written premiums and business mix together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting and earnings and loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items.
Expenses. Incurred loss and LAE increased by 59.6% to $2,600.2 million in 2003 from $1,629.4 million in 2002. The increase in incurred losses and LAE was principally attributable to the increase in net premiums earned, the impact of changes in the Companys mix of business and reserve adjustments for prior period losses.
Incurred losses and LAE in 2003 reflected ceded losses and LAE of $278.4 million compared to ceded losses and LAE in 2002 of $287.7 million. The ceded losses and LAE in 2003 included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program and $81.1 million under the LM/Mt. McKinley reinsurance agreement. The ceded losses and LAE in 2002 included $11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program, respectively, and $56.7 million under the LM/Mt. McKinley reinsurance agreement.
48
Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and adverse development on prior period events, and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million before corporate level reinsurance and taxes. Catastrophe losses, net of contract specific cessions, were $36.8 million in 2003, relating principally to the May 2003 tornado and hailstorm events and hurricanes Fabian and Isabel, compared to $30.2 million in 2002.
(Dollars in millions) Segment Net Catastrophe Losses | |||||||||
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Segment | 2003 | 2002 | |||||||
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U.S. Reinsurance | $ | 23 | .9 | $ | 5 | .4 | |||
U.S. Insurance | 1 | .4 | - | ||||||
Specialty Underwriting | 3 | .2 | 1 | .1 | |||||
International | 1 | .1 | 18 | .2 | |||||
Bermuda | 7 | .2 | 5 | .5 | |||||
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Total | $ | 36 | .8 | $ | 30 | .2 | |||
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Net adverse prior period reserve adjustments for the year ended December 31, 2003 were $256.9 million, which were net of a cession of $85 million under the 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program. For the year ended December 31, 2002, net adverse prior period reserve adjustments were $140.1 million, which were net of cessions of $11 million and $90 million under the 2001 and 2000 accident year aggregate excess of loss component of the Companys corporate retrocessional program, respectively.
The U.S. Reinsurance segment accounted for $134.2 million and $96.7 million of the non-A&E net prior period reserve adjustments for the years ended December 31, 2003 and 2002, respectively. The two principal underwriting areas responsible for these deficiencies are professional liability and general casualty. During the late 1990s and early 2000s, there had been a proliferation of claims relating to bankruptcies and other financial management improprieties. This increased number of claims combined with larger claims has significantly increased incurred losses on the professional liability policies. In the general casualty area, the Company continues to experience losses greater than historical trends for accident years 1998 through 2003. These losses are being driven by adverse trends in litigation and economic variability. In both the professional liability and general casualty reinsurance areas, the Company relies upon loss reports from ceding companies. Although the Company generally records reserves at higher levels than those reported by ceding companies, actual reported results have exceeded the initial loss indications. The reserve adjustments in these areas were partially offset by favorable reserve development relating to property reinsurance for the 2002 accident year.
The U.S. Insurance segment reflected $58.7 million and $14.0 million of net prior period reserve adjustments for years ended December 31, 2003 and 2002, respectively, principally due to California workers compensation insurance. This was a relatively new book of business and was written in a challenging political and economic environment. While management believes the cumulative results through 2003 remain positive, there has been some deterioration in claim frequency and severity related to accident years 2001 and 2002.
The Specialty Underwriting segment had favorable net prior period reserve adjustments of $23.9 million and $0.4 million for the years ended December 31, 2003 and 2002, respectively. The favorable adjustments for 2003, related primarily to A&H business and cessions under the corporate retrocessional program and related principally to the 2000 through 2002 accident years.
49
The International segment had an unfavorable net prior period reserve adjustment of $15.8 million and a favorable net prior period reserve adjustment of $6.2 million for the years ended December 31, 2003 and 2002, respectively. These reserve adjustments relate primarily to general casualty business written in the U.S. and Canada on both a quota share and excess basis for accident years 1996 through 2002, with the larger development on the 1998 through 2000 years.
The Bermuda segment reflected $21.9 million of unfavorable non-A&E net prior period reserve adjustments for the year ended December 31, 2003 and $11.7 million of development for the year ended December 31, 2002.
Reserve development related to A&E exposures were $50.2 million and $23.5 million for the years ended December 31, 2003 and 2002, respectively. The Company has A&E exposure related to contracts written by the Company prior to 1986 and to claim obligations acquired as part of the Mt. McKinley acquisition in September 2000. The reserve strengthening on business written by the Company, net of reinsurance, was $16.7 million in the U.S. Reinsurance segment and the net strengthening on the acquired business was $33.5 million in the Bermuda segment in 2004. Substantially all of the Companys A&E exposures relate to insurance and reinsurance contracts with coverage periods prior to 1986.
(Dollars in millions) Segment Net Prior Period Reserve Adjustments | ||||||||||||
|
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|
|||||||||
Segment | 2003 | 2002 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | $ | 150 | .9 | $ | 102 | .9 | ||||||
U.S. Insurance | 58 | .7 | 14 | .0 | ||||||||
Specialty Underwriting | (23 | .9 | ) | (0 | .4) | |||||||
International | 15 | .8 | (6 | .2) | ||||||||
Bermuda | 55 | .4 | 29 | .8 | ||||||||
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Total | $ | 256 | .9 | $ | 140 | .1 | ||||||
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In all cases, the prior period development reflects managements judgment as to the implications of losses and claim information reported during the period on the Companys reserve balances.
The segment components of the increase in incurred losses and LAE in 2003 from 2002 were a 97.6% ($523.1 million) increase in the U.S. Reinsurance operation, an 45.1% ($83.2 million) increase in the International operation, a 39.9% ($172.7 million) increase in the U.S Insurance operation and a $209.7 million increase in the Bermuda operation, partially offset by a 5.7% ($18.0 million) decrease in the Specialty Underwriting operation. These changes generally reflect increases in premiums earned, changes in the current year loss expectation assumptions for business written, generally reflecting continued improvement in market conditions and pricing, an increase in catastrophe losses and the net prior period reserve development discussed above. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and the mix of business by class and type.
The Companys loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, decreased by 2.1 percentage points to 69.6% in 2003 from 71.7% in 2002, reflecting the premiums earned and incurred losses and LAE discussed above, as well as the general firming of rates, terms and conditions and changes in business mix.
50
The following table shows the loss ratios for each of the Companys operating segments for 2003 and 2002. The loss ratios for all operations were impacted by the expense factors noted above.
Segment Loss Ratios | ||||||||||||
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|
|
|||||||||
Segment | 2003 | 2002 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 74 | .4% | 73 | .8% | ||||||||
U.S. Insurance | 73 | .5% | 75 | .5% | ||||||||
Specialty Underwriting | 63 | .0% | 68 | .1% | ||||||||
International | 58 | .0% | 58 | .0% | ||||||||
Bermuda | 66 | .5% | 83 | .0% |
Segment underwriting expenses increased by 54.0% to $952.6 million in 2003 from $618.5 million in 2002. Commission, brokerage, taxes and fees increased by $312.2 million, principally reflecting increases in premium volume and changes in the mix of business, together with the Companys emphasis on acquisition cost control. Segment other underwriting expenses increased by $21.9 million as the Company expanded operations to support its increased business volume. Contributing to these underwriting expense increases were an 84.8% ($170.9 million) increase in the U.S. Reinsurance operation, a 36.3% ($32.7 million) increase in the International operation, a 24.7% ($36.7 million) increase in the U.S. Insurance operation, a $90.7 million increase in the Bermuda operation and a 2.3% ($3.1 million) increase in the Specialty Underwriting operation. The changes for each operations expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, changes in the use of specific reinsurance as well as the underwriting performance of the underlying business. The Companys expense ratio, which is calculated by dividing underwriting expenses by net premiums earned, was 25.6% in 2003 compared to 27.3% in 2002.
Segment Expense Ratios | ||||||||||||
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Segment | 2003 | 2002 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 26 | .1% | 27 | .7% | ||||||||
U.S. Insurance | 22 | .5% | 25 | .9% | ||||||||
Specialty Underwriting | 29 | .9% | 29 | .8% | ||||||||
International | 26 | .6% | 28 | .3% | ||||||||
Bermuda | 23 | .6% | 21 | .1% |
The Companys combined ratio, which is the sum of the loss and expense ratios, decreased by 3.8 percentage points to 95.2% in 2003 compared to 99.0% in 2002.
The following table shows the combined ratios for each of the Companys operating segments in 2003 and 2002. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above.
Segment Combined Ratios | ||||||||||||
|
|
|
|
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Segment | 2003 | 2002 | ||||||||||
|
|
|
|
|||||||||
U.S. Reinsurance | 100 | .5% | 101 | .5% | ||||||||
U.S. Insurance | 96 | .0% | 101 | .5% | ||||||||
Specialty Underwriting | 92 | .9% | 97 | .9% | ||||||||
International | 84 | .6% | 86 | .3% | ||||||||
Bermuda | 90 | .1% | 104 | .1% |
Investments. Net investment income increased 14.8% to $402.6 million in 2003 from $350.7 million in 2002, principally reflecting the effects of investing $1,653.8 million of cash flow from operations for the twelve months ended December 31, 2003, $209.9 million of net proceeds from Holdings issuance of junior
51
subordinated debt securities in November 2002 and $316.8 million of net proceeds from the issuance of Groups common shares in April 2003, all partially offset by the effects of the lower interest rate environment.
The following table shows a comparison of various investment yields for the periods indicated:
2003 | 2002 | |||||||||||
|
|
|
|
|||||||||
Imbedded pre-tax yield of cash and invested assets at December 31, 2003 and 2002 | 4 | .8% | 5 | .3% | ||||||||
Imbedded after-tax yield of cash and invested assets at December 31, 2003 and 2002 | 4 | .1% | 4 | .6% | ||||||||
Annualized pre-tax yield on average cash and invested assets for the twelve months
ended December 31, 2003 and 2002 |
5 | .1% | 5 | .6% | ||||||||
Annualized after-tax yield on average cash and invested assets for the twelve months
ended December 31, 2003 and 2002 |
4 | .4% | 4 | .6% |
The Company, because of its income orientation, considers total return, the combination of income yield and capital appreciation/depreciation, to be less relevant as a measure of performance than may be the case for investment portfolios managed with alternate strategies. The following table provides a comparison of the Companys total return by asset class to broadly accepted industry benchmarks for 2003 and 2002.
2003 | 2002 | |||||||||||
|
|
|
|
|||||||||
Fixed income portfolio total return | 6 | .2% | 8 | .7% | ||||||||
Lehman bond aggregate | 4 | .1% | 10 | .3% | ||||||||
Common equity portfolio total return | 17 | .0% | (14 | .4)% | ||||||||
S&P 500 | 28 | .7% | (22 | .1)% |
Net realized capital losses were $38.0 million in 2003, reflecting realized capital losses on the Companys investments of $88.7 million, which included $25.7 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, and $46.2 million related to the impairment on interest only strips in accordance with EITF 99-20, partially offset by $50.7 million of realized capital gains, which included $16.8 million of realized capital gains on sales of the interest only strips, compared to net realized capital losses of $50.0 million in 2002. The net realized capital losses in 2002 reflected realized capital losses on the Companys investments of $142.8 million, which included $101.3 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, of which $33.0 million was for WorldCom, Inc., partially offset by $92.8 million of realized capital gains. The company owned no interest only strips during 2002.
The Company has a small number of credit default swaps, which it no longer writes, and specialized equity put options in its product portfolio. These products meet the definition of a derivative under FAS 133. Net derivative income from these derivative transactions in 2003, was $5.9 million, which principally reflects changes in fair value of the specialized equity put options, compared to net derivative expenses of $14.5 million in 2002, which principally related to the specialized equity put options. See also Note 2 of Notes to the Consolidated Financial Statements.
Other expense in 2003 was $1.0 million compared to $2.1 million in 2002. The decrease in net expenses for 2003 was due to foreign exchange gains, partially offset by other miscellaneous expenses.
Corporate underwriting expenses not allocated to segments increased to $6.0 million for 2003 compared with $3.2 million for 2002 as the Company expanded its infrastructure to support increased business volume.
Interest expense in 2003 was $57.3 million compared to $44.6 million in 2002. Interest expense in 2003 reflected $38.9 million relating to the senior notes, $17.0 million relating to the junior subordinated debt securities and $1.4 million relating to borrowings under the Companys revolving credit facility. Interest
52
expense in 2002 reflected $38.9 million relating to the issuance of the senior notes, $2.2 million relating to the junior subordinated debt securities and $3.5 million relating to borrowings under the Companys revolving credit facility.
Income Taxes. The Company recognized income tax expense of $65.2 million in 2003 compared to $30.7 million in 2002 . The increase in taxes generally reflects the improved underwriting and investment income results.
Net Income. Net income was $426.0 million in 2003 compared to net income of $231.3 million in 2002, reflecting improved underwriting and investment income results partly offset by increased income taxes.
CRITICAL ACCOUNTING POLICIES
The following is a summary of the
critical accounting policies related to accounting estimates that (1) require management
to make assumptions about highly uncertain matters and (2) could materially impact the
consolidated financial statements if management made different assumptions.
LOSS AND LAE RESERVES. The Companys most critical accounting policy is the determination of its loss and LAE reserves. The Company maintains reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims relating to both its insurance and reinsurance businesses. Because reserves are estimates of ultimate losses and LAE, management, using a variety of statistical and actuarial techniques, monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves as necessary. Management considers many factors when setting reserves, including: (1) the Companys exposure base, generally its premiums earned; (2) its expected loss ratios on current year writings as determined through extensive interaction between its underwriters and actuaries by product and class categories; (3) internal actuarial methodologies which analyze the Companys loss reporting and payment experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments and product mix; (4) current legal interpretations of coverage and liability; (5) economic conditions; and (6) the uncertainties discussed below regarding reserve requirements for A&E claims. Based on these considerations, management believes that adequate provision has been made for the Companys insurance and reinsurance loss and LAE reserves. Actual losses and LAE ultimately paid may deviate, perhaps substantially, from such reserves, impacting income in the period in which the change in reserves is made. See also Note 1 of Notes of the Consolidated Financial Statements.
The Company acknowledges that there is more uncertainty in establishing loss reserves on assumed business as compared to direct business. At December 31, 2004 the Company had assumed loss reserves of $5,939.1 million, of which $313.0 million were loss reserves on A&E business.
Reserving for assumed reinsurance requires evaluating loss information received from ceding companies. Depending on the type of contract and the contractual reporting requirements, ceding companies report losses to the Company in many forms. Generally, proportional/quota share contracts require the submission of a monthly/quarterly account, which includes premium and loss settlement activity for the period with corresponding reserves as established by the ceding company. This information is recorded into the Companys records. For certain proportional contracts, there is also an individual loss reporting clause, which requires a detailed loss report on claims that exceed a certain dollar threshold or relate to a particular type of loss. Excess of loss and facultative contracts generally require individual loss reporting with precautionary notices generally sent when losses reach a significant percentage of the attachment point of the contract. All individual loss reports and supporting claim information are managed by the Companys experienced claims staff. Based on the evaluation of the claim, the Company may choose to establish additional case reserves over that reported by the ceding company. The Underwriting, Claim, Reinsurance Accounting and Internal Audit departments of the Company perform various reviews of the ceding carriers, particularly larger ceding carriers, to ensure that underwriting and claims procedures meet required standards. The claim information received from the ceding
53
companies is compiled into loss development triangles. Accepted actuarial methodologies, supplemented by judgment where appropriate, are then used to develop the appropriate IBNR for the Company. Included in the determination of IBNR, is a factor for reporting lags of the ceded carriers. Each quarter, the Company compares its actual reported losses for the quarter and cumulatively since the most recently completed reserve study to the expected reported losses for the respective period, which may result in additional reserving actions. This is done by aggregate class and/or type of business. This information is used as a tool in the judgmental process by which management assesses the overall adequacy of loss and LAE reserves.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company continues to receive claims under expired contracts, both insurance and reinsurance, asserting alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Companys asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Companys environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damages caused by the release of hazardous substances into the land, air or water.
The Companys reserves include an estimate of the Companys ultimate liability for A&E claims. This estimate is made based on judgmental assessment of the underlying exposures as the result of (1) long and variable reporting delays, both from insureds to insurance companies and from ceding companies to reinsurers; (2) historical data, which is more limited and variable on A&E losses than historical information on other types of casualty claims; and (3) unique aspects of A&E exposures for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of the Companys potential losses from A&E claims. Among the uncertainties are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) the potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) questions concerning interpretation and application of insurance and reinsurance coverage; and (g) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.
With respect to asbestos claims in particular, several additional factors have emerged in recent years that further compound the difficulty in estimating the Companys liability. These developments include: (a) continued growth in the number of claims filed, in part reflecting a much more aggressive plaintiff bar and including claims against defendants formerly regarded as peripheral; (b) a disproportionate percentage of claims filed by individuals with no functional injury, which should have little to no financial value but that have increasingly been considered in jury verdicts and settlements; (c) the growth in the number and significance of bankruptcy filings by companies as a result of asbestos claims (including, more recently, bankruptcy filings in which companies attempt to resolve their asbestos liabilities in a manner that is prejudicial to insurers and forecloses insurers from the negotiation of bankruptcy plans); (d) the concentration of claims in a small number of states that favor plaintiffs; (e) the growth in the number of claims that might impact the general liability portion of insurance policies rather than the product liability portion; (f) measures adopted by specific courts to ameliorate the worst procedural abuses; (g) an increase in settlement values being paid to asbestos claimants, especially those with cancer or functional impairment; (h) legislation in some states to address asbestos litigation issues; and (i) the potential that other states or the U.S. Congress may adopt legislation on asbestos litigation.
Management believes that these uncertainties and factors continue to render reserves for A&E and particularly asbestos losses significantly less subject to traditional actuarial analysis than reserves for other types of losses. Given these uncertainties, management believes that no meaningful range for such ultimate losses can be established. The Company establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for the Company or its ceding companies.
54
In connection with the acquisition of Mt. McKinley, which has significant exposure to A&E claims, LM provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinleys reserves as of September 19, 2000 and The Prudential guaranteed LMs obligations to Mt. McKinley. Cessions under this reinsurance agreement exhausted the limit available under the contract at December 31, 2003. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, depending on coverage under the Companys various reinsurance arrangements, could have a material adverse effect on the Companys future financial condition, results of operations and cash flows. See also Note 1 and 3 of Notes to the Consolidated Financial Statements.
With respect to Mt. McKinley, where the Company has a direct relationship with policyholders, the Companys aggressive litigation posture and the uncertainties inherent in the asbestos coverage and bankruptcy litigation have provided an opportunity to actively engage in settlement negotiations with a number of those policyholders who have potentially significant asbestos liabilities. Those discussions are oriented towards achieving reasonable negotiated settlements that limit Mt. McKinleys liability to a given policyholder to a sum certain. In 2004, the Company has concluded such settlements or reached agreement in principle with 9 of its high profile policyholders. The Company currently has identified 15 policyholders based on their past claim activity and/or potential future liabilities as High Profile Policyholders and its settlement efforts are generally directed at such policyholders, in part because their exposures have developed to the point where both the policyholder and the Company have sufficient information to be motivated to settle. The Company believes that this active approach will ultimately result in a more cost-effective liquidation of Mt. McKinleys liabilities than a passive approach, although it may also introduce additional variability in Mt. McKinleys losses and cash flows as reserves are adjusted to reflect the development of negotiations and, ultimately, potentially accelerated settlements.
There is less potential for similar settlements with respect to the Companys reinsurance asbestos claims. Ceding companies, with their direct obligation to insureds and overall responsibility for claim settlements, are not consistently aggressive in developing claim settlement information and conveying this information to reinsurers, which can introduce significant and perhaps inappropriate delays in the reporting of asbestos claims/exposures to reinsurers. These delays not only extend the timing of reinsurance claim settlements, but also restrict the information available to estimate the reinsurers ultimate exposure. At December 31, 2004 the Company had asbestos loss reserves of $632.3 million, of which $313.0 million was for assumed business and $319.3 was for direct business. See the reserve discussion under the heading Financial Condition.
REINSURANCE RECEIVABLES. The Company utilizes reinsurance agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances without relieving the insurer of its obligation to the policyholder. In the event reinsurers were unable to meet their obligations under these reinsurance agreements or were able to successfully challenge losses ceded by the Company under the reinsurance contracts, the Company would not be able to realize the full value of the reinsurance recoverable balance. In some cases, the Company may hold partial collateral, including letters of credit and funds held arrangements, for these agreements. The Company establishes reserves for uncollectible balances based on managements assessment of the collectibility of the outstanding balances. To minimize exposure from uncollectible reinsurance receivables, the Company has a reinsurance credit security committee that generally evaluates the financial strength of a reinsurer prior to entering into a reinsurance arrangement. Additionally, creditworthy foreign reinsurers of business written in the U.S. are generally required to secure their obligations. Management believes that adequate provision has been made for the Companys uncollectible balances. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income in the period in which the change in reserves is made. See also Note 1 of Notes to the Consolidated Financial Statements. See also Financial Condition.
PREMIUMS WRITTEN AND EARNED. Premiums written by the Company are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the
55
remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Premiums earned, and the related costs, which have not yet been reported to the Company, are estimated and accrued. Standard accepted actuarial methodologies are used to estimate earned but not reported premium at each financial reporting date.
The following table displays the estimated earned premiums before reduction for related expenses for the periods indicated at December 31:
(Dollars in thousands) | Earned But Not Reported Premium By Segment | ||||||||||
2004 | 2003 | 2002 | |||||||||
|
|
|
|||||||||
U.S. Reinsurance | $ | 485,880 | $ | 391,885 | $ | 140,823 | |||||
U.S. Insurance | 38,487 | 38,430 | 31,013 | ||||||||
Specialty Underwriting | 136,687 | 105,865 | 106,245 | ||||||||
International | 216,632 | 169,847 | 122,760 | ||||||||
Bermuda | 233,940 | 120,349 | 53,721 | ||||||||
|
|
|
|||||||||
Total | $ | 1,111,626 | $ | 826,376 | $ | 454,562 | |||||
|
|
|
These earned but not reported premiums are combined with reported premiums to comprise the exposure base for determining the Companys incurred losses and loss and LAE reserves. Commission expense and incurred losses related to the change in earned but not reported premium is not differentiated from current period reported premium and the effects of both are included in current period company and segment financial results. See also Note 1 of Notes to the Consolidated Financial Statements.
INVESTMENT VALUATION. The Companys investment portfolio consists of investments available for sale and accordingly these securities are marked to market on a quarterly basis. Most securities are traded on national exchanges where market values are readily available. The Company holds some privately placed securities that are either valued by an investment advisor or by the Company using cash flow projections. Through the second quarter of 2004 the Company owned interest only strips that were accounted for in accordance with EITF 99-20, which set forth the rules for determining when these securities must be written down to fair value due to impairment. Unrealized gains and losses from market fluctuations are reflected as comprehensive income, while market value declines that are considered other than temporary impairments are reflected in the income statement as realized capital losses. The Company considers many factors when determining whether a market value decline is other than temporary, including: (1) the length of time the market value has been below book value, (2) the credit strength of the issuer, (3) the issuers market sector, (4) the length of time to maturity and (5) for asset backed securities, increases in prepayments. If management assessments change in the future, the Company may ultimately record a realized loss after management originally concluded that the decline in value was temporary. See also Note 1 of Notes to the Consolidated Financial Statements.
FINANCIAL CONDITION
CASH
AND INVESTED ASSETS.
Aggregate invested assets, including cash and
short-term investments, were $11,530.2 million at December 31, 2004, $9,321.3 million at
December 31, 2003 and $7,265.6 million at December 31, 2002. The increase in cash and
invested assets in 2004 from 2003 resulted primarily from $1,487.6 million in cash flows
from operations generated during 2004, $320.0 million from net proceeds of the issuance
of junior subordinated debt securities, $250 million from net proceeds of the issuance of
senior notes and $40.1 million in net pre-tax unrealized appreciation of the Companys
investments, partially offset by a $70 million repayment on the revolving credit
agreement. The increase in cash and invested assets in 2003 from 2002 resulted primarily
from $1,653.8 million in cash flows from operations generated during 2003, $316.8
56
million of net proceeds from the offering of common shares in April 2003 and $68.1 million in net unrealized appreciation of the Companys investments.
The Companys current investment strategy generally seeks to maximize after-tax income through a high quality, diversified, taxable and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. Although not a primary objective, the Company actively considers total return performance, in particular as respects the exposures of its fixed income portfolio to variability in unrealized appreciation/depreciation as interest rates shift. The Companys mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Companys current and projected operating results, market conditions and the Companys tax position. The fixed maturities in the investment portfolio are comprised of available for sale securities. Additionally, the Company is expanding its investments in equity securities, principally public equity index securities, which it believes will enhance the risk-adjusted total return of the investment portfolio.
Commencing with the second quarter of 2003 and through the second quarter of 2004, the Company had investments in interest only strips. These investments were aimed at mitigating potential decreases in unrealized appreciation on the Companys fixed income portfolio during a period where management judged that there was extraordinary potential for an increase in general interest rates. These fixed maturity securities give the holder the right to receive interest payments at a stated coupon rate on an underlying pool of mortgages. The interest payments on the outstanding mortgages are guaranteed by entities generally rated AAA. The ultimate cash flow from these investments is primarily dependent upon the average life of the mortgage pool. Generally, as market interest rates and, more specifically, market mortgage rates decline, mortgagees tend to refinance which will decrease the average life of a mortgage pool and decrease expected cash flows. Conversely, as market interest rates and, more specifically, market mortgage rates rise, repayments will slow and the ultimate cash flows will tend to rise. Accordingly, the market value of these investments tends to increase as general interest rates rise and decline as general interest rates fall. These movements are generally counter to the impact of interest rate movements on the Companys other fixed income investments. The Company liquidated its interest only strip investment portfolio in the second quarter of 2004, at which point management concluded the extraordinary potential for increases in general interest rates had subsided to a more normal level.
57
The tables below summarize the composition of and the characteristics of the Companys investment portfolio at December 31:
2004 | 2003 | 2002 | |||||||||
|
|
|
|||||||||
Fixed maturities | 86 | .3% | 93 | .6% | 93 | .4% | |||||
Equity securities | 5 | .6% | 1 | .7% | 0 | .7% | |||||
Short-term investments | 5 | .1% | 1 | .6% | 2 | .3% | |||||
Other invested assets | 1 | .4% | 1 | .1% | 0 | .7% | |||||
Cash | 1 | .6% | 2 | .0% | 2 | .9% | |||||
|
|
|
|||||||||
Total investments and cash | 100 | .0% | 100 | .0% | 100 | .0% | |||||
2004 |
2003 | 2002 | |||||||||
|
|
|
|||||||||
Fixed income portfolio duration | 5.2 years | 4.2 years | 5.4 years | ||||||||
Fixed income composite credit quality | Aa2 | Aa2 | Aa2 | ||||||||
Imbedded end of period yield, pre-tax | 4 | .7% | 4 | .8% | 5 | .3% | |||||
Imbedded end of period yield, after-tax | 4 | .1% | 4 | .1% | 4 | .6% |
The increase in short-term investments is due principally to maintaining liquidity to repay the maturing $250 million of senior notes due in March 2005. The increase in equity securities reflects a modest and continuing reweighting of the Companys target investment mix.
The Company, because of its historical income orientation, has generally considered total return, the combination of income yield and capital appreciation/depreciation, to be relatively less important as a measure of performance than its overall income yield. With changes the Company perceives in overall investment market conditions, and more specifically the acquisition of $496.5 million of equity securities into the overall investment portfolio in 2004, the Company is reexamining the weighting of total return in its overall investment strategy.
The following table provides a comparison of the Companys total return by asset class to broadly accepted industry benchmarks for the periods indicated:
Years Ended December 31, | ||||||||||||
|
|
|
||||||||||
2004 | 2003 | |||||||||||
|
|
|
||||||||||
Fixed income portfolio total return | 6 | .5% | 6 | .2% | ||||||||
Lehman bond aggregate | 4 | .3% | 4 | .1% | ||||||||
Common equity portfolio total return | 21 | .9% | 17 | .0% | ||||||||
S&P 500 | 10 | .9% | 28 | .7% |
REINSURANCE RECEIVABLES. Reinsurance receivables for both paid and unpaid losses totaled $1,210.8 million at December 31, 2004, $1,284.1 million at December 31, 2003, and $1,116.4 million at December 31, 2002. At December 31, 2004, $405.0 million, or 33.4%, was receivable from subsidiaries of London Life. These receivables are effectively secured by a combination of letters of credit and funds held arrangements under which the Company has retained the premium payments due the retrocessionaire, recognized liabilities for such amounts and reduced such liabilities as payments are due from the retrocessionaire. In addition, $160.0 million, or 13.2%, was receivable from LM, whose obligations are guaranteed by The Prudential, $132.5 million, or 10.9%, was receivable from Transatlantic and $100.0 million, or 8.3%, was receivable from Continental, which is partially secured by funds held arrangements. No other retrocessionaire accounted for more than 5% of the Companys receivables.
58
LOSS AND LAE RESERVES. Gross loss and LAE reserves totaled $7,836.3 million at December 31, 2004, $6,361.2 million at December 31, 2003, and $4,905.6 million at December 31, 2002. The increase in 2004, 2003 and 2002 is primarily attributable to increased premiums earned, increase in catastrophe losses, net prior period reserve adjustments in select areas and normal variability in claim settlements.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Due to the sale and in accordance with FAS 131, the Company restated the International and Bermuda segments for the years ended December 31, 2003 and 2002 to conform to December 31, 2004 segment reporting.
The following tables summarize gross outstanding loss and LAE reserves, segregated into case reserves and IBNR reserves, which are managed on a combined basis, for the periods indicated.
Gross Reserves By Segment | |||||||||||||||||||||||
As of December 31, 2004 | |||||||||||||||||||||||
(Dollars in thousands) |
Case
Reserves |
IBNR
Reserves |
Total
Reserves |
% of
Total |
|||||||||||||||||||
|
|
|
|
||||||||||||||||||||
U.S. Reinsurance | $ | 1,354,647 | $ | 2,174,762 | $ | 3,529,409 | 45 | .0% | |||||||||||||||
U.S. Insurance | 599,200 | 793,451 | 1,392,651 | 17 | .7% | ||||||||||||||||||
Specialty Underwriting | 215,187 | 158,793 | 373,980 | 4 | .8% | ||||||||||||||||||
International | 421,804 | 359,073 | 780,877 | 10 | .0% | ||||||||||||||||||
Bermuda | 425,273 | 605,791 | 1,031,064 | 13 | .2% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total excluding A&E | 3,016,111 | 4,091,870 | 7,107,981 | 90 | .7% | ||||||||||||||||||
A&E | 571,939 | 156,386 | 728,325 | 9 | .3% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total including A&E | $ | 3,588,050 | $ | 4,248,256 | $ | 7,836,306 | 100 | .0% | |||||||||||||||
|
|
|
|
As of December 31, 2003 |
|||||||||||||||||||||||
(Dollars in thousands) |
Case
Reserves |
IBNR
Reserves |
Total
Reserves |
% of
Total |
|||||||||||||||||||
|
|
|
|
||||||||||||||||||||
U.S. Reinsurance | $ | 1,271,956 | $ | 1,835,902 | $ | 3,107,858 | 48 | .9% | |||||||||||||||
U.S. Insurance | 445,802 | 620,895 | 1,066,697 | 16 | .7% | ||||||||||||||||||
Specialty Underwriting | 228,572 | 80,839 | 309,411 | 4 | .9% | ||||||||||||||||||
International | 353,686 | 149,717 | 503,403 | 7 | .9% | ||||||||||||||||||
Bermuda | 256,059 | 352,559 | 608,618 | 9 | .6% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total excluding A&E | 2,556,075 | 3,039,912 | 5,595,987 | 88 | .0% | ||||||||||||||||||
A&E | 483,433 | 281,824 | 765,257 | 12 | .0% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total including A&E | $ | 3,039,508 | $ | 3,321,736 | $ | 6,361,244 | 100 | .0% | |||||||||||||||
|
|
|
|
59
As of December 31, 2002 | |||||||||||||||||||||||
(Dollars in thousands) |
Case
Reserves |
IBNR
Reserves |
Total
Reserves |
% of
Total |
|||||||||||||||||||
|
|
|
|
||||||||||||||||||||
U.S. Reinsurance | $ | 1,143,500 | $ | 1,459,749 | $ | 2,603,249 | 53 | .1% | |||||||||||||||
U.S. Insurance | 242,306 | 452,290 | 694,596 | 14 | .2% | ||||||||||||||||||
Specialty Underwriting | 234,809 | 50,929 | 285,738 | 5 | .8% | ||||||||||||||||||
International | 295,212 | 59,052 | 354,264 | 7 | .2% | ||||||||||||||||||
Bermuda | 187,585 | 112,228 | 299,813 | 6 | .1% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total excluding A&E | 2,103,412 | 2,134,248 | 4,237,660 | 86 | .4% | ||||||||||||||||||
A&E | 430,115 | 237,807 | 667,922 | 13 | .6% | ||||||||||||||||||
|
|
|
|
||||||||||||||||||||
Total including A&E | $ | 2,533,527 | $ | 2,372,055 | $ | 4,905,582 | 100 | .0% | |||||||||||||||
|
|
|
|
The increases by segment generally reflect increases in earned premium, changes in business mix and the impact of reserve reestimations together with claim settlement activity. The fluctuations for A&E reflect the impact of reserve reevaluations and claim settlement activity.
The Companys loss and LAE reserves reflect estimates of ultimate claim liability. Such estimates are reevaluated on an ongoing basis, including re-estimates of prior period reserves, taking into consideration all available information and, in particular, newly reported loss and claim experience. The effect of such reevaluations impacts incurred losses for the current period. The Company notes that its analytical methods and processes operate at multiple levels including individual contracts, groupings of like contracts, classes and lines of business, internal business units, segments, legal entities, and in the aggregate. The complexities of the Companys business and operations require analyses and adjustments, both qualitative and quantitative, at these various levels. Additionally, the attribution of reserves, change in reserves and incurred losses, between accident year and underwriting year requires adjustments and allocations, both qualitative and quantitative, at these various levels. All of these processes, methods and practices appropriately balance actuarial science, business expertise and management judgment in a manner intended to assure the accuracy, precision and consistency of the Companys reserving practices, which are fundamental to the Companys operation. The Company notes however, that the underlying reserves remain estimates, which are subject to variation, and that the relative degree of variability is generally least when reserves are considered in the aggregate and generally increases as the focus shifts to more granular data levels.
There can be no assurance that reserves for, and losses from, claim obligations will not increase in the future. However, management believes that the Companys existing reserves and reserving methodologies lessen the probability that any such increase would have a material adverse effect on the Companys financial condition, results of operations or cash flows. In this context, the Company notes that over the past 10 years, its past calendar year operations have been affected variably by effects from prior period reserve re-estimates, with such effects ranging from a favorable $35.4 million, representing 1.2% of the net prior period reserves for the year in which the adjustment was made, to an unfavorable $312.0 million, representing 6.0% of the net prior period reserves for the year in which the adjustment was made. The Company has noted that variability has increased over the past three years and has taken actions to attempt to reduce this year to year variability prospectively.
60
The following table represents the reserve levels and ranges as of December 31, 2004 for each of the Companys business segments.
The Company has included ranges for loss reserve estimates determined by the Companys actuaries, which are derived through a combination of objective and subjective criteria. The Company notes that its presentation of this information is not directly comparable to similar presentations of other companies as there are no consistently applied actuarial or accounting standards governing such presentations. The Company further notes that its recorded reserves reflect the Companys best point estimate of its liabilities and that its actuarial methodologies focus on such point estimates around which ranges are subsequently developed.
Depending on the specific segment, the range derived for the loss reserves, excluding reserves for A&E exposures, ranges from minus 5.0% to minus 8.3% for the low range and from plus 5.0% to plus 8.3% for the high range. Both the higher and lower ranges are associated with the Specialty Underwriting segment. Within each range, managements best estimate of loss reserves is based on the point estimate derived by the Companys actuaries in detailed reserve studies. Such ranges are necessarily subjective due to the lack of generally accepted actuarial standards with respect to their development. In particular, the Company notes that the width of the range is dependent on the level of confidence associated with the outcome. For the above presentation, management has assumed what it believes is a reasonable confidence level but notes that there can be no assurance that the Companys claim obligations will not vary within and potentially outside of these ranges, requiring incurred loss adjustments in the period the variability is recognized. The Company is not able to establish a meaningful range for A&E reserves.
Additional losses, including those relating to latent injuries, and other exposures, which are as yet unrecognized, the type or magnitude of which cannot be foreseen by the Company or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional
61
contracts, could have material adverse effects on the Companys future financial condition, results of operations and cash flows.
The Company generally has exposure to A&E losses through its Mt. McKinley operation with respect to insurance policies and through Everest Re with respect to reinsurance contracts. In each case, the Companys management and analysis of its exposures takes into account a number of features of its business that differentiate the Companys exposures from many other insurers and reinsurers that have significant A&E exposures.
Mt. McKinley began writing small amounts of A&E exposed insurance in 1975 and increased the volume of its writings in 1977. These writings ceased in 1984, giving Mt. McKinley an approximate 10-year window of potential A&E exposure, which is appreciably shorter than is the case for many companies with significant A&E exposure. Additionally, due to changes in and standardization of policy forms, it is rare for policies in the 1970s and 1980s to have been issued without aggregate limits on at least the product liability coverage offered; policies issued in earlier decades are generally more at risk of not having aggregate limits.
The vast majority of Mt. McKinleys A&E exposed insurance policies are excess casualty policies, with aggregate coverage limits, which by definition also have protection afforded by underlying coverage. Mt. McKinleys attachment points vary but usually are protected by millions, often tens of millions, of dollars of underlying coverage. The excess nature of most of Mt. McKinleys policies also offers protection against non-product claims (for example, claims arising under general liability coverage). Although under some circumstances an excess policy could be exposed to non-product claims, such claims generally pose more of a risk to primary policies because non-product claims are generally less likely to aggregate. In addition, environmental claims arise under general liability coverage, and generally do not aggregate. Thus, these claims tend to create exposure for primary policies to a greater extent than excess policies.
Virtually all of the Mt. McKinley policies that are still potentially exposed to claims have policy language providing that expenses were paid within limits rather than in addition to limits. This is a substantial difference from primary coverage, which would most often cover expenses in addition to limits.
Everest Re was formed in 1973 but was not fully engaged in underwriting casualty business, under which A&E exposures generally arise, until 1974, and it effectively eliminated A&E exposures through contract exclusions effected in 1984. Therefore, Everest Re has an approximate 11-year window of A&E exposure, much shorter than that of many reinsurance companies that have significant A&E exposures. In the earlier years of its existence, Everest Re was not as heavily involved in casualty business as in property business, which generally is not exposed to asbestos claims. Everest Re generally took smaller lines of exposure per contract than many other reinsurers operating in the casualty reinsurance market and those lines were generally also smaller than the excess limits provided by Mt. McKinley policies. This means that the potential adverse development on Everest Res reinsurance business would not be subject to the same level of volatility as would be the case for companies having greater exposures per risk. Everest Re reinsured both primary and excess policies. However, its claim experience to date indicates that the majority of its reinsurance supported excess policies. As a result, most of Everest Res exposure derives from excess policies similar to those written by Mt. McKinley.
With respect to both the Mt. McKinley and Everest Re operations, the Company was not a member of the Asbestos Claims Facility (Wellington) or the Center for Claims Resolution (CCR) claim settlement facilities. Insurers supporting those facilities made broad commitments concerning the application of insurance coverage to asbestos claims. With respect to its direct insurance exposures, the fact that the Company has not made those commitments may allow it to resolve insurance exposure to Wellington/CCR insureds more economically than if it had joined these facilities. With respect to its reinsurance exposures, although the Company was not a signatory to the Wellington or CCR facilities, it has, within the bounds of its reinsurance contracts, generally supported ceding companies that were signatories. Because the insurers supporting these
62
facilities have generally paid their exposures more quickly than non-signatory insurers, the Company believes that this has generally meant that it has paid its reinsurance exposure more quickly than it likely would have if it had not been subject to Wellington/CCR payments.
The Company believes that its A&E exposures are unique and differentiated, by the points noted above, from those insurers and reinsurers with appreciable A&E exposure but there can be no assurance that such factors will protect the Company from adverse development, perhaps material, or allow it to secure advantages in the settlement of its claims obligations.
63
The following table summarizes incurred losses with respect to A&E on both a gross and net of retrocessions basis for the periods indicated:
Asbestos and Environmental Reserves
Years Ended December 31, |
|||||||||||
|
|
|
|||||||||
(Dollars in millions) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross Basis: | |||||||||||
Beginning of period reserves | $ | 765 | .3 | $ | 667 | .9 | $ | 644 | .4 | ||
|
|
|
|||||||||
Incurred losses and LAE: | |||||||||||
Reported losses | 297 | .1 | 128 | .6 | 180 | .9 | |||||
Change in IBNR | (125 | .4) | 44 | .0 | (85 | .9) | |||||
|
|
|
|||||||||
Total incurred losses and LAE | 171 | .7 | 172 | .6 | 95 | .0 | |||||
Paid losses | (208 | .7) | (75 | .2) | (71 | .5) | |||||
|
|
|
|||||||||
End of period reserves | $ | 728 | .3 | $ | 765 | .3 | $ | 667 | .9 | ||
|
|
|
|||||||||
Net Basis: | |||||||||||
Beginning of period reserves | $ | 534 | .4 | $ | 527 | .5 | $ | 568 | .6 | ||
|
|
|
|||||||||
Incurred losses and LAE: | |||||||||||
Reported losses | 271 | .8 | 15 | .9 | 102 | .7 | |||||
Change in IBNR | (112 | .4) | 34 | .3 | (79 | .2) | |||||
|
|
|
|||||||||
Total incurred losses and LAE | 159 | .4 | 50 | .2 | 23 | .5 | |||||
Paid losses | (187 | .1) | (43 | .3) | (64 | .6) | |||||
|
|
|
|||||||||
End of period reserves | $ | 506 | .7 | $ | 534 | .4 | $ | 527 | .5 | ||
|
|
|
At December 31, 2004, the gross reserves for A&E losses were comprised of $148.5 million representing case reserves reported by ceding companies, $151.3 million representing additional case reserves established by the Company on assumed reinsurance claims, $272.1 million representing case reserves established by the Company on direct insurance claims, including Mt. McKinley, and $156.4 million representing IBNR reserves.
The gross incurred losses for A&E exposures increased by $171.7 million and $172.6 million for the years ended December 31, 2004 and 2003, respectively. These increases are the result of reevaluations by management reflecting additional information received from insureds and ceding companies, ongoing litigation, additional claims received and settlement activity. Management closely monitors this additional information and adjusts reserves accordingly. The net incurred losses primarily reflect the impact of the reinsurance agreement between Mt. McKinley and LM.
Industry analysts have developed a measurement, known as the survival ratio, to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a companys current net reserves by the three year average of paid losses, and therefore measures the number of years that it would take to exhaust the current reserves based on historical payment patterns. Using this measurement, the Companys net three year A&E survival ratio was 5.2 years at December 31, 2004. Adjusting for the effect of the reinsurance ceded under the reinsurance agreement with LM, this ratio rises to the equivalent of 6.8 years at December 31, 2004. The cession of $160.0 million to the stop loss reinsurance provided by LM in connection with the acquisition of Mt. McKinley results in unpaid proceeds that are not reflected in past net payments and effectively extend the funding available for future net payments.
Because the survival ratio was developed as a comparative measure of reserve strength and not of absolute reserve adequacy, the Company considers, but does not rely on, the survival ratio when evaluating its reserves.
64
In particular, the Company notes that loss payout variability, which can be material, due in part to the Companys orientation to negotiated settlements, particularly on its Mt. McKinley exposures, significantly impairs the credibility and utility of this measure as an analytical tool. During 2004, the Company made asbestos net claim payments of $134.3 million on Mt McKinley high profile claimants where the claim was either closed or a settlement was reached. Such payments, which are effectively non-repetitive, do for 2004, and will for 2005 and 2006, distort the Companys three year survival ratio. Adjusting for such settlements, recognizing total settlements are generally considered fully reserved to an agreed settlement, the Company considers that its adjusted survival ratio for net unsettled claims is 16.0 years.
Developments in 2004 and 2003 affecting asbestos exposures in general and the Companys asbestos exposures in particular, together with enhancements in the Companys claim management and analytical processes, resulted in the reserve strengthening noted earlier. These developments and actions have increased the emphasis on asbestos exposures as a separate component of the Companys A&E exposures. Despite the Companys approach of handling A&E exposures on a combined basis, management believes additional disclosure of the asbestos element of its A&E exposures is appropriate.
The following tables summarize reserve and claim activity for asbestos claims, on both a gross and net of ceded reinsurance basis, for the periods indicated with particular emphasis on the differentiation of insured categories within the Mt. McKinley operation, which the Company believes reflects the most volatile element of its asbestos exposures for the years ended December 31:
65
66
Net Asbestos Exposures (1) | |||||||||||
|
|
|
|||||||||
(Dollars in millions) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Beginning of period reserves: | |||||||||||
Direct Operations (Mt. McKinley) | |||||||||||
Settlements in place ("SIP") (2) | $ | 99.3 | $ | 65.4 | $ | 39.4 | |||||
Actively managed (3) | - | 5.9 | 28.5 | ||||||||
Remaining high profile insureds | 89.7 | 132.8 | 36.8 | ||||||||
Losses Ceded to Prupac | (160.0 | ) | (80.7 | ) | (19.6 | ) | |||||
Other direct exposures | 9.4 | 1.5 | 1.8 | ||||||||
IBNR | 165.3 | 84.8 | 94.5 | ||||||||
|
|
|
|||||||||
203.7 | 209.7 | 181.5 | |||||||||
Reinsurance Operations (Everest Re) | |||||||||||
Case reserves | 183.5 | 123.5 | 110.7 | ||||||||
IBNR | 32.7 | 70.2 | 97.3 | ||||||||
|
|
|
|||||||||
216.2 | 193.7 | 207.9 | |||||||||
|
|
|
|||||||||
Total beginning of period reserves | 419.9 | 403.4 | 389.4 | ||||||||
|
|
|
|||||||||
Incurred losses and LAE: | |||||||||||
Direct Operations (Mt. McKinley) | |||||||||||
SIP settlements in place (2) | 146.3 | 57.6 | 29.8 | ||||||||
Actively managed (3) | - | (0.6 | ) | 1.1 | |||||||
Remaining high profile insureds | 22.1 | (39.3 | ) | 97.5 | |||||||
Losses Ceded to Prupac | - | (79.3 | ) | (61.1) | |||||||
Other direct exposures | 3.1 | 8.5 | 2.8 | ||||||||
IBNR | (101.6 | ) | 80.5 | (9.7 | ) | ||||||
|
|
|
|||||||||
69.9 | 27.4 | 60.4 | |||||||||
Reinsurance Operations (Everest Re) | |||||||||||
Reported Losses | 91.8 | 60.3 | 27.0 | ||||||||
IBNR | (1.7 | ) | (37.5 | ) | (27.1 | ) | |||||
|
|
|
|||||||||
90.1 | 22.8 | (0.1) | |||||||||
|
|
|
|||||||||
Total incurred losses and LAE | 160.0 | 50.2 | 60.3 | ||||||||
|
|
|
|||||||||
Paid losses: | |||||||||||
Direct Operations (Mt. McKinley) | |||||||||||
SIP settlements in place (2) | 134.3 | 23.7 | 3.8 | ||||||||
Actively managed (3) | - | 5.2 | 23.7 | ||||||||
Remaining high profile insureds | 7.0 | 3.8 | 1.5 | ||||||||
Other direct exposures | 1.1 | 0.6 | 3.1 | ||||||||
|
|
|
|||||||||
142.4 | 33.4 | 32.1 | |||||||||
Reinsurance Operations (Everest Re) | 29.7 | 0.3 | 14.2 | ||||||||
|
|
|
|||||||||
Total paid losses | 172.1 | 33.7 | 46.3 | ||||||||
|
|
|
|||||||||
End of period reserves: | |||||||||||
Direct Operations (Mt. McKinley) | |||||||||||
SIP settlements in place (2) | 111.4 | 99.3 | 65.4 | ||||||||
Actively managed (3) | - | (0.0) | 5.9 | ||||||||
Remaining high profile insureds | 104.6 | 89.7 | 132.8 | ||||||||
Losses Ceded to Prupac | (160.0 | ) | (160.0 | ) | (80.7 | ) | |||||
Other direct exposures | 11.4 | 9.4 | 1.5 | ||||||||
IBNR | 63.8 | 165.3 | 84.8 | ||||||||
|
|
|
|||||||||
131.2 | 203.7 | 209.7 | |||||||||
Reinsurance Operations (Everest Re) | |||||||||||
Case reserves | 245.6 | 183.5 | 123.5 | ||||||||
IBNR | 31.0 | 32.7 | 70.2 | ||||||||
|
|
|
|||||||||
276.6 | 216.2 | 193.7 | |||||||||
|
|
|
|||||||||
Total end of period reserves (4) | $ | 407.8 | $ | 419.9 | $ | 403.4 | |||||
|
|
|
|||||||||
______________
(1) Some totals may not reconcile due to rounding. |
|||||||||||
(2)
Under SIP agreements, payments depend upon the insured's actual claims experience and may be subject to annual caps
or other controls on the rate of payment. |
|||||||||||
(3)
Actively Managed means that Mt. McKinley is managing the defense of claims against the insured.
|
|||||||||||
(4)
Includes $232.0 million ceded to and collected from
The Prudential as part of the Company's stop loss protection resulting
from the initial public offering in 1995. |
|||||||||||
3 Year Survival Ratio |
4.9 | ||||||||||
3 Year Survival Ratio excluding stop loss | 6.8 | ||||||||||
3 Year Survival Ratio excluding SIP, actively managed & stop loss | 22.3 |
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The Companys net three year survival ratio on its asbestos exposures only was 4.9 years for the period ended December 31, 2004. This three year survival ratio, when adjusted for the effect of the reinsurance ceded under the stop loss cover from LM, was 6.8 years and, when adjusted for settlements in place and structured settlements, which are either fully funded by reserves or subject to financial terms that substantially limit the potential variability in the liability, and the stop loss protection from LM, was 22.3 years.
SHAREHOLDERS EQUITY. The Companys shareholders equity increased to $3,712.5 million as of December 31, 2004 from $3,164.9 million as of December 31, 2003, principally reflecting $494.9 million of net income in 2004, $26.5 million in net proceeds from options exercised, an increase of $25.7 million in net unrealized appreciation of investments and a $22.9 million increase in foreign currency translation, partially offset by $22.4 million in shareholder dividends. The Companys shareholders equity increased to $3,164.9 million as of December 31, 2003 from $2,368.6 million as of December 31, 2002, principally reflecting $426.0 million of net income in 2003, $316.8 million in net proceeds from Groups offering of 4.5 million common shares in April 2003, an increase of $36.4 million in net unrealized appreciation of investments and a $22.2 million increase in foreign currency translation, partially offset by $19.6 million in shareholder dividends. Dividends of $22.4 million, $19.6 million and $16.3 million were declared and paid by the Company in 2004, 2003 and 2002, respectively.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL.
The Companys business operations are in part dependent on the
Companys financial strength, and the markets perception thereof, as
measured by shareholders equity, which was $3,712.5 million and $3,164.9
million at December 31, 2004 and 2003, respectively. The Company has flexibility
with respect to capitalization as a result of its perceived financial
strength, including its financial strength ratings as assigned by independent
rating agencies, and its access to the debt and equity markets. The Company
continuously monitors its capital and financial position, as well as investment
and security market conditions, both in general and with respect to the
Companys securities, and responds accordingly.
From time to time the Company has used open market share repurchases to effectively adjust its capital position. It made no such purchases in 2004. In September 2004, the Companys existing authorization to purchase up to 1.7 million shares was amended to authorize the repurchase of up to 5 million shares. The Company notes that, outside of its open market repurchase program, it repurchased 4,800 shares in 2004 from employees in connection with restricted share vestings where individual employees chose to discharge withholding tax liabilities on vesting shares by surrendering of a portion of such shares. At December 31, 2004, 5 million shares remained under the existing repurchase authorization.
The Company has a shelf registration statement on Form S-3 on file with the Securities and Exchange Commission (SEC), which was declared effective by the SEC on December 22, 2003, that provides for the issuance of up to $975 million of securities. Generally, under this shelf registration statement, Group is authorized to issue common shares, preferred shares, debt securities, warrants and hybrid securities, Holdings is authorized to issue debt securities and Capital Trust II and Everest Re Capital Trust III (Capital Trust III) are authorized to issue trust preferred securities. The following securities have been issued pursuant to that registration statement, which at December 31, 2004 has a remaining balance of $405.0 million.
o | On March 29, 2004, Capital Trust II, an unconsolidated affiliate, issued trust preferred securities resulting in a takedown from the shelf registration statement of $320 million. In conjunction with the issuance of Capital Trust IIs trust preferred securities, Holdings issued $329.9 million of 6.20% junior subordinated debt securities due March 29, 2034 to Capital Trust II. Part of the proceeds from the junior subordinated debt securities issuance was used for capital contributions to Holdings operating subsidiaries. |
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o | On October 6, 2004, Holdings completed a public offering of $250.0 million principal amount of 5.40% senior notes due October 15, 2014. The net proceeds will be utilized to retire existing debt at Holdings, which is coming due in March 2005, and for other general corporate purposes. |
On July 30, 2002, the Company filed a shelf registration statement on Form S-3 with the SEC, providing for the issuance of up to $475.0 million of securities. Generally, under this shelf registration statement, Group was authorized to issue common shares, preferred shares, debt securities, warrants and hybrid securities, Holdings was authorized to issue debt securities and Capital Trust was authorized to issue trust preferred securities. This shelf registration statement became effective on September 26, 2002 and was effectively exhausted with the April 23, 2003 transaction described below. The following securities were issued pursuant to that registration statement.
o | On November 14, 2002, pursuant to a trust agreement between Holdings and JPMorgan Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware trustee, Capital Trust, an unconsolidated affiliate, completed a public offering of $210.0 million of 7.85% trust preferred securities, resulting in net proceeds of $203.4 million. The proceeds of the issuance were used to purchase $210 million of 7.85% junior subordinated debt securities of Holdings that will be held in trust by the property trustee for the benefit of the holders of the trust preferred securities. In conjunction with the issuance of Capital Trusts trust preferred securities, Holdings issued $216.5 million of 7.85% junior subordinated debt securities due November 15, 2032 to Capital Trust. The proceeds from the junior subordinated debt securities issuance were primarily used for capital contributions to Holdings operating subsidiaries. |
o | On April 23, 2003, the Company expanded the size of the remaining shelf registration to $318 million by filing a Post-Effective Amendment under Rule 462(b) of the Securities Act of 1933, as amended, and General Instruction IV of Form S-3 promulgated there under. On the same date, the Company issued 4,480,135 of its common shares at a price of $70.75 per share, which resulted in $317.0 million in proceeds, before expenses of approximately $0.2 million. This transaction effectively exhausted the September 26, 2002 shelf registration. |
Capital Trust will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on November 15, 2032. Holdings may elect to redeem the junior subordinated debt securities, in whole or in part, at any time after November 14, 2007. If such an early redemption occurs, the outstanding trust preferred securities would also be proportionately redeemed.
On November 7, 2001, the Company filed a shelf registration statement on Form S-3 with the SEC, providing for the issuance of up to $575.0 million of common equity. On February 27, 2002, the Company completed an offering of 5,000,000 of its common shares at a price of $69.25 per share, which resulted in $346.3 million of proceeds before expenses of approximately $0.5 million related to the offering. The Company has used the net proceeds for working capital and general corporate purposes. On October 2, 2002, the Company filed a post-effective amendment to this registration statement that removed the remaining securities from registration.
On March 14, 2000, Holdings completed public offerings of $200.0 million principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net proceeds of these offerings and additional funds were distributed by Holdings to Group.
LIQUIDITY. The Companys current investment strategy generally seeks to maximize after-tax income through a high quality, diversified, taxable bond and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Companys mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Companys current and projected operating results, market conditions and tax position. With changes the Company perceives in overall investment market conditions, and more specifically
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the acquisition of $496.5 million of equity securities into the overall investment portfolio in 2004, the Company is reweighting its view of total return.
The Companys liquidity requirements are generally met from positive cash flow from operations. Positive cash flow results from reinsurance and insurance premiums being collected prior to disbursements for claims, which disbursements generally take place over an extended period after the collection of premiums, sometimes a period of many years. Collected premiums are generally invested, prior to their use in such disbursements, and investment income provides additional funding for loss payments. The Companys net cash flows from operating activities were $1,487.6 million, $1,653.8 million and $742.7 million for the years ended December 31, 2004, 2003 and 2002, respectively. Additionally, these cash flows reflected net tax payments of $100.0 million, $52.6 million and $10.0 million for the years ended December 31, 2004, 2003 and 2002, respectively; catastrophe loss payments of $201.6 million, $96.0 million and $62.0 million for the years ended December 31, 2004, 2003 and 2002, respectively; and a $46.8 million payment on a terminated annuity reinsurance arrangement for the year ended December 31, 2004. The decrease in net cash flows from operations in 2004 compared with 2003 was primarily due to higher claim payments on catastrophes and increased A&E settlements, which totaled $187.1 million, $43.3 million and $64.6 million for the years ended December 31, 2004, 2003 and 2002, respectively. The increase in cash flow from 2002 reflects business growth and favorable underwriting results.
In periods for which disbursements for claims and benefits, policy acquisition costs and other operating expenses exceed premium inflows, cash flow from insurance operations would be negative. The effect on cash flow from operations would be partially offset by cash flow from investment income. Additionally, cash flow from investment maturities, both short term investments and longer term maturities, would further mitigate the impact on total cash flow.
As the exact timing of the payment of claims and benefits cannot be predicted with certainty, the Company maintains portfolios of long term invested assets with varying maturities, along with short-term investments that are intended to provide adequate cash for payment of claims. At December 31, 2004 and December 31, 2003 the Company held cash and short-term investments of $770.8 million and $336.7 million, respectively. Part of the short-term cash position at December 31, 2004 will be used to pay the $250 million of senior notes that come due on March 15, 2005. In addition to these cash and short-term investments at December 31, 2004, the Company had $0.3 billion, at fair value, of available for sale fixed maturity securities maturing within one year, $1.9 billion maturing within two to five years and $7.7 billion maturing after five years. These securities, in conjunction with the short-term investments and positive cash flow from operations, provide adequate sources of liquidity for the expected payment of losses in the near future. The Company does not anticipate selling securities or using available credit facilities to pay losses and LAE but has the ability to do so. Management expects the trend of positive cash flow from operations, which in general reflects the strength of overall pricing over the 2003 and 2004 years, to persist over the near term. However, in the intermediate and long term, the trend continuation will be impacted by the extent to which competitive pressures weaken overall pricing available in the Companys markets and the extent to which the Company successfully implements its strategy of emphasizing profitability over volume should persist.
Effective December 8, 2004, Group, Bermuda Re, and Everest International entered into a new three year, $750 million group credit facility with a syndicate of lenders (Group Credit Facility). Wachovia Bank is the administrative agent for the Group Credit Facility. The Group Credit Facility consists of two tranches. Tranche one provides up to $250 million of revolving credit for liquidity and general corporate purposes, and for the issuance of standby letters of credit. The interest on the revolving loans shall, at the option of each of the borrowers, be either (1) Base Rate Loans (as defined below) or (2) an adjusted London Interbank Offered Rate (LIBOR) plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depend on Groups senior unsecured debt rating.
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Tranche two exclusively provides up to $500 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth amount. Minimum net worth is an amount equal to the sum of (i) $2,373 million plus (ii) (A) 25% of consolidated net income for each of Groups fiscal quarters and (B) 50% of any increase in consolidated net worth attributable to the issuance of ordinary and preferred shares. The base amount is reset at the end of each fiscal year to be the greater of 70% of Groups consolidated net worth as of the last day of the fiscal year and the calculated minimum amount of net worth prior to the last day of the fiscal year. As of December 31, 2004, the Company was in compliance with these covenants.
During the year ended December 31, 2004, there were no borrowings under tranche one of the Group Credit Facility. As of December 31, 2004, the Company has $66.0 million of letters of credit outstanding under tranche two of the Group Credit Facility. In addition, the Company has $284.9 million in letters of credit outstanding at December 31, 2004 under a $300 million bilateral agreement with Citibank. All of these letters of credit are collateralized by the Companys cash and investments. These letters of credit are generally used to collateralize reinsurance assumed by Bermuda Re from jurisdictions where collateralization is generally required for the ceding company to receive credit for such reinsurance recoverables from its principal regulator. Bermuda Re and Everest International also used trust arrangements to provide collateralization to ceding companies, including affiliates. The Company generally avoids providing collateral except where required for ceding companies to receive credit from their regulators. Additionally, at December 31, 2004, $188.9 million of assets were deposited in trust accounts, primarily on behalf of Bermuda Re, as security for reinsurance recoverables of certain non-affiliated ceding companies.
Effective October 10, 2003, Holdings entered into a new three year, $150.0 million senior revolving credit facility with a syndicate of lenders, replacing the December 21, 1999, three year senior revolving credit facility, which expired on December 19, 2003. Both the October 10, 2003 and December 21, 1999 senior revolving credit agreements, which have similar terms, are referred to as the Holdings Credit Facility. Wachovia Bank is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) an adjusted LIBOR plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings senior unsecured debt rating.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $1.0 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions. As of December 31, 2004, the Company was in compliance with these covenants.
During the year ended December 31, 2004, there were payments made of $70.0 million and there were no incremental borrowings made under Holdings Credit Facility. During the year ended December 31, 2003, there were no payments made and no incremental borrowings made under Holdings Credit Facility. During the year ended December 31, 2002, there were payments made of $80 million and new Holdings Credit Facility borrowings of $45 million. As of December 31, 2004 and 2003, there were outstanding Holdings Credit Facility borrowings of $0.0 million and $70.0 million, respectively. Interest expense incurred in connection with these borrowings was $1.2 million, $1.4 million and $3.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.
71
The Companys 2004 total cash flow, as distinguished from its cash flow from operations, activity in 2004 included $320.0 million of new investable cash from Holdings issuance of junior subordinated debt securities in March and $246.7 million of new investable cash from Holdingsissuance of senior notes securities in October. The total cash flow activity in 2003 included $316.8 million of new investable cash resulting from Groups offering of common shares in April. The total cash flow activity in 2002 included $346.3 million of new investable cash resulting from Groups offering of common shares in February and $209.9 million of new investable cash from Holdings issuance of junior subordinated debt securities in November.
EXPOSURE TO CATASTROPHES. As with other reinsurers, the Companys operating results and financial condition can be adversely affected by volatile and unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires and explosions. Any such catastrophic event could generate insured losses in one or many of the Companys treaties or lines of business, including property and/or casualty exposures. Although the Company attempts to limit its exposure to acceptable levels, including through the purchase of reinsurance when considered to be cost effective, it is possible that an actual catastrophic event or multiple catastrophic events could have a material adverse effect on the financial condition, results of operations and cash flows of the Company.
The Company employs various techniques, including licensed modeling software, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the PML. The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Companys greatest catastrophe exposure world wide from any single event is to a U.S. earthquake affecting the west coast including workers compensation exposure where the Company estimates it has a pre-tax PML exposure of $427 million. The Company further estimates that its second largest exposure relates to a hurricane affecting the U.S. east coast with a pre-tax PML of $390 million. There can be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML.
The Company employs a retrocessional approach under which the Company may purchase reinsurance to cover specific business written or exposure accumulations or as a corporate level retrocessional program covering the potential accumulation or aggregation of exposures across some or all of the Companys operations. All reinsurance purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost effective protection. The level of reinsurance coverage varies over time, reflecting the underwriters and/or Companys view of the changing dynamics of both the underlying exposure and the reinsurance markets.
If a single catastrophe were to occur that resulted in $427 million of gross loss and LAE in 2005 (an amount equivalent to the Companys PML including its property and workers compensation exposures), management estimates that the effect on the Companys income before and after taxes would be approximately $427 million and $341 million, respectively. Such impact represents approximately 9.2% of the Companys beginning of year capital. Such estimates involve multiple variables, including which Everest entity would experience the loss, and as a result there can be no assurance that this amount would not be exceeded.
For 2003, 2004 and thus far in 2005, the Company has chosen not to purchase corporate retrocessional protection and to generally de-emphasize the purchase of specific reinsurance by its underwriters, reflecting the Companys view that its exposures, in the context of its capital and financial position and current market pricing, do not warrant reinsurance purchases at current retrocessional price levels. For 1999, 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage, which provided up to
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$175.0 million of recoveries per accident year if Everest Res consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provided for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. There are no remaining limits available under these coverages. See ITEM 1, Business Risk Management and Retrocession Arrangements for further details.
CONTRACTUAL OBLIGATIONS. The following table shows the Companys contractual obligations for the year ended December 31, 2004:
The senior notes and junior subordinated debt contractual obligations are the responsibility of Holdings. While the Company has sufficient cash flow, liquidity, investments and access to capital markets to satisfy these obligations, and in particular has the current liquidity to payoff the 8.5% senior notes maturing in March 2005, Holdings generally depends for its funding upon dividends from Everest Re, its operating insurance subsidiary, capital contributions from Group or access to the capital markets. The Companys various operating insurance and reinsurance subsidiaries have sufficient cash flow, liquidity and investments to settle outstanding reserves for losses and LAE. Management believes that the Company, and each of its entities, have sufficient financial resources, or ready access thereto, to meet all obligations.
DIVIDENDS
During 2004, 2003 and 2002, the
Company declared and paid shareholder dividends of $22.4 million, $19.6 million and $16.3
million, respectively. As an insurance holding company, the Company is partially dependent
on dividends and other permitted payments from its subsidiaries to pay cash dividends to
its shareholders. The payment of dividends to Group by Holdings and to Holdings by Everest
Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by
Bermuda Re is subject to Bermuda insurance regulatory restrictions. Management expects
that, absent extraordinary catastrophe losses, such restrictions should not affect Everest
Res ability to declare and pay dividends sufficient to support Holdings
general corporate needs and Holdings and Bermuda Res ability to declare and
pay dividends sufficient to support Groups general corporate needs. For the years
ended December 31, 2004, 2003 and 2002, Everest Re paid dividends to Holdings of $70
million, $45 million and $85 million, respectively. Bermuda Re paid dividends to Group of
$15 million in 2004. See ITEM 1, Business Regulatory Matters
Dividends and Note 14A of Notes to Consolidated Financial Statements.
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APPLICATION OF NEW ACCOUNTING STANDARDS
In January 2003, FASB issued
Financial Interpretation No. 46, Consolidation of Variable Interest Entities(FIN
46). FIN 46 addresses whether certain types of entities, referred to as variable
interest entities (VIEs), should be consolidated or deconsolidated in a
companys financial statements. During October 2003, the FASB deferred the effective
date of FIN 46 provisions for VIEs created prior to February 1, 2003 to the first
reporting period ending after December 15, 2003. During December 2003, the FASB issued
FIN 46R, replacing FIN 46. FIN 46R is effective, for entities that had not adopted FIN 46
as of December 24, 2003, no later than the end of the first reporting period that ends on
or after March 15, 2004. The Company adopted FIN 46R in the first quarter of 2004,
resulting in the deconsolidation of Everest Re Capital Trust (Capital Trust)
and Everest Re Capital Trust II (Capital
Trust II). For 2003 and 2002, where applicable, the financial statements have been
restated to reflect the deconsolidation.
In March 2004, the Emerging Issue Task Force (EITF) reached a final consensus on Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This issue establishes guidance for determining whether to record impairment losses associated with investments in certain equity and debt securities. The application of this issue was required for reporting periods beginning after June 15, 2004. On September 30, 2004, the FASB issued a FASB Staff Position EITF Issue 03-1-1, which delayed the effective date for the measurement and recognition guidance included in paragraphs 10 through 20 of EITF Issue 03-1. The Company is unable to predict the impact on other-than-temporary impairments until the guidance is finalized. Currently, the Company continues to apply Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), and the Securities and Exchange Commission (SEC)s Staff Accounting Bulletin Topic 5:M, Other Than Temporary Impairment Of Certain Investments In Debt And Equity Securities and believes that unrealized losses in its investment portfolio are temporary in nature.
In December 2004, the Financial accounting Standards Board (FASB) issued FASB Statement 123(R) Share-Based Payment (FAS 123(R)). FAS 123(R) requires all share-based compensation awards granted, modified or settled after December 15, 1994 to be accounted for using the fair value method of accounting. Under the modified prospective application, compensation cost is recognized for the outstanding, non-vested awards based on the grant date fair value of those awards as calculated under FAS 123. The Company does not expect the adoption of the statement to have a material impact on the Companys financial condition or results of operation. The application of this issue will become effective for interim or annual periods beginning after June 15, 2005.
MARKET SENSITIVE INSTRUMENTS
The SECs Financial Reporting
Release #48 requires registrants to clarify and expand upon the existing financial
statement disclosure requirements for derivative financial instruments, derivative
commodity instruments and other financial instruments (collectively, market
sensitive instruments). The Company does not generally enter into market sensitive
instruments for trading purposes.
The Companys current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Companys mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions and the Companys tax position. The fixed maturities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, the Company invests in equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio. The Company has also engaged in a small number of credit default swaps and specialized equity options.
The overall investment strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Companys capital structure and other factors, are used to develop a net liability analysis. This
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analysis includes estimated payout characteristics for which the investments of the Company provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the period, including the acquisition of interest only strips in 2003 and early 2004, which market value increases as interest rates rise and decreases as interest rates fall. The addition of these securities to the portfolio reduced the impact of interest rate shift on the entire portfolio. As interest rates rose during the second quarter of 2004, the Company fully liquidated its interest only strip investment portfolio.
The Companys $11.5 billion investment portfolio at December 31, 2004 is principally comprised of fixed maturity securities, which are subject to interest rate risk and foreign currency rate risk, and equity securities, which are subject to equity price risk. The impact of these risks on the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact.
Interest rate risk is the potential change in value of the fixed maturity portfolio, including short-term investments, due to change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $1,474.0 million of mortgage-backed securities in the $9,947.2 million fixed maturity portfolio. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security.
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The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on the Companys fixed maturity portfolio as of December 31, 2004 and 2003 based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions. In general, for 2003, the lower volatility was attributable to the Companys investments in interest only strips, the effect of which was to reduce overall portfolio duration and therefore sensitivity to interest rate moves.
2004
Interest Rate Shift in Basis Points |
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Total Market Value | $ | 11,798.6 | $ | 11,172.8 | $ | 10,533.0 | $ | 9,882.1 | $ | 9,262.2 | |||||||
Market Value Change from Base (%) | 12.0 | % | 6.1 | % | 0.0 | % | (6.2 | )% | (12.1 | )% | |||||||
Change in Unrealized Appreciation | |||||||||||||||||
After-tax from Base ($) | $ | 936.7 | $ | 472.1 | $ | - | $ | (478.9 | )% | $ | (936.3 | ) |
2003 Interest Rate Shift in Basis Points |
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Total Market Value | $ | 9,858.7 | $ | 9,353.9 | $ | 8,878.7 | $ | 8,483.5 | $ | 8,004.1 | |||||||
Market Value Change from Base (%) | 11.0 | % | 5.4 | % | 0.0 | % | (4.5 | )% | (9.9 | )% | |||||||
Change in Unrealized Appreciation | |||||||||||||||||
After-tax from Base ($) | $ | 713.2 | $ | 341.9 | $ | - | $ | (290.2 | )% | $ | (643.8 | ) |
The Company had $7,836.3 million and $6,361.2 million of reserves for losses and LAE as of December 31, 2004 and December 31, 2003. These amounts are recorded at their nominal or estimated ultimate payment amount, as opposed to fair value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the fair value of the reserves is less than the nominal value. As interest rates rise, the fair value of the reserves decreases and conversely, if interest rates decline, the fair value will increase. These movements are the opposite of the interest rate impacts on the fair value of investments since reserves are future obligations. While the difference between fair value and nominal value is not reflected in the Companys financial statements, the Company financial results will include investment income over time from the investment portfolio until the claims are paid. The Companys loss and loss reserve obligations have an expected duration of approximately 4.5 years, which is reasonably consistent with the Companys fixed income portfolio. If the company were to discount its loss and LAE reserves, net of reinsurance receivable on unpaid losses, the discount would be approximately $1.5 billion resulting in a discounted reserve balance of approximately $5.2 billion, representing approximately 50% of the fixed maturity market value. The existence of such obligations, and the variable differential between ultimate and fair value, which in theory applies equally to invested assets and insurance liability, provides substantial mitigation of the economic effects of interest rate variability even though such mitigation is not reflected in the Companys financial statements.
Foreign currency rate risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of the Companys non-U.S./Bermuda (foreign) operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Generally, the Company prefers to maintain the capital of its operations in U.S. dollar assets, although this
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varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with Financial Accounting Standards Board Statement No. 52, the Company translates the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. As of December 31, 2004, there has been no material change in exposure to foreign exchange rates as compared to December 31, 2003.
The tables below display the potential impact of a parallel 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure in 10% increments as of December 31, 2004 and 2003. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the U.S. dollar reporting currency. The growth in exposure between 2004 and 2003 principally arises from increases in the level of foreign currency investments, which are generally commensurate with changes in the Companys mix of business. All amounts are in U.S. dollars and are presented in millions.
2004
Change in Foreign Exchange Rates in Percent |
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Total After-tax Foreign Exchange Exposure | $ | (180.8) | $ | (95.1) | $ | - | $ | 102.0 | $ | 209.2 |
2003 Change in Foreign Exchange Rates in Percent |
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Total After-tax Foreign Exchange Exposure | $ | (78.5) | $ | (42.1) | $ | - | $ | 46.2 | $ | 95.4 |
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in exchange traded and mutual funds, which invest principally in high quality common and preferred stocks that are traded on the major exchanges in the U.S.. The primary objective in managing the equity portfolio is to provide long-term capital growth through market appreciation and income.
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The tables below display the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 2004 and 2003. The growth in exposure is primarily due to the growth in the equity portfolio. All amounts are in U.S. dollars and are presented in millions.
2004
Change in Equity Values in Percent |
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Market Value of the Equity Portfolio | $ | 520.7 | $ | 585.8 | $ | 650.9 | $ | 716.0 | $ | 781.0 | |||||||
After-tax Change in Unrealized Appreciation | $ | (84.6 | ) | $ | (42.3 | ) | $ | - | $ | 42.3 | $ | 84.6 |
2003 Change in Equity Values in Percent |
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-20% | -10% | 0% | 10% | 20% | |||||||||||||
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Market Value of the Equity Portfolio | $ | 118.3 | $ | 133.1 | $ | 147.9 | $ | 162.7 | $ | 177.5 | |||||||
After-tax Change in Unrealized Appreciation | $ | (16.5 | ) | $ | (8.3 | ) | $ | - | $ | 8.3 | $ | 16.5 |
Although not considered material in the context of the Companys aggregate exposure to market sensitive instruments, the Company has issued five specialized equity put options based on the Standard & Poors 500 (S&P 500) index that are market sensitive and sufficiently unique to warrant supplemental disclosure.
During 2001, the Company sold five specialized equity put options based on the S&P 500 index for total consideration, net of commissions, of $16.9 million. These contracts each have a single exercise date, with maturities ranging from 18 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts will be payable under these contracts if the S&P 500 index is at or above the strike price on the exercise dates. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the December 31, 2004 index value, the Company estimates the probability for each contract of the S&P 500 index being below the strike price on the exercise date to be less than 6.4%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero.
As these specialized equity put options are derivatives within the framework of FAS 133, the Company reports the fair value of these instruments in its balance sheet and records any changes to fair value in its statement of operations. The Company has recorded fair values for its obligations on these specialized equity put options at December 31, 2004 and 2003 of $21.5 million and $16.5 million, respectively; however, the Company does not believe that the ultimate settlement of these transactions is likely to require a payment that would exceed the initial consideration received or any payment at all.
As there is no active market for these instruments, the determination of their fair value is based on an industry accepted option pricing model, which requires estimates and assumptions, including those regarding volatility and expected rates of return.
78
The tables below estimate the impact of potential movements in interest rates and the S&P 500 index, which are the principal factors affecting fair value of these instruments, looking forward from the fair value at December 31, 2004 and 2003. These are estimates and there can be no assurance regarding future market performance. The asymmetrical results of the interest rate and S&P 500 index shifts reflect that the liability cannot fall below zero whereas it can increase to its theoretical maximum.
As of December 31, 2004
S&P 500 Index Put Options Obligation - Sensitivity Analysis (Dollars in millions) |
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Interest Rate Shift in Basis Points: | -100 | -50 | 0 | 50 | 100 | ||||||||||||
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Total Market Value | $ | 33.3 | $ | 26.8 | $ | 21.5 | $ | 17.1 | $ | 13.6 | |||||||
Market Value Change from Base (%) | (55.0 | )% | (24.8 | )% | 0.0 | % | 20.2 | % | 36.6 | % | |||||||
S&P Index Shift in Points: |
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Total Market Value | $ | 28.4 | $ | 24.6 | $ | 21.5 | $ | 18.8 | $ | 16.5 | |||||||
Market Value Change from Base (%) | (32.5 | )% | (14.8 | )% | 0.0 | % | 12.5 | % | 23.0 | % | |||||||
Combined Interest Rate / S&P Index Shift: |
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Total Market Value | $ | 42.9 | $ | 30.5 | $ | 21.5 | $ | 14.9 | $ | 10.2 | |||||||
Market Value Change from Base (%) | (99.6 | )% | (42.2 | )% | 0.0 | % | 30.6 | % | 52.5 | % |
As of December 31, 2003 S&P 500 Index Put Options Obligation - Sensitivity Analysis (Dollars in millions) |
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Interest Rate Shift in Basis Points: | -100 | -50 | 0 | 50 | 100 | ||||||||||||
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Total Market Value | $ | 26.8 | $ | 21.1 | $ | 16.5 | $ | 12.9 | $ | 10.0 | |||||||
Market Value Change from Base (%) | (61.8 | )% | (27.6 | )% | 0.0 | % | 22.1 | % | 39.7 | % | |||||||
S&P Index Shift in Points: |
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Total Market Value | $ | 23.2 | $ | 19.5 | $ | 16.5 | $ | 14.1 | $ | 12.1 | |||||||
Market Value Change from Base (%) | (40.1 | )% | (18.0 | )% | 0.0 | % | 14.7 | % | 26.9 | % | |||||||
Combined Interest Rate / S&P Index Shift: |
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Total Market Value | $ | 36.2 | $ | 24.7 | $ | 16.5 | $ | 10.9 | $ | 7.1 | |||||||
Market Value Change from Base (%) | (118.7 | )% | (49.2 | )% | 0.0 | % | 34.1. | % | 57.3 | % |
SAFE HARBOR DISCLOSURE
This
report contains forward-looking statements within the meaning of the U.S. federal
securities laws. The Company intends these forward-looking statements to be covered by
the safe harbor provisions for forward-looking statements in the federal securities laws.
In some cases, these statements can be identified by the use of forward-looking words
such as may, will, should, could, anticipate,
estimate, expect, plan, believe, predict,
potential and intend. Forward-looking statements contained in
this report include information regarding the Companys reserves for losses and LAE,
the adequacy of the Companys provision for uncollectible balances, estimates of the
Companys catastrophe exposure, the effects of catastrophic events on the Companys
financial statements, the ability of Everest Re, Holdings and Bermuda Re to pay dividends
79
and the settlement costs of the Companys specialized equity put options. Forward-looking statements only reflect the Companys expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Companys expectations. Important factors that could cause the Companys actual events or results to be materially different from the Companys expectations include those discussed below under the caption Risk Factors. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
RISK FACTORS
The following risk factors, in
addition to the other information provided in this report, should be considered when
evaluating the Company. If the circumstances contemplated by the individual risk factors
materialize, the Companys business, financial condition or results of operations
could be materially and adversely affected and the trading price of the Companys
common shares could decline significantly.
RISKS RELATING TO THE COMPANYS BUSINESS
The Companys results could be adversely affected by catastrophic events.
Like all insurance and reinsurance companies, the Company is exposed to unpredictable catastrophic events, including weather-related and other natural catastrophes, as well as acts of terrorism. Any material reduction in the Companys operating results caused by the occurrence of one or more catastrophes could inhibit its ability to pay dividends or to meet its interest and principal payment obligations. The Company defines a catastrophe as an event that causes a pre-tax loss on property exposures before reinsurance of at least $5.0 million, before corporate level reinsurance and taxes. By way of illustration, during the past five calendar years, pre-tax catastrophe losses, net of contract specific reinsurance but before cessions under corporate reinsurance programs, were as follows:
Calendar year | Pre-tax catastrophe losses | ||||
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2004 | $ | 403.0 million | |||
2003 | $ | 36.8 million | |||
2002 | $ | 30.2 million | |||
2001 | $ | 222.6 million | |||
2000 | $ | 13.9 million |
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If the Companys loss reserves are inadequate to meet its actual losses, net income would be reduced or it could incur a loss.
The Company is required to maintain reserves to cover its estimated ultimate liability of losses and loss adjustment expenses for both reported and unreported claims incurred. These reserves are only estimates of what the Company believes the settlement and administration of claims will cost based on facts and circumstances known to it. In setting reserves for its reinsurance liabilities, the Company relies on claim data supplied by its ceding companies and brokers. This information is not always timely or accurate and can result in inaccurate loss projections. Because of the uncertainties that surround estimating loss reserves and LAE, the Company cannot be certain that ultimate losses will not exceed these estimates of losses and loss adjustment reserves. If the Companys reserves are insufficient to cover its actual losses and loss adjustment expenses, the Company would have to augment its reserves and incur a charge to its earnings. These charges could be material. By way of illustration, during the past five calendar years, the reserve re-estimation process affected the Companys net income in the following manner:
Calendar year | Effect on pre-tax net income | |
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2004 | $ | 312.0 million decrease |
2003 | $ | 256.9 million decrease |
2002 | $ | 140.1 million decrease |
2001 | $ | no change |
2000 | $ | 7.8 million decrease |
See ITEM 1, Business Changes in Historical Reserves, which provides a more detailed chart showing the effect of reserve re-estimates on calendar year operating results for the past ten years.
The difficulty in estimating the Companys reserves is increased because loss reserves include reserves for potential A&E liabilities. A&E liabilities are especially hard to estimate for many reasons, including the long waiting periods between exposure and manifestation of any bodily injury or property damage, difficulty in identifying the source of the asbestos or environmental contamination, long reporting delays and difficulty in properly allocating liability for the asbestos or environmental damage. Legal tactics and judicial and legislative developments affecting the scope of insurers liability, which can be difficult to predict, also contribute to uncertainties in estimating reserves for A&E liabilities.
The failure to accurately assess underwriting risk could reduce the Companys net income or generate a net loss.
The Companys success depends on its ability to accurately assess the risks associated with the businesses on which the risk is retained. If the Company fails to accurately assess the risks it retains, it may fail to establish adequate premium rates to cover its losses and LAE. This could reduce the Companys net income and even result in a net loss. Losses may arise from events or exposures that are not anticipated when the coverage is priced. An example of an unanticipated event is the terrorist attacks on September 11, 2001. Neither the magnitude of loss on a single line of business nor the combined impact on several lines of business from an act of terrorism on such a large scale was contemplated when the Company priced its coverages. In addition to unanticipated events, the Company also faces the unanticipated expansion of its exposures, particularly in long-tail liability lines. An example of this is the ongoing expansion of the scope of insurers legal liability for A&E exposures discussed above.
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Decreases in pricing for property and casualty reinsurance and insurance could reduce the Companys net income.
The Company writes primarily property and casualty reinsurance and insurance. The worldwide reinsurance and insurance businesses are highly competitive, yet cyclical by product and market. These cycles, as well as other business, economic and societal trends that influence aggregate supply and demand for property and casualty insurance and reinsurance products, are outside of the Companys control.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased in part due to the relative profitability achieved by many reinsurers over 2002 and 2003 and the attendant buildup of capital in these market participants. However, this profitability and capital buildup varied significantly by participant reflecting the fact that the industry generally still remained exposed to fundamental issues that had negatively impacted its aggregate capacity in 2002 and 2003, including weak investment market conditions and adverse loss emergence. Both of these had tended to depress the industrys aggregate financial performance and perceptions of financial strength of industry participants over this period albeit with significant variation by individual market participant. The industry experienced a record level of catastrophe losses during 2004, particularly in the second half of the year, and it remains unclear whether the aggregate catastrophe losses experienced by the industry will reverse, stop or even moderate the trends toward market softening, particularly as respects property classes. Further discussion of competitive issues can be found in ITEM 1, Business Competition.
If rating agencies downgrade their ratings of the Companys insurance subsidiaries, future prospects for growth and profitability could be significantly and adversely affected.
The Companys insurance company subsidiaries, other than Mt. McKinley, which is in runoff, currently hold an A+ (Superior) financial strength rating from A.M. Best. Everest Re, Bermuda Re and Everest National hold an AA (Very Strong) financial strength rating from Standard & Poors. Everest Re and Bermuda Re hold an Aa3 (Excellent)" financial strength rating from Moodys. Financial strength ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, an unfavorable rating or the lack of a rating of its reinsurers may adversely affect the rating of a company purchasing reinsurance. A downgrade or withdrawal of any of these ratings might adversely affect the Companys ability to market its insurance products and could have a material and adverse effect on future prospects for growth and profitability. During the last five years, no active subsidiary of the Company had experienced financial strength rating downgrade. However, the Company cannot assure that a downgrade will not occur in the future. Consistent with market practice, many of the Companys treaty reinsurance business allows the ceding company to terminate the contract or seek collateralization of the Companys obligations in the event of a rating downgrade below a certain threshold. The termination provision would generally be triggered only if a rating fell below A.M. Bests A- rating level, which is three levels below Everest Res current rating of A+. Everest Re also has more modest exposure to reinsurance contracts that contain provisions for obligatory funding of outstanding liabilities in the event of a rating agency downgrade. That provision would also generally be triggered only if Everest Res rating fell below A.M. Bests A- rating level.
The Companys reinsurers may not satisfy their obligations.
The Company is subject to credit risk with respect to its reinsurers because the transfer of risk to a reinsurer does not relieve it of its liability to the insured. In addition, reinsurers may be unwilling to pay the Company even though they are able to do so. The failure of one or more of the Companys reinsurers to honor their obligations to it in a timely fashion would impact its cash flow and reduce its net income and could cause it to incur a significant loss.
82
If the Company is unable or chooses not to purchase reinsurance and transfer risk to reinsurers, its net income could be reduced or it could incur a net loss in the event of unusual loss experience.
The Company is generally less reliant on the purchase of reinsurance than many of its competitors, in part because of its strategic emphasis on underwriting discipline and management of the cycles inherent in its business. The Company tries to separate its risk taking process from its risk mitigation process in order to avoid developing too great a reliance on reinsurance. Thus, the Company generally evaluates, underwrites, selects and prices its products prior to consideration of reinsurance. However, the Companys underwriters generally consider purchasing reinsurance with respect to specific insurance contracts or programs, and its senior management generally considers purchasing reinsurance with respect to its overall operations, where reinsurance is deemed prudent from a risk mitigation perspective or is expected to have a positive cost/benefit relationship. Since the Company generally purchases reinsurance only when it expects a net benefit, the percentage of business that it reinsures, as indicated in the chart below, varies considerably from year to year, depending on its view of the relationship between cost and expected benefit for the contract period.
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||
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Percentage of ceded written premiums to gross written premiums | 3 | .7% | 5 | .6% | 7 | .3% | 16 | .8% | 12 | .0% |
Changes in the availability and cost of reinsurance, which are subject to market conditions that are outside of the Companys control, have thus reduced to some extent its ability to use reinsurance to tailor the risks it assumes on a contract or program basis or to mitigate or balance exposures across its reinsurance operations. Because the Company has reduced its level of reinsurance purchases, its net income could be reduced in the event of a large unreinsured event or adverse overall experience.
The Companys industry is highly competitive and it may not be able to compete successfully in the future.
The Companys industry is highly competitive and subject to pricing cycles that can be particularly pronounced. The ease of entry for well-capitalized competitors further exacerbates this market cycle. The Company competes on a global basis in the U.S., Bermuda and other international markets. According to Standard & Poors, the Company ranks among the top ten global reinsurance groups where 80% of the market share is concentrated. The top twenty groups in the Companys industry represent 95% of the markets revenues. The leaders in this market are Munich Re, Swiss Re, Berkshire Hathaway, Hannover Re and Employers Re. Relative to the Company, some of these competitors may have greater financial resources, longer operating histories, and extensive business relationships that transcend the industry, any of which can be a significant competitive advantage. Forces outside the industry can also impact the Companys market, including such factors as economic, regulatory, legal, and geophysical. The Company may not be able to compete successfully in the future should there be a significant change to the competitive landscape of its market.
The Company is dependent on its key personnel.
The Companys success has been, and will continue to be, dependent on the ability to retain the services of existing key executive officers and to attract and retain additional qualified personnel in the future. The loss of the services of any key executive officer or the inability to hire and retain other highly qualified personnel in the future could adversely affect the ability of the Company to conduct business. Generally, the Company considers key executive officers to be those individuals who have the greatest influence in setting overall policy and controlling operations: Chairman and Chief Executive Officer, Joseph V. Taranto (age 56), President and Chief Operating Officer, Thomas J. Gallagher (age 56), and Executive Vice President and Chief Financial Officer, Stephen L. Limauro (age 53). Of those three officers, the Company only has an employment contract with Mr. Taranto. That contract has been previously filed with the SEC and was most recently amended on April 18, 2003 to extend Mr. Tarantos term of employment from March 31, 2004 until March 31, 2006. The Company is
83
not aware that any of the above three officers are planning to leave the Company or retire in the near future. The Company does not maintain any key employee insurance on any of its employees.
Special considerations apply to the Companys Bermuda operations. Under Bermuda law, non-Bermudians, other than spouses of Bermudians and individuals holding permanent resident certificates, are not permitted to engage in any gainful occupation in Bermuda without a work permit issued by the Bermuda government. A work permit is only granted or extended if the employer can show that, after a proper public advertisement, no Bermudian, spouse of a Bermudian or individual holding a permanent resident certificate is available who meets the minimum standards for the position. The Bermuda government has announced a policy that places a six-year term limit on individuals with work permits, subject to specified exemptions for persons deemed to be key employees. Currently, all six of the Companys Bermuda-based professional employees who require work permits have been granted permits by the Bermuda government that expire at various times between March 2006 and February 2008. This includes Mark de Saram, the chief executive officer of the Companys Bermuda reinsurance operation. In the event his work permit were not renewed, the Company could lose his services, thereby adversely affecting its ability to conduct its business in Bermuda until it was able to replace him with an individual in Bermuda who did not require a work permit or who was granted the permit.
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The value of the Companys investment portfolio and the investment income it receives from that portfolio could decline as a result of market fluctuations and economic conditions.
A significant portion of the Companys investment portfolio consists of fixed income securities and smaller portions consist of equity securities and other investments. Both the fair market value of these assets and the investment income from these assets fluctuate depending on general economic and market conditions. For example, the fair market value of the Companys fixed income securities generally increases or decreases in an inverse relationship with fluctuations in interest rates. The fair market value of its fixed income securities can also decrease as a result of any downturn in the business cycle that causes the credit quality of those securities to deteriorate. The net investment income that the Company realizes from future investments in fixed income securities will generally increase or decrease with interest rates. Interest rate fluctuations also can cause net investment income from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, to differ from the income anticipated from those securities at the time of purchase. In addition, if issuers of individual investments are unable to meet their obligations, investment income will be reduced and realized capital losses may arise. Because all of the Companys securities are classified as available for sale, changes in the market value of its securities are reflected in its financial statements. Similar treatment is not available for liabilities. As a result, a decline in the value of the securities in the Companys portfolio could reduce its net income or cause it to incur a loss. The following table quantifies the portion of the Companys investment portfolio that consists of fixed income securities, equity securities and investments that carry prepayment risk.
(Dollars in thousands)
Type of Security |
As of
December 31, 2004 |
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Fixed income: | |||||
Mortgage-backed securities | $ | 1,474,006 | |||
Other asset-backed | 248,736 | ||||
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Total asset-backed | 1,722,742 | ||||
Other fixed income | 8,224,430 | ||||
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Total fixed income | 9,947,172 | ||||
Equity securities | 650,871 | ||||
Other invested assets | 161,324 | ||||
Cash and short-term investments | 770,805 | ||||
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Total Investments and Cash | $ | 11,530,172 | |||
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Further discussion of market-sensitive instruments can be found in ITEM 7, Managements Discussion and Analysis of Financial Condition and Results of Operations Market Sensitive Instruments.
The Company may experience foreign currency exchange losses.
The Companys functional currency is the U.S. dollar. However, the Company writes a portion of its business in currencies other than U.S. dollars. During the year ended December 31, 2004, the Company wrote approximately 23.5% of its reinsurance coverages in currencies other than U.S. dollars. The Company also maintains a portion of its investment portfolio in investments denominated in currencies other than U.S. dollars. As of December 31, 2004, the Company maintained approximately 10.7% of its investment portfolio in investments denominated in currencies other than U.S. dollars. Consequently, quarterly exchange rate fluctuations may have a material impact on the Companys quarterly net income. During 2004, 2003, 2002, the impact on the Companys quarterly pre-tax net income from exchange rate fluctuations ranged from a loss of $3.6 million to a gain of $7.8 million. Further discussion of foreign currency rate risk can be found in ITEM 7,
85
Managements Discussion and Analysis of Financial Condition and Results of Operations Market Sensitive Instruments.
RISKS RELATING TO REGULATION
Insurance laws and regulations restrict the Companys ability to operate and any failure to comply with those laws and regulations could have a material adverse effect on its business.
The Company is subject to extensive and increasing regulation under U.S., state and foreign insurance laws. These laws limit the amount of dividends that can be paid to the Company by its operating subsidiaries, impose restrictions on the amount and type of investments that the Company can hold, prescribe solvency, accounting and internal control standards that must be met and maintained and require the Company to maintain reserves. These laws also require disclosure of material intercompany transactions and require prior approval of extraordinary transactions. These extraordinary transactions include declaring dividends from operating subsidiaries that exceed statutory thresholds. These laws also generally require approval of changes of control of insurance companies. The application of these laws could affect the Companys liquidity and ability to pay dividends, interest and other payments on securities, as applicable, and could restrict the ability to expand business operations through acquisitions of new insurance subsidiaries. In addition, the Company cannot assure that it will have or can maintain all required licenses and approvals or that its business fully complies with the wide variety of applicable laws and regulations or the relevant authoritys interpretation of the laws and regulations. If the Company does not have the requisite licenses and approvals or does not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend the Company from carrying on some or all activities or monetarily penalize the Company. These types of actions could have a material adverse effect on the Companys business. To date, no material fine, penalty or restriction has been imposed on the Company for failure to comply with any insurance law or regulation.
Regulatory challenges in the U.S. could adversely affect the ability of Bermuda Re to conduct business.
Bermuda Re does not intend to be licensed or admitted as an insurer or reinsurer in any U.S. jurisdiction. Under current law, Bermuda Re generally will be permitted to reinsure U.S. risks from its office in Bermuda without obtaining those licenses. However, the insurance and reinsurance regulatory framework has become subject to increased scrutiny. In the past, there have been congressional and other initiatives in the U.S. regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate reinsurers domiciled outside the U.S. If Bermuda Re were to become subject to any insurance laws of the U.S. or any U.S. state at any time in the future, it might be required to post deposits or maintain minimum surplus levels and might be prohibited from engaging in lines of business or from writing some types of policies. Complying with those laws could have a material adverse effect on the Companys ability to conduct business in Bermuda and international markets.
Bermuda Re may need to be licensed or admitted in additional jurisdictions to develop its business.
As Bermuda Res business develops, it will monitor the need to obtain licenses in jurisdictions other than Bermuda and the UK where it has an authorized branch in order to comply with applicable law or to be able to engage in additional insurance-related activities. In addition, Bermuda Re may be at a competitive disadvantage in jurisdictions where it is not licensed or does not enjoy an exemption from licensing relative to competitors that are so licensed or exempt from licensing. Bermuda Re may not be able to obtain any additional licenses that it determines are necessary or desirable. Furthermore, the process of obtaining those licenses is often costly and may take a long time.
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Bermuda Res ability to write reinsurance may be severely limited if it is unable to arrange for security to back its reinsurance.
Many jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements without appropriate security. Bermuda Res reinsurance clients typically require it to post a letter of credit or enter into other security arrangements. If Bermuda Re is unable to obtain or maintain a letter of credit facility on commercially acceptable terms or is unable to arrange for other types of security, its ability to operate its business may be severely limited. If Bermuda Re defaults on any letter of credit that it obtains, it may be required to prematurely liquidate a substantial portion of its investment portfolio and other assets pledged as collateral.
RISKS RELATING TO THE COMPANYS SECURITIES
Because of the Companys holding company structure, its ability to pay dividends, interest and principal is dependent on its receipt of dividends, loan payments and other funds from its subsidiaries.
The Company and Holdings are holding companies, each of whose most significant assets consists of the stock of their operating subsidiaries. As a result, each of the Companys and Holdings ability to pay dividends, interest or other payments on its securities in the future will depend on the earnings and cash flows of the operating subsidiaries and the ability of the subsidiaries to pay dividends or to advance or repay funds to it. This ability is subject to general economic, financial, competitive, regulatory and other factors beyond the Companys control. Payment of dividends and advances and repayments from some of the operating subsidiaries are regulated by U.S., state and foreign insurance laws and regulatory restrictions, including minimum solvency and liquidity thresholds. Accordingly, the operating subsidiaries may not be able to pay dividends or advance or repay funds to the Company and Holdings in the future, which could prevent it from paying dividends, interest or other payments on its securities.
Provisions in the Companys bye-laws could have an anti-takeover effect, which could diminish the value of its common shares.
The Companys bye-laws contain provisions that may entrench directors and make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control that a shareholder might consider favorable. The effect of these provisions could be to prevent a shareholder from receiving the benefit from any premium over the market price of our common shares offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our common shares if they are viewed as discouraging takeover attempts in the future.
For example, the Companys bye-laws contain the following provisions that could have an anti-takeover effect:
o | election of directors is staggered, meaning that the members of only one of three classes of directors are selected each year; |
o | shareholders have limited ability to remove directors; |
o | the total voting power of any shareholder owning more than 9.9% of the common shares will be reduced to 9.9% of the total voting power of the common shares; |
o | the board of directors may decline to register any transfer of common shares if it has reason to believe that the transfer would result in: |
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o | any person that is not an investment company beneficially owning more than 5.0% of any class of the issued and outstanding share capital of the Company, |
o | any person holding controlled shares in excess of 9.9% of any class of the issued and outstanding share capital of the Company, or |
o | any adverse tax, regulatory or legal consequences to the Company, any of its subsidiaries or any of its shareholders; |
o | the Company also has the option to redeem or purchase all or part of a shareholders common shares to the extent the board of directors determines it is necessary or advisable to avoid or cure any adverse or potential adverse consequences if: |
o | any person that is not an investment company beneficially owns more than 5.0% of any class of the issued and outstanding share capital of the Company, |
o | any person holds controlled shares in excess of 9.9% of any class of the issued and outstanding share capital of the Company, or |
o | share ownership by any person may result in adverse tax, regulatory or legal consequences to the Company, any of its subsidiaries or any other shareholder. |
The Board of Directors has indicated that it will apply these bye-law provisions in such manner that passive institutional investors will be treated similarly to investment companies. For this purpose, passive institutional investors include all persons who are eligible, pursuant to Rule 13d-1(b)(1) under the U.S. Securities Exchange Act of 1934, to file a short-form statement on Schedule 13G, but excluding any insurance company or any parent holding company or control person of an insurance company.
Applicable insurance laws may also have an anti-takeover effect.
Before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where that insurance company is domiciled. Prior to granting approval of an application to acquire control of a domestic insurance company, a state insurance commissioner will consider such factors as the financial strength of the applicant, the integrity and competence of the applicants board of directors and executive officers, the acquirors plans for changes to the insurance companys board of directors and executive officers, the acquirors plans for the future operations of the insurance company and any anti-competitive results that may arise from the consummation of the acquisition of control. Because any person who acquired control of the Company would thereby acquire indirect control of its insurance company subsidiaries in the U.S., the insurance change of control laws of Delaware, Arizona, California and Georgia would apply to such a transaction. This could have the effect of delaying or even preventing such a change of control.
Investors in the Company may have more difficulty in protecting their interests than investors in a U.S. corporation.
The Companies Act 1981 of Bermuda (the Companies Act), differs in material respects from the laws applicable to U.S. corporations and their shareholders. The following is a summary of material differences between the Companies Act, as modified in some instances by provisions of the Companys bye-laws, and Delaware corporate law that could make it more difficult for investors in the Company to protect their interests than investors in a U.S. corporation. Because the following statements are summaries, they do not address all aspects of Bermuda law that may be relevant to the Company and its shareholders.
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Alternate Directors. The Companys bye-laws provide, as permitted by Bermuda law, that each director may appoint an alternate director, who shall have the power to attend and vote at any meeting of the board of directors or committee at which that director is not personally present and to sign written consents in place of that director. Delaware law does not provide for alternate directors.
Committees of the Board of Directors. The Companys bye-laws provide, as permitted by Bermuda law, that the board of directors may delegate any of its powers to committees that the board appoints, and those committees may consist partly or entirely of non-directors. Delaware law allows the board of directors of a corporation to delegate many of its powers to committees, but those committees may consist only of directors.
Interested Directors. Bermuda law and the Companys bye-laws provide that if a director has a personal interest in a transaction to which the Company is also a party and if the director discloses the nature of this personal interest at the first opportunity, either at a meeting of directors or in writing to the directors, then the Company will not be able to declare the transaction void solely due to the existence of that personal interest and the director will not be liable to the Company for any profit realized from the transaction. In addition, after a director has made the declaration of interest referred to above, he or she is allowed to be counted for purposes of determining whether a quorum is present and to vote on a transaction in which he or she has an interest, unless disqualified from doing so by the chairman of the relevant board meeting. Under Delaware law, an interested director could be held liable for a transaction in which that director derived an improper personal benefit. Additionally, under Delaware law, a corporation may be able to declare a transaction with an interested director to be void unless one of the following conditions is fulfilled:
o | the material facts as to the interested directors relationship or interests are disclosed or are known to the board of directors and the board in good faith authorizes the transaction by the affirmative vote of a majority of the disinterested directors, |
o | the material facts are disclosed or are known to the shareholders entitled to vote on the transaction and the transaction is specifically approved in good faith by the holders of a majority of the voting shares or |
o | the transaction is fair to the corporation as of the time it is authorized, approved or ratified. |
Transactions with Significant Shareholders. As a Bermuda company, the Company may enter into business transactions with its significant shareholders, including asset sales, in which a significant shareholder receives, or could receive, a financial benefit that is greater than that received, or to be received, by other shareholders with prior approval from the Companys board of directors but without obtaining prior approval from the shareholders. In the case of an amalgamation, in which two or more companies join together and continue as a single company, a resolution of shareholders approved by a majority of at least 75% of the votes cast is required in addition to the approval of the board of directors, except in the case of an amalgamation with and between wholly-owned subsidiaries. If the Company were a Delaware corporation, any business combination with an interested shareholder (which, for this purpose, would include mergers and asset sales of greater than 10% of the Companys assets that would otherwise be considered transactions in the ordinary course of business) within a period of three years from the time the person became an interested shareholder would require prior approval from shareholders holding at least 66 2/3% of the Companys outstanding common shares not owned by the interested shareholder, unless the transaction qualified for one of the exemptions in the relevant Delaware statute or the Company opted out of the statute. For purposes of the Delaware statute, an interested shareholder is generally defined as a person who together with that persons affiliates and associates owns, or within the previous three years did own, 15% or more of a corporations outstanding voting shares.
Takeovers. Under Bermuda law, if an acquiror makes an offer for shares of a company and, within four months of the offer, the holders of not less than 90% of the shares that are the subject of the offer tender their shares, the acquiror may give the nontendering shareholders notice requiring them to transfer their shares on the terms of
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the offer. Within one month of receiving the notice, dissenting shareholders may apply to the court objecting to the transfer. The burden is on the dissenting shareholders to show that the court should exercise its discretion to enjoin the transfer. The court will be unlikely to do this unless there is evidence of fraud or bad faith or collusion between the acquiror and the tendering shareholders aimed at unfairly forcing out minority shareholders. Under another provision of Bermuda law, the holders of 95% of the shares of a company (the acquiring shareholders) may give notice to the remaining shareholders requiring them to sell their shares on the terms described in the notice. Within one month of receiving the notice, dissenting shareholders may apply to the court for an appraisal of their shares. Within one month of the courts appraisal, the acquiring shareholders are entitled either to acquire all shares involved at the price fixed by the court or cancel the notice given to the remaining shareholders. If shares were acquired under the notice at a price below the courts appraisal price, the acquiring shareholders must either pay the difference in price or cancel the notice and return the shares thus acquired to the shareholder, who must then refund the purchase price. There are no comparable provisions under Delaware law.
Inspection of Corporate Records. Members of the general public have the right to inspect the public documents of the Company available at the office of the Registrar of Companies and the Companys registered office, both in Bermuda. These documents include the memorandum of association, which describes the Companys permitted purposes and powers, any amendments to the memorandum of association and documents relating to any increase or reduction in the Companys authorized share capital. Shareholders of the Company have the additional right to inspect the Companys bye-laws, minutes of general meetings of shareholders and audited financial statements that must be presented to the annual general meeting of shareholders. The register of shareholders of the Company also is open to inspection by shareholders without charge, and to members of the public for a fee. The Company is required to maintain its share register at its registered office in Bermuda. The Company also maintains a branch register in the offices of its transfer agent in the U.S., which is open for public inspection as required under the Companies Act. The Company is required to keep at its registered office a register of its directors and officers that is open for inspection by members of the public without charge. However, Bermuda law does not provide a general right for shareholders to inspect or obtain copies of any other corporate records. Under Delaware law, any shareholder may inspect or obtain copies of a corporations shareholder list and its other books and records for any purpose reasonably related to that persons interest as a shareholder.
Shareholders Suits. The rights of shareholders under Bermuda law are not as extensive as the rights of shareholders under legislation or judicial precedent in many U.S. jurisdictions. Class actions and derivative actions are generally not available to shareholders under the laws of Bermuda. However, the Bermuda courts ordinarily would be expected to follow English case law precedent, which would permit a shareholder to bring an action in the name of the Company to remedy a wrong done to the Company where the act complained of is alleged to be beyond the corporate power of the Company or illegal or would result in the violation of the Companys memorandum of association or bye-laws. Furthermore, the court would give consideration to acts that are alleged to constitute a fraud against the minority shareholders or where an act requires the approval of a greater percentage of the Companys shareholders than actually approved it. The winning party in an action of this type generally would be able to recover a portion of attorneys fees incurred in connection with the action. Under Delaware law, class actions and derivative actions generally are available to stockholders for breach of fiduciary duty, corporate waste and actions not taken in accordance with applicable law. In these types of actions, the court has discretion to permit the winning party to recover its attorneys fees.
Limitation of Liability of Directors and Officers . The Companys bye-laws provide that the Company and its shareholders waive all claims or rights of action that they might have, individually or in the right of the Company, against any director or officer for any act or failure to act in the performance of that directors or officers duties. However, this waiver does not apply to claims or rights of action that arise out of fraud or dishonesty. This waiver may have the effect of barring claims arising under U.S. federal securities laws. Under Delaware law, a corporation may include in its certificate of incorporation provisions limiting the personal
90
liability of its directors to the corporation or its stockholders for monetary damages for many types of breach of fiduciary duty. However, these provisions may not limit liability for any breach of the duty of loyalty, acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, the authorization of unlawful dividends, stock repurchases or stock redemptions, or any transaction from which a director derived an improper personal benefit. Moreover, these provisions would not be likely to bar claims arising under U.S. federal securities laws.
Indemnification of Directors and Officers. The Companys bye-laws provide that the Company shall indemnify its directors or officers to the full extent permitted by law against all actions, costs, charges, liabilities, loss, damage or expense incurred or suffered by them by reason of any act done, concurred in or omitted in the conduct of the Companys business or in the discharge of their duties. Under Bermuda law, this indemnification may not extend to any matter involving fraud or dishonesty of which a director or officer may be guilty in relation to the Company, as determined in a final judgment or decree not subject to appeal. Under Delaware law, a corporation may indemnify a director or officer who becomes a party to an action, suit or proceeding because of his position as a director or officer if (1) the director or officer acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and (2) if the action or proceeding involves a criminal offense, the director or officer had no reasonable cause to believe his or her conduct was unlawful.
Enforcement of Civil Liabilities. The Company is organized under the laws of Bermuda. Some of its directors and officers may reside outside the U.S. A substantial portion of the Companys assets are or may be located in jurisdictions outside the U.S. A person may not be able to effect service of process within the U.S. on directors and officers of the Company and those experts who reside outside the U.S. A person also may not be able to recover against them or the Company on judgments of U.S. courts or to obtain original judgments against them or the Company in Bermuda courts, including judgments predicated upon civil liability provisions of the U.S. federal securities laws.
Dividends. Bermuda law does not allow a company to declare or pay a dividend, or make a distribution out of contributed surplus, if there are reasonable grounds for believing that the Company, after the payment is made, would be unable to pay its liabilities as they become due, or that the realizable value of the Companys assets would be less, as a result of the payment, than the aggregate of its liabilities and its issued share capital and share premium accounts. The share capital account represents the aggregate par value of the Companys issued shares, and the share premium account represents the aggregate amount paid for issued shares over and above their par value. Under Delaware law, subject to any restrictions contained in the Companys certificate of incorporation, a company may pay dividends out of the surplus or, if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Surplus is the amount by which the net assets of a corporation exceed its stated capital. Delaware law also provides that dividends may not be paid out of net profits at any time when stated capital is less than the capital represented by the outstanding stock of all classes having a preference upon the distribution of assets.
RISKS RELATING TO TAXATION
If U.S. tax law changes, the Companys net income may be reduced.
In the last few years, some members of Congress have expressed concern about U.S. corporations that move their place of incorporation to low-tax jurisdictions. Also, some members of Congress have expressed concern over a competitive advantage that foreign-controlled insurers and reinsurers may have over U.S. controlled insurers and reinsurers due to the purchase of reinsurance by U.S. insurers from affiliates operating in some foreign jurisdictions, including Bermuda. Although the recently enacted legislation, which increases the U.S. tax burden on so-called inverting companies, does not apply to the Company, the Company does not know whether any similar legislation disadvantageous to the Companys Bermuda insurance subsidiaries will ever be
91
enacted into law. If it were enacted, the U.S. tax burden on the Companys Bermuda operations, or on some business ceded from its licensed U.S. insurance subsidiaries to some offshore reinsurers, could be increased. This could reduce the Companys net income.
The Company and/or Bermuda Re may be subject to U.S. corporate income tax, which would reduce the Companys net income.
The income of Bermuda Re is a significant portion of the Companys worldwide income from operations. The Company has established guidelines for the conduct of its Bermuda operations that are designed to ensure that Bermuda Re is not engaged in the conduct of a trade or business in the U.S. Based on its compliance with those guidelines, the Company believes that Bermuda Re should not be required to pay U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the Internal Revenue Service (IRS) successfully contended that Bermuda Re was engaged in a trade or business in the U.S., Bermuda Re would be required to pay U.S. corporate income tax on any income that is subject to the taxing jurisdiction of the U.S., and possibly the U.S. branch profits tax. Even if the IRS successfully contended that Bermuda Re was engaged in a U.S. trade or business, the U.S.-Bermuda tax treaty would preclude the IRS from taxing Bermuda Res income except to the extent that its income were attributable to a permanent establishment maintained by that subsidiary. The Company does not believe that Bermuda Re has a permanent establishment in the U.S. If the IRS successfully contended that Bermuda Re did have income attributable to a permanent establishment in the U.S., Bermuda Re would be subject to U.S. tax on that income.
Based on its compliance with guidelines designed to ensure that it generates only immaterial amounts, if any, of income that is subject to the taxing jurisdiction of the U.S., the Company believes that it should be required to pay only immaterial amounts, if any, of U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the U.S., it would be required to pay U.S. corporate income tax on that income, and possibly the U.S. branch profits tax. Prior to the current year, even if the IRS had successfully contended that the Company had material amounts of income that was subject to the taxing jurisdiction of the U.S., the U.S.-Barbados tax treaty would have precluded the IRS from taxing its income, except to the extent that its income was attributable to a permanent establishment maintained by it in the U.S. Since the Company moved its principal executive offices out of Barbados as of December 31, 2004 and since the United States and Barbados recently made effective a protocol to the U.S.-Barbados tax treaty, which strengthens the limitation of benefits provisions of that treaty, the U.S.-Barbados tax treaty will no longer provide any protection to the Company. Nevertheless, the Company does not believe that it has material amounts of income subject to the taxing jurisdiction of the U.S. If the IRS successfully contended, however, that the Company did have income subject to tax in the U.S. the imposition of tax on that income would reduce the Companys net income.
If Bermuda Re became subject to U.S. income tax on its income or if it became subject to U.S. income tax on more than immaterial amounts of income, its income could also be subject to the U.S. branch profits tax. In that event, the Company and Bermuda Re would be subject to taxation at a higher combined effective rate than if they were organized as U.S. corporations. The combined effect of the 35% U.S. corporate income tax rate and the 30% branch profits tax rate is a net tax rate of 54.5%. The imposition of these taxes would reduce the Companys net income.
The Organization for Economic Cooperation and Development and the European Union are considering measures that might increase the Companys taxes and reduce our net income.
A number of multinational organizations, including the Organization for Economic Cooperation and Development (the OECD), have recently identified some countries as not participating in adequate information exchange, engaging in harmful tax practices or not maintaining adequate controls to prevent
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corruption, such as money laundering activities. The OECD has threatened non-member jurisdictions that do not agree to cooperate with the OECD with punitive sanctions by OECD member countries, though specific sanctions have yet to be adopted by OECD member countries. It is as yet unclear as to what these sanctions will be, who will adopt them and when or if they will be imposed. The OECD published a list of uncooperative tax havens, which are those jurisdictions from whom the OECD has not received commitments to the OECDs principles of regulatory and tax transparency and effective exchange of information. The government of Bermuda has made these commitments. As a result, Bermuda is not currently listed as an uncooperative tax haven. However, it is possible that the OECD could change its view in the future and decide to list Bermuda as an uncooperative tax haven, or that one of the other multinational organizations could take a different view from the OECD and decide to recommend sanctions against Bermuda. Any sanctions imposed on Bermuda could increase the Companys taxes and reduce its net income. In addition, the Company is not able to predict what changes will arise from the commitments given to the OECD by the government of Bermuda or whether those changes will subject it to additional taxes.
The Company and/or Bermuda Re may become subject to Bermuda tax, which would reduce the Companys net income.
The Company and Bermuda Re currently are not subject to income or capital gains taxes in Bermuda. Both companies have received an assurance from the Bermuda Minister of Finance under The Exempted Undertakings Tax Protection Act 1966 of Bermuda to the effect that if any legislation is enacted in Bermuda that imposes any tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then that tax will not apply to them or to any of the Companys operations or its shares, debentures or other obligations until March 28, 2016. This assurance does not prevent the application of any of those taxes to persons ordinarily resident in Bermuda and does not prevent the imposition of any tax payable in accordance with the provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation to any land leased to the Company or Bermuda Re. There are currently no procedures for extending these assurances. As a result, the Company and Bermuda Re could be subject to taxes in Bermuda after March 28, 2016, which could reduce the Companys net income.
The Companys net income will be reduced if U.S. excise and withholding taxes are increased.
Bermuda Re is subject to an excise tax on reinsurance and insurance premiums it collects with respect to risks located in the U.S. In addition, Bermuda Re may be subject to withholding tax on dividend income from U.S. sources. These taxes could increase and other taxes could be imposed in the future on Bermuda Res business, which could reduce the Companys net income.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
See Market Sensitive Instruments in ITEM 7.
ITEM 8. Financial Statements and Supplementary Data
The financial statements and schedules listed in the accompanying Index to Financial Statements and Schedules on page F-1 are filed as part of this report.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934 (the Exchange Act), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Managements Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal controls over financial reporting. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework . Based on our assessment we concluded that, as of December 31, 2004, the Companys internal control over financial reporting is effective based on those criteria.
Managements assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, the Companys independent registered public accounting firm, as stated in their report in Part IV, Item 15, Report of Independent Registered Public Accounting Firm.
Changes in Internal Control over Financial Reporting
As required by Rule 13a-15(d) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated our internal control over financial reporting to determine whether any changes occurred during the fourth fiscal quarter covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the fourth quarter.
ITEM 9B.
Other
Information
None.
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PART III
ITEM 10.
Directors and Executive
Officers of the Registrant
Reference is made to the sections captioned Election of Directors, Information Concerning Nominees, Information Concerning Continuing Directors and Executive Officers, Compliance with Section 16(a) of the Exchange Act and Code of Ethics for CEO and Senior Financial Officers in the Companys proxy statement for the 2004 Annual General Meeting of Shareholders, which will be filed with the Commission within 120 days of the close of the Companys fiscal year ended December 31, 2004 (the Proxy Statement), which sections are incorporated herein by reference.
ITEM 11. Executive Compensation
Reference is made to the sections captioned Directors Compensation and Compensation of Executive Officers in the Proxy Statement, which are incorporated herein by reference, except that the Compensation Committee Report and the Performance Graph are not so incorporated.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Reference is made to the sections captioned Common Share Ownership by Directors and Executive Officers, Principal Holders of Common Shares and Equity Compensation Plans in the Proxy Statement, which are incorporated herein by reference.
ITEM 13. Certain Relationships and Related Transactions
Reference is made to the section captioned Certain Transactions with Directors in the Proxy Statement, which is incorporated herein by reference.
ITEM 14. Principal Accountant Fees and Services
Reference is made to the section captioned Audit Committee Report in the Proxy Statement, which is incorporated herein by reference.
PART IV
ITEM 15.
Exhibits and Financial
Statement Schedules
Financial Statements and Schedules
The financial statements and
schedules listed in the accompanying Index to Financial Statements and Schedules on page
F-1 are filed as part of this report.
Exhibits
The exhibits listed on the
accompanying Index to Exhibits on page E-1 are filed as part of this report except that
the certifications in Exhibit 32 are being furnished to the SEC, rather than filed with
the SEC, as permitted under applicable SEC rules.
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Reports on Form 8-K
A report
on Form 8-K was furnished on October 1, 2004, under Item 7.01, relating to the Companys
October 1, 2004 news release announcing its estimated losses from Florida hurricanes.
A report on Form 8-K was furnished on October 7, 2004, under Item 7.01, relating to the Companys October 7, 2004 news release announcing the pricing on October 6, 2004 of a Senior Note Offering by its wholly owned subsidiary, Everest Reinsurance Holdings, Inc.
A report on Form 8-K was filed on October 14, 2004, under Item 1.01, 1.02 and 7.01, relating to executive changes at Everest Reinsurance (Bermuda), Ltd.
A report on Form 8-K was furnished on October 19, 2004, under Item 2.02, relating to the Companys October 18, 2004 news release setting forth its third quarter 2004 earnings.
A report on Form 8-K was furnished on November 5, 2004, under Item 7.01, clarifying the application of certain types of passive investors of the share transfer restrictions and share repurchase rights contained in the registrants Bye-Laws.
A report on Form 8-K was filed on December 14, 2004, under Item 1.01 and 2.03, containing the Credit Agreement dated December 8, 2004 among the Company and two of its subsidiaries with Wachovia Bank, N.A. and a syndicate of lenders and an amendment to the employment agreement with Mark de Saram.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 15, 2005.
EVEREST RE GROUP, LTD. | |
By: /s/ JOSEPH V. TARANTO |
|
Joseph V. Taranto | |
(Chairman and Chief Executive Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ JOSEPH V. TARANTO Joseph V. Taranto |
Chairman and Chief Executive Officer and Director (Principal Executive Officer) |
March 15, 2005 |
/s/ STEPHEN L. LIMAURO Stephen L. Limauro |
Executive Vice President and Chief Financial Officer (Principal Financial Officer) |
March 15, 2005 |
/s/ KEITH T. SHOEMAKER Keith T. Shoemaker |
Comptroller (Principal Accounting Officer) |
March 15, 2005 |
/s/ MARTIN ABRAHAMS Martin Abrahams |
Director |
March 15, 2005 |
/s/ KENNETH J. DUFFY Kenneth J. Duffy |
Director |
March 15, 2005 |
/s/ JOHN R. DUNNE John R. Dunne |
Director |
March 15, 2005 |
/s/ THOMAS J. GALLAGHER Thomas J. Gallagher |
Director |
March 15, 2005 |
/s/ WILLIAM F. GALTNEY, JR. William F. Galtney, Jr. |
Director |
March 15, 2005 |
/s/ JOHN A. WEBER John A. Weber |
Director |
March 15, 2005 |
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INDEX TO FINANCIAL STATEMENTS AND SCHEDULES | ||
Everest Re Group, Ltd. |
Pages | |
Report of Independent Registered Public Accounting Firm |
F-2 |
|
Consolidated Balance Sheets at December 31, 2004 and 2003 |
F-4 |
|
Consolidated Statements of Operations and Comprehensive Income for the Years Ended |
||
December 31, 2004, 2003 and 2002 | F-5 | |
Consolidated Statements of Changes in Shareholders Equity for the Years Ended |
||
December 31, 2004, 2003 and 2002 | F-6 | |
Consolidated Statements of Cash Flows for the Years Ended |
||
December 31, 2004, 2003 and 2002 | F-7 | |
Notes to Consolidated Financial Statements |
F-8 | |
Schedules | ||
I Summary of Investments Other Than Investments in Related Parties at |
||
December 31, 2004 | S-1 | |
II Condensed Financial Information of Registrant: Balance Sheets as of December 31, 2004 and 2003 |
S-2 | |
Statements of Operations for the Years Ended December 31, 2004, 2003 and 2002 |
S-3 | |
Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002 |
S-4 | |
III Supplementary Insurance Information as of December 31, 2004 and 2003 |
||
and for the Years Ended December 31, 2004, 2003 and 2002 | S-5 | |
IV Reinsurance for the Years Ended December 31, 2004, 2003 and 2002 |
S-6 |
Schedules other than those listed above are omitted for the reason that they are not applicable or the information is otherwise contained in the Financial Statements.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Shareholders
of Everest Re Group, Ltd.:
We have completed an integrated audit of Everest Re Group, Ltd.s 2004 consolidated financial statements and of its internal control over financial reporting as of 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedules
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Everest Re Group, Ltd. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, managements assessment, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control- Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes
F-2
in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
New York, New York
March 11, 2005
F-3
F-4
F-5
F-6
F-7
EVEREST RE GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Business and Basis of
Presentation
Everest Re Group, Ltd.
(Group), a Bermuda company, was established in 1999 as a wholly-owned
subsidiary of Everest Reinsurance Holdings, Inc. (Holdings). On February 24,
2000, a corporate restructuring was completed and Group became the new parent holding
company of Holdings. Holders of shares of common stock of Holdings automatically became
holders of the same number of common shares of Group. Prior to the restructuring, Group
had no significant assets or capitalization and had not engaged in any business or prior
activities other than in connection with the restructuring. Group, through its
subsidiaries, principally provides reinsurance and insurance in the U.S., Bermuda and
international markets. As used in this document, the Company means Group and
its subsidiaries, except when referring to periods prior to February 24, 2000, when it
means Holdings and its subsidiaries. Prior to December 31, 2004, Groups principal
executive office was located in Barbados. On December 31, 2004 the Company effectively
closed its principal executive office in Barbados and established its principal executive
office in Bermuda.
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America. The statements include the following domestic and foreign direct and indirect subsidiaries of Group: Holdings, Everest Reinsurance (Bermuda), Ltd. (Bermuda Re), Everest International Reinsurance, Ltd. (Everest International), formerly AFC Re Ltd., Mt. McKinley Insurance Company (Mt. McKinley), formerly Gibraltar Casualty Company, Everest Global Services, Inc. (Global Services), Everest Advisors (UK), Ltd., Everest Advisors (Ireland) Limited, Everest Re Advisors, Ltd., Everest Reinsurance Company (Everest Re), Everest National Insurance Company (Everest National), Everest Indemnity Insurance Company (Everest Indemnity), Everest Re Holdings, Ltd. (Everest Ltd.), Everest Security Insurance Company (Everest Security), formerly Southeastern Security Insurance Company, Everest Insurance Company of Canada (Everest Canada), Mt. McKinley Managers, L.L.C. (Managers), Workcare Southeast, Inc. (Workcare Southeast), and Workcare Southeast of Georgia, Inc. (Workcare Georgia). All amounts are reported in U.S. dollars.
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (and disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
B. Investments
Fixed maturity
investments are all classified as available for sale. Unrealized appreciation and
depreciation, as a result of temporary changes in market value during the period, are
reflected in shareholdersequity, net of income taxes in accumulated other
comprehensive income. Equity securities are carried at market value with unrealized
appreciation or depreciation, as a result of temporary changes in market value during the
period, are reflected in shareholders equity, net of income taxes in accumulated
other comprehensive income. Unrealized losses on fixed maturities and equity
securities, which are deemed other than temporary, are charged to net income as realized
capital losses. Short-term investments are stated at cost, which approximates market
value. Realized gains or losses on sale of investments are determined on the basis of
identified cost. For non-publicly traded securities, market prices are determined through
the use of pricing models that evaluate securities relative to the U.S. Treasury yield
curve, taking into account the issue type, credit quality and cash flow characteristics
of
F-8
each security. For publicly traded securities, market value is based on quoted market prices. Retrospective adjustments are employed to recalculate the values of loan-backed and asset-backed securities. Each acquisition lot is reviewed to recalculate the effective yield. The recalculated effective yield is used to derive a book value as if the new yield were applied at the time of acquisition. Outstanding principal factors from the time of acquisition to the adjustment date are used to calculate the prepayment history for all applicable securities. Conditional prepayment rates, computed with life to date factor histories and weighted average maturities, are used to affect the calculation of projected and prepayments for pass through security types. Other invested assets include limited partnerships and rabbi trusts. Limited partnerships are valued pursuant to the equity method of accounting, which management believes approximates market value. The Supplemental Retirement Plan Rabbi Trust, the Deferred Compensation Plan Rabbi Trust and the Supplemental Savings Plan Rabbi Trust are carried at market value. Cash includes cash and bank time deposits with original maturities of ninety days or less.
C. Uncollectible
Receivable Balances
The Company provides reserves for
uncollectible reinsurance balances based on managements assessment of the
collectibility of the outstanding balances. Such reserves were $37.1 million at December
31, 2004 and $33.6 million at December 31, 2003. See also Note 11.
D. Deferred Acquisition
Costs
Acquisition costs, consisting
principally of commissions and brokerage expenses and certain premium taxes and fees
associated with the Companys reinsurance and insurance business incurred at the time
a contract or policy is issued, are deferred and amortized over the period in which the
related premiums are earned, generally one year. Deferred acquisition costs are limited to
their estimated realizable value based on the related unearned premiums, anticipated
claims and claim expenses and anticipated investment income. Deferred acquisition costs
amortized to income were $975.2 million, $863.9 million and $551.8 million in 2004, 2003
and 2002, respectively.
The present value of in force annuity business is included in deferred acquisition costs. This value is amortized over the expected life of the business at the time of acquisition. The amortization each year will be a function of the gross profits each year in relation to the total gross profits expected over the life of the business, discounted at an assumed net credit rate.
E. Reserve for Losses and
Loss Adjustment Expenses
The reserve for losses and loss
adjustment expenses (LAE) is based on individual case estimates and reports
received from ceding companies. A provision is included for losses and LAE incurred but
not reported (IBNR) based on past experience. A provision is also included for
certain potential liabilities relating to asbestos and environmental (A&E)
exposures, which liabilities cannot be estimated with traditional reserving techniques.
See also Note 3. The reserves are reviewed continually and any changes in estimates are
reflected in earnings in the period the adjustment is made. Management believes that
adequate provision has been made for the Companys losses and LAE. Loss and LAE
reserves are presented gross of reinsurance receivables and incurred losses and LAE are
presented net of ceded reinsurance.
Accruals for contingent commission liabilities are established for reinsurance contracts that provide for the stated commission percentage to increase or decrease based on the loss experience of the contract. Changes in the estimated liability for such arrangements are recorded as contingent commissions. Accruals for contingent commission liabilities are determined through the review of the contracts that have these adjustable features and are estimated based on expected loss and LAE.
F-9
F. Future Policy Benefit
Reserve
Liabilities for future policy benefits
on annuity policies are carried at their accumulated values. Reserves for policy benefits
include both mortality and morbidity claims in the process of settlement and IBNR claims.
Interest rate assumptions used to estimate liabilities for policy benefits range from 4.0%
to 7.3%. Actual experience in a particular period may vary.
G. Premium Revenues
Written premiums are earned ratably
over the periods of the related insurance and reinsurance contracts or policies. Unearned
premium reserves are established to cover the remainder of the unexpired contract period.
Such reserves are established based upon reports received from ceding companies or
computed using pro rata methods based on statistical data. Written and earned premiums,
and the related costs, which have not yet been reported to the Company are estimated and
accrued. Premiums are net of ceded reinsurance.
Annuity premiums are recognized as revenue over the premium-paying period of the policies.
H. Income Taxes
Holdings and its wholly-owned
subsidiaries file a consolidated U.S. federal income tax return. Foreign branches of
subsidiaries file local tax returns as required. Group and its other subsidiaries, not
included in Holdings consolidated tax return, file separate company U.S. federal
income tax returns, where required. The UK branch of Bermuda Re files a UK income tax
return. Deferred income taxes have been recorded to recognize the tax effect of temporary
differences between the financial reporting and income tax bases of assets and
liabilities.
I. Foreign Currency
Assets and liabilities relating to
foreign operations are translated into U.S. dollars at the exchange rates in effect at the
balance sheet date; revenues and expenses are translated into U.S. dollars using average
exchange rates. Gains and losses resulting from translating foreign currency financial
statements, net of deferred income taxes, are excluded from net income and accumulated in
shareholders equity. Gains and losses resulting from foreign currency transactions
are recorded through the statement of operations.
J. Earnings per Share
Basic earnings per share are
calculated by dividing net income by the weighted average number of common shares
outstanding. Diluted earnings per share reflect the potential dilution that could occur if
options granted under various stock-based compensation plans were exercised resulting in
the issuance of common shares that then shared in the earnings of the entity. See also
Note 16.
F-10
Net income per common share has been computed below, based upon weighted average common and dilutive shares outstanding.
(Dollars in thousands, except per share amounts) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Net income (numerator) |
$ | 494,858 | $ | 426,028 | $ | 231,303 | |||||
|
|
|
|||||||||
Weighted average common and effect of | |||||||||||
dilutive shares used in the computation | |||||||||||
of net income per share: | |||||||||||
Weighted average shares outstanding | |||||||||||
- basic (denominator) | 55,929 | 54,023 | 50,325 | ||||||||
Effect of dilutive shares | 897 | 987 | 814 | ||||||||
|
|
|
|||||||||
Weighted average shares outstanding | |||||||||||
- diluted (denominator) | 56,826 | 55,010 | 51,139 | ||||||||
|
|
|
|||||||||
Net income per common share: | |||||||||||
Basic | $ | 8.85 | $ | 7.89 | $ | 4.60 | |||||
Diluted | $ | 8.71 | $ | 7.74 | $ | 4.52 |
All options to purchase common shares outstanding at the end of 2004 were included in the computation of earnings per diluted share because the average market price of the common shares was greater than the options exercise price at the end of 2004. Options to purchase 247,956 common shares at prices ranging from $70.18 to $73.615 per share and 212,000 common shares at prices ranging from $63.31 to $70.18 per share were outstanding at the end of 2003 and 2002, respectively, but were not included in the computation of earnings per diluted share for the respective years because the options exercise price was greater than the average market price of the common shares at the end of such years. All outstanding options expire on or between October 6, 2005 and September 21, 2014.
K. Segmentation
The Company,
through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance,
Specialty Underwriting, International and Bermuda. See also Note 18.
L. Derivatives
The Company has remaining in its
product portfolio one credit default swap, which it no longer offers, and five specialized
equity put options. These products meet the definition of a derivative under Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities (FAS 133). The Companys position in these
contracts is unhedged and is accounted for as a derivative in accordance with FAS 133.
Accordingly, these contracts are carried at fair value and are recorded in Other
liabilities in the consolidated balance sheets and changes in fair value are
recorded in the consolidated statements of operations and comprehensive income.
M. Deposit Assets and Liabilities
In the normal course of its operations, the Company may enter into contracts that do
not meet the risk transfer provisions of Statement of Financial Accounting Standards No.
113, Accounting and Reporting for Reinsurance of Short Duration and Long Duration
Contracts. Such contracts are accounted for using the deposit accounting method.
For such contracts, the Company originally records deposit liabilities for an amount
equivalent to the assets received. Actuarial studies are used to estimate the final
liabilities under such contracts with any change reflected in the consolidated statements
of operations and comprehensive income.
F-11
N. Stock-based Employee
Compensation
Prior to 2002, the Company accounted for its stock-based employee
compensation plans (See Note 16) under the recognition and measurement provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. Effective January 1, 2002, the
Company adopted the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (FAS
123) prospectively to all employee awards granted, modified or settled after
January 1, 2002.
Had the compensation cost for the Companys stock-based compensation plans been determined based on the fair value at the grant dates for awards prior to January 1, 2002 under those plans consistent with the method of FAS 123, the Companys net income and earnings per share would have been reduced to the pro forma amounts indicated below:
(Dollar values in thousands, except per share amounts) | 2004 | 2003 | 2002 | |||||||||||
|
|
|
||||||||||||
Net income | As reported | $ | 494,858 | $ | 426,028 | $ | 231,303 | |||||||
Pro forma | $ | 493,931 | $ | 424,063 | $ | 227,249 | ||||||||
Earnings per share - basic | As reported | $ | 8.85 | $ | 7.89 | $ | 4.60 | |||||||
Pro forma | $ | 8.83 | $ | 7.85 | $ | 4.52 | ||||||||
Earnings per share - diluted | As reported | $ | 8.71 | $ | 7.74 | $ | 4.52 | |||||||
Pro forma | $ | 8.69 | $ | 7.70 | $ | 4.44 |
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yields ranging from 0.5% to 0.9%, (ii) expected volatility ranging from 32.9% to 45.8%, (iii) risk-free interest rates ranging from a low of 4.7% to a high of 7.0% and (iv) expected life of 7.3-7.5 years.
O. Policyholder Dividends
The
Company issues certain insurance policies with dividend payment features. These
policyholders share in the operating results of their respective policies in the form of
dividends declared. Dividends to policyholders are accrued during the period in which the
related premiums are earned and are determined based on the terms of the individual
policies.
P. Application of New Accounting
Standards
In January 2003, FASB issued Financial Interpretation No. 46, Consolidation
of Variable Interest Entities(FIN 46). FIN 46 addresses whether certain
types of entities, referred to as variable interest entities (VIEs), should
be consolidated or deconsolidated in a companys financial statements. During
October 2003, the FASB deferred the effective date of FIN 46 provisions for VIEs created
prior to February 1, 2003 to the first reporting period ending after December 15, 2003.
During December 2003, the FASB issued FIN 46R, replacing FIN 46. FIN 46R is effective,
for entities that had not adopted FIN 46 as of December 24, 2003, no later than the end
of the first reporting period that ends on or after March 15, 2004. The Company adopted
FIN 46R in the first quarter of 2004, resulting in the deconsolidation of Everest Re
Capital Trust (Capital Trust) and Everest Re Capital Trust II (Capital
Trust II). For 2003 and 2002, where applicable, the financial statements have been
restated to reflect the deconsolidation.
In March 2004, the Emerging Issue Task Force (EITF) reached a final consensus on Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This issue establishes guidance for determining whether to record impairment losses associated with investments in certain equity and debt securities. The application of this issue was required for reporting periods beginning after June 15, 2004. On September 30, 2004, the FASB issued a FASB Staff Position EITF Issue 03-1-1, which delayed the effective date for the measurement and recognition guidance included in paragraphs 10 through 20 of EITF Issue 03-1.
F-12
The Company is unable to predict the impact on other-than-temporary impairments until the guidance is finalized. Currently, the Company continues to apply Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), and the Securities and Exchange Commission (SEC)s Staff Accounting Bulletin Topic 5:M, Other Than Temporary Impairment Of Certain Investments In Debt And Equity Securities and believes that unrealized losses in its investment portfolio are temporary in nature.
In December 2004, the Financial accounting Standards Board (FASB) issued FASB Statement 123(R) Share-Based Payment (FAS 123(R)). FAS 123(R) requires all share-based compensation awards granted, modified or settled after December 15, 1994 to be accounted for using the fair value method of accounting. Under the modified prospective application, compensation cost is recognized for the outstanding, non-vested awards based on the grant date fair value of those awards as calculated under FAS 123. The Company does not expect the adoption of the statement to have a material impact on the Companys financial condition or results of operation. The application of this issue will become effective for interim or annual periods beginning after June 15, 2005.
Q. Investments Interest
Only Strips
Commencing with the second quarter of 2003 and through the second quarter
of 2004, the Company had investments in interest only strips of mortgage-backed
securities (interest only strips). These securities give the holder the right
to receive interest payments at a stated coupon rate on an underlying pool of mortgages.
The interest payments on the outstanding mortgages are guaranteed by entities generally
rated AAA. The ultimate cash flow from these investments is primarily dependent upon the
average life of the mortgage pool. Generally, as market interest rates and, more
specifically, market mortgage rates decline, mortgagees tend to refinance which will
decrease the average life of a mortgage pool and decrease expected cash flows.
Conversely, as market interest rates and, more specifically, mortgage rates rise,
repayments will slow and the ultimate cash flows will tend to rise. Accordingly, the
market value of these investments tends to increase as general interest rates rise and
decline as general interest rates fall. These movements are generally counter to the
impact of interest rate movements on the Companys other fixed income investments.
As interest rates rose during the second quarter of 2004, the Company fully liquidated
its interest only strip investment portfolio.
The Company accounted for its investment in interest only strips in accordance with EITF No. 99-20, Recognition of Interest Income and Impairment on Purchases and Beneficial Interests in Securitized Financial Assets(EITF 99-20). EITF 99-20 sets forth the rules for recognizing interest income on all credit-sensitive mortgage and asset-backed securities and certain prepayment-sensitive securities, including agency interest only strips, whether purchased or retained in securitization, as well as the rules for determining when these securities must be written down to fair value because of impairment. EITF 99-20 requires decreases in the valuation of residual interests in securitizations to be recorded as a reduction to the carrying value of the residual interests through a charge to earnings, rather than an unrealized loss in shareholders equity, when any portion of the decline in fair value is attributable to, as defined by EITF 99-20, an impairment loss. This portfolio was liquidated during the second quarter of 2004. The Company recorded realized capital losses due to impairments of $49.7 million, net of income tax benefit of $15.4 million for the year ended December 31, 2004 and realized capital losses due to impairments of $37.3 million, net of income tax benefit of $8.8 million for the year ended December 31, 2003. As a result of liquidating the interest only strip investment portfolio during the second quarter of 2004, the Company recognized realized capital gains of $91.0 million, net of income taxes of $27.2 million.
F-13
2. INVESTMENTS
The amortized cost, market value, and gross unrealized appreciation and depreciation of fixed maturity investments and equity securities are presented in the tables below:
Amortized | Unrealized | Unrealized | Market | |||||||||||
(Dollars in thousands) | Cost | Appreciation | Depreciation | Value | ||||||||||
|
|
|
|
|||||||||||
As of December 31, 2004 | ||||||||||||||
Fixed maturities - available for sale | ||||||||||||||
U.S. Treasury securities and | ||||||||||||||
obligations of U.S. government | ||||||||||||||
agencies and corporations | $ | 184,070 | $ | 2,130 | $ | 774 | $ | 185,426 | ||||||
Obligations of U.S. states | ||||||||||||||
and political subdivisions | 3,281,442 | 160,186 | 2,306 | 3,439,322 | ||||||||||
Corporate securities | 3,211,693 | 137,433 | 17,669 | 3,331,457 | ||||||||||
Mortgage-backed securities | 1,468,793 | 13,286 | 8,073 | 1,474,006 | ||||||||||
Foreign government securities | 921,498 | 31,225 | 625 | 952,098 | ||||||||||
Foreign corporate securities | 542,121 | 24,610 | 1,868 | 564,863 | ||||||||||
|
|
|
|
|||||||||||
Total fixed maturities | $ | 9,609,617 | $ | 368,870 | $ | 31,315 | $ | 9,947,172 | ||||||
|
|
|
|
|||||||||||
Equity securities | $ | 571,717 | $ | 79,154 | $ | - | $ | 650,871 | ||||||
|
|
|
|
|||||||||||
As of December 31, 2003 |
||||||||||||||
Fixed maturities - available for sale | ||||||||||||||
U.S. Treasury securities and | ||||||||||||||
obligations of U.S. government | ||||||||||||||
agencies and corporations | $ | 151,969 | $ | 6,017 | $ | 600 | $ | 157,386 | ||||||
Obligations of U.S. states | ||||||||||||||
and political subdivisions | 2,798,386 | 156,390 | 3,143 | 2,951,633 | ||||||||||
Corporate securities | 2,969,232 | 172,654 | 24,824 | 3,117,062 | ||||||||||
Mortgage-backed securities | 1,369,214 | 26,735 | 12,618 | 1,383,331 | ||||||||||
Foreign government securities | 708,119 | 24,567 | 2,060 | 730,626 | ||||||||||
Foreign corporate securities | 360,803 | 26,468 | 423 | 386,848 | ||||||||||
|
|
|
|
|||||||||||
Total fixed maturities | $ | 8,357,723 | $ | 412,831 | $ | 43,668 | $ | 8,726,886 | ||||||
|
|
|
|
|||||||||||
Equity securities | $ | 146,407 | $ | 7,975 | $ | 1 | $ | 154,381 | ||||||
|
|
|
|
F-14
The amortized cost and market value of fixed maturities are shown in the following table by contractual maturity. Mortgage-backed securities generally are more likely to be prepaid than other fixed maturities. As the stated maturity of such securities may not be indicative of actual maturities, the total for mortgage-backed securities is shown separately.
December 31, 2004 | ||||||||
|
|
|||||||
(Dollars in thousands) |
Amortized
Cost |
Market
Value |
||||||
|
|
|||||||
Fixed maturities - available for sale | ||||||||
Due in one year or less | $ | 280,230 | $ | 283,443 | ||||
Due after one year through five years | 1,854,984 | 1,917,764 | ||||||
Due after five years through ten years | 2,425,939 | 2,499,801 | ||||||
Due after ten years | 3,579,671 | 3,772,158 | ||||||
Mortgage-backed securities | 1,468,793 | 1,474,006 | ||||||
|
|
|||||||
Total | $ | 9,609,617 | $ | 9,947,172 | ||||
|
|
Proceeds from sales of fixed maturity investments during 2004, 2003 and 2002 were $1,451.2 million, $1,219.0 million and $2,029.1 million, respectively. Gross gains of $163.8 million, $49.9 million and $91.9 million and gross losses of $8.3 million, $16.8 million and $41.3 million were realized on those fixed maturity sales during 2004, 2003 and 2002, respectively. Proceeds from sales of equity security investments during 2004, 2003 and 2002 were $18.0 million, $8.1 million and $19.9 million, respectively. Gross gains of $0.5 million, $0.8 million and $0.9 million and gross losses of $0.9 million, $0.0 million and $0.3 million were realized on those equity sales during 2004, 2003 and 2002, respectively.
The changes in net unrealized gains (losses) of investments of the Company are derived from the following sources:
Years Ended December 31, | |||||||||||
|
|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Increase (decrease) during the period | |||||||||||
between the market value and cost of | |||||||||||
investments carried at market value, | |||||||||||
and deferred taxes thereon: | |||||||||||
Fixed maturities | $ | (31,608 | ) | $ | 50,144 | $ | 146,295 | ||||
Equity securities | 71,179 | 17,342 | (10,323 | ) | |||||||
Other invested assets | 520 | 648 | (32 | ) | |||||||
Deferred taxes | (14,376 | ) | (31,773 | ) | (31,741 | ) | |||||
|
|
|
|||||||||
Increase in unrealized appreciation, | |||||||||||
net of deferred taxes, included in shareholders' equity | $ | 25,715 | $ | 36,361 | $ | 104,199 | |||||
|
|
|
The Company frequently reviews its investment portfolio for declines in market value and focuses its attention on securities whose fair value has fallen below 80% of their amortized value at the time of review. The Company then assesses whether the decline in value is temporary or other than temporary. In making its assessment, the Company evaluates the current market and interest rate environment as well as specific issuer information. Generally, a change in the market or interest rate environment does not constitute impairment but rather a temporary decline in market value. Temporary declines in market value are recorded as an unrealized loss in accumulated other comprehensive income. If the Company determines that the decline is other than
F-15
temporary, the carrying value of the investment is written down to fair value and a realized loss is recorded in the Companys consolidated statements of operations and comprehensive income. The Companys assessments are based on the issuers current financial position and timeliness with respect to interest and/or principal payments, and speed of repayments on asset-backed securities, as well as relevant information provided by rating agencies, investment advisors and analysts.
The table below displays the aggregate fair value and gross unrealized depreciation, by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2004:
Duration of unrealized loss
|
||||||||||||||||||||||||||
Less than 12 months
|
Greater than 12 months
|
Total
|
||||||||||||||||||||||||
(Dollars in thousands) | Fair Value |
Gross
Unrealized Depreciation |
Fair Value |
Gross
Unrealized Depreciation |
Fair Value |
Gross
Unrealized Depreciation |
||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||
Fixed maturity securities | ||||||||||||||||||||||||||
U.S. government | ||||||||||||||||||||||||||
agencies and authorities | $ | 34,410 | $ | (267 | ) | $ | 10,104 | $ | (507 | ) | $ | 44,514 | $ | (774 | ) | |||||||||||
States, municipalities | ||||||||||||||||||||||||||
and political subdivisions | 110,425 | (1,256 | ) | 106,054 | (1,050 | ) | 216,479 | (2,306 | ) | |||||||||||||||||
Foreign governments | 18,696 | (141 | ) | 197,657 | (484 | ) | 216,353 | (625 | ) | |||||||||||||||||
All other corporate | 1,124,541 | (14,956 | ) | 552,082 | (12,654 | ) | 1,676,623 | (27,610 | ) | |||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||
Total fixed maturities | 1,288,072 | (16,620 | ) | 865,897 | (14,695 | ) | 2,153,969 | (31,315 | ) | |||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||
Equity securities | - | - | - | - | - | - | ||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||
Total | $ | 1,288,072 | $ | (16,620 | ) | $ | 865,897 | $ | (14,695 | ) | $ | 2,153,969 | $ | (31,315 | ) | |||||||||||
|
|
|
|
|
|
The aggregate fair value and gross unrealized losses related to investments in an unrealized loss position as of December 31, 2004 is $2,154.0 million and $31.3 million, respectively. The $16.6 million of unrealized losses related to securities that have been in an unrealized loss position for one year or less are primarily comprised of highly rated government, municipal and corporate bonds and are primarily related to the general movements in interest rates throughout the year. Of these unrealized losses, $14.8 million are related to securities that are rated investment grade or better by a Nationally Recognized Statistical Rating Organization.
The $14.7 million of unrealized losses related to securities that have been in an unrealized loss position for one year or more are also primarily comprised of highly rated government, municipal and corporate bonds and generally relate to the general movements in interest rates throughout the year. Of these unrealized losses, $13.1 million are related to securities that are rated investment grade or better by a Nationally Recognized Statistical Rating Organization.
The Company, given the size of its investment portfolio and capital position, has the ability to hold these securities until recovery of market value. In addition, all securities currently in an unrealized loss position are current with respect to principal and interest payments.
F-16
The components of net investment income are presented in the table below:
Years Ended December 31, | |||||||||||
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|
|
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(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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Fixed maturities | $ | 475,906 | $ | 418,711 | $ | 379,062 | |||||
Equity securities | 8,453 | 2,114 | 926 | ||||||||
Short-term investments | 6,913 | 3,045 | 5,087 | ||||||||
Other income | 44,126 | 19,517 | 1,708 | ||||||||
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Total gross investment income | 535,398 | 443,387 | 386,783 | ||||||||
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Interest credited on funds held | 23,641 | 24,434 | 19,205 | ||||||||
Interest credited to future | |||||||||||
policy benefit reserves | 10,748 | 12,173 | 14,036 | ||||||||
Other investment expenses | 5,101 | 4,170 | 2,874 | ||||||||
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|
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Total investment expenses | 39,490 | 40,777 | 36,115 | ||||||||
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Total net investment income | $ | 495,908 | $ | 402,610 | $ | 350,668 | |||||
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Other income for 2004, 2003 and 2002 primarily includes income (expense) on limited partnership investments of $41.8 million, $17.5 million and $(0.6) million, respectively.
The Company has contractual commitments to invest up to an additional $186.4 million related to its limited partnership investments at December 31, 2004. These commitments will be funded as required by the partnership agreements, which have investment periods that expire no later than 2011.
The components of realized capital gains (losses) are presented in the table below:
Years Ended December 31, | |||||||||||
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(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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Fixed maturities | $ | 90,008 | $ | (38,798 | ) | $ | (50,689 | ) | |||
Equity securities | (395 | ) | 768 | 620 | |||||||
Short-term investments | 1 | 4 | 26 | ||||||||
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Total | $ | 89,614 | $ | (38,026 | ) | $ | (50,043 | ) | |||
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The realized capital losses for 2004 and 2003 included $0.5 million and $25.7 million, respectively, relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis and $65.1 million and $46.2 million, respectively, related to the impairment on interest only strips in accordance with EITF 99-20. Realized capital losses for 2002 included $101.3 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis.
Securities with a carrying value amount of $1,088.6 million at December 31, 2004 were on deposit with various state or governmental insurance departments in compliance with insurance laws.
During 2001, the Company sold five European put options based on the Standard & Poors 500 (S&P 500) index for total consideration, net of commission, of $16.9 million. These contracts each have a single exercise date with maturities ranging from 18 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts would be payable under these contracts if the S&P 500 index is at or above the strike price on the exercise dates. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount
F-17
due would vary proportionately with the percentage the index was below the strike price. Based on historical index values and trends, the Company estimates the probability for each contract of the S&P 500 being below the strike price on the exercise date ranges from .43% to 6.37%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero. The present value of these theoretical maximum payouts using a 6% discount factor is $161.9 million.
Because there are no published market values available for these long term index put options, a Black-Scholes model is used to estimate fair value. The factors used in determining fair value are the S&P 500 index value at the financial statement date, current interest rates matching the duration of the puts and estimated volatility, with current market option volatility extrapolated to the put maturities using historical data. Movements in the mark to model are reflected through the income statement.
During 2000, the Company entered into three credit swap derivative contracts, which provide credit default protection on a portfolio of referenced securities. As of December 31, 2004 the Company had one remaining credit default swap. The Company recorded net after-tax losses from these contracts of $0.0 million, $0.0 million and $3.9 million in 2004, 2003 and 2002, respectively, to reflect them at fair value. As of December 31, 2004 and 2003, the remaining maximum after-tax net loss exposure under these contracts is $0.0 million and $2.9 million, respectively.
The Companys position in these contracts is unhedged and is accounted for as derivatives in accordance with FAS 133. Accordingly, these contracts are carried at fair value with changes in fair value recorded in the consolidated statements of operations and comprehensive income.
F-18
3. RESERVE FOR LOSSES AND LAE
Activity in the reserve for losses and LAE is summarized as follows:
Years Ended December 31, | |||||||||||
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|
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|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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Reserves at January 1 | $ | 6,361,245 | $ | 4,905,582 | $ | 4,278,267 | |||||
Less reinsurance recoverables | 1,261,100 | 1,088,589 | 883,460 | ||||||||
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Net balance at January 1 | 5,100,145 | 3,816,993 | 3,394,807 | ||||||||
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Incurred related to: | |||||||||||
Current year | 2,979,122 | 2,343,271 | 1,489,271 | ||||||||
Prior years | 312,017 | 256,925 | 140,111 | ||||||||
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Total incurred losses and LAE | 3,291,139 | 2,600,196 | 1,629,382 | ||||||||
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Paid related to: | |||||||||||
Current year | 607,066 | 501,119 | 352,910 | ||||||||
Prior years | 1,141,663 | 902,596 | 892,690 | ||||||||
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|||||||||
Total paid losses and LAE | 1,748,729 | 1,403,715 | 1,245,600 | ||||||||
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|||||||||
Foreign Exchange/Translation Adjustment | 78,890 | 86,671 | 38,404 | ||||||||
Net balance at December 31 |
6,721,445 | 5,100,145 | 3,816,993 | ||||||||
Plus reinsurance recoverables | 1,114,861 | 1,261,100 | 1,088,589 | ||||||||
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|||||||||
Balance at December 31 | $ | 7,836,306 | $ | 6,361,245 | $ | 4,905,582 | |||||
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Gross loss and LAE reserves totaled $7,836.3 million at December 31, 2004, $6,361.2 million at December 31, 2003, and $4,905.6 million at December 31, 2002. The increase in 2004 is primarily attributable to increased premiums earned, net prior period reserve adjustments in select areas, increase in catastrophe losses and normal variability in claim settlements. The increase in 2003 was primarily attributable to increased premiums earned, net prior period reserve adjustments in select areas and normal variability in claim settlement.
Reinsurance receivables for both paid and unpaid losses totaled $1,210.8 million at December 31, 2004, $1,284.1 million at December 31, 2003, and $1,116.4 million at December 31, 2002. At December 31, 2004, $405.0 million, or 33.4%, was receivable from subsidiaries of London Reinsurance Group (London Life). These receivables are effectively secured by a combination of letters of credit and funds held arrangements under which the Company has retained the premium payments due the retrocessionaire, recognized liabilities for such amounts and reduced such liabilities as payments are due from the retrocessionaire. In addition, $160.0 million, or 13.2%, was receivable from Prudential Property and Casualty Insurance Company of Indiana (Prupac), which in late 2003 was purchased by LM Property and Casualty Insurance Company (LM) and whose obligations continue to be guaranteed by The Prudential Insurance Company of America (The Prudential) and $132.5 million, or 10.9%, was receivable from Transatlantic Reinsurance Company (Transatlantic) and $100.0 million, or 8.3%, was receivable from Continental Insurance Company (Continental), which is partially secured by funds held arrangements. No other retrocessionaire accounted for more than 5% of the Companys receivables.
Prior year incurred losses increased by $312.0 million in 2004 and $256.9 million in 2003. The increase was the result of modest reserve strengthening in select areas, most notably in asbestos exposures, directors and officers, surety and workers compensation lines.
F-19
Activity in the reserve for future policy benefits is summarized as follows:
Years Ended December 31, | |||||||||||
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|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
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|||||||||
Balance at beginning of year | $ | 205,275 | $ | 227,925 | $ | 238,753 | |||||
Liabilities assumed | 300 | 512 | 6,563 | ||||||||
Adjustments to reserves | 8,544 | 11,239 | 8,519 | ||||||||
Benefits paid in the current year | (19,543 | ) | (34,401 | ) | (25,910 | ) | |||||
Contract terminations | (42,397 | ) | - | - | |||||||
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|||||||||
Balance at end of year | $ | 152,179 | $ | 205,275 | $ | 227,925 | |||||
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The Company continues to receive claims under expired contracts, both insurance and reinsurance, asserting alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Companys asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Companys environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damages caused by the release of hazardous substances into the land, air or water.
The Companys reserves include an estimate of the Companys ultimate liability for A&E claims. This estimate is made based on a judgmental assessment of the underlying exposures as the result of (1) long and variable reporting delays, both from insureds to insurance companies and from ceding companies to reinsurers; (2) historical data, which is more limited and variable on A&E losses than historical information on other types of casualty claims; and (3) unique aspects of A&E exposures for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of the Companys potential losses from A&E claims. Among the uncertainties are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) the potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) questions concerning interpretation and application of insurance and reinsurance coverage; and (g) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.
With respect to asbestos claims in particular, several additional factors have emerged in recent years that further compound the difficulty in estimating the Companys liability. These developments include: (a) continued growth in the number of claims filed, in part reflecting a much more aggressive plaintiffs bar and including claims against defendants formerly regarded as peripheral; (b) a disproportionate percentage of claims filed by individuals with no functional injury, which should have little to no financial value but that have increasingly been considered in jury verdicts and settlements; (c) the growth in the number and significance of bankruptcy filings by companies as a result of asbestos claims (including, more recently, bankruptcy filings in which companies attempt to resolve their asbestos liabilities in a manner that is prejudicial to insurers and forecloses insurers from the negotiation of bankruptcy plans); (d) the concentration of claims in a small number of states that favor plaintiffs; (e) the growth in the number of claims that might impact the general liability portion of insurance policies rather than the product liability portion; (f) measures adopted by specific courts to ameliorate the worst procedural abuses; (g) an increase in settlement values being paid to asbestos claimants, especially those with cancer or functional impairment; (h) legislation in some states to address asbestos litigation issues; and (i) the potential that other states or the U. S. Congress may adopt legislation on asbestos litigation.
F-20
Management believes that these uncertainties and factors continue to render reserves for A&E and particularly asbestos losses significantly less subject to traditional actuarial analysis than reserves for other types of losses. Given these uncertainties; management believes that no meaningful range for such ultimate losses can be established. The Company establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for the Company or its ceding companies.
In connection with the acquisition of Mt. McKinley, which has significant exposure to A&E claims, Prupac, a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinleys reserves as of September 19, 2000 and The Prudential guaranteed Prupacs obligations to Mt. McKinley. In late 2003, Prupac was purchased by LM and all obligations of Prupac continue to be guaranteed by The Prudential. Cessions under this reinsurance agreement exhausted the limit available under the contract at December 31, 2003.
With respect to Mt. McKinley, where the Company has a direct relationship with policyholders, the Companys aggressive litigation posture and the uncertainties inherent in the asbestos coverage and bankruptcy litigation have provided an opportunity to actively engage in settlement negotiations with a number of those policyholders who have potentially significant asbestos liabilities. Those discussions are oriented towards achieving reasonable negotiated settlements that limit Mt. McKinleys liability to a given policyholder to a sum certain. In 2004, the Company has concluded such settlements or reached agreement in principle with several of its high profile policyholders. The Company has currently identified 15 policyholders based on their past claim activity and/or potential future liabilities as High Profile Policyholders and its settlement efforts are generally directed at such policyholders, in part because their exposures have developed to the point where both the policyholder and the Company have sufficient information to be motivated to settle. The Company believes that this active approach will ultimately result in a more cost-effective liquidation of Mt. McKinleys liabilities than a passive approach, although it may also introduce additional variability in Mt. McKinleys losses and cash flows.
There is less potential for similar settlements with respect to the Companys reinsurance asbestos claims. Ceding companies, with their direct obligation to insureds and overall responsibility for claim settlements, are not consistently aggressive in developing claim settlement information and conveying this information to reinsurers, which can introduce significant and perhaps inappropriate delays in the reporting of asbestos claims/exposures to reinsurers. These delays not only extend the timing of reinsurance claim settlements, but also restrict the information available to estimate the reinsurers ultimate exposure.
Due to the uncertainties discussed above, the ultimate losses attributable to A&E, and particularly asbestos, may be subject to more variability than are non-A&E reserves and such variation could have a material adverse effect on the Companys financial condition, results of operations and/or cash flows.
F-21
The following table summarizes incurred losses with respect to A&E on both a gross and net of retrocessional basis for the periods indicated:
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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Gross basis | |||||||||||
Beginning of reserves | $ | 765,257 | $ | 667,922 | $ | 644,390 | |||||
Incurred losses | 171,729 | 172,596 | 95,004 | ||||||||
Paid losses | (208,661 | ) | (75,261 | ) | (71,472 | ) | |||||
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End of period reserves | $ | 728,325 | $ | 765,257 | $ | 667,922 | |||||
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Net basis | |||||||||||
Beginning of reserves | $ | 534,369 | $ | 527,462 | $ | 568,592 | |||||
Incurred losses | 159,422 | 50,230 | 23,491 | ||||||||
Paid losses | (187,116 | ) | (43,323 | ) | (64,621 | ) | |||||
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End of period reserves | $ | 506,675 | $ | 534,369 | $ | 527,462 | |||||
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At December 31, 2004, the gross reserves for A&E losses were comprised of $148.5 million representing case reserves reported by ceding companies, $151.3 million representing additional case reserves established by the Company on assumed reinsurance claims, $272.1 million representing case reserves established by the Company on direct excess insurance claims, including Mt. McKinley and $156.4 million representing IBNR reserves.
4. CREDIT LINE
Effective December 8, 2004, Group, Bermuda Re, and Everest International entered into a new three year, $750 million senior credit facility with a syndicate of lenders (Group Credit Facility). Wachovia Bank is the administrative agent for the Group Credit Facility. The Group Credit Facility consists of two tranches. Tranche one provides up to $250 million of revolving credit for liquidity and general corporate purposes, and for the issuance of standby letters of credit. The interest on the revolving loans shall, at the option of each of the borrowers, be either (1) Base Rate Loans (as defined below) or (2) an adjusted London Interbank Offered Rate (LIBOR) plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depend on Groups senior unsecured debt rating. Tranche two exclusively provides up to $500 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth amount. Minimum net worth is an amount equal to the sum of (i) $2,373 million (base amount) plus (ii) (A) 25% of consolidated net income for each of Groups fiscal quarters and (B) 50% of any increase in consolidated net worth attributable to the issuance of ordinary and preferred shares. The base amount is reset at the end of each fiscal year to be the greater of 70% of Group's consolidated net worth as of the last day of the fiscal year and the calculated minimum amount of net worth prior to the last day of the fiscal year. As of December 31, 2004, the Company was in compliance with these covenants.
For the year ended December 31, 2004, there were no borrowings under tranche one of the Group Credit Facility. During the year ended December 31, 2004, there was $66.0 million used of the $500 million available for tranche two standby letters of credit. See Note 7.
Effective October 10, 2003, Holdings entered into a new three year, $150.0 million senior revolving credit facility with a syndicate of lenders, replacing the December 21, 1999, three year senior revolving credit facility,
F-22
which expired on December 19, 2003. Both the October 10, 2003 and December 21, 1999 senior revolving credit agreements, which have similar terms, are referred to as Holdings Credit Facility. Wachovia Bank is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) an adjusted LIBOR plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate in each case plus 0.5% per annum. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings senior unsecured debt rating.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $1.0 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions. As of December 31, 2004, the Company was in compliance with these covenants.
During the year ended December 31, 2004, there were payments made of $70.0 million and there were no incremental borrowings made under the Holdings Credit Facility. During the year ended December 31, 2003, there were no payments made and no incremental borrowings under the Holdings Credit Facility. During the year ended December 31, 2002, there were payments made of $80 million and new Holdings Credit Facility borrowings of $45 million. As of December 31, 2004 and 2003, there were outstanding Holdings Credit Facility borrowings of $0.0 million and $70.0 million, respectively. Interest expense incurred in connection with these borrowings was $1.2 million, $1.4 million and $3.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.
5. SENIOR NOTES
On October 12, 2004, Holdings completed a public offering of $250.0 million principal amount of 5.40% senior notes due October 15, 2014. On March 14, 2000, Holdings completed public offerings of $200.0 million principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million principal amount of 8.50% senior notes due March 15, 2005. Interest expense incurred in connection with these senior notes was $42.0 million, $38.9 million and $38.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. Market value, which is based on quoted market price at December 31, 2004 was $250.3 million for the 5.4% senior notes, $236.7 million for the 8.75% senior notes and $252.7 million for the 8.5% senior notes.
6. JUNIOR SUBORDINATED DEBT SECURITIES PAYABLE
On March 29, 2004, Holdings issued $329.9 million of 6.20% junior subordinated debt securities due March 29, 2034 to Capital Trust II. Holdings can redeem the junior subordinated debt securities before their maturity at 100% of their principal amount plus accrued interest as of the date of redemption, in whole or in part, on one or more occasions at any time on or after March 30, 2009; or at any time, in whole, but not in part, within 90 days of the occurrence and continuation of specific events.
On November 14, 2002, Holdings issued $216.5 million of 7.85% junior subordinated debt securities due November 15, 2032 to Capital Trust. Holdings can redeem the junior subordinated debt securities before their maturity at 100% of their principal amount plus accrued interest as of the date of redemption, in whole or in part, on one or more occasions at any time on or after November 14, 2007; or at any time, in whole, but not in part, within 90 days of the occurrence and continuation of specific events.
Fair value, which is primarily based on quoted market price of the related trust preferred securities at December, 31 2004 was $238.8 million for the 7.85% junior subordinated debt securities and $309.9 million for the 6.20% junior subordinated debt securities.
F-23
Interest expense incurred in connection with these junior subordinated notes was $32.4 million, $17.0 million and $2.2 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Capital Trust and Capital Trust II are wholly owned finance subsidiaries of Holdings.
Holdings considers that the mechanisms and obligations relating to the trust preferred securities, taken together, constitute a full and unconditional guarantee by Holdings of Capital Trust and Capital Trust IIs payment obligations with respect to their respective trust preferred securities.
There are certain regulatory and contractual restrictions on the ability of Holdings operating subsidiaries to transfer funds to Holdings in the form of cash dividends, loans or advances. The insurance laws of the State of Delaware, where Holdings direct insurance subsidiaries are domiciled, require regulatory approval before those subsidiaries can pay dividends or make loans or advances to Holdings that exceed certain statutory thresholds. In addition, the terms of Holdings Credit Facility require Everest Re, Holdings principal insurance subsidiary, to maintain a certain statutory surplus level as measured at the end of each fiscal year. At December 31, 2004, $1,901.0 million of the $2,565.0 million in net assets of Holdings consolidated subsidiaries were subject to the foregoing regulatory restrictions.
7. LETTERS OF CREDIT
The Company has arrangements available for the issuance of letters of credit, which letters are generally collateralized by the Companys cash and investments. Citibank is a bilateral agreement, while the Wachovia Syndicated Facility is a syndicate of lenders (see Note 4, tranche two of the Group Credit Facility), with Wachovia acting as administrative agent. Under similar arrangements, at December 31, 2004 and 2003, letters of credit for $350.9 million and $246.2 million, respectively, were issued and outstanding, generally supporting reinsurance provided by the Companys non-U.S. operations. The following table summarizes the Companys letters of credit as of December 31, 2004. All dollar amounts are in thousands.
Bank | Commitment | In Use | Year of Expiry | |||||||||
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Citibank | $ | 300,000 | $ |
11,661
10,975 3,843 158,100 88,760 11,528 |
08/31/2005
12/31/2005 01/28/2006 12/31/2006 12/31/2007 12/31/2008 |
|||||||
|
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Total Citibank Agreement | $ | 284,867 | ||||||||||
|
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Wachovia Syndicated Facility |
Tranche 1
Tranche 2 |
$
$ |
250,000
500,000 |
$ |
-
1,750 1,289 46,725 16,285 |
-
10/31/2005 11/03/2005 11/13/2005 12/31/2005 |
||||||
|
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Total Wachovia Syndicated Facility | $ | 66,049 | ||||||||||
|
||||||||||||
Total letters of credit | $ | 350,916 | ||||||||||
|
F-24
8. TRUST AGREEMENTS
Certain subsidiaries of the Company, principally Bermuda Re, a Bermuda insurance company and direct subsidiary of Group, have established trust agreements as security for assumed losses payable of certain non-affiliated ceding companies, which effectively use Company investments as collateral. At December 31, 2004, the total amount on deposit in trust accounts was $188.9 million.
9. OPERATING LEASE AGREEMENTS
The future minimum rental commitments, exclusive of cost escalation clauses, at December 31, 2004 for all of the Companys operating leases with remaining non-cancelable terms in excess of one year are as follows:
(Dollars in thousands) | |||||
2005 |
$ | 5,672 | |||
2006 | 5,702 | ||||
2007 | 5,641 | ||||
2008 | 5,188 | ||||
2009 | 4,903 | ||||
Thereafter | 6,664 | ||||
|
|||||
Net commitments | $ | 33,770 | |||
|
All of these leases, the expiration terms of which range from 2005 to 2013, are for the rental of office space. Rental expense, net of sublease rental income, was $7.6 million, $6.8 million and $6.7 million for 2004, 2003 and 2002, respectively.
10. INCOME TAXES
Under current Bermuda law, no income or capital gains taxes are imposed on Group and its Bermuda subsidiaries. The Minister of Finance of Bermuda has also assured Group and its Bermuda subsidiaries that, pursuant to The Exempted Undertakings Tax Protection Act of 1966, they will be exempt until 2016 from any such taxes imposed in the future. No tax is imposed on capital gains. Through 2004, Group was registered in Barbados as an external company and licensed as an international business company. This provided Group with certain tax benefits, including a preferred rate of corporation tax on profits and gains in Barbados and exemption from withholding tax on dividend payments.
F-25
All the income of the U.S. subsidiaries is subject to the applicable federal, foreign, state and local taxes on corporations. Additionally, the income of foreign branches of the Companys insurance operating companies, in particular the UK branch of Bermuda Re, is subject to various income taxes. The provision for income taxes in the consolidated statement of income has been determined by reference to the individual income of each entity and the respective applicable tax laws. It reflects the permanent differences between financial and taxable income relevant to each entity. The significant components of the provision are as follows:
Years Ended December 31, | |||||||||||
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|
|
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(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
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|
|
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Current tax: | |||||||||||
U.S | $ | 45,913 | $ | 106,950 | $ | 12,717 | |||||
Foreign | 50,359 | 7,359 | 12,317 | ||||||||
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|
|
|||||||||
Total current tax | 96,272 | 114,309 | 25,034 | ||||||||
Total deferred U.S. tax (benefit) expense | (31,419 | ) | (49,124 | ) | 5,707 | ||||||
|
|
|
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Total income tax expense | $ | 64,853 | $ | 65,185 | $ | 30,741 | |||||
|
|
|
The weighted average expected tax provision has been calculated using the pre-tax income (loss) in each jurisdiction multiplied by that jurisdictions applicable statutory tax rate. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the years ended December 31, 2004 and 2003 is provided below:
Years Ended December 31, | |||||||||||
|
|
||||||||||
(Dollars in thousands) | 2004 | 2003 | |||||||||
|
|
||||||||||
Expected tax provision at weighted average rate | $ | 130,173 | $ | 94,896 | |||||||
Increase (reduction) in taxes resulting from: | |||||||||||
Tax exempt income | (53,717 | ) | (43,885 | ) | |||||||
Disallowed expenses | 5,133 | 216 | |||||||||
Sale of UK Branch | (20,088 | ) | - | ||||||||
Other | 3,352 | 13,958 | |||||||||
|
|
||||||||||
Total income tax provision | $ | 64,853 | $ | 65,185 | |||||||
|
|
F-26
Deferred income taxes reflect the tax effect of the temporary differences between the value of assets and liabilities for financial statement purposes and such values as measured by the UK and U.S. tax laws and regulations. The principal items making up the net deferred income tax asset are as follows:
Years Ended December 31, | |||||||||||
|
|
||||||||||
(Dollars in thousands) | 2004 | 2003 | |||||||||
|
|
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Deferred tax assets: | |||||||||||
Reserve for losses and LAE | $ | 243,817 | $ | 211,220 | |||||||
Unearned premium reserve | 70,812 | 70,273 | |||||||||
Impairments | 1,688 | 16,838 | |||||||||
Deferred compensation | 5,886 | 7,597 | |||||||||
Capital loss carryforward | - | 1,109 | |||||||||
Sale of UK Branch | 9,543 | - | |||||||||
Net operating loss and foreign tax credit carryforwards | 48,727 | 21,899 | |||||||||
Other assets | 21,601 | 16,401 | |||||||||
|
|
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Total deferred tax assets | 402,074 | 345,337 | |||||||||
|
|
||||||||||
Deferred tax liabilities: | |||||||||||
Deferred acquisition costs | 71,293 | 76,821 | |||||||||
Investments | 8,529 | 4,838 | |||||||||
Net unrealized appreciation of investments | 125,505 | 111,130 | |||||||||
Foreign currency translation | 28,697 | 6,291 | |||||||||
Other liabilities | 8,176 | 986 | |||||||||
|
|
||||||||||
Total deferred tax liabilities | 242,200 | 200,066 | |||||||||
|
|
||||||||||
Net deferred tax assets | $ | 159,874 | $ | 145,271 | |||||||
|
|
Management believes that it is more likely than not that the Company will realize the benefits of its net deferred tax assets and, accordingly, no valuation allowance has been recorded for the periods presented.
Tax benefits of $8.4 million and $3.5 million related to compensation expense deductions for stock options exercised in 2004 and 2003, respectively, are reflected in the change in shareholders equity in additional paid in capital.
11. REINSURANCE
The Company utilizes reinsurance agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from reinsurers of a portion of losses and LAE under certain circumstances without relieving the insurer of its obligation to the policyholder. Losses and LAE incurred and premiums earned are after deduction for reinsurance. In the event reinsurers were unable to meet their obligations under reinsurance agreements, the Company would not be able to realize the full value of the reinsurance recoverable balances. The Company may hold partial collateral, including letters of credit and funds held, under these agreements. See also Note 1C.
The Company considers purchasing corporate level retrocessional protection covering the potential accumulation of exposures. Such consideration includes balancing the underlying exposures against the availability of cost-effective retrocessional protection. For years ended December 31, 1999, 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage that provided up to $175.0 million of coverage for each year. These excess of loss policies provided coverage if Everest Res consolidated statutory basis accident
F-27
year loss ratio exceeded a loss ratio attachment point for each year of coverage. The attachment point was net of inuring reinsurance and included adjustable premium provisions that effectively caused the Company to offset, on a pre-tax income basis up to approximately 57% of such ceded losses. The maximum recovery for each year is $175.0 million before giving effect to the adjustable premium. During 2002 and 2003, the Company ceded $90.0 million and $85.0 million of losses, respectively, to the 2000 cover, effectively reducing the limit available under the contract to $0.0 million. During 2002, the Company ceded $11.0 million of losses to the 2001 cover, reducing the limit available under the contract to $0.0 million. The Company did not purchase similar coverage subsequent to December 31, 2001.
In addition, the Company had coverage under an aggregate excess of loss reinsurance agreement provided by Prupac, a wholly-owned subsidiary of The Prudential, in connection with the Companys acquisition of Mt. McKinley in September 2000. This agreement covers 80% or $160 million of the first $200 million of any adverse loss reserve development on the carried reserves of Mt. McKinley at the date of acquisition and reimburses the Company as such losses are paid by the Company. There were $160.0 million of cessions under this reinsurance at December 31, 2003, reducing the limit available under the contract to $0.0 million. On October 31, 2003, LM completed its purchase of Prupac and its obligations from The Prudential. The Prudential continues to guarantee LMs obligation under this agreement.
Premiums written and earned are comprised of the following:
Years Ended December 31, | |||||||||||
|
|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Written premiums: | |||||||||||
Direct | $ | 1,293,545 | $ | 1,223,841 | $ | 864,335 | |||||
Assumed | 3,410,589 | 3,349,961 | 1,982,166 | ||||||||
Ceded | (172,646 | ) | (258,413 | ) | (208,881 | ) | |||||
|
|
|
|||||||||
Net written premiums | $ | 4,531,488 | $ | 4,315,389 | $ | 2,637,620 | |||||
|
|
|
|||||||||
Premiums earned: | |||||||||||
Direct | $ | 1,181,278 | $ | 1,021,881 | $ | 672,823 | |||||
Assumed | 3,430,270 | 2,939,510 | 1,793,461 | ||||||||
Ceded | (186,466 | ) | (223,540 | ) | (192,607 | ) | |||||
|
|
|
|||||||||
Net premiums earned | $ | 4,425,082 | $ | 3,737,851 | $ | 2,273,677 | |||||
|
|
|
The amounts deducted from losses and LAE incurred for net reinsurance recoveries were $141.0 million, $278.4 million and $287.7 million for the years ended December 31, 2004, 2003 and 2002, respectively.
As of December 31, 2004, the Company carried as an asset $1,210.8 million in reinsurance receivables with respect to losses ceded. Of this amount, $405.0 million, or 33.4%, was receivable from subsidiaries of London Life, $160.0 million, or 13.2%, was receivable from LM, $132.5 million, or 10.9%, was receivable from Transatlantic, and $100.0 million, or 8.3%, was receivable from Continental. As of December 31, 2003, the Company carried an asset $1,284.1 million in reinsurance receivables with respect to losses ceded. Of this amount, $494.5 million, or 38.5%, was receivable from subsidiaries of London Life, $160.0 million, or 12.5%, was receivable from LM, $145.0 million, or 11.3%, was receivable from Continental and $96.7 million, or 7.5%, was receivable from Transatlantic. No other retrocessionaire accounted for more than 5% of the Companys receivables.
The Companys arrangements with London Life and Continental are managed on a funds held basis, which means that the Company has not released premium payments to the retrocessionaire but rather retains such
F-28
payments to secure obligations of the retrocessionaire, records them as a liability, credits interest on the balances at a stated contractual rate and reduces the liability account as payments become due. As of December 31, 2004, such funds had reduced the Companys net exposure to London Life to $184.1 million, effectively 100% of which has been secured by letters of credit, and its exposure to Continental to $43.7 million. As of December 31, 2003, such funds had reduced the Companys net exposure to London Life to $204.9 million, effectively 100% of which had been secured by letters of credit, and its exposure to Continental to $53.3 million. LMs obligations are guaranteed by The Prudential.
12. COMPREHENSIVE INCOME
The components of comprehensive income for the periods ended December 31, 2004, 2003 and 2002 are shown in the following table:
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Net income | $ | 494,858 | $ | 426,028 | $ | 231,303 | |||||
|
|
|
|||||||||
Other comprehensive income, before tax: | |||||||||||
Foreign currency translation adjustments | 26,610 | 33,524 | 5,346 | ||||||||
Unrealized gains on securities | |||||||||||
arising during the period | 129,705 | 30,108 | 85,897 | ||||||||
Less: reclassification adjustment for | |||||||||||
realized (gains) losses included in net income | (89,614 | ) | 38,026 | 50,043 | |||||||
|
|
|
|||||||||
Other comprehensive income, before tax | 66,701 | 101,658 | 141,286 | ||||||||
|
|
|
|||||||||
Income tax expense related to | |||||||||||
items of other comprehensive income: | |||||||||||
Tax expense | |||||||||||
from foreign currency translation | 3,665 | 11,350 | 1,883 | ||||||||
Tax expense from unrealized | |||||||||||
gains arising during the period | 34,474 | 23,764 | 13,146 | ||||||||
Tax expense (benefit) from realized | |||||||||||
(gains) losses included in net income | 20,098 | (8,009 | ) | (18,595 | ) | ||||||
|
|
|
|||||||||
Income tax expense related to | |||||||||||
items of other comprehensive income: | 18,041 | 43,123 | 33,624 | ||||||||
Other comprehensive income, net of tax | 48,660 | 58,535 | 107,662 | ||||||||
|
|
|
|||||||||
Comprehensive income | $ | 543,518 | $ | 484,563 | $ | 338,965 | |||||
|
|
|
F-29
The following table shows the components of the change in accumulated other comprehensive income for the years ended December 31, 2004 and 2003.
(Dollars in thousands) | 2004 | 2003 | ||||||||||||
|
|
|
|
|||||||||||
Beginning balance of accumulated | ||||||||||||||
other comprehensive income | $ | 280,077 | $ | 221,542 | ||||||||||
|
|
|||||||||||||
Beginning balance of foreign | ||||||||||||||
currency translation adjustments | $ | 13,453 | $ | (8,721 | ) | |||||||||
Current period change in foreign |
||||||||||||||
currency translation adjustments | 22,945 | 22,945 | 22,174 | 22,174 | ||||||||||
|
|
|
|
|||||||||||
Ending balance of foreign | ||||||||||||||
currency translation adjustments | 36,398 | 13,453 | ||||||||||||
|
|
|||||||||||||
Beginning balance of | ||||||||||||||
unrealized gains on securities | 266,624 | 230,263 | ||||||||||||
Current period change |
||||||||||||||
in unrealized gains on securities | 25,715 | 25,715 | 36,361 | 36,361 | ||||||||||
|
|
|
|
|||||||||||
Ending balance of unrealized | ||||||||||||||
gains on securities | $ | 292,339 | $ | 266,624 | ||||||||||
|
|
|||||||||||||
Current period change in accumulated | ||||||||||||||
other comprehensive income | 48,660 | 58,535 | ||||||||||||
|
|
|||||||||||||
Ending balance of accumulated | ||||||||||||||
other comprehensive income | $ | 328,737 | $ | 280,077 | ||||||||||
|
|
13. EMPLOYEE BENEFIT PLANS
A. Defined Benefit Pension Plans
The Company maintains both qualified and non-qualified defined benefit pension plans
for its U.S. employees. Generally, the Company computes the benefits based on average
earnings over a period prescribed by the plans and credited length of service. The Companys
non-qualified defined benefit pension plan, effected in October 1995, provides
compensating pension benefits for participants whose benefits have been curtailed under
the qualified plan due to Internal Revenue Code limitations.
Although not required to make contributions under Internal Revenue Service guidelines, the Company contributed $3.3 million and $1.5 million to the qualified and non-qualified plans, respectively, in 2004 and $7.7 million and $1.2 million to the qualified and non-qualified plans, respectively, in 2003. Pension expense for the Companys plans for the years ended December 31, 2004, 2003 and 2002 were $4.8 million, $3.7 million and $3.6 million, respectively.
F-30
The following table summarizes the status of these plans for the periods indicated:
Years Ended December 31, | |||||||||||
|
|
||||||||||
(Dollars in thousands) | 2004 | 2003 | |||||||||
|
|
||||||||||
Change in projected benefit obligation: | |||||||||||
Benefit obligation at beginning of year | $ | 50,773 | $ | 39,796 | |||||||
Service cost | 3,273 | 2,295 | |||||||||
Interest cost | 3,397 | 2,692 | |||||||||
Actuarial gain | 9,410 | 6,331 | |||||||||
Plan change | - | 190 | |||||||||
Administrative expenses paid | (338 | ) | (219 | ) | |||||||
Benefits paid | (351 | ) | (312 | ) | |||||||
|
|
||||||||||
Benefit obligation at end of year | 66,164 | 50,773 | |||||||||
|
|
||||||||||
Change in plan assets: | |||||||||||
Fair value of plan assets at beginning of year | 37,564 | 23,344 | |||||||||
Actual return on plan assets | 4,487 | 5,794 | |||||||||
Actual contributions during the year | 4,793 | 8,957 | |||||||||
Administrative expenses paid | (338 | ) | (219 | ) | |||||||
Benefits paid | (351 | ) | (312 | ) | |||||||
|
|
||||||||||
Fair value of plan assets at end of year | 46,155 | 37,564 | |||||||||
|
|
||||||||||
Funded status | (20,009 | ) | (13,209 | ) | |||||||
Unrecognized prior service cost | 747 | 874 | |||||||||
Unrecognized net loss | 20,576 | 13,652 | |||||||||
|
|
||||||||||
Net amount recognized | $ | 1,314 | $ | 1,317 | |||||||
|
|
Plan assets are comprised of shares in investment trusts with approximately 68% and approximately 32% of the underlying assets consisting of equity securities and fixed maturities, respectively.
Net periodic pension cost included the following components for the periods indicated:
Years Ended December 31, | |||||||||||
|
|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Service cost | $ | 3,273 | $ | 2,295 | $ | 1,877 | |||||
Interest cost | 3,397 | 2,692 | 2,376 | ||||||||
Expected return on assets | (3,358 | ) | (2,082 | ) | (1,861 | ) | |||||
Amortization of net loss from earlier periods | 1,357 | 705 | 275 | ||||||||
Amortization of unrecognized prior service cost | 127 | 127 | 898 | ||||||||
|
|
|
|||||||||
Net periodic pension cost | $ | 4,796 | $ | 3,737 | $ | 3,565 | |||||
|
|
|
The weighted average discount rates used to determine the actuarial present value of the projected benefit obligation for 2004, 2003 and 2002 were 5.75%, 6.0% and 6.75%, respectively. The rate of compensation increase used to determine the actuarial present value of the projected benefit obligation for 2004, 2003 and 2002 was 4.50%. The expected long-term rate of return on plan assets for 2004, 2003 and 2002 was 9.0%.
F-31
Amounts recognized in the statement of financial position consist of for the periods indicated:
Pension Benefits | |||||||||||
|
|
||||||||||
2004 | 2003 | ||||||||||
|
|
||||||||||
Prepaid benefit cost | $ | 1,538 | $ | 1,538 | |||||||
Accrued benefit cost | (224 | ) | (221 | ) | |||||||
Intangible assets | 747 | 245 | |||||||||
Accumulated other comprehensive income | (747 | ) | (245 | ) | |||||||
|
|
||||||||||
Net amount recognized | $ | 1,314 | $ | 1,317 | |||||||
|
|
The Company also maintains both qualified and non-qualified defined contribution plans (Savings Plan and Non-Qualified Savings Plan, respectively) covering U.S. employees. Under the plans, the Company contributes up to a maximum 3% of the participants compensation based on the contribution percentage of the employee. The Non-Qualified Savings Plan provides compensating savings plan benefits for participants whose benefits have been curtailed under the Savings Plan due to Internal Revenue Code limitations. The Companys incurred expenses related to these plans were $1.0 million, $0.8 million and $0.7 million for 2004, 2003 and 2002, respectively.
In addition, the Company maintains several defined contribution pension plans covering non-U.S. employees. Each non-U.S. office (Canada, London, Belgium, Singapore and Bermuda) maintains a separate plan for the non-U.S. employees working in that location. The Company contributes various amounts based on salary, age, and/or years of service. The contributions as a percentage of salary for the branch offices range from 2% to 10%. The contributions are generally used to purchase pension benefits from local insurance providers. The Companys incurred expenses related to these plans were $0.4 million for 2004, 2003 and 2002.
The following table summarizes the Accumulated Benefit Obligation for years ended December 31, 2004, and 2003, respectively.
Pension Plan | Supplemental Plan | Total | |
|
|
|
|
Accumulated Benefit Obligation- 2004 | 39,247,669 | 9,652,519 | 48,900,188 |
Accumulated Benefit Obligation- 2003 | 30,762,256 | 6,310,955 | 37,073,211 |
F-32
The asset allocation percentages for the qualified and non-qualified benefit plans at December 31, 2004 and 2003, by asset category are as follows:
Qualified Benefit Plan | Non-Qualified Benefit Plan | |||||||||||||
|
|
|
|
|||||||||||
Asset Category: | 2 | 004 | 2 | 003 | 2 | 004 | 2 | 003 | ||||||
|
|
|
|
|||||||||||
Equity securities | 67 | .88% | 70 | .59% | 67 | .75% | 71 | .01% | ||||||
Debt securities | 31 | .36% | 28 | .66% | 31 | .76% | 28 | .59% | ||||||
Other | 0 | .76% | 0 | .75% | 0 | .49% | 0 | .40% | ||||||
|
|
|
|
|||||||||||
Total | 100 | .00% | 100 | .00% | 100 | .00% | 100 | .00% |
The Company engages a third party investment administrator to manage the qualified and non-qualified plan for its U.S. employees. The assets in both plans consist of debt and equity mutual funds. Due to the long term nature of the plans, the target asset allocation for each plan consists of 68% equities and 32% bonds.
The Company expects to contribute approximately $3.5 million and $1.3 million in 2005 to the qualified and non-qualified plan, respectively.
B. Post-retirement Plan
Beginning
January 1, 2002, the Company established the Retiree Health Plan. This plan provides
health care benefits for eligible retired employees (and their eligible dependants), who
have elected coverage. The Company currently anticipates that most covered employees will
become eligible for these benefits if they retire while working for the Company. The cost
of these benefits is shared with the retiree. The Company accrues the postretirement
benefit expense during the period of the employees service.
A health care inflation rate for pre-medicare claims of 11% in 2004 was assumed to change to 10% in 2005; and then decrease one percentage point annually to 5% in 2010, and then remain at that level.
A health care inflation rate for post-medicare claims of 7% in 2004, was assumed to change to 6% in 2005; and then decrease one percentage point annually to 5% in 2006, and then remain at that level.
Changes in the assumed health care cost trend can have a significant effect on the amounts reported for the health care plans. A one percent change in the rate would have the following effects on:
(Dollars in thousands) |
Percentage
Point Increase ($ Impact) |
Percentage
Point Decrease ($ Impact) |
||||||
|
|
|||||||
a. Effect on total service and interest cost components | $ | 193 | $ | (149 | ) | |||
b. Effect on accumulated postretirement | $ | 1,479 | $ | (1,169 | ) |
Benefit expense for this plan for the year ended December 31, 2004, 2003 and 2002 was $0.8 million, $0.7 million and $0.6 million, respectively.
F-33
The following table summarizes the status of this plan for the periods indicated:
Years Ended December 31, | |||||||||||
|
|
||||||||||
(Dollars in thousands) | 2004 | 2003 | |||||||||
|
|
||||||||||
Change in projected benefit obligation: | |||||||||||
Benefit obligation at beginning of year | $ | 6,870 | $ | 4,272 | |||||||
Service cost | 419 | 372 | |||||||||
Interest cost | 363 | 358 | |||||||||
Assumption change | 308 | 867 | |||||||||
Liability (gain) loss | (308 | ) | 186 | ||||||||
Actuarial (gain) loss | (509 | ) | 833 | ||||||||
Benefits paid | (32 | ) | (18 | ) | |||||||
|
|
||||||||||
Benefit obligation at end of year | 7,111 | 6,870 | |||||||||
|
|
||||||||||
Funded status | (7,111 | ) | (6,870 | ) | |||||||
Unrecognized net loss | 1,133 | 1,659 | |||||||||
|
|
||||||||||
(Accrued) postretirement benefit cost | $ | (5,978 | ) | $ | (5,211 | ) | |||||
|
|
Net periodic cost included the following components for the periods indicated:
Years Ended December 31, | |||||||||||
|
|
|
|||||||||
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Service cost | $ | 419 | $ | 372 | $ | 327 | |||||
Interest cost | 363 | 358 | 294 | ||||||||
Net loss recognition | 17 | 20 | - | ||||||||
|
|
|
|||||||||
Net periodic cost | $ | 799 | $ | 750 | $ | 621 | |||||
|
|
|
The following table summarizes the Accumulated Benefit Obligation for the years ended December 31, 2004 and 2003, respectively.
Post Retirement Plan | |||||
|
|||||
Accumulated Benefit Obligation- 2004 | 7,111,438 | ||||
Accumulated Benefit Obligation- 2003 | 6,870,054 |
14. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
A. Dividend Restrictions
Under
Bermuda law, Group is prohibited from declaring or paying a dividend if such payment
would reduce the realizable value of its assets to an amount less than the aggregate
value of its liabilities and its issued share capital and share premium (additional
paid-in capital) accounts. Groups ability to pay dividends and its operating
expenses is dependent upon dividends from its subsidiaries. The payment of such dividends
by insurer subsidiaries is limited under Bermuda law and the laws of the various U.S.
states in which Groups insurance and reinsurance subsidiaries are domiciled or
deemed domiciled. The limitations are generally based upon net income and compliance with
applicable policyholders surplus or minimum solvency margin and liquidity ratio
requirements as determined in accordance with the relevant statutory accounting
practices.
F-34
Under Bermuda law, Bermuda Re is prohibited from declaring or making payment of a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, exceeds its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Monetary Authority is required if Bermuda Res dividend payments would reduce its prior year-end total statutory capital by 15.0% or more.
Delaware law provides that an insurance company which is a member of an insurance holding company system and is domiciled in the state shall not pay dividends without giving prior notice to the Insurance Commissioner of Delaware and may not pay dividends without the approval of the Insurance Commissioner if the value of the proposed dividend, together with all other dividends and distributions made in the preceding twelve months, exceeds the greater of (1) 10% of statutory surplus or (2) net income, not including realized capital gains, each as reported in the prior years statutory annual statement. In addition, no dividend may be paid in excess of unassigned earned surplus. At December 31, 2004, Everest Re had $209.3 million available for payment of dividends in 2005 without prior regulatory approval.
B. Statutory Financial
Information
Everest Re prepares its statutory
financial statements in accordance with accounting practices prescribed or permitted by
the National Association of Insurance Commissioners (NAIC) and the Delaware
Insurance Department. Prescribed statutory accounting practices are set forth in the NAIC
Accounting Practices and Procedures Manual. The capital and statutory surplus of Everest
Re was $2,093.2 million (unaudited) and $1,715.5 million at December 31, 2004 and 2003,
respectively. The statutory net income of Everest Re was $175.8 million (unaudited),
$164.6 million and $77.6 million for the years ended December 31, 2004, 2003 and 2002,
respectively.
Bermuda Re prepares its statutory financial statements in conformity with the accounting principles set forth in Bermuda in The Insurance Act 1978, amendments thereto and related regulations. The statutory capital and surplus of Bermuda Re was $1,471.2 million (unaudited) and $1,222.3 million at December 31, 2004 and 2003, respectively. The statutory net income of Bermuda Re was $241.6 million (unaudited), $128.9 million and $67.5 million for the years ended December 31, 2004, 2003, and 2002 respectively.
15. CONTINGENCIES
The Company does not believe that there are any material pending legal proceedings to which it or any of its subsidiaries is a party or of which any of their properties are subject.
In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Companys rights and obligations under insurance, reinsurance and other contractual agreements. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation and arbitration. In all such matters, the Company believes that its positions are legally and commercially reasonable. However, there can be no assurances that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on the Companys results of operations.
In 1993 and prior, the Company had a business arrangement with The Prudential wherein, for a fee, the Company accepted settled claim payment obligations of certain property and casualty insurers, and, concurrently, became the owner of the annuity or assignee of the annuity proceeds funded by the property and casualty insurers specifically to fulfill these fully settled obligations. In these circumstances, the Company would be liable if The
F-35
Prudential, which has an A+ (Superior) financial strength rating from A.M. Best Company (A.M. Best), were unable to make the annuity payments. The estimated cost to replace all such annuities for which the Company was contingently liable at December 31, 2004 and 2003 was $156.0 million and $153.8 million, respectively.
Prior to its 1995 initial public offering, the Company had purchased annuities from an unaffiliated life insurance company with an A+ (Superior) financial strength rating from A.M. Best to settle certain claim liabilities of the Company. Should the life insurance company become unable to make the annuity payments, the Company would be liable for those claim liabilities. The estimated cost to replace such annuities at December 31, 2004 and 2003 was $17.4 million and $16.0 million respectively.
16. STOCK BASED COMPENSATION PLANS
The Company has a 2002 Stock Incentive Plan (2002 Employee Plan), a 1995 Stock Incentive Plan (1995 Employee Plan), a 2003 Non-Employee Director Equity Compensation Plan (2003 Director Plan), a 1995 Stock Option Plan for Non-Employee Directors (1995 Director Plan) and has awarded options to non-employee directors in Board actions in 2001, 2000 and 1999. In 2002 the Company implemented FAS No. 123, and related interpretations in accounting for these plans and Board actions. Accordingly, option compensation expense of $3.3 million, $2.0 million and $0.6 million have been recognized in the accompanying consolidated financial statements for years ended December 31, 2004, 2003 and 2002, respectively, for stock options granted under the 2002 Employee Plan, the 1995 Employee Plan, the 2003 Director Plan and the 1995 Director Plan.
A summary of the status of the Companys shareholder approved and non-approved plans as of December 31, 2004, 2003 and 2002 and changes during the years then ended is presented in the following table:
Compensation Plans Approved by Shareholders:
2004 | 2003 | 2002 | ||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||
Shares |
Weighted-
Average Exercise Price |
Shares |
Weighted-
Average Exercise Price |
Shares |
Weighted-
Average Exercise Price |
|||||||||||||||
|
|
|
|
|
|
|||||||||||||||
Outstanding, | ||||||||||||||||||||
beginning of year | 2,373,409 | $45.41 | 2,407,524 | $41.23 | 2,038,474 | $37.52 | ||||||||||||||
Granted | 435,500 | 74.36 | 250,956 | 73.47 | 477,000 | 55.66 | ||||||||||||||
Exercised | 461,075 | 29.63 | 243,071 | 32.67 | 58,850 | 29.58 | ||||||||||||||
Forfeited | 29,300 | 58.43 | 42,000 | 50.01 | 49,100 | 38.26 | ||||||||||||||
|
|
|
||||||||||||||||||
Outstanding, | ||||||||||||||||||||
end of year | 2,318,534 | $53.82 | 2,373,409 | $45.41 | 2,407,524 | $41.23 | ||||||||||||||
|
|
|
||||||||||||||||||
Options exercisable | ||||||||||||||||||||
at year-end | 1,156,921 | 1,248,333 | 1,092,879 | |||||||||||||||||
|
|
|
||||||||||||||||||
Weighted-average | ||||||||||||||||||||
fair value of | ||||||||||||||||||||
options exercisable | ||||||||||||||||||||
at year-end | $43.88 | $37.20 | $35.72 | |||||||||||||||||
|
|
|
F-36
Under the 2003 Director Plan, 500,000 common shares have been authorized to be granted as stock options or stock awards to non-employee directors of the Company. At December 31, 2004, there were 487,500 remaining shares available to be granted under the 2003 Director Plan. Under the 2002, Employee Plan 4,000,000 common shares have been authorized to be granted as stock options, stock awards or restricted stock awards to officers and key employees of the Company. At December 31, 2004, there were 2,731,350 remaining shares available to be granted under the 2002 Employee Plan. Under the 1995 Director Plan, a total of 50,000 common shares have been authorized to be granted as stock options to non-employee directors of the Company. At December 31, 2004, there were 37,439 remaining shares available to be granted under the 1995 Director Plan. The 2002 Employee Plan replaced the 1995 Employee Plan; therefore, no further awards will be granted under the 1995 Employee Plan.
Compensation Plans Not Approved by Shareholders:
2004 | 2003 | 2002 | ||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||
Shares |
Weighted-
Average Exercise Price |
Shares |
Weighted-
Average Exercise Price |
Shares |
Weighted-
Average Exercise Price |
|||||||||||||||
|
|
|
|
|
|
|||||||||||||||
Outstanding, | ||||||||||||||||||||
beginning of year | 96,000 | $36.22 | 96,000 | $36.22 | 96,000 | $36.22 | ||||||||||||||
Granted | - | - | - | - | - | - | ||||||||||||||
Exercised | - | - | - | - | - | - | ||||||||||||||
Forfeited | - | - | - | - | - | - | ||||||||||||||
|
|
|
||||||||||||||||||
Outstanding, | ||||||||||||||||||||
end of year | 96,000 | $36.22 | 96,000 | $36.22 | 96,000 | $36.22 | ||||||||||||||
|
|
|
||||||||||||||||||
Options exercisable | ||||||||||||||||||||
at year-end | 96,000 | 82,680 | 59,333 | |||||||||||||||||
|
|
|
||||||||||||||||||
Weighted-average | ||||||||||||||||||||
fair value of | ||||||||||||||||||||
options exercisable | ||||||||||||||||||||
at year-end | $36.22 | $34.32 | $32.76 | |||||||||||||||||
|
|
|
Compensation plans not approved by shareholders refer to Board actions in 2001, 2000 and 1999, which awarded options to non-employee directors. The Board actions were designed to award non-employee directors with the options to purchase common stock to increase the ownership interest in the Company of non-employee directors whose services are considered essential to the Companys continued progress, to align such interests with those of the shareholders of the Company and to provide them with a further incentive to serve as directors to the Company. Under Board actions in 2001, 2000 and 1999 a total of 40,000, 30,000 and 26,000 common shares have been granted as stock options to non-employee directors of the Company.
Options granted under the 2002 Employee Plan and the 1995 Employee Plan vest at 20% per year over five years, options granted under the 1995 Director Plan vest at 50% per year over two years and options granted under the 2003 Director Plan and the 2001, 2000 and 1999 Board actions vest at 33% per year over three years. All options are exercisable at fair market value of the stock at the date of grant and expire ten years after the date of grant. Restricted shares granted under the 2002 Employee Plan and the 1995 Employee Plan vest at 20% per year over five years.
F-37
The following table summarizes information about stock options outstanding at December 31, 2004:
Options Outstanding | Options Exercisable | ||||||||||||||||
|
|
|
|
|
|||||||||||||
Range of
Exercise Prices |
Number
Outstanding at 12/31/04 |
Weighted-
Average Remaining Contractual Life |
Weighted-
Average Exercise Price |
Number
Exercisable at 12/31/04 |
Weighted-
Average Exercise Price |
||||||||||||
|
|
|
|
|
|
||||||||||||
$15.78 - $23.66 | 19,432 | 0.9 | $18.08 | 19,432 | $18.08 | ||||||||||||
$23.66 - $31.55 | 362,126 | 4.6 | $27.37 | 298,416 | $27.80 | ||||||||||||
$31.55 - $39.44 | 408,620 | 3.3 | $38.25 | 408,620 | $38.25 | ||||||||||||
$39.44 - $47.33 | 3,500 | 5.7 | $46.09 | 1,500 | $46.09 | ||||||||||||
$47.33 - $55.21 | 314,200 | 6.7 | $48.01 | 190,900 | $48.01 | ||||||||||||
$55.21 - $63.10 | 435,300 | 7.7 | $55.60 | 163,500 | $55.60 | ||||||||||||
$63.10 - $70.99 | 217,206 | 6.4 | $66.53 | 126,403 | $66.41 | ||||||||||||
$70.99 - $78.88 | 654,150 | 9.4 | $74.11 | 44,150 | $73.62 | ||||||||||||
|
|
|
|
||||||||||||||
2,414,534 | 6.6 | $53.12 | 1,252,921 | $43.29 | |||||||||||||
|
|
|
|
In addition to the 2002 Employee Plan, the 1995 Employee Plan, the 2003 Director Plan and the 1995 Director Plan, Group issued 2,283 common shares in 2004, 1,312 common shares in 2003 and 2,248 common shares in 2002 to the Companys non-employee directors as compensation for their service as directors in 2004, 2003 and 2002, respectively. These issuances had aggregate values of $185,000, $100,000 and $145,000, respectively.
Since its 1995 initial public offering, the Company has issued to certain key employees of the Company 181,500 restricted shares of stock, of which 19,960 restricted shares have been cancelled. Upon issuance of restricted shares, unearned compensation is charged to shareholders equity for the cost of the restricted stock and is amortized over the vesting period. The amount of earned compensation recognized as expense with respect to restricted stock awards was $1,316,224, $382,835 and $41,708 for 2004, 2003 and 2002, respectively. The Company acquired 5,100; 563 and 488 common shares at a cost of $380,809, $42,449 and $26,882 in 2004, 2003 and 2002, respectively, from employees who chose to pay required withholding taxes with shares exercised under the stock option grants or restricted shares, which became unrestricted. The Company acquired 604 common shares at a cost of $49,999 in 2003 from a non-employee director who chose to pay the option exercise price with shares. Also in 2004, 2003 and 2002, the Company recorded contributions of paid in capital in the amount of $8.4 million, $3.5 million and $0.7 million, respectively, representing the tax benefits attributable to the difference between the amount of compensation expense deductible for tax purposes with respect to the stock awards and the amount of such compensation expense reflected in the Companys financial statements.
17. RELATED-PARTY TRANSACTIONS
During the normal course of business, the Company, through its affiliates, engages in reinsurance and brokerage and commission business transactions, which management believes to be at arms-length, with companies controlled by or affiliated with its outside directors. Such transactions, individually and in the aggregate, are not material to the Companys financial condition, results of operations and cash flows.
F-38
18. SEGMENT REPORTING
The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the U.S. The Specialty Underwriting operation writes accident and health (A&H), marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through Everest Res branches in Canada and Singapore, in addition to foreign business written through Everest Res Miami and New Jersey offices. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and reinsurance to the United Kingdom and European markets through its UK branch.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments based upon their underwriting gain (loss) or underwriting results. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses. The Company utilizes inter-affiliate reinsurance, but such reinsurance generally does not impact segment results, as business is generally reported within the segment in which the business was first produced. The accounting policies of the operating segments are generally the same as those described in Note 1K, Summary of Significant Accounting Policies.
The Company does not maintain separate balance sheet data for its operating segments. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re, a Bermuda insurance company and direct subsidiary of Group. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Due to the sale and in accordance with Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (FAS 131), the Company restated the International and Bermuda segments for the years ended December 31, 2003 and 2002 to conform to December 31, 2004 segment reporting.
The following tables present the relevant underwriting results for the operating segments for the three years ended December 31:
U.S. Reinsurance | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 1,478,159 | $ | 1,752,302 | $ | 894,555 | |||||
Net written premiums | 1,468,466 | 1,687,333 | 834,234 | ||||||||
Premiums earned |
$ | 1,473,545 | $ | 1,423,841 | $ | 726,352 | |||||
Incurred losses and loss adjustment expenses | 1,168,563 | 1,059,087 | 535,950 | ||||||||
Commission and brokerage | 373,581 | 350,641 | 182,558 | ||||||||
Other underwriting expenses | 23,390 | 21,670 | 18,876 | ||||||||
|
|
|
|||||||||
Underwriting loss | $ | (91,989 | ) | $ | (7,557 | ) | $ | (11,032 | ) | ||
|
|
|
F-39
U.S. Insurance | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 1,167,808 | $ | 1,069,527 | $ | 821,442 | |||||
Net written premiums | 1,019,716 | 923,147 | 705,313 | ||||||||
Premiums earned |
$ | 937,576 | $ | 823,601 | $ | 573,081 | |||||
Incurred losses and loss adjustment expenses | 658,777 | 605,602 | 432,917 | ||||||||
Commission and brokerage | 130,380 | 146,782 | 122,806 | ||||||||
Other underwriting expenses | 44,834 | 38,569 | 25,802 | ||||||||
|
|
|
|||||||||
Underwriting gain (loss) | $ | 103,585 | $ | 32,648 | $ | (8,444 | ) | ||||
|
|
|
Specialty Underwriting |
|||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 487,072 | $ | 502,888 | $ | 488,583 | |||||
Net written premiums | 470,571 | 498,013 | 486,979 | ||||||||
Premiums earned |
$ | 459,284 | $ | 468,932 | $ | 459,973 | |||||
Incurred losses and loss adjustment expenses | 302,010 | 295,397 | 313,352 | ||||||||
Commission and brokerage | 129,209 | 133,531 | 130,552 | ||||||||
Other underwriting expenses | 7,068 | 6,475 | 6,363 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 20,997 | $ | 33,529 | $ | 9,706 | |||||
|
|
|
International |
|||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 687,657 | $ | 520,800 | $ | 364,476 | |||||
Net written premiums | 684,390 | 518,919 | 351,004 | ||||||||
Premiums earned |
$ | 655,694 | $ | 461,607 | $ | 318,207 | |||||
Incurred losses and loss adjustment expenses | 419,101 | 267,707 | 184,490 | ||||||||
Commission and brokerage | 161,106 | 113,091 | 80,853 | ||||||||
Other underwriting expenses | 11,298 | 9,734 | 9,256 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 64,189 | $ | 71,075 | $ | 43,608 | |||||
|
|
|
F-40
Bermuda | |||||||||||
(Dollars in thousands) |
2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Gross written premiums | $ | 883,439 | $ | 728,285 | $ | 277,445 | |||||
Net written premiums | 888,345 | 687,977 | 260,090 | ||||||||
Premiums earned |
$ | 898,983 | $ | 559,870 | $ | 196,064 | |||||
Incurred losses and loss adjustment expenses | 742,688 | 372,403 | 162,673 | ||||||||
Commission and brokerage | 180,900 | 119,888 | 35,018 | ||||||||
Other underwriting expenses | 13,998 | 12,222 | 6,433 | ||||||||
|
|
|
|||||||||
Underwriting (loss) gain | $ | (38,603 | ) | $ | 55,357 | $ | (8,060 | ) | |||
|
|
|
The following table reconciles the underwriting results for the operating segments to income before tax as reported in the consolidated statements of operations and comprehensive income for the three years ended December 31:
(Dollars in thousands) | 2004 | 2003 | 2002 | ||||||||
|
|
|
|||||||||
Underwriting gain | $ | 58,179 | $ | 185,052 | $ | 25,778 | |||||
Net investment income | 495,908 | 402,610 | 350,668 | ||||||||
Realized gain (loss) | 89,614 | (38,026 | ) | (50,043 | ) | ||||||
Net derivative (expense) income | (2,660 | ) | 5,851 | (14,509 | ) | ||||||
Corporate expenses | (6,532 | ) | (5,953 | ) | (3,186 | ) | |||||
Interest expense | (75,539 | ) | (57,288 | ) | (44,573 | ) | |||||
Other income (expense) | 741 | (1,033 | ) | (2,091 | ) | ||||||
|
|
|
|||||||||
Income before taxes | $ | 559,711 | $ | 491,213 | $ | 262,044 | |||||
|
|
|
The Company produces business in its U.S., Bermuda and international operations. The net income and assets of the individual foreign countries in which the Company writes business are not identifiable in the Companys financial records. The largest country, other than the U.S., in which the Company writes business is the United Kingdom, with $346.6 million of written premium for the year ended December 31, 2004. No other country represented more than 5% of the Companys revenues.
Approximately 16.9%, 13.1% and 15.9% of the Companys gross written premiums in 2004, 2003 and 2002, respectively, were sourced through the Companys largest intermediary.
F-41
19. UNAUDITED QUARTERLY FINANCIAL DATA
Summarized quarterly financial data for the periods ended were as follows:
(Dollars in thousands, except per share amounts) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | ||||||||||
|
|
|
|
|||||||||||
2004 Operating data: | ||||||||||||||
Gross written premiums | $ | 1,224,893 | $ | 1,085,604 | $ | 1,217,191 | $ | 1,176,446 | ||||||
Net written premiums | 1,177,950 | 1,050,855 | 1,179,748 | 1,122,935 | ||||||||||
Premiums earned | 1,055,065 | 1,004,258 | 1,139,862 | 1,225,897 | ||||||||||
Net investment income | 100,897 | 136,845 | 123,784 | 134,382 | ||||||||||
Net realized | ||||||||||||||
capital (loss) gain | (34,908 | ) | 116,681 | 10,125 | (2,284 | ) | ||||||||
Total claims and | ||||||||||||||
underwriting expenses | 957,905 | 918,768 | 1,236,387 | 1,260,375 | ||||||||||
Net income | $ | 126,101 | $ | 263,967 | $ | 11,463 | $ | 93,327 | ||||||
|
|
|
|
|||||||||||
Net income per | ||||||||||||||
common share - basic | $ | 2.26 | $ | 4.72 | $ | 0.20 | $ | 1.67 | ||||||
Net income per | ||||||||||||||
common share - diluted | $ | 2.22 | $ | 4.64 | $ | 0.20 | $ | 1.64 | ||||||
2003 Operating data: |
||||||||||||||
Gross written premiums | $ | 1,001,840 | $ | 1,068,733 | $ | 1,239,597 | $ | 1,263,636 | ||||||
Net written premiums | 951,933 | 988,427 | 1,183,707 | 1,191,328 | ||||||||||
Premiums earned | 744,870 | 851,988 | 1,046,353 | 1,094,640 | ||||||||||
Net investment income | 93,505 | 102,187 | 100,411 | 106,507 | ||||||||||
Net realized | ||||||||||||||
capital (loss) gain | (13,235 | ) | 1,747 | (30,055 | ) | 3,517 | ||||||||
Total claims and | ||||||||||||||
underwriting expenses | 696,140 | 813,371 | 993,735 | 1,055,506 | ||||||||||
Net income | $ | 94,367 | $ | 109,555 | $ | 100,326 | $ | 121,780 | ||||||
|
|
|
|
|||||||||||
Net income per | ||||||||||||||
common share - basic | $ | 1.85 | $ | 2.03 | $ | 1.81 | $ | 2.19 | ||||||
Net income per | ||||||||||||||
common share - diluted | $ | 1.83 | $ | 1.99 | $ | 1.77 | $ | 2.15 |
F-42
EVEREST RE GROUP, LTD. | |||||||||||
SCHEDULE I SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2004 |
|||||||||||
Column A |
Column B | Column C | Column D | ||||||||
|
|
|
|
||||||||
(Dollars in thousands) | Cost |
Market
Value |
Amount
Shown In Balance Sheet |
||||||||
|
|
|
|||||||||
Fixed maturities-available for sale | |||||||||||
Bonds: | |||||||||||
U.S. government and government agencies | $ | 184,070 | $ | 185,426 | $ | 185,426 | |||||
State, municipalities and political subdivisions | 3,281,442 | 3,439,322 | 3,439,322 | ||||||||
Foreign government securities | 921,498 | 952,098 | 952,098 | ||||||||
Foreign corporate securities | 542,121 | 564,863 | 564,863 | ||||||||
Public utilities | 316,626 | 329,891 | 329,891 | ||||||||
All other corporate bonds | 2,872,667 | 2,977,692 | 2,977,692 | ||||||||
Mortgage pass-through securities | 1,468,793 | 1,474,006 | 1,474,006 | ||||||||
Redeemable preferred stock | 22,400 | 23,874 | 23,874 | ||||||||
|
|
|
|||||||||
Total fixed maturities-available for sale | 9,609,617 | 9,947,172 | 9,947,172 | ||||||||
Equity securities | 571,717 | 650,871 | 650,871 | ||||||||
Short-term investments | 585,875 | 585,875 | 585,875 | ||||||||
Other invested assets | 160,188 | 161,324 | 161,324 | ||||||||
Cash | 184,930 | 184,930 | 184,930 | ||||||||
|
|
|
|||||||||
Total investments and cash | $ | 11,112,327 | $ | 11,530,172 | $ | 11,530,172 | |||||
|
|
|
S-1
S-2
S-3
S-4
EVEREST RE GROUP, LTD. | |||||||||||||||||||||||||||||
SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION | |||||||||||||||||||||||||||||
Column A |
Column B | Column C | Column D | Column E | Column F | Column G | Column H | Column I | Column J | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
Geographic Area
(Dollars in thousands) |
Deferred
Acquisition Costs |
Reserve for
Losses and Loss Adjustment Expenses |
Unearned
Premium Reserves |
Premiums
Earned |
Net
Investment Income |
Incurred
Loss and Loss Adjustment Expenses |
Amortization
of Deferred Acquisition Costs |
Other
Operating Expenses |
Net
Written Premium |
||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
December 31, 2004 | |||||||||||||||||||||||||||||
Domestic | $ | 163,600 | $ | 5,379,732 | $ | 1,226,099 | $ | 2,870,405 | $ | 305,546 | $ | 2,129,350 | $ | 633,170 | $ | 81,824 | $ | 2,958,753 | |||||||||||
International | 40,524 | 819,142 | 161,073 | 655,694 | 23,477 | 419,101 | 161,106 | 11,298 | 684,390 | ||||||||||||||||||||
Bermuda | 127,785 | 1,637,432 | 208,458 | 898,983 | 166,885 | 742,688 | 180,900 | 13,998 | 888,345 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Total | $ | 331,909 | $ | 7,836,306 | $ | 1,595,630 | $ | 4,425,082 | $ | 495,908 | $ | 3,291,139 | $ | 975,176 | $ | 107,120 | $ | 4,531,488 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
December 31, 2003 | |||||||||||||||||||||||||||||
Domestic | $ | 169,765 | $ | 4,402,636 | $ | 1,134,706 | $ | 2,716,374 | $ | 247,841 | $ | 1,960,086 | $ | 630,954 | $ | 72,667 | $ | 3,108,493 | |||||||||||
International | 29,052 | 615,394 | 128,783 | 461,607 | 21,047 | 267,707 | 113,091 | 9,734 | 518,919 | ||||||||||||||||||||
Bermuda | 134,397 | 1,343,215 | 236,150 | 559,870 | 133,722 | 372,403 | 119,888 | 12,222 | 687,977 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Total | $ | 333,214 | $ | 6,361,245 | $ | 1,499,639 | $ | 3,737,851 | $ | 402,610 | $ | 2,600,196 | $ | 863,933 | $ | 94,623 | $ | 4,315,389 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
December 31, 2002 | |||||||||||||||||||||||||||||
Domestic | $ | 133,824 | $ | 3,481,424 | $ | 702,970 | $ | 1,759,406 | $ | 229,924 | $ | 1,282,219 | $ | 435,916 | $ | 54,227 | $ | 2,026,526 | |||||||||||
International | 19,976 | 480,381 | 70,262 | 318,207 | 16,805 | 184,490 | 80,853 | 9,256 | 351,004 | ||||||||||||||||||||
Bermuda | 53,615 | 943,777 | 99,108 | 196,064 | 103,939 | 162,673 | 35,018 | 6,433 | 260,090 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Total | $ | 207,415 | $ | 4,905,582 | $ | 872,340 | $ | 2,273,677 | $ | 350,668 | $ | 1,629,382 | $ | 551,787 | $ | 69,916 | $ | 2,637,620 | |||||||||||
|
|
|
|
|
|
|
|
|
S-5
EVEREST RE GROUP, LTD. | |||||||||||||||||
SCHEDULE IV REINSURANCE | |||||||||||||||||
Column A |
Column B | Column C | Column D | Column E | Column F | ||||||||||||
|
|
|
|
|
|
||||||||||||
(Dollars in thousands) |
Gross
Amount |
Ceded to
Other Companies |
Assumed
from Other Companies |
Net
Amount |
Assumed
to Net |
||||||||||||
|
|
|
|
|
|
||||||||||||
December 31, 2004 | |||||||||||||||||
Total property and liability insurance | |||||||||||||||||
premiums earned | $ | 1,181,278 | $ | 186,466 | $ | 3,430,270 | $ | 4,425,082 | 77.5 | % | |||||||
December 31, 2003 | |||||||||||||||||
Total property and liability insurance | |||||||||||||||||
premiums earned | $ | 1,021,881 | $ | 223,540 | $ | 2,939,510 | $ | 3,737,851 | 78.6 | % | |||||||
December 31, 2002 | |||||||||||||||||
Total property and liability insurance | |||||||||||||||||
premiums earned | $ | 672,823 | $ | 192,607 | $ | 1,793,461 | $ | 2,273,677 | 78.9 | % |
S-6
EXHIBIT 10.46
Description of Non-Employee Director Compensation Arrangements
As annual compensation for their services in 2004 and 2005, the Everest Re Group, Ltd. non-employee directors are paid $60,000 plus reimbursement for reasonable out-of-pocket expenses. Payment is made quarterly in arrears and may be in the form of cash or, at each directors individual election and as permitted under the 2003 Non-Employee Director Equity Compensation Plan, in Company stock, with the number of shares determined by the fair market value of the shares as of the last day of each quarter. In addition, the non-employee directors are eligible to participate in the 1995 Stock Option Plan for Non-Employee Directors and the 2003 Non-Employee Director Equity Compensation Plan.
Exhibit 10.47
2003 NON-EMPLOYEE DIRECTOR EQUITY COMPENSATION PLAN
(As Amended Effective November 20, 2003)
This Agreement is made as of the Grant Date (as defined in paragraph 1 below), by and between Everest Re Group, Ltd. (the Corporation) and the Participant.
WHEREAS, the Corporation maintains the Everest Re Group, Ltd. 2003 Non-Employee Director Equity Compensation Plan (the Plan), which is incorporated into and forms part of this Agreement, and the Participant has been selected by the committee administering the Plan (the Committee) to receive a Non-qualified Stock Option Award under the Plan;
NOW, THEREFORE, IT IS AGREED, by and between the Corporation and the Participant, as follows;
1. Terms of Option. The following terms used in this Agreement shall have the meanings set forth in this paragraph 1:
(a) | The Participant is ______________ . |
(b) | The Grant Date is ______________ . |
(c) | The number of Covered Shares is ______________ Common Shares. |
(d) | The Exercise Price is $ _____________ per share. |
Other capitalized terms used in this Agreement are as defined herein, or as defined in the Plan.
2. Exercise. This Agreement specifies the terms of the option (the Option) granted to the Participant to purchase the number of Covered Shares at the Exercise Price per share as set forth in paragraph 1. The Option is not intended to constitute an incentive stock option as that term is defined in Section 422(b) of the Code. The Option may be exercised only in accordance with the Plan, as supplemented by this Agreement, and not otherwise.
(a) | Subject to the limitations of this Agreement, each Installment of Covered Shares shall become vested and exercisable on and after the Vesting Date for such Installment as described in the following schedule (but only if the Participants Date of Termination has not occurred before the Vesting Date): |
INSTALLMENT |
VESTING DATE APPLICABLE TO
INSTALLMENT |
34% of Covered Shares |
First Anniversary of the Grant Date |
33% of Covered Shares |
Second Anniversary of the Grant Date |
33% of Covered Shares |
Third Anniversary of the Grant Date |
(b) | The Option may not be exercised for less than the lesser of 50 Common Shares or the full number of Common Shares for which the Option is then exercisable. |
(c) | Notwithstanding the foregoing, the Option shall become fully vested and exercisable as follows: |
(i) | in the event of a Change in Control, or |
(ii) | if the Participants service as a director is terminated by reason of death or disability (as determined by the Committee). |
(d) | The Option may be exercised on or after the date of the Participants termination only as to that portion of the Covered Shares for which it was exercisable, or became exercisable, upon the Date of Termination. |
3. Expiration . the Option shall not be exercisable after the Corporations close of business on the last business day that occurs prior to the Expiration Date. The Expiration date shall be the earliest to occur of the following:
(a) | the ten-year anniversary of the grant date; |
(b) | if the Date of Termination occurs by reason of the Participants death or disability, as determined by the Committee, then the three-year anniversary of the Date of Termination; |
(c) | if the Date of Termination occurs by reason of the Participants removal as a director for Cause, then the Date of Termination; or |
(d) | if the termination occurs for reasons other than provided in subparagraph (b) or (c) above, then the three-year anniversary of the Date of Termination. |
4. Method of Exercise . to the extent then exercisable, the Option may be exercised by the Participant by giving written notice of exercise to the Corporation in such form as may be provided by the Committee specifying the number of Common Shares with respect to which the Option is to be exercised and the Exercise Price therefore and such other information as the Committee may require. Such exercise shall be effective upon receipt by the Corporation of such written notice together with the required payment of the Exercise Price and any applicable withholding taxes.
5. Payment of Exercise Price . Payment of the Exercise Price, and any applicable withholding taxes, may be made by any of the following methods:
(a) | by cash, or by check payable to the Corporation; |
(b) | by the delivery of shares of Stock owned for at least six months by the holder of the Option having a Fair Market Value equal to the aggregate Exercise Price; |
(c) | by a combination of cash, check or such Common Shares; or |
(d) | the Participant may also simultaneously exercise Options and sell the Common Shares thereby acquired, pursuant to a brokerage or similar arrangement approved in advance by the Committee, and use the proceeds from such sale as payment of the Exercise Price and any applicable withholding taxes. Subject to the foregoing, the Corporation will deliver to the Participant within a reasonable period of time thereafter, a certificate or certificates representing the Common Shares so acquired, registered in the name of the Participant or in accordance with other |
delivery instructions provided by the Participant and acceptable by the Committee. |
6. Transferability. Except as otherwise provided in this paragraph 6, the Option is not transferable other than as designated by the Participant by will or by the laws of descent and distribution, and during the Participants life, may be exercised only by the Participant. However, the Participant, with the approval of the Committee, may transfer the Option for no consideration to or for the benefit of the Participants Immediate Family (including, without limitation, to a trust for the benefit of the Participants Immediate Family or to a partnership or limited liability company for one or more members of the Participants Immediate Family), subject to such limits as the Committee may establish, and the transferee shall remain subject to all the terms and conditions applicable to the Option prior to such transfer. The foregoing right to transfer the Option shall apply to the right to consent to amendments to this Agreement and, in the discretion of the Committee, shall also apply to the right to transfer ancillary rights associated with the Option. The term Immediate Family means the Participants spouse, parents, children, stepchildren, adoptive relationships, sisters, brothers and grandchildren (and, for this purpose, shall also include the Participant).
7. Rights as a Stockholder. The Participant shall have no rights as a shareholder with respect to any Common shares subject to the Option until the date the Participant becomes the holder of record with regard thereto. Except as provided in Section 9 of the Plan, no adjustment shall be made for dividends or other rights with respect to such Common Shares.
8. Holding Period for Directors. For purposes of Section 16 of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder, at least six (6) months must lapse from the date of the Participants acquisition of the Option to the date of its exercise.
9. No Right to Continued Services. Nothing herein shall obligate the Corporation or any Subsidiary or affiliate of the Corporation to continue the Participants services for any particular period or on any particular basis of compensation.
10. Burden and Benefit. The terms and provisions of this Agreement shall be binding upon, and shall inure to the benefit of, the Participant and his or her executors or administrators, heirs, and personal and legal representatives.
11. Execution. No person shall have any rights under this Option unless and until the Participant has executed and delivered this Agreement to the Corporation. By executing this Option Agreement, the Participant shall be deemed to have accepted and consented to any action taken under the Plan by the Committee, the Board of Directors or their delegates.
12. Modifications. No change or modification of this Agreement shall be valid unless it is in writing and signed by the parties hereto.
13. Entire Agreement. This Agreement, together with the Plan, sets forth all of the promises, agreements, conditions, understandings, warranties and representations, oral or written, express or implied, between the parties hereto with respect to the Option. The terms and conditions of the Plan are incorporated by reference herein, and to the extent that any conflict may exist between any term or provision of this Agreement and any term or provision of the Plan, the term or provision of the Plan shall control.
14. Genders. The use of any gender herein shall be deemed to include the other gender and the use of the singular herein shall be deemed to include the plural and vice versa, wherever appropriate.
15. Notices. Any and all notices required herein shall be addressed: (i) if to the Corporation, to the principal executive office of the Corporation; and (ii) if to the Participant, to his or her address as reflected in the records of the Corporation.
16. Invalid or Unenforceable Provisions. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if the invalid or unenforceable provisions were omitted.
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statement on Forms S-8 (File Nos. 333-1972, 333-05771, 333-97049, and 333-105483) and Form S-3 (File No. 333-106595) of Everest Re Group, Ltd. of our reports dated March 11, 2005 relating to the financial statements, managements assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appear in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated March 11, 2005 relating to the financial statement schedules, which appears in this Form 10-K. We also consent to the reference to us under the heading Selected Financial Data in this Form 10-K.
PricewaterhouseCoopers LLP
New
York, New York
March 11, 2005
Exhibit 31.1
CERTIFICATIONS
I, Joseph V. Taranto, certify that:
1. | I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: |
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and |
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting. |
March 15, 2005
/s/ JOSEPH V. TARANTO |
|
________________________ | |
Joseph V. Taranto | |
Chairman and | |
Chief Executive Officer |
Exhibit 31.2
CERTIFICATIONS
I, Stephen L. Limauro, certify that:
1. | I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: |
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and |
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting. |
March 15, 2005
/s/ STEPHEN L. LIMAURO |
|
________________________ | |
Stephen L. Limauro | |
Executive Vice President and | |
Chief Financial Officer |
Exhibit 32.1
CERTIFICATIONS PURSUANT
TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K for the year ended December 31, 2004 of Everest Re Group, Ltd., a company organized under the laws of Bermuda (the Company), filed with the Securities and Exchange Commission on the date hereof (the Report), the undersigned hereby certify, pursuant to 18 U.S.C. ss. 1350, as enacted by section 906 of the Sarbanes-Oxley Act of 2002, that:
1. | The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934, and |
2. | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
March 15, 2005
/s/ JOSEPH V. TARANTO |
|
________________________ | |
Joseph V. Taranto | |
Chairman and | |
Chief Executive Officer |
/s/ STEPHEN L. LIMAURO |
|
________________________ | |
Stephen L. Limauro | |
Executive Vice President and | |
Chief Financial Officer |