**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

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**FORM10-Q**

 

| ý |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------|--------|-----------------------------------------------------------------------------------------------|
|   |   |                                                                                          |
| **OR** |
|   |   |                                                                                          |
| o      |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the quarterly period ended September 30, 2002**

 

**Commission File Number 000-23481**

 

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**ESG RELIMITED**

(Exactname of registrant as specified in its charter)

 

| **Bermuda**                                                                            |   | **Not Applicable**                    |
|----------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of   Incorporation of organization)                      |   | (I.R.S.  Employer Identification No.) |
|                                                                                   |   |                                  |
| **16 Church Street   Hamilton HM11, Bermuda**(Address of executive offices, zip  code) |
|                                                                                   |   |                                  |
| **(441) 295-2185**                                                                     |
| (Registrant’s  telephone number, including area code)                             |

 

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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  o  No  ý

 

The number of theRegistrant’s common shares (par value $1.00 per share) outstanding as of March14, 2003 was 11,100,673.

 

 

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**Explanatory Note**

 

**We are restating our financial statements for the periodsended September 30, 2001, December 31, 2001, March 31, 2002 and June 30, 2002due to the incorrect accounting treatment for a co-reinsurance contract enteredinto with ACE Capital Re Overseas Ltd. We have also restated our financial statements for the year endedDecember 31, 2001 for an error in our Foreign Currency Translationaccount.  (See notes 5 and 6 to theaccompanying Condensed Consolidated Financial Statements).  Accordingly, the results for prior periodsas reflected in this Form 10-Q differ from previously filed financialinformation.**

 

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**TABLE OF CONTENTS**

 
| ITEM        |                                                                                        |
|-------------|---------------------------------------------------------------------------------------------|
|        |                                                                                        |
| **PART I**  |
|        |                                                                                        |
| Item 1.     | Financial Statements and Supplementary Data                                                 |
| Item 2.     | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
| Item 3.     | Quantitative and Qualitative Disclosures about  Market Risk                                 |
| Item 4.     | Controls and Procedures                                                                     |
|        |                                                                                        |
| **PART II** |
|        |                                                                                        |
| Item 1.     | Legal Proceedings                                                                           |
| Item 2.     | Changes in Securities  and Use of Proceeds                                                  |
| Item  3.    | Defaults  Upon Senior Securities                                                            |
| Item 4.     | Submission of Matters to  a Vote of Security Holders                                        |
| Item 5.     | Other Information                                                                           |
| Item 6.     | Exhibits and Reports on Form 8-K                                                            |

 

Unless the context requiresotherwise, references in this Form 10-Q to “ESG,” “we,” “us,” “our” and “ours”mean ESG Re Limited and the subsidiaries through which it operates.

 

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# **PARTI** — FINANCIALINFORMATION

# **ITEM1**. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

# **ESG RE LIMITED**

# **CondensedConsolidated Balance Sheets**

# **(U.S. dollars inthousands except share and per share data)**

 
|                                                                                                                                                                                                                          |   | **September  30,   2002** |    | **December  31,   2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|---------|--------------------------|--------|
|                                                                                                                                                                                                                          |   | **(Unaudited)**           |    | **As  Restated**         |   |
| ASSETS                                                                                                                                                                                                                        |   |                      |    |                     |   |
| Investments available for sale, at fair value (cost: $95,990 and  $146,369)                                                                                                                                                   |   | $                         | 99,290  |                     | $      | 144,844 |   |
| Cash and cash equivalents                                                                                                                                                                                                     |   | 9,998                     |    | 3,915                    |   |
| Other investments                                                                                                                                                                                                             |   | 7,044                     |    | 6,172                    |   |
| Total investments and cash                                                                                                                                                                                                    |   | 116,332                   |    | 154,931                  |   |
| Accrued investment income                                                                                                                                                                                                     |   | 1,464                     |    | 2,028                    |   |
| Management fees receivable                                                                                                                                                                                                    |   | 650                       |    | 296                      |   |
| Reinsurance balances receivable                                                                                                                                                                                               |   | 181,311                   |    | 190,526                  |   |
| Reinsurance recoverable on incurred losses                                                                                                                                                                                    |   | 36,874                    |    | 28,630                   |   |
| Funds retained by ceding companies                                                                                                                                                                                            |   | 29,856                    |    | 24,629                   |   |
| Prepaid reinsurance premiums                                                                                                                                                                                                  |   | 996                       |    | 1,523                    |   |
| Deferred acquisition costs                                                                                                                                                                                                    |   | 39,317                    |    | 38,886                   |   |
| Receivable for securities sold                                                                                                                                                                                                |   | 0                         |    | 2,318                    |   |
| Deferred tax asset                                                                                                                                                                                                            |   | 1,354                     |    | 1,339                    |   |
| Other assets                                                                                                                                                                                                                  |   | 8,339                     |    | 7,277                    |   |
| Cash and cash equivalents held in a fiduciary capacity                                                                                                                                                                        |   | 879                       |    | 1,724                    |   |
|                                                                                                                                                                                                                          |   |                      |    |                     |   |
| TOTAL ASSETS                                                                                                                                                                                                                  |   | $                         | 417,372 |                     | $      | 454,107 |   |
|                                                                                                                                                                                                                          |   |                      |    |                     |   |
| LIABILITIES                                                                                                                                                                                                                   |   |                      |    |                     |   |
| Unpaid losses and loss expenses                                                                                                                                                                                               |   | $                         | 165,582 |                     | $      | 148,905 |   |
| Unearned premiums                                                                                                                                                                                                             |   | 85,363                    |    | 100,718                  |   |
| Acquisition costs payable                                                                                                                                                                                                     |   | 40,622                    |    | 42,843                   |   |
| Reinsurance balances payable                                                                                                                                                                                                  |   | 41,956                    |    | 51,927                   |   |
| Fair value of forward exchange contracts                                                                                                                                                                                      |   | 19                        |    | —                   |   |
| Accrued expenses, accounts payable, and other liabilities ($54 and  $85 due to related parties)                                                                                                                               |   | 10,425                    |    | 12,920                   |   |
| Fiduciary liabilities                                                                                                                                                                                                         |   | 879                       |    | 1,724                    |   |
| Total liabilities                                                                                                                                                                                                             |   | 344,846                   |    | 359,037                  |   |
|                                                                                                                                                                                                                          |   |                      |    |                     |   |
| SHAREHOLDERS’ EQUITY                                                                                                                                                                                                     |   |                      |    |                     |   |
| Preference shares, 50,000,000 shares authorized; no shares issued and  outstanding as of September 30, 2002 and December 31, 2001                                                                                   |   | —                    |    | —                   |   |
| Class B common shares, 100,000,000 shares authorized; no shares  issued and outstanding as of September 30, 2002 and December 31,  2001                                                                             |   | —                    |    | —                   |   |
| Common shares, par value $1 per share; 100,000,000 shares authorized;  11,906,605 shares issued and outstanding as of September 30, 2002 and  11,831,063 shares issued and outstanding as of December 31, 2001 |   | 11,907                    |    | 11,831                   |   |
| Additional paid-in capital                                                                                                                                                                                                    |   | 208,430                   |    | 208,221                  |   |
| Unearned compensation                                                                                                                                                                                                         |   | (288                      | )       | (333                     | )      |
| Accumulated other comprehensive income:                                                                                                                                                                                       |   |                      |    |                     |   |
| Foreign currency translation adjustments, net of tax                                                                                                                                                                          |   | (1,434                    | )       | (201                     | )      |
| Unrealized gains/(losses) on securities, net of tax                                                                                                                                                                           |   | 3,300                     |    | (1,525                   | )      |
| Accumulated other comprehensive income/(loss)                                                                                                                                                                                 |   | 1,866                     |    | (1,726                   | )      |
| Retained deficit                                                                                                                                                                                                              |   | (149,389                  | )       | (122,923                 | )      |
| Total shareholders’ equity                                                                                                                                                                                               |   | 72,526                    |    | 95,070                   |   |
|                                                                                                                                                                                                                          |   |                      |    |                     |   |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                                               |   | $                         | 417,372 |                     | $      | 454,107 |   |

##### ** **

##### **Theaccompanying notes are an integral part of the condensed consolidated financialstatements**

##### ** **

##### **4**

##### ****

##### ** **

# **ESG RE LIMITED**

# **CondensedConsolidated Statements of Operations**

# **(U.S. dollars inthousands except share and per share data)**

# **(Unaudited)**

# ** **

|                                                  |   | **Three  Months Ended**   |   | **Nine  Months Ended**    |   |
|-------------------------------------------------------|--------|---------------------------|--------|---------------------------|--------|
|                                                  |   | **September  30,   2002** |   | **September  30,   2001** |   | **September  30,   2002** |   | **September  30,   2001** |   |
|                                                  |   |                      |   | **As Restated**           |   |   |   | **As Restated** |   |
| REVENUES                                              |   |                      |   |                      |   |   |   |   |   |
| Net premiums written                                  |   | $                         | 38,170 |                      | $      | 8,898 |   | $ | 86,149 |   | $ | 75,763 |   |
| Change in unearned premiums                           |   | (2,841                    | )      | 19,861                    |   | 15,786 |   | 33,787 |   |
|                                                  |   |                      |   |                      |   |   |   |   |   |
| Net premiums earned                                   |   | 35,329                    |   | 28,759                    |   | 101,935 |   | 109,550 |   |
| Management fee revenue                                |   | 652                       |   | (132                      | )      | 1,831 |   | 288 |   |
| Net investment income                                 |   | 1,501                     |   | 2,512                     |   | 5,462 |   | 9,247 |   |
| Loss on equity investments                            |   | —                    |   | —                    |   | — |   | (29 | ) |
| Net realized investment gains/(losses)                |   | 459                       |   | 215                       |   | (1,155 | ) | (2,517 | ) |
|                                                  |   | 37,941                    |   | 31,354                    |   | 108,073 |   | 116,539 |   |
| EXPENSES                                              |   |                      |   |                      |   |   |   |   |   |
| Losses and loss expenses                              |   | 18,513                    |   | 15,870                    |   | 75,987 |   | 72,093 |   |
| Acquisition costs                                     |   | 13,740                    |   | 8,980                     |   | 33,397 |   | 33,983 |   |
| Administrative expenses                               |   | 7,383                     |   | 6,407                     |   | 25,155 |   | 20,225 |   |
|                                                  |   | 39,636                    |   | 31,257                    |   | 134,539 |   | 126,301 |   |
| (LOSS)/INCOME FROM CONTINUING OPERATIONS BEFORE TAXES |   | (1,695                    | )      | 97                        |   | (26,466 | ) | (9,762 | ) |
| Income tax expense                                    |   | —                    |   | —                    |   | — |   | — |   |
|                                                  |   |                      |   |                      |   |   |   |   |   |
| NET (LOSS)/INCOME                                     |   | (1,695                    | )      | 97                        |   | (26,466 | ) | (9,762 | ) |
| PER SHARE DATA                                        |   |                      |   |                      |   |   |   |   |   |
| Basic net (loss)/income per share                     |   | (0.14                     | )      | 0.01                      |   | (2.23 | ) | (0.83 | ) |
| Diluted net (loss)/income                             |   | (0.14                     | )      | 0.01                      |   | (2.23 | ) | (0.83 | ) |
| WEIGHTED AVERAGE SHARES   OUTSTANDING            |   |                      |   |                      |   |   |   |   |   |
| Basic                                                 |   | 11,884,173                |   | 11,787,725                |   | 11,847,055 |   | 11,786,000 |   |
| Diluted                                               |   | 11,884,173                |   | 11,787,725                |   | 11,847,055 |   | 11,786,000 |   |
|                                                       |        |                           |        |                           |        |  |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**ESG RE LIMITED**

# **Condensed ConsolidatedStatements of Cash Flows**

**(U.S. dollars in thousands)**

**(Unaudited)**

 
|                                                                       |   | **Nine  Months Ended**    |    |
|----------------------------------------------------------------------------|--------|---------------------------|---------|
|                                                                       |   | **September  30,   2002** |    | **September  30,   2001** |   |
|                                                                       |   |                      |    | **As Restated** |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES                                      |   |                      |    |   |   |
| Net cash used in operating activities                                      |   | $                         | (42,219 | ) | $ | (23,982 | ) |
|                                                                       |   |                      |    |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                       |   |                      |    |   |   |
| Cost of fixed maturity investments acquired — available for sale      |   | (184,612                  | )       | (183,557 | ) |
| Proceeds from sale of fixed maturity investments — available for sale |   | 236,674                   |    | 189,465 |   |
| Funding of other investments                                               |   | (872                      | )       | (854 | ) |
| Purchases of fixed assets                                                  |   | (2,888                    | )       | (1,262 | ) |
| Net cash provided by investing activities                                  |   | 48,302                    |    | 3,792 |   |
|                                                                       |   |                      |    |   |   |
| Net increase/(decrease) in cash                                            |   | 6,083                     |    | (20,190 | ) |
| Cash and cash equivalents at January 1                                     |   | 3,915                     |    | 26,032 |   |
|                                                                       |   |                      |    |   |   |
| Cash and cash equivalents at September 30                                  |   | 9,998                     |    | 5,842 |   |
| SUPPLEMENTAL CASH FLOW INFORMATION                                         |   |                      |    |   |   |
| NON-CASH FINANCING TRANSACTION:                                            |   |                      |    |   |   |
| Issuance of common shares for services                                     |   | $                         | 76      |   | $ | 58 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**ESG RE LIMITED**

#### **CondensedConsolidated Statements of Comprehensive Income/(Loss)**

**(U.S. dollars in thousands)**

**(Unaudited)**

 
|                                     |   | **Three  Months Ended**   |   | **Nine Months  Ended**    |   |
|------------------------------------------|--------|---------------------------|--------|---------------------------|--------|
|                                     |   | **September  30,   2002** |   | **September  30,   2001** |   | **September  30,   2002** |   | **September  30,   2001** |   |
|                                     |   |                      |   | **As Restated**           |   |   |   | **As Restated** |   |
| Net (loss)/income                        |   | $                         | (1,695 | )                         | $      | 97 |   | $ | (26,466 | ) | $ | (9,762 | ) |
| Other comprehensive income, net of tax:  |   |                      |   |                      |   |   |   |   |   |
| Foreign currency translation adjustments |   | 26                        |   | 305                       |   | (1,233 | ) | 638 |   |
| Net unrealized gains on securities       |   | 2,203                     |   | 3,838                     |   | 4,825 |   | 5,241 |   |
| Other comprehensive income               |   | 2,229                     |   | 4,143                     |   | 3,592 |   | 5,879 |   |
|                                     |   |                      |   |                      |   |   |   |   |   |
| Comprehensive income/(loss)              |   | 534                       |   | 4,240                     |   | (22,874 | ) | (3,883 | ) |
|                                          |        |                           |        |                           |        |  |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**NOTES TOTHE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1. BASIS OF PRESENTATION**

 

The accompanying unauditedcondensed consolidated financial statements of ESG Re Limited have beenprepared on a going concern basis, which contemplates the realization of assetsand satisfaction of liabilities in the normal course of business, in accordancewith generally accepted accounting principles in the United States of America(“U.S. GAAP”) and pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”), which do not require all of the financialstatements and footnotes required by U.S. GAAP.  In the opinion ofmanagement, these unaudited condensed consolidated financial statements reflectall adjustments considered necessary for a fair presentation of financialposition, results of operations and comprehensive income as of and for theperiods presented.  The results of operations for any interim period arenot necessarily indicative of the results for a full year.

 

In these financialstatements, the condensed consolidated statements of operations, cash flows andcomprehensive income for the three and nine months ended September 30, 2001 andfor the condensed consolidated balance sheet as of December 31, 2001 reflectthe impact of restatements made in respect of accounting for foreign currencytranslation and co-reinsurance transactions with ACE INA Overseas InsuranceCompany Ltd. as outlined in notes 5 and 6 to these financial statements.

 

We reported losses of $26.5million and $15.9 million together with negative cashflows from operations of$42.2 million and $42.5 million in the nine months ended September 30, 2002 andthe year ended 2001 respectively. Furthermore, our shareholders’ equity has reduced from $95.0 million asat December 31, 2001 to $72.5 million as at September 30, 2002.

 

We recognize that ourability to continue to operate in the insurance/reinsurance markets isdependent upon the successful implementation of our business plan for 2003 andfuture years.

 

Our 2003 business plancontains the following critical assumptions, each of which must occur in orderfor the plan to be successful and enable us to maintain our liquidity andcapital base:

 

•                  Maintaining premiums earned during 2003 at asimilar level to 2002 with an overall loss and acquisition cost ratiocomparable to 2002.

•                  Significant increases in net written premiumsover 2002.  We currently expect theseincreases to come from our North America medical and Direct segment business.

•                  Reduction in operating expenses, as wecomplete projects in respect of legacy issues and reduce operating activities ina number of overseas locations.

•                  No significant deterioration in loss andlegal reserves in respect of estimated claims incurred on business earned todate.

 

The plan is also dependentup a number of other key assumptions including achieving a sufficientinvestment yield, hedging significant foreign exchange exposures and managingtied capital in line with claim reserves and new business written.

 

In addition to the businessplan, we have identified a number of other possible cash flows.  These include partial or full divestment ofinvestments together with the continuation of selective commutation of bothinwards contracts in respect of the early underwriting years.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Our condensed consolidatedfinancial statements have been prepared in accordance with U.S. GAAP.  Oursignificant accounting policies include the following:

 

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(A)                              PREMIUM REVENUES

 

We estimate and recognizepremiums written at the inception of the reinsurance contract based uponinformation received from intermediaries and ceding companies.  We compareestimated written premiums to actual premiums as reported by ceding companieson a periodic basis.  The timeliness and frequency of ceding companyreports vary considerably by ceding company, line of business and geographicarea, therefore the actual ultimate premium written may not be known withcertainty for prolonged periods following the expiration of the reinsurancecontract.  Differences between such estimates and actual amounts asreported by ceding companies are recorded in the periods in which the actualamounts are determined.

 

The reinsurance contractswhich we enter are primarily of short duration.  For retroactive contractsthe amount by which the amount paid for reinsurance coverage exceeds therecorded liabilities is charged to earnings.  If the liabilities exceedthe amount paid the excess is deferred and amortized into income over theremaining settlement period.  Premiums written are recognized as earnedover the coverage period in proportion to the amount of protectionprovided.  Unearned premium reserves are established to cover theunexpired contract period.

 

(B)                                RESERVE FOR LOSSES AND LOSS EXPENSES

 

The reserve for unpaid lossesand loss adjustment expenses includes an estimate of reported case reserves andan estimate for losses incurred but not reported.  Case reserves areestimated based on ceding company reports and other data considered relevant tothe estimation process.  We have some specific historical experience on asignificant number of our programs on which to base our estimate of lossesincurred but not reported.  There is a reliance on the expectations ofceding companies about ultimate loss ratios at the inception of the contracts,supplemented by industry experience and current legal interpretations ofcoverage and liability, which increases the uncertainty involved in the lossestimation process.  The reserves as established by management arereviewed quarterly and adjustments are made in the periods in which they becomeknown.  Although management believes that an adequate provision has beenmade for the liability for losses and loss expenses based on all availableinformation, there can be no assurance that the ultimate losses will not differsignificantly from the amounts provided.

 

(C)                                 INVESTMENTS

 

Fixed maturity securitiesare classified as available for sale and are reported at estimated fairvalue.  Investments that are available for sale are expected to be heldfor an indefinite period but may be sold depending on interest rates and otherconsiderations.  Other investments over which we exercise significantinfluence are accounted for under the equity method.  Otherwise theseinvestments are accounted for at cost.  Unrealized investment gains andlosses on investments available for sale, net of applicable deferred incometax, are reported as a separate component of “accumulated other comprehensiveincome.”  Realized gains or losses on sale of investments are determinedon the basis of average cost.  The costs of investments available for saleand other investments are adjusted for impairments in value that are consideredto be other than temporary.

 

(D)                                DEFERRED ACQUISITION COSTS

 

We defer costs relating to theproduction of new business, primarily commissions and telemarketing costs inrespect of our Direct business, and include them in the deferred acquisitioncost asset to the extent that they are recoverablefrom future related policy revenues.  Weamortize the deferred acquisition costs in respect of commissions over theperiods in which the related premiums are earned.  We amortize thedeferred acquisition costs in relation to telemarketing over the expected lifeof the policies. We review our deferred costs to determine if they arerecoverable from future income, including investment income, and, if they arenot, we charge them as an expense.

 

(E)                                 REINSURANCE PREMIUMS CEDED

 

Reinsurance premiums cededare reported as prepaid reinsurance premiums and amortized over the respectivecontract or policy periods in proportion to the amount of insurance protectionprovided.

 

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 Commissions on reinsurance ceded are deferred over the terms ofthe contracts of reinsurance to which they relate and amortized in proportionto the amount of insurance protection provided.

 

(F)                                  FOREIGNCURRENCY TRANSLATION

 

Our functional and reportingcurrency is the U.S. dollar.  Foreign currency receivables or payablesthat are denominated in a currency other than U.S. dollars are translated intoU.S. dollars at the rates of exchange in effect at the balance sheetdate.  Revenues and expenses are translated into U.S. dollars usingweighted average exchange rates for the period.  The resulting exchangegains or losses are included in the results of operations.  Exchange gainsand losses related to the translation of investments available for sale areincluded in the net unrealized appreciation (depreciation) of investments, netof deferred income taxes, as a separate component of “accumulated othercomprehensive income.”  Assets and liabilities related to foreignoperations, whose functional currency is other than US dollars, are translatedinto U.S. dollars at the exchange rate in effect at the balance sheet date;revenues and expenses are translated into U.S. dollars using weighted averageexchange rates for the period.  Gains and losses resulting fromtranslating foreign currency financial statements, net of deferred income taxes,are excluded from income and included as a separate component of “accumulatedother comprehensive income.”

 

(G)                                USE OF ESTIMATES

 

The preparation of financialstatements in accordance with U.S. GAAP requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period as well as the disclosure of such amounts.  Actualresults, particularly for premiums written, premiums earned, loss and legalreserves could materially differ from those estimates and assumptions.

 

(H)                               FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The carrying value of ourinvestments available for sale approximates their fair value and is based onquoted market prices.  Due to the uncertainty with respect to both thetiming and amount of the proceeds to be realized from our other investments, itis not practicable to determine the fair value of these otherinvestments.  The carrying values of other financial instruments,including cash and cash equivalents, accrued investment income, and otherreceivables and payables approximate their estimated fair value due to theshort term nature of the balances.

 

(I)                                    DERIVATIVES

 

The Company enters intoforward exchange contracts to protect against exchange rate fluctuations.  Hedge Accounting is not utilized for theseinstruments.  Accordingly, those contractsare carried out at fair value with changes in fair value recorded in theStatement of Operations.  The Companydoes not utilize derivatives for speculative purposes.

 

**3. ACCOUNTING PRONOUNCEMENTS**

 

On July 30, 2002, the FASBissued SFAS No. 146, *Accounting for CostsAssociated With Exit or Disposal Activities*. This statement requirescosts associated with exit or disposal activities to be recognized when thecosts are incurred, rather than at a date of commitment to an exit or disposalplan. SFAS 146 is effective for disposal activities after December 31, 2002.The adoption of SFAS 146 did not have an impact on our financial position,results of operations or cash flows.

 

On October 3, 2002 the FASBissued SFAS No. 147, *Acquisitions of certainFinancial Institutions*.  This statement provides guidance on theaccounting for the acquisition of a financial institution and requires that theexcess of fair value of liabilities assumed over the fair value of tangible andintangible assets acquired in a business combination represents goodwill thatshould be accounted for under

 

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 SFAS142, *Goodwill and other Tangible Assets*. Thus, the specialized Accounting guidance in paragraph 5 of Statement No. 72will not apply to periods ended after September 30, 2002.  The adoption ofSFAS 147 did not have an impact on our financial position, results ofoperations or cash flows for the period ended September 30, 2002.

 

 In December 2002, the FASB issued SFAS No. 148, Accounting forStock Based Compensation - Transition and Disclosure – an amendment of FASB123.  This statement providesalternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock based employee compensation.  In addition, this statement amendsdisclosure requirements of Statement 123 to ensure that fair value disclosuresare prominent in both annual and interim financial statements.  As discussed in note 2(k) we account forstock based compensation under APB No. 25 and provide the fair value methoddisclosures required by SFAS No. 123 and SFAS No. 148.  The adoption of the provisions of SFAS 148did not have a material effect on our financial position, operations or cashflows.

 

InNovember 2002, the FASB approved FASB Interpretation No. (“FIN”) 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others”. FIN 45 elaborates on the existing disclosure requirements for mostguarantees, including loan guarantees such as standby letters of credit.  It also clarifies that at the time a companyissues a guarantee, the company must recognize an initial liability for thefair value, or market value, of the obligations it assumes under that guaranteeand must disclose that information in its interim and annual financialstatements.  FIN 45 is effective on aprospective basis to guarantees issued or modified after December 31,2002.  The disclosure requirements ofFIN 45 are effective for financial statements of interim or annual periodsending after December 15, 2002.  TheCompany is currently evaluating the impact of the application of thisinterpretation, but does not expect a material impact from the application ofFIN 45 on our consolidated financial statements.

 

FIN 46, *Consolidation of Variable Interest Entities*,clarifies the application of Accounting Research Bulletin No. 51,"Consolidated Financial Statements, " to certain entities in whichequity investors do not have the characteristics of a controlling financialinterest or do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. FIN 46 is applicable immediately for variable interest entitiescreated after January 31, 2003. For variable interest entities created prior toJanuary 31, 2003, the provisions of FIN 46 are applicable no later than July 1,2003. The Company does not expect this Interpretation to have a material effecton the consolidated financial statements.

 

**4. COMMITMENTS AND CONTINGENCIES**

 

*(A)**     **EMPLOYMENT CONTRACTS, LEASEAND OTHER COMMITMENTS*

 

We have employment contracts with a number ofemployees for original terms of one to five years that have total minimumcommitments of $0.2 million at September 30, 2002 and had total minimumcommitments of $0.6 million at December 31, 2001, excluding any performancebonuses that are determined by our Board of Directors.  The contractsinclude various non-compete clauses following termination of employment.

 

ESG and its subsidiaries have various obligationsunder operating leases.  The future minimum commitments at September 30,2002 under operating leases, other commitments (4Sigma) and employmentcontracts are as follows:

 
| **U.S. dollars in thousands** |   | **Employment  Commitments** |   | **Lease  & Other Commitments** |   | **Total** |   |
|-------------------------------|--------|-----------------------------|--------|-----------------------------------------|--------|-----------|--------|
| Years Ending December 31,     |   |                        |   |                                    |   |      |   |
| 2002                          |   | 119                         |   | 539                                     |   | 658       |   |
| 2003                          |   | 72                          |   | 782                                     |   | 854       |   |
| 2004                          |   | —                      |   | 570                                     |   | 570       |   |
| 2005                          |   | —                      |   | 287                                     |   | 287       |   |
| 2006                          |   | —                      |   | 200                                     |   | 200       |   |
| Over five years               |   | —                      |   | 926                                     |   | 926       |   |
| Total                         |   | 191                         |   | 3,304                                   |   | 3,495     |   |

 

In November 2001, we committed to make anadditional capital injection in 4Sigma of $1.8 million, in increments of$100,000 as funds are required by 4Sigma to meet operating expenses inaccordance with the 

 

11

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4Sigma business plan, in exchange for 1.8million shares of Series E preferred stock.  As of September 30, 2002, wehad invested $1.5 million of this commitment.

 

*(B)**     **LETTERS OF CREDIT AND TRUSTACCOUNTS*

 

As of September 30, 2002, Secured Letters ofCredit and Trust Accounts in the aggregate amount of $87.7 million have beenissued in favor of ceding companies with $24.8 million related to Letters ofCredit issued and $62.9 million related to Trust Accounts in force.  TheLetters of Credit and Trust Accounts are secured by a lien on our fixedmaturities investment portfolio, equal to 120% of the amount of the outstandingLetters of Credit, and 102% of the amount of the outstanding TrustAccounts.  As of December 31, 2001, Secured Letters of Credit and TrustAccounts in the amount of $91.0 million were issued in favor of cedingcompanies.

 

*(C)**    **FORWARD CONTRACT COLLATERAL*

 

As at September 30, 2002, $1.0 million washeld in a Collateral Account by the Bank of New York as security for enteringinto a forward currency contract with us.

 

*(D)  PENSION OBLIGATIONS*

 

A subsidiary of ESG is obligated to makecontributions to defined contribution pension plans for employees.  As ofSeptember 30, 2002 and December 31, 2001, there were outstanding liabilitiesfor pension contributions of $305 thousand and $294 thousand, respectively.

 

*(E) LITIGATION*

 

We and our subsidiaries, incommon with the insurance industry in general, are subject to litigation,including claims for punitive damages, in the normal course of business. We do not believe that such litigation will have a material adverse effect onour financial condition, future operating results, or liquidity.

 

In February 2000,Odyssey Re (Sphere Drake) instituted an action in England against a broker,Stirling Cooke Brown and others, alleging fraud and conspiracy on thereinsurance placement of 1997 and 1998 Personal Accident and WorkersCompensation “carve out” business with Odyssey Re.  During 1998, ESGaccepted a 25% quota share reinsurance treaty with Odyssey Re.  This treatyterminated as of December 31, 1998, but we renewed our participation for 1999directly with the underwriting agent involved in the 1998 year.  InDecember 1999, we gave notice to rescind our contract with Odyssey Re (UK) formisrepresentation and failure to disclose material facts.  On November 29,2000, we filed suit in the High Court to seek a judicial confirmation of ourrescission.  On February 5, 2001, Odyssey Re filed a response.  In December 2002, Odyssey Re accepted ourrescission of this treaty in return for a contribution to its legal fees.  Therefore, we have no further liability onthis contract.  We have also givennotice we intend to rescind the 1999 account.  This matter is in discoveryand is now set for arbitration in late 2003. We believe the outcome of the pending litigation between Odyssey Re(Sphere Drake) and Stirling Cook Brown and others will have an impact on thisarbitration.  Our legal reserve isintended to cover the expected fees and indemnity for a number of matters inlitigation and arbitration.  The legalreserve as at September 30, 2002 was $1.3 million.  We review this reserve each quarter based on the developments inthat quarter on the matters covered by the legal reserve.

 

**5. RESTATEMENT OF FINANCIAL STATEMENTS – Foreign Currency Translation**

 

During the second quarter of2002, we determined that foreign currency translation adjustments included inaccumulated other comprehensive income and other expenses, had been misstatedby $3,992 thousand due to an error in the internal system that consolidates thefinancial results of our subsidiaries. At the time we were unable to determinethe periods in which the original errors occurred and therefore to correct thiserror, we have restated our financial statements for the fiscal year December31, 2001 in order

 

12

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to reflect a fourth quarter adjustment toforeign currency translation adjustments, included in accumulated othercomprehensive income, other expenses, and consolidated statements of changes inshareholders’ equity of $3,992 thousand. The restated accounts were filed in our Form 10-K (Amendment No. 4)filing of August 22, 2002.

 

Following furtherinvestigation we have subsequently determined that the error of $3,992koccurred in the following years:

 

 
|   |   | **U.S.  dollars in thousands** |   |
|--------|--------|--------------------------------|--------|
| 1999   |   | $                              | 488    |   |
| 2000   |   | 4,071                          |   |
| 2001   |   | (567                           | )      |
|   |   | $                              | 3,992  |   |

 

We have further restated, inour published Annual Report and Consolidated Financial Statements for the yearsended December 31, 2002 and 2001, our financial statements for the fiscal yearended December 31, 2001 in order to reflect foreign currency translationadjustments included in accumulated other comprehensive income, other expenses,and consolidated statements of changes in shareholders’ equity.  The adjustment and restatement has had thefollowing impact on our consolidated statement of operations and consolidatedbalance sheet for the year ended December 31, 2001:

 
|                                                                                          |   | **December 31, 2001**U.S. dollars in  thousands (except per share data) |    |
|-----------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------|---------|
|                                                                                          |   | **As Restated**                                                         |    | **As  Previously Reported** |   |
| Other expenses                                                                                |   | $                                                                       | 8,549   |   | $ | 13,108 |   |
| Net Loss                                                                                      |   | $                                                                       | 15,873  |   | $ | 20,432 |   |
| Net loss per share                                                                            |   | $                                                                       | 1.35    |   | $ | 1.73 |   |
| Foreign currency translation adjustments, in accumulated other  comprehensive income          |   | $                                                                       | (201    | ) | $ | (201 | ) |
| Foreign currency translation adjustments, in consolidated statements  of comprehensive income |   | $                                                                       | 567     |   | $ | 5,130 |   |
| Retained deficit                                                                              |   | $                                                                       | 122,923 |   | $ | 122,923 |   |

 

Thisrestatement had no impact on our consolidated statement of operations for thethree and nine months ended September 30, 2001.

 

**6.  RESTATEMENT OFFINANCIAL STATEMENTS – Co-reinsurance Agreements with ACE INA OverseasInsurance Company Ltd.**

 

We signed a co-reinsurancecontract with ACE INA Overseas Insurance Company Ltd. (“ACE”) in November 2001that became effective retroactively as of January 1, 2001.  Under SFAS 113, the premiums written duringthe retroactive period were deemed to be written on our own account with theco-reinsurance to ACE treated as a retroactive retrocession arrangement.  However, we did not show premiums earned,losses and loss adjustment expenses and acquisition costs in our reportedrevenues and expenses, in respect of the retroactive period, in the third andfourth quarters of 2001 and the first and second quarters of 2002.  During the quarter ended September 30, 2002,we realized this error in our treatment of the ACE contract and subsequentlyrestated our figures for the affected quarters to reflect the correctaccounting treatment of this contract. In accordance with SFAS 113, we did not recognize any of the profits ofthe ACE share of the reinsurance contract in our statement of operations andhence, there was no impact on our reported net income or net loss in anyaffected period.  The following tableshows the impact that the correct accounting for this contract had on ourconsolidated balance sheet as at December 31, 2001.

 

13

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|                            |   | **December  31, 2001  U.S. dollars in thousands** |    |
|---------------------------------|--------|---------------------------------------------------|---------|
|                            |   | **As  Restated**                                  |    | **As  Previously Reported** | ** ** |
| Deferred acquisition costs      |   | $                                                 | 38,886  |   | $ | 40,308 |   |
| Unpaid loss & loss expenses |   | $                                                 | 148,905 |   | $ | 146,383 |   |
| Unearned premiums               |   | $                                                 | 100,718 |   | $ | 104,395 |   |
| Acquisition costs payable       |   | $                                                 | 42,843  |   | $ | 43,110 |   |
| Shareholders equity             |   | $                                                 | 95,070  |   | $ | 95,070 |   |

 

The following table showsthe impact that the correct accounting for this contract had on ourconsolidated statement of operations for the three and nine months endedSeptember 30, 2001.

 
|                     |   | **Three  months ended September   30, 2001** |   | **Nine  months ended September   30, 2001** |   |
|--------------------------|--------|----------------------------------------------|--------|---------------------------------------------|--------|
|                     |   | **As Restated**                              |   | **As  previously Restated**                 |   | **As  Restated** |   | **As  previously Restated** |   |
| Net earned premiums      |   | 28,759                                       |   | 27,232                                      |   | 109,550 |   | 108,023 |   |
| Loss & loss expenses |   | 15,870                                       |   | 14,762                                      |   | 72,093 |   | 70,985 |   |
| Acquisition costs        |   | 8,980                                        |   | 8,561                                       |   | 33,983 |   | 33,564 |   |
| Net Income/(Loss)        |   | 97                                           |   | 97                                          |   | (9,762 | ) | (9,762 | ) |

 

**7. EARNINGS PER SHARE**

 

Class A warrants topurchase up to 1,381,200 common shares at $20 per share were outstanding as ofSeptember 30, 2001 and 2002. Class B warrants to purchase up to 1,381,200common shares at $1.50 per share were outstanding as of September 30, 2002 and2001.  Options to purchase up to2,518,301 common shares, issued at exercise prices ranging between $2.01 and$26.00, were outstanding as of September 30, 2001. Options to purchase upto 2,343,047 common shares, issued at exercise prices ranging between $2.01 and$26.00, were outstanding as of September 30, 2002. The incremental sharesfrom assumed exercise ofoptionsand warrants have not been included in the earnings per share calculation asthey have an anti-dilutive effect on the net loss per common share.

 

** 8. SEGMENT INFORMATION**

 

We operate two complementarybusiness segments, ESG Reinsurance and ESG Direct.  Our larger segment ESG Reinsurance, provides medical, personalaccident, credit life, disability and special risks reinsurance to selectedinsurers and reinsurers.  Our smallerbut growing segment ESG Direct provides direct marketing services, expertise inthe development of reinsurance and insurance products and supporting technologyto financial institutions in Asia, Europe and Australia.  We do not maintain separate balance sheetdata for our operating segments. Accordingly, we do not review and evaluate the financial results of theoperating segments based upon balance sheet data.

 

**UnderwritingResults**

 

Underwriting results for thethree and nine months ended September 30, 2002 and 2001, by line of businessand in total, for the ESG Reinsurance segment were as follows:

 
| **Three months ended September  30, 2002 (unaudited)** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                                        |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                                      |   | 30,785                         |   | 315          |   | (821       | )      | (9       | )      | 3,334     |   | 33,604    |   |
| Net premiums written                                        |   | 28,028                         |   | 820          |   | (783       | )      | (7       | )      | 3,272     |   | 31,330    |   |
| Net premiums earned                                         |   | 23,971                         |   | 2,383        |   | (774       | )      | 483      |   | 2,827     |   | 28,890    |   |
| Losses and loss expenses                                    |   | 14,303                         |   | (1,709       | )      | (5         | )      | 2,478    |   | 2,952     |   | 18,019    |   |
| Acquisition costs                                           |   | 7,043                          |   | 984          |   | (72        | )      | 82       |   | 1,177     |   | 9,214     |   |
| Technical profit/(loss)                                     |   | 2,625                          |   | 3,108        |   | (697       | )      | (2,077   | )      | (1,302    | )      | 1,657     |   |
| Operating costs                                             |   | 4,711                          |   | 2            |   | 181        |   | 27       |   | 251       |   | 5,172     |   |
| Net underwriting (loss)/income                              |   | (2,086                         | )      | 3,106        |   | (878       | )      | (2,104   | )      | (1,553    | )      | (3,515    | )      |

 

14

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| **Nine months ended September  30, 2002 (unaudited)** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|------------------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                                       |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                                     |   | 65,862                         |   | 12,414       |   | (1,051     | )      | 270      |   | 2,213     |   | 79,708    |   |
| Net premiums written                                       |   | 53,706                         |   | 11,616       |   | (1,047     | )      | 210      |   | 2,765     |   | 67,250    |   |
| Net premiums earned                                        |   | 73,124                         |   | 9,421        |   | (590       | )      | (3       | )      | 2,641     |   | 84,593    |   |
| Losses and loss expenses                                   |   | 52,899                         |   | 16,799       |   | 277        |   | 2,868    |   | 2,280     |   | 75,123    |   |
| Acquisition costs                                          |   | 18,291                         |   | 2,789        |   | (19        | )      | 187      |   | 1,074     |   | 22,322    |   |
| Technical profit/(loss)                                    |   | 1,934                          |   | (10,167      | )      | (848       | )      | (3,058   | )      | (713      | )      | (12,852   | )      |
| Operating costs                                            |   | 14,922                         |   | 2,818        |   | 239        |   | 128      |   | 563       |   | 18,670    |   |
| Net underwriting loss                                      |   | (12,988                        | )      | (12,985      | )      | (1,087     | )      | (3,186   | )      | (1,276    | )      | (31,522   | )      |

 
| **Three months ended September  30, 2001** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                            |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                          |   | 21,218                         |   | 1,495        |   | (202       | )      | (1,746   | )      | 455       |   | 21,220    |   |
| Net premiums written                            |   | 9,430                          |   | 967          |   | (221       | )      | (1,714   | )      | 442       |   | 8,904     |   |
| Net premiums earned                             |   | 18,215                         |   | 5,734        |   | 317        |   | (383     | )      | 558       |   | 24,441    |   |
| Losses and loss expenses                        |   | 3,839                          |   | 10,452       |   | 171        |   | (252     | )      | 761       |   | 14,971    |   |
| Acquisition costs                               |   | 5,473                          |   | 1,145        |   | 591        |   | 4        |   | (534      | )      | 6,679     |   |
| Technical profit/(loss)                         |   | 8,903                          |   | (5,863       | )      | (445       | )      | (135     | )      | 331       |   | 2,791     |   |
| Operating costs                                 |   | 4,029                          |   | 640          |   | 73         |   | (83      | )      | 121       |   | 4,780     |   |
| Net underwriting income/(loss)                  |   | 4,874                          |   | (6,503       | )      | (518       | )      | (52      | )      | 210       |   | (1,989    | )      |

 
| **Nine months ended September  30, 2001** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                           |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                         |   | 67,271                         |   | 12,052       |   | (3,349     | )      | (3,139   | )      | 2,412     |   | 75,247    |   |
| Net premiums written                           |   | 50,867                         |   | 8,858        |   | (3,144     | )      | (4,000   | )      | 2,241     |   | 54,822    |   |
| Net premiums earned                            |   | 62,879                         |   | 32,700       |   | (1,143     | )      | (898     | )      | 2,455     |   | 95,993    |   |
| Losses and loss expenses                       |   | 37,473                         |   | 33,281       |   | (1,726     | )      | (1,628   | )      | 1,924     |   | 69,324    |   |
| Acquisition costs                              |   | 19,650                         |   | 7,574        |   | 673        |   | 110      |   | (953      | )      | 27,054    |   |
| Technical profit/(loss)                        |   | 5,756                          |   | (8,155       | )      | (90        | )      | 620      |   | 1,484     |   | (385      | )      |
| Operating costs                                |   | 11,664                         |   | 3,364        |   | (480       | )      | (180     | )      | 448       |   | 14,816    |   |
| Net underwriting (loss)/income                 |   | (5,908                         | )      | (11,519      | )      | 390        |   | 800      |   | 1,036     |   | (15,201   | )      |

 

Underwriting results for the three and ninemonths ended September 30, 2002 and 2001, by line of business and in total, forESG Direct segment were as follows:

 
| **Three months ended September 30,  2002 (unaudited)** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|--------------------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                                   |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                                 |   | 5,583                          |   | 1,257      |   | 6,840     |   |
| Net premiums written                                   |   | 5,583                          |   | 1,257      |   | 6,840     |   |
| Net premiums earned                                    |   | 5,583                          |   | 856        |   | 6,439     |   |
| Losses and loss expenses                               |   | 320                            |   | 174        |   | 494       |   |
| Acquisition costs                                      |   | 3,654                          |   | 872        |   | 4,526     |   |
| Technical profit/(loss)                                |   | 1,609                          |   | (190       | )      | 1,419     |   |
| Operating costs                                        |   | 1,279                          |   | 832        |   | 2,111     |   |
| Net underwriting income/(loss)                         |   | 330                            |   | (1,022     | )      | (692      | )      |

 

15

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| **Nine months ended September 30, 2002  (unaudited)** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|-------------------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                                  |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                                |   | 15,616                         |   | 3,283      |   | 18,899    |   |
| Net premiums written                                  |   | 15,616                         |   | 3,283      |   | 18,899    |   |
| Net premiums earned                                   |   | 15,676                         |   | 1,666      |   | 17,342    |   |
| Losses and loss expenses                              |   | 311                            |   | 553        |   | 864       |   |
| Acquisition costs                                     |   | 10,067                         |   | 1,008      |   | 11,075    |   |
| Technical profit/(loss)                               |   | 5,298                          |   | 105        |   | 5,403     |   |
| Operating costs                                       |   | 3,790                          |   | 2,384      |   | 6,174     |   |
| Net underwriting income/(loss)                        |   | 1,508                          |   | (2,279     | )      | (771      | )      |

 
| **Three months ended September 30,  2001** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|--------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                       |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                     |   | 4,132                          |   | (4,138     | )      | (6        | )      |
| Net premiums written                       |   | 4,132                          |   | (4,138     | )      | (6        | )      |
| Net premiums earned                        |   | 4,122                          |   | 196        |   | 4,318     |   |
| Losses and loss expenses                   |   | 849                            |   | 50         |   | 899       |   |
| Acquisition costs                          |   | 2,423                          |   | (122       | )      | 2,301     |   |
| Technical profit/(loss)                    |   | 850                            |   | 268        |   | 1,118     |   |
| Operating costs                            |   | 1,489                          |   | 38         |   | 1,527     |   |
| Net underwriting (loss)/income             |   | (639                           | )      | 230        |   | (409      | )      |

 
| **Nine months ended September 30, 2001** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                     |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                   |   | 12,709                         |   | 8,232      |   | 20,941    |   |
| Net premiums written                     |   | 12,709                         |   | 8,232      |   | 20,941    |   |
| Net premiums earned                      |   | 12,665                         |   | 892        |   | 13,557    |   |
| Losses and loss expenses                 |   | 2,520                          |   | 249        |   | 2,769     |   |
| Acquisition costs                        |   | 7,105                          |   | (176       | )      | 6,929     |   |
| Technical profit/(loss)                  |   | 3,040                          |   | 819        |   | 3,859     |   |
| Operating costs                          |   | 4,671                          |   | 458        |   | 5,129     |   |
| Net underwriting (loss)/income           |   | (1,631                         | )      | 361        |   | (1,270    | )      |

 

16

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**Report of Independent Accountants**

 

To the Board of Directors andShareholders

ESG Re Limited

 

 

We have reviewed the condensedconsolidated balance sheet of ESG Re Limited and subsidiaries as of September30, 2002, and the related condensed consolidated statements of operations andcomprehensive income/loss for the three-month and nine-month periods endedSeptember 30, 2002 and 2001, and cash flows for the nine-month periods endedSeptember 30, 2002 and 2001 included in the accompanying Securities andExchange Commission Form 10-Q for the period ended September 30, 2002. Thesefinancial statements are the responsibility of the Company’s management.

 

We conducted our review inaccordance with standards established by the American Institute of CertifiedPublic Accountants. A review of interim financial information consistsprincipally of applying analytical procedures to financial data, and makinginquiries of persons responsible for financial and accounting matters. It issubstantially less in scope than an audit conducted in accordance withgenerally accepted auditing standards, the objective of which is the expressionof an opinion regarding the financial statements taken as a whole. Accordingly,we do not express such an opinion.

 

Based on our reviews, we arenot aware of any material modifications that should be made to the condensedconsolidated financial statements referred to above for them to be inconformity with accounting principles generally accepted in the United Statesof America.

 

We have previously audited, inaccordance with auditing standards generally accepted in the United States ofAmerica, the consolidated restated balance sheet as of December 31, 2001, andthe related restated consolidated statements of operations, comprehensiveincome/loss,  shareholders’ equity, andcash flows for the year then ended (not presented herein); and in our reportdated March 31, 2003, we expressed an unqualified opinion on those consolidatedfinancial statements. In our opinion, the information set forth in theaccompanying condensed consolidated balance sheet as of December 31, 2001 isfairly stated in all material respects in relation to the consolidated balancesheet from which it has been derived, after giving effect to the restatementdiscussed in the following paragraph.

 

The condensed consolidatedbalance sheet as of December 31, 2001 and the condensed consolidated statementsof operations and comprehensive income/loss for the three-month and nine-monthperiods ended September 30, 2001 and cash flows for the nine-month period endedSeptember 30, 2001 have been restated. The effects of the restatements are set out in Notes 5 and 6 to theunaudited condensed consolidated financial statements.

 

 

BDO International

 

Dublin Ireland

 

Date: March 31, 2003

 

17

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**ITEM 2****.  MANAGEMENT DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

*The following discussion and analysis addresses thefinancial condition of ESG as of September 30, 2002 compared with December 31,2001 and our results of operation for the three months and nine months endedSeptember 30, 2002, compared with the same period last year.  Ourindependent accountants have reviewed our unaudited condensed consolidatedfinancial statements for the three months and nine months ended September 30,2002 in accordance with standards established by the American Institute ofCertified Public Accountants.  The results of our operations for the threeand nine month periods ended September 30, 2002 are not necessarily indicativeof our results for the full year.*

 

*Certain statements and information included in this Form10-Q constitute “forward-looking statements” within the meaning of the PrivateLitigation Reform Act of 1995.  These statements express our intentions,strategies, or predictions for the future.  Actual results may differ fromESG’s predictions.   For more information regarding forward-lookingstatements, please see “Cautionary Statement Regarding Forward-LookingStatements,” below.*

 

 **Restatementof Financial Statements**

 

We have restated ourfinancial statements for the year ended December 31, 2001 due to the incorrectaccounting treatment for a co-reinsurance contract entered into with ACE INAOverseas Insurance Company Ltd. (“ACE”) and for an error in our ForeignCurrency Translation account.  Thefollowing table summarizes the financial effects of these restatements:

** **
|                      |   | **As previously reported**                            |    | **Foreign   Currency Translation restatement** |   | **ACE Contract********restatement** |   | **As restated** |   |
|---------------------------|--------|-------------------------------------------------------|---------|------------------------------------------------|--------|-------------------------------------|--------|-----------------|--------|
|                      |   | **U.S. dollars in thousands (except per share data)** |    |
| Net premiums earned       |   | $                                                     | 153,220 |                                           | $      | —                              |   | $               | 3,677  |   | $ | 156,897 |   |
| Loss and loss expenses    |   | 104,566                                               |    | —                                         |   | 2,522                               |   | 107,088         |   |
| Acquisition costs         |   | 45,840                                                |    | —                                         |   | 1,155                               |   | 46,995          |   |
| Other expenses            |   | 13,108                                                |    | (4,559                                         | )      | —                              |   | 8,549           |   |
|                      |   |                                                  |    |                                           |   |                                |   |            |   |
| Net loss                  |   | (20,432                                               | )       | 4,559                                          |   | —                              |   | (15,873         | )      |
| Net loss per share        |   | (1.73                                                 | )       | 0.38                                           |   | —                              |   | (1.35           | )      |
|                      |   |                                                  |    |                                           |   |                                |   |            |   |
| Total Assets              |   | 455,529                                               |    | —                                         |   | (1,422                              | )      | 454,107         |   |
| Total Liabilities         |   | 360,459                                               |    | —                                         |   | (1,422                              | )      | 359,037         |   |
| Shareholder’s Equity |   | 95,070                                                |    | —                                         |   | —                              |   | 95,070          |   |
|                           |        |                                                       |         |                                                |        |                                     |        |                 |        |  |  |  |  |

 

*Foreign Currency Translation*

 

During the second quarter of2002, we determined that foreign currency translation adjustments included inaccumulated other comprehensive income and other expenses, had been misstatedby $3,992 thousand due to an error in the internal system that consolidates thefinancial results of our subsidiaries. At the time we were unable to determinethe periods in which the original errors occurred and therefore to correct thiserror, we restated our financial statements for the fiscal year December 31,2001 in order to reflect a fourth quarter adjustment to foreign currencytranslation adjustments, included in accumulated other comprehensive income,other expenses, and consolidated statements of changes in shareholders’ 

 

18

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equity of $3,992 thousand.  The restated accounts were filed in our Form10-K (Amendment No. 4) filing of August 22, 2002.

 

Following furtherinvestigation we have subsequently determined that the error of $3,992koccurred in the following years:

 
|   |   | **U.S.  dollars in thousands** |   |
|--------|--------|--------------------------------|--------|
| 1999   |   | $                              | 488    |   |
| 2000   |   | 4,071                          |   |
| 2001   |   | (567                           | )      |
|   |   | $                              | 3,992  |   |

 

We have further restated, inour published Annual Report and Consolidated Financial Statements for the yearsended December 31, 2002 and 2001, our financial statements for the fiscal yearended December 31, 2001 in order to reflect foreign currency translationadjustments, included in accumulated other comprehensive income, otherexpenses, and consolidated statements of changes in shareholders’ equity.  The adjustment and restatement has had thefollowing impact on our consolidated statement of operations and consolidatedbalance sheet for the year ended December 31, 2001:

 
|                                                                                          |   | **December 31, 2001**U.S. dollars in  thousands (except per share data) |    |
|-----------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------|---------|
|                                                                                          |   | **As  Restated**                                                        |    | **As  Previously Reported** |   |
| Other expenses                                                                                |   | $                                                                       | 8,549   |   | $ | 13,108 |   |
| Net Loss                                                                                      |   | $                                                                       | 15,873  |   | $ | 20,432 |   |
| Net loss per share                                                                            |   | $                                                                       | 1.35    |   | $ | 1.73 |   |
| Foreign currency translation adjustments, in accumulated other  comprehensive income          |   | $                                                                       | (201    | ) | $ | (201 | ) |
| Foreign currency translation adjustments, in consolidated statements  of comprehensive income |   | $                                                                       | 567     |   | $ | 5,130 |   |
| Retained deficit                                                                              |   | $                                                                       | 122,923 |   | $ | 122,923 |   |

 

Thisrestatement had no impact on our consolidated statement of operations for thethree and nine months ended September 30, 2001.

 

Theforeign currency translation account includes adjustments arising from theprocess of translating the financial statements of non U.S. dollar subsidiariesinto U.S. dollars.  Assets andliabilities of these subsidiaries are translated into U.S. dollars at theexchange rate in effect at the balance sheet date.  Revenues and expenses (“statement of operations”) for thesesubsidiaries are translated into U.S. dollars using weighted average exchangerates for the period. Retained earnings, share capital and investments insubsidiaries are translated at historic rates. Translation adjustments arising are included in the equity section ofthe balance sheet.

 

*Co-Reinsurance Agreement with ACE INA Overseas Insurance Company Ltd.*

 

We signed a co-reinsurancecontract with ACE INA Overseas Insurance Company Ltd. (“ACE”) in November 2001that became effective retroactively as of January 1, 2001.  Under SFAS 113, the premiums written duringthe retroactive period were deemed to be written on our own account with theco-reinsurance to ACE treated as a retroactive retrocession arrangement.  However, we did not show premiums earned,losses and loss adjustment expenses and acquisition costs in our reportedrevenues and expenses, in respect of the retroactive period, in the third andfourth quarters of 2001 and the first and second quarters of 2002.  During the quarter ended September 30, 2002,we realized this error in our treatment of the ACE contract and subsequentlyrestated our figures for the affected quarters to reflect the correctaccounting treatment of this contract. In accordance with SFAS 113, we did not recognize any of the profits ofthe ACE share of the reinsurance contract in our statement of operations andhence, there was no impact on our reported net 

 

19

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income or net loss in any affectedperiod.  The following table shows theimpact that the correct accounting for this contract had on our consolidatedbalance sheet as of December 31, 2001.

 
|                            |   | **December  31, 2001  U.S. dollars in thousands** |    |
|---------------------------------|--------|---------------------------------------------------|---------|
|                            |   | **As  Restated**                                  |    | **As  Previously  Reported** | ** ** |
| Deferred acquisition costs      |   | $                                                 | 38,886  |   | $ | 40,308 |   |
| Unpaid loss & loss expenses |   | $                                                 | 148,905 |   | $ | 146,383 |   |
| Unearned premiums               |   | $                                                 | 100,718 |   | $ | 104,395 |   |
| Acquisition costs payable       |   | $                                                 | 42,843  |   | $ | 43,110 |   |
| Shareholders equity             |   | $                                                 | 95,070  |   | $ | 95,070 |   |

 

The following table showsthe impact that the correct accounting for this contract had on ourconsolidated statement of operations for the three and nine months endedSeptember 30, 2001.

 
|                     |   | **Three  months ended September   30, 2001** |   | **Nine  months ended September   30, 2001** |   |
|--------------------------|--------|----------------------------------------------|--------|---------------------------------------------|--------|
|                     |   | **As  Restated**                             |   | **As  previously  Restated**                |   | **As Restated** |   | **As  previously  Restated** |   |
| Net earned premiums      |   | 28,759                                       |   | 27,232                                      |   | 109,550 |   | 108,023 |   |
| Loss & loss expenses |   | 15,870                                       |   | 14,762                                      |   | 72,093 |   | 70,985 |   |
| Acquisition costs        |   | 8,980                                        |   | 8,561                                       |   | 33,983 |   | 33,564 |   |
| Net Income/(Loss)        |   | 97                                           |   | 97                                          |   | (9,762 | ) | (9,762 | ) |

 

**PrincipalActivities and Sources of Revenue**

 

Our principal activitiesinclude providing accident, health, credit, life, and special risk reinsuranceand related product marketing and development services.  We also managepremiums on behalf of co-reinsurers on North American business written in2001.  We report the results of our business activities under twosegments: ESG Reinsurance and ESG Direct.  We evaluate the results ofthese segments based on business writings out of each of our producing offices. ESG Reinsurance provides traditional reinsurance products, primarily in theU.S. medical insurance market, and ESG Direct provides direct marketingservices, bancassurance services, and supporting technologies, as well astargeted reinsurance products for credit life and other special risks.

 

We derive our revenuesprincipally from:

 

•                  premiums for reinsurance products,

•                  fees for direct marketing services,

•                   managementfees, and

•                  investment income.

 

**Results ofOperations**

 

**TotalRevenues**

 

Our total revenues for thethree and nine months ended September 30, 2002 were $37.9 million and $108.1million, respectively, compared with total revenues of $31.4 million and $116.5million for the three and nine months ended September 30, 2001, respectively.

 

20

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The increase in revenues inthe quarter ended September 30, 2002 reflects an increase of $5.7 million inpremiums earned on North American medical business combined with an increase of$2.1 million of earned premiums in the Direct segment.

 

Our net loss for the threeand nine months ended September 30, 2002 was $1.7 million and $26.5 million,respectively, compared to a net gain of $97 thousand and a net loss of $9.8million for the three and nine months ended September 30, 2001, respectively.

 

  In the quarter we hada technical profit of $3.1 million. This included a profit on the North American business of $1.7 millionand a loss of $3.0 million on the Latin America business.

 

Net loss per share for thethree and nine months ended September 30, 2002 was $0.14 and $2.23,respectively, compared with a net gain per share of $0.01 and a net loss of$0.83 for the three and nine months ended September 30, 2001, respectively.

 

**NetUnderwriting Income**

 

For the three and ninemonths ended September 30, 2002, we managed, on our own behalf and on behalf ofour co-reinsurers, total gross premiums of $26.3 million and $90.3 million,respectively, of which $(14.1) million and $(8.3) million related to businessplaced with co-reinsurers and we retroceded $2.3 million and $12.4 million,resulting in net premiums written of $38.2 million and $86.2 million,respectively.  For the three and ninemonths ended September 30, 2001, we managed, on our own behalf and on behalf ofour co-reinsurers, total gross premiums of $43.3 million and $122.0 million, ofwhich we placed $22.1 million and $25.9 million with co-reinsurers andretroceded $12.2 million and $20.4 million, resulting in net premiums writtenof $9.0 million and $75.8, respectively.

 

The decrease in grossmanaged premiums during the three months ended September 30, 2002 as comparedto the corresponding period in 2001, is primarily a result of the non-renewalof some of our North American medical business for the 2002 underwriting year.

 

The increase in net writtenpremiums over the comparable period in 2001, is primarily due to the impact, inthe third quarter of 2001, of a 50% co-reinsurance management agreement betweenESG Re North America Ltd., a subsidiary of the Company, and ACE INA OverseasInsurance Company Ltd., which was only in effect for underwriting year 2001.

 

For the three months endedSeptember 30, 2002, we managed total premiums of $26.3 million, of which $19.5million was attributable to ESG Reinsurance, and $6.8 million was attributableto ESG Direct.  Of $38.1 million net premiums written in the same quarter,$31.3 million was attributable to ESG Reinsurance, and $6.8 million wasattributable to ESG Direct.

 

For the quarter endedSeptember 30, 2001, we had gross and net written premiums of $4.1 million inAsia which were offset by premium adjustments of $4.1 million in respect of theBancassurance business in Europe, resulting in zero gross and net writtenpremiums for the quarter.

 

In the fourth quarter of2001, we revised our initial estimates of the annual gross written premium onour Bancassurance business made in the first quarter 2001 from $16.6 million to$6.7 million.  During the three and ninemonths ended September 30, 2002, the reduction in gross written premium forthis business amounted to $4.1 million and $8.6 million, respectively.

 

 Gross and net premiumswritten and net premiums earned for the three and nine months ended September30, 2002 and 2001 were as follows:

 

21

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|                             |   | **Three  months ended September 30** |   |
|----------------------------------|--------|--------------------------------------|--------|
| **ESG Reinsurance**              |   | **2002**                             |   | **2001** |   |
|                             |   | **U.S.  dollars in millions**        |   |
| Total premiums managed           |   | 19.5                                 |   | 43.3 |   |
| Amount placed with co-reinsurers |   | 14.1                                 |   | (22.1 | ) |
| Gross premiums written           |   | 33.6                                 |   | 21.2 |   |
| Retroceded                       |   | (2.3                                 | )      | (12.3 | ) |
| Net premiums written             |   | 31.3                                 |   | 8.9 |   |
|                             |   |                                 |   |   |   |
| Net premiums earned              |   | 28.9                                 |   | 24.4 |   |

 
|                             |   | **Nine  months ended September 30** |   |
|----------------------------------|--------|-------------------------------------|--------|
| **ESG Reinsurance**              |   | **2002**                            |   | **2001** |   |
|                             |   | **U.S.  dollars in millions**       |   |
| Total premiums managed           |   | 71.4                                |   | 101.1 |   |
| Amount placed with co-reinsurers |   | 8.3                                 |   | (25.9 | ) |
| Gross premiums written           |   | 79.7                                |   | 75.2 |   |
| Retroceded                       |   | (12.4                               | )      | (20.4 | ) |
| Net premiums written             |   | 67.3                                |   | 54.8 |   |
|                             |   |                                |   |   |   |
| Net premiums earned              |   | 84.6                                |   | 96.0 |   |

 
|                             |   | **Three  months ended September 30** |   |
|----------------------------------|--------|--------------------------------------|--------|
| **ESG Direct**                   |   | **2002**                             |   | **2001** |   |
|                             |   | **U.S.  dollars in millions**        |   |
| Total premiums managed           |   | 6.8                                  |   | — |   |
| Amount placed with co-reinsurers |   | —                               |   | — |   |
| Gross premiums written           |   | 6.8                                  |   | — |   |
| Retroceded                       |   | —                               |   | — |   |
| Net premiums written             |   | 6.8                                  |   | — |   |
|                             |   |                                 |   |   |   |
| Net premiums earned              |   | 6.4                                  |   | 4.3 |   |

 
|                             |   | **Nine  months ended September 30** |   |
|----------------------------------|--------|-------------------------------------|--------|
| **ESG Direct**                   |   | **2002**                            |   | **2001** |   |
|                             |   | **U.S.  dollars in millions**       |   |
| Total premiums managed           |   | 18.9                                |   | 20.9 |   |
| Amount placed with co-reinsurers |   | —                              |   | — |   |
| Gross premiums written           |   | 18.9                                |   | 20.9 |   |
| Retroceded                       |   | —                              |   | — |   |
| Net premiums written             |   | 18.9                                |   | 20.9 |   |
|                             |   |                                |   |   |   |
| Net premiums earned              |   | 17.3                                |   | 13.6 |   |

 

22

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**UnderwritingResults**

 

Underwriting results for thethree and nine months ended September 30, 2002 and 2001, by line of businessand in total, for the ESG Reinsurance segment were as follows:

 
| **Three months ended September  30, 2002** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                            |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                          |   | 30,785                         |   | 315          |   | (821       | )      | (9       | )      | 3,334     |   | 33,604    |   |
| Net premiums written                            |   | 28,028                         |   | 820          |   | (783       | )      | (7       | )      | 3,272     |   | 31,330    |   |
| Net premiums earned                             |   | 23,971                         |   | 2,383        |   | (774       | )      | 483      |   | 2,827     |   | 28,890    |   |
| Losses and loss expenses                        |   | 14,303                         |   | (1,709       | )      | (5         | )      | 2,478    |   | 2,952     |   | 18,019    |   |
| Acquisition costs                               |   | 7,043                          |   | 984          |   | (72        | )      | 82       |   | 1,177     |   | 9,214     |   |
| Technical profit/(loss)                         |   | 2,625                          |   | 3,108        |   | (697       | )      | (2,077   | )      | (1,302    | )      | 1,657     |   |
| Operating costs                                 |   | 4,711                          |   | 2            |   | 181        |   | 27       |   | 251       |   | 5,172     |   |
| Net underwriting (loss)/income                  |   | (2,086                         | )      | 3,106        |   | (878       | )      | (2,104   | )      | (1,553    | )      | (3,515    | )      |

 
| **Nine months ended September  30, 2002** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                           |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                         |   | 65,862                         |   | 12,414       |   | (1,051     | )      | 270      |   | 2,213     |   | 79,708    |   |
| Net premiums written                           |   | 53,706                         |   | 11,616       |   | (1,047     | )      | 210      |   | 2,765     |   | 67,250    |   |
| Net premiums earned                            |   | 73,124                         |   | 9,421        |   | (590       | )      | (3       | )      | 2,641     |   | 84,593    |   |
| Losses and loss expenses                       |   | 52,899                         |   | 16,799       |   | 277        |   | 2,868    |   | 2,280     |   | 75,123    |   |
| Acquisition costs                              |   | 18,291                         |   | 2,789        |   | (19        | )      | 187      |   | 1,074     |   | 22,322    |   |
| Technical profit/(loss)                        |   | 1,934                          |   | (10,167      | )      | (848       | )      | (3,058   | )      | (713      | )      | (12,852   | )      |
| Operating costs                                |   | 14,922                         |   | 2,818        |   | 239        |   | 128      |   | 563       |   | 18,670    |   |
| Net underwriting loss                          |   | (12,988                        | )      | (12,985      | )      | (1,087     | )      | (3,186   | )      | (1,276    | )      | (31,522   | )      |

 
| **Three months ended September  30, 2001** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                            |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                          |   | 21,218                         |   | 1,495        |   | (202       | )      | (1,746   | )      | 455       |   | 21,220    |   |
| Net premiums written                            |   | 9,430                          |   | 967          |   | (221       | )      | (1,714   | )      | 442       |   | 8,904     |   |
| Net premiums earned                             |   | 18,215                         |   | 5,734        |   | 317        |   | (383     | )      | 558       |   | 24,441    |   |
| Losses and loss expenses                        |   | 3,839                          |   | 10,452       |   | 171        |   | (252     | )      | 761       |   | 14,971    |   |
| Acquisition costs                               |   | 5,473                          |   | 1,145        |   | 591        |   | 4        |   | (534      | )      | 6,679     |   |
| Technical profit/(loss)                         |   | 8,903                          |   | (5,863       | )      | (445       | )      | (135     | )      | 331       |   | 2,791     |   |
| Operating costs                                 |   | 4,029                          |   | 640          |   | 73         |   | (83      | )      | 121       |   | 4,780     |   |
| Net underwriting income/(loss)                  |   | 4,874                          |   | (6,503       | )      | (518       | )      | (52      | )      | 210       |   | (1,989    | )      |

 
| **Nine months ended September  30, 2001** |   | **Medical**                    |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|------------------------------------------------|--------|--------------------------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                           |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                         |   | 67,271                         |   | 12,052       |   | (3,349     | )      | (3,139   | )      | 2,412     |   | 75,247    |   |
| Net premiums written                           |   | 50,867                         |   | 8,858        |   | (3,144     | )      | (4,000   | )      | 2,241     |   | 54,822    |   |
| Net premiums earned                            |   | 62,879                         |   | 32,700       |   | (1,143     | )      | (898     | )      | 2,455     |   | 95,993    |   |
| Losses and loss expenses                       |   | 37,473                         |   | 33,281       |   | (1,726     | )      | (1,628   | )      | 1,924     |   | 69,324    |   |
| Acquisition costs                              |   | 19,650                         |   | 7,574        |   | 673        |   | 110      |   | (953      | )      | 27,054    |   |
| Technical profit/(loss)                        |   | 5,756                          |   | (8,155       | )      | (90        | )      | 620      |   | 1,484     |   | (385      | )      |
| Operating costs                                |   | 11,664                         |   | 3,364        |   | (480       | )      | (180     | )      | 448       |   | 14,816    |   |
| Net underwriting (loss)/income                 |   | (5,908                         | )      | (11,519      | )      | 390        |   | 800      |   | 1,036     |   | (15,201   | )      |

 

23

----

 

The key elements in the performance of theReinsurance segment for the quarter were –

 
| (i)   | Of the $2.1 million loss  in the life business, $1.9 million related to the strengthening of reserves  on the Latin American business.                                                                                                                       |
|-------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (ii)  | Within the medical portfolio,  an underwriting profit before operating costs of $4.8 million on the North  American business.                                                                                                                                |
| (iii) | An increase in premium  written for other business relating primarily to guarantee business in  Continental Europe.  This reflects the recognition of profit for the  2001 and 2002 underwriting years for treaties that were successfully  arbitrated. |

 

The operating ratios for the three and ninemonths ended September 30, 2002 and 2001, by line of business and in total, forthe ESG Reinsurance segment were as follows:

 
| **Three months ended September  30, 2002** |   | **Medical** |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------------|--------|-------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                            |   |        |   |         |   |       |   |     |   |      |   |      |   |
| Loss ratio                                      |   | 59.7        | %      | (71.7        | )%     | 0.6        | %      | 513.0    | %      | 104.4     | %      | 62.4      | %      |
| Acquisition expense ratio                       |   | 29.4        | %      | 41.3         | %      | 9.3        | %      | 17.0     | %      | 41.6      | %      | 31.9      | %      |
| Loss and acquisition expense ratio              |   | 89.1        | %      | (30.4        | )%     | 9.9        | %      | 530.0    | %      | 146.0     | %      | 94.3      | %      |
| Operating expense ratio                         |   |        |   |         |   |       |   |     |   |      |   | 17.9      | %      |
| Combined ratio                                  |   |        |   |         |   |       |   |     |   |      |   | 112.2     | %      |

 
| **Nine  months ended September 30, 2002** |   | **Medical** |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|-------------------------------------------|--------|-------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                      |   |        |   |         |   |       |   |     |   |      |   |      |   |
| Loss ratio                                |   | 72.3        | %      | 178.3        | %      | (46.9      | )%     | n/m      |   | 86.3      | %      | 88.8      | %      |
| Acquisition expense ratio                 |   | 25.0        | %      | 29.6         | %      | 3.2        | %      | n/m      |   | 40.7      | %      | 26.4      | %      |
| Loss and acquisition expense ratio        |   | 97.3        | %      | 207.9        | %      | (43.7      | )%     | n/m      |   | 127.0     | %      | 115.2     | %      |
| Operating expense ratio                   |   |        |   |         |   |       |   |     |   |      |   | 22.1      | %      |
| Combined ratio                            |   |        |   |         |   |       |   |     |   |      |   | 137.3     | %      |

 
| **Three  months ended September 30, 2001** |   | **Medical** |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|--------------------------------------------|--------|-------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                       |   |        |   |         |   |       |   |     |   |      |   |      |   |
| Loss ratio                                 |   | 21.1        | %      | 182.3        | %      | 53.9       | %      | 65.8     | %      | 136.4     | %      | 61.3      | %      |
| Acquisition expense ratio                  |   | 30.0        | %      | 20.0         | %      | 186.4      | %      | (1.0     | )%     | (95.7     | )%     | 27.3      | %      |
| Loss and acquisition expense ratio         |   | 51.1        | %      | 202.3        | %      | 240.3      | %      | 64.8     | %      | 40.7      | %      | 88.6      | %      |
| Operating expense ratio                    |   |        |   |         |   |       |   |     |   |      |   | 19.6      | %      |
| Combined ratio                             |   |        |   |         |   |       |   |     |   |      |   | 108.2     | %      |

 
| **Nine months ended September 30, 2001** |   | **Medical** |   | **Accident** |   | **Credit** |   | **Life** |   | **Other** |   | **Total** |   |
|------------------------------------------|--------|-------------|--------|--------------|--------|------------|--------|----------|--------|-----------|--------|-----------|--------|
|                                     |   |        |   |         |   |       |   |     |   |      |   |      |   |
| Loss ratio                               |   | 59.6        | %      | 101.8        | %      | 151.1      | %      | 181.3    | %      | 78.4      | %      | 72.2      | %      |
| Acquisition expense ratio                |   | 31.3        | %      | 23.2         | %      | (58.9      | )%     | (12.3    | )%     | (38.8     | )%     | 28.2      | %      |
| Loss and acquisition expense ratio       |   | 90.9        | %      | 125.0        | %      | 92.2       | %      | 169.0    | %      | 39.6      | %      | 100.4     | %      |
| Operating expense ratio                  |   |        |   |         |   |       |   |     |   |      |   | 15.4      | %      |
| Combined ratio                           |   |        |   |         |   |       |   |     |   |      |   | 115.8     | %      |

 

We calculated the operating expense ratiosfor the three and nine months ended September 30, 2002 and September 30, 2001by expressing total administrative expenses net of corporate office expense, asa

 

24

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percentageof net premiums earned.  For a more detailed discussion of operatingexpenses, refer to commentary on “Administrative Expenses”.

 

Underwriting results for the three and nine months ended September 30,2002 and 2001, by line of business and in total, for the ESG Direct segmentwere as follows:

 
| **Three months ended September 30,  2002** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|--------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                       |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                     |   | 5,583                          |   | 1,257      |   | 6,840     |   |
| Net premiums written                       |   | 5,583                          |   | 1,257      |   | 6,840     |   |
| Net premiums earned                        |   | 5,583                          |   | 856        |   | 6,439     |   |
| Losses and loss expenses                   |   | 320                            |   | 174        |   | 494       |   |
| Acquisition costs                          |   | 3,654                          |   | 872        |   | 4,526     |   |
| Technical profit/(loss)                    |   | 1,609                          |   | (190       | )      | 1,419     |   |
| Operating costs                            |   | 1,279                          |   | 832        |   | 2,111     |   |
| Net underwriting income/(loss)             |   | 330                            |   | (1,022     | )      | (692      | )      |

 
| **Nine months ended September 30, 2002** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                     |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                   |   | 15,616                         |   | 3,283      |   | 18,899    |   |
| Net premiums written                     |   | 15,616                         |   | 3,283      |   | 18,899    |   |
| Net premiums earned                      |   | 15,676                         |   | 1,666      |   | 17,342    |   |
| Losses and loss expenses                 |   | 311                            |   | 553        |   | 864       |   |
| Acquisition costs                        |   | 10,067                         |   | 1,008      |   | 11,075    |   |
| Technical profit/(loss)                  |   | 5,298                          |   | 105        |   | 5,403     |   |
| Operating costs                          |   | 3,790                          |   | 2,384      |   | 6,174     |   |
| Net underwriting income/(loss)           |   | 1,508                          |   | (2,279     | )      | (771      | )      |

 
| **Three months ended September 30,  2001** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|--------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                       |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                     |   | 4,132                          |   | (4,138     | )      | (6        | )      |
| Net premiums written                       |   | 4,132                          |   | (4,138     | )      | (6        | )      |
| Net premiums earned                        |   | 4,122                          |   | 196        |   | 4,318     |   |
| Losses and loss expenses                   |   | 849                            |   | 50         |   | 899       |   |
| Acquisition costs                          |   | 2,423                          |   | (122       | )      | 2,301     |   |
| Technical profit/(loss)                    |   | 850                            |   | 268        |   | 1,118     |   |
| Operating costs                            |   | 1,489                          |   | 38         |   | 1,527     |   |
| Net underwriting (loss)/income             |   | (639                           | )      | 230        |   | (409      | )      |

 
| **Nine months ended September 30, 2001** |   | **Accident**                   |   | **Credit** |   | **Total** |   |
|------------------------------------------|--------|--------------------------------|--------|------------|--------|-----------|--------|
|                                     |   | **U.S.  dollars in thousands** |   |
| Gross premiums written                   |   | 12,709                         |   | 8,232      |   | 20,941    |   |
| Net premiums written                     |   | 12,709                         |   | 8,232      |   | 20,941    |   |
| Net premiums earned                      |   | 12,665                         |   | 892        |   | 13,557    |   |
| Losses and loss expenses                 |   | 2,520                          |   | 249        |   | 2,769     |   |
| Acquisition costs                        |   | 7,105                          |   | (176       | )      | 6,929     |   |
| Technical profit/(loss)                  |   | 3,040                          |   | 819        |   | 3,859     |   |
| Operating costs                          |   | 4,671                          |   | 458        |   | 5,129     |   |
| Net underwriting (loss)/income           |   | (1,631                         | )      | 361        |   | (1,270    | )      |

 

Theincrease in written premiums in the credit line of business results frompremium adjustments made during the third quarter 2001 in respect of theBancassurance business.

 

Theoperating ratios for the three and nine months ended September 30, 2002 and2001, by line of business and in total, for the ESG Direct segment were asfollows:

 

25

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| **Three Months Ended September 30,  2002** |   | **Accident** |   | **Credit** |   | **Total** |   |
|--------------------------------------------|--------|--------------|--------|------------|--------|-----------|--------|
| Loss ratio                                 |   | 5.7          | %      | 20.3       | %      | 7.7       | %      |
| Acquisition expense ratio                  |   | 65.4         | %      | 101.9      | %      | 70.3      | %      |
| Loss and acquisition expense ratio         |   | 71.1         | %      | 122.2      | %      | 78.0      | %      |
| Operating expense ratio                    |   |         |   |       |   | 32.8      | %      |
| Combined ratio                             |   |         |   |       |   | 110.8     | %      |

 
| **Nine Months Ended September 30, 2002** |   | **Accident** |   | **Credit** |   | **Total** |   |
|------------------------------------------|--------|--------------|--------|------------|--------|-----------|--------|
| Loss ratio                               |   | 2.0          | %      | 33.2       | %      | 5.0       | %      |
| Acquisition expense ratio                |   | 64.2         | %      | 60.5       | %      | 63.9      | %      |
| Loss and acquisition expense ratio       |   | 66.2         | %      | 93.7       | %      | 68.9      | %      |
| Operating expense ratio                  |   |         |   |       |   | 35.6      | %      |
| Combined ratio                           |   |         |   |       |   | 104.5     | %      |

 
| **Three Months Ended September 30,  2001** |   | **Accident** |   | **Credit** |   | **Total** |   |
|--------------------------------------------|--------|--------------|--------|------------|--------|-----------|--------|
| Loss ratio                                 |   | 20.6         | %      | 25.5       | %      | 20.8      | %      |
| Acquisition expense ratio                  |   | 58.8         | %      | (62.2      | )%     | 53.3      | %      |
| Loss and acquisition expense ratio         |   | 79.4         | %      | (36.7      | )%     | 74.1      | %      |
| Operating expense ratio                    |   |         |   |       |   | 35.4      | %      |
| Combined ratio                             |   |         |   |       |   | 109.5     | %      |

 
| **Nine Months Ended September 30, 2001** |   | **Accident** |   | **Credit** |   | **Total** |   |
|------------------------------------------|--------|--------------|--------|------------|--------|-----------|--------|
| Loss ratio                               |   | 19.9         | %      | 27.9       | %      | 20.4      | %      |
| Acquisition  expense ratio               |   | 56.1         | %      | (19.7      | )%     | 51.1      | %      |
| Loss and acquisition expense ratio       |   | 76.0         | %      | 8.2        | %      | 71.5      | %      |
| Operating expense ratio                  |   |         |   |       |   | 37.8      | %      |
| Combined ratio                           |   |         |   |       |   | 109.3     | %      |

 

**Geographic Spread**

 

The distribution of grosswritten premiums, by geographic region, for each geographic segment, for thethree and nine months ended September 30, 2002 and 2001, was as follows:

 
| **Three Months Ended September 30** |   | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|--------|----------|--------|
| **ESG Reinsurance**                 |   |     |   |     |   |
|                                |   |     |   |     |   |
| Western Europe                      |   | 11.2     | %      | 0.5      | %      |
| North America                       |   | 75.6     | %      | 83.7     | %      |
| Latin America                       |   | 12.6     | %      | 6.2      | %      |
| Asia                                |   | 0.0      | %      | (4.3     | )%     |
| Other                               |   | 0.6      | %      | 13.9     | %      |
| Total                               |   | 100.0    | %      | 100.0    | %      |

 
| **Three Months Ended September 30** |   | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|--------|----------|--------|
| **ESG Direct**                      |   |     |   |     |   |
|                                |   |     |   |     |   |
| Western Europe                      |   | 18.4     | %      | n/m      |   |
| Asia                                |   | 81.6     | %      | n/m      |   |
| Total                               |   | 100.0    | %      | n/m      |   |

 
| **Nine Months Ended September 30** |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| **ESG Reinsurance**                |   |     |   |     |   |
|                               |   |     |   |     |   |
| Western Europe                     |   | 28.3     | %      | 23.2     | %      |
| North America                      |   | 56.4     | %      | 62.2     | %      |
| Latin America                      |   | 12.4     | %      | 6.3      | %      |
| Asia                               |   | 0.0      | %      | 0.4      | %      |
| Other                              |   | 2.9      | %      | 7.9      | %      |
| Total                              |   | 100.0    | %      | 100.0    | %      |

 

26

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| **Nine Months Ended September 30** |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| **ESG Direct**                     |   |     |   |     |   |
|                               |   |     |   |     |   |
| Western Europe                     |   | 17.4     | %      | 39.3     | %      |
| Asia                               |   | 82.6     | %      | 60.7     | %      |
| Total                              |   | 100.0    | %      | 100.0    | %      |

 

**Product Mix**

 

The distribution of grosspremiums written by line of business, for the three and nine months endedSeptember 30, 2002 and 2001 was as follows:

 
| **Three Months Ended September 30,** |   | **2002** |   | **2001** |   |
|--------------------------------------|--------|----------|--------|----------|--------|
| **ESG Reinsurance**                  |   |     |   |     |   |
|                                 |   |     |   |     |   |
| Medical                              |   | 91.6     | %      | 99.9     | %      |
| Personal accident                    |   | 0.9      | %      | 7.1      | %      |
| Credit                               |   | (2.5     | )%     | (0.9     | )%     |
| Life                                 |   | n/m      |   | (8.2     | )%     |
| Other                                |   | 10.0     | %      | 2.1      | %      |
| Total                                |   | 100.0    | %      | 100.0    | %      |

 
| **Three Months Ended September 30,** |   | **2002** |   | **2001** |   |
|--------------------------------------|--------|----------|--------|----------|--------|
| **ESG Direct**                       |   |     |   |     |   |
|                                 |   |     |   |     |   |
| Personal accident                    |   | 81.6     | %      | n/m      |   |
| Credit                               |   | 18.4     | %      | n/m      |   |
| Total                                |   | 100.0    | %      | n/m      |   |

 
| **Nine Months Ended September 30,** |   | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|--------|----------|--------|
| **ESG Reinsurance**                 |   |     |   |     |   |
|                                |   |     |   |     |   |
| Medical                             |   | 82.6     | %      | 89.4     | %      |
| Personal accident                   |   | 15.6     | %      | 16.0     | %      |
| Credit                              |   | (1.3     | )%     | (4.4     | )%     |
| Life                                |   | 0.3      | %      | (4.2     | )%     |
| Other                               |   | 2.8      | %      | 3.2      | %      |
| Total                               |   | 100.0    | %      | 100.0    | %      |

 
| **Nine Months Ended September 30,** |   | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|--------|----------|--------|
| **ESG Direct**                      |   |     |   |     |   |
|                                |   |     |   |     |   |
| Personal accident                   |   | 82.6     | %      | 60.7     | %      |
| Credit                              |   | 17.4     | %      | 39.3     | %      |
| Total                               |   | 100.0    | %      | 100.0    | %      |

 

**Management Fee Revenue**

 

For the three and ninemonths ended September 30, 2002, we earned $652 thousand and $1.8 million,respectively, in management fee revenue.  Management fee revenue was$(132) thousand for the three months ended September 30, 2001, representing adownward adjustment of estimated commissions due to us and $288 thousand forthe nine months ended September 30, 2001.  The majority of management

 

27

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fee revenue in 2002 and 2001 consists of feesearned on those premiums managed on behalf of our co-reinsurers. Management fees increased in the third quarter of 2002, primarily due to therecognition of fees earned on our co-reinsured North American business for the2001 underwriting year. The North American business was not co-reinsured forthe 2002 underwriting year.

 

**Net Investment Income**

 

At September 30, 2002, ourcash and invested assets totaled $116.3 million, compared with cash andinvested assets of $154.9 million as at December 31, 2001.  This decreasein our cash and invested assets is primarily due to negative operating cashflows and costs associated with developing the ESG Direct segment.  Netinvestment income decreased by $1.0 million from $2.5 million in the threemonths ended September 30, 2001 to $1.5 million in the three months endedSeptember 30, 2002.  The decrease is a function of the decline in the sizeof our overall investment portfolio.

 

Thefollowing table reflects the investment results for the three months endedSeptember 30, 2002:

 
|                      |   | **Average  Investments**       |   | **Net  Investment  Income** |   | **Annualized  Effective  Yield** |   | **Net  Realized  Investment  Gains/(Losses)** |   |
|---------------------------|--------|--------------------------------|--------|-----------------------------|--------|----------------------------------|--------|-----------------------------------------------|--------|
|                      |   | **U.S.  dollars in thousands** |   |
|                      |   |                           |   |                        |   |                             |   |                                          |   |
| Investments               |   | 106,055                        |   | 1,421                       |   | 5.4                              | %      | 459                                           |   |
| Other investments         |   | 6,830                          |   | 70                          |   | 4.1                              | %      | —                                        |   |
| Cash and cash equivalents |   | 6,715                          |   | 10                          |   | 0.6                              | %      | —                                        |   |
| Total                     |   | 119,600                        |   | 1,501                       |   | 5.0                              | %      | 459                                           |   |

 

Thefollowing table reflects the investment results for the three months endedSeptember 30, 2001:

 
|                      |   | **Average  Investments**       |   | **Net  Investment  Income** |   | **Annualized  Effective  Yield** |   | **Net  Realized  Investment  Gains/(Losses)** |   |
|---------------------------|--------|--------------------------------|--------|-----------------------------|--------|----------------------------------|--------|-----------------------------------------------|--------|
|                      |   | **U.S.  dollars in thousands** |   |
|                      |   |                           |   |                        |   |                             |   |                                          |   |
| Investments               |   | 164,483                        |   | 2,305                       |   | 5.6                              | %      | 215                                           |   |
| Other investments         |   | 14,375                         |   | 107                         |   | 3.0                              | %      | —                                        |   |
| Cash and cash equivalents |   | 6,641                          |   | 100                         |   | 6.0                              | %      | —                                        |   |
| Total                     |   | 185,499                        |   | 2,512                       |   | 5.4                              | %      | 215                                           |   |

 

Thefollowing table reflects the investment results for the nine months endedSeptember 30, 2002:

 
|                      |   | **Average  Investments**       |   | **Net  Investment  Income** |   | **Annualized  Effective  Yield** |   | **Net  Realized  Investment  Gains/(Losses)** |   |
|---------------------------|--------|--------------------------------|--------|-----------------------------|--------|----------------------------------|--------|-----------------------------------------------|--------|
|                      |   | **U.S.  dollars in thousands** |   |
|                      |   |                           |   |                        |   |                             |   |                                          |   |
| Investments               |   | 122,501                        |   | 5,160                       |   | 5.7                              | %      | (1,155                                        | )      |
| Other investments         |   | 7,582                          |   | 228                         |   | 4.0                              | %      | —                                        |   |
| Cash and cash equivalents |   | 5,219                          |   | 74                          |   | 1.9                              | %      | —                                        |   |
| Total                     |   | 135,302                        |   | 5,462                       |   | 5.4                              | %      | (1,155                                        | )      |

 

Thefollowing table reflects the investment results for the nine months endedSeptember 30, 2001:

 

28

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|                      |   | **Average  Investments**       |   | **Net  Investment  Income** |   | **Annualized  Effective  Yield** |   | **Net  Realized  Investment  Gains/(Losses)** |   |
|---------------------------|--------|--------------------------------|--------|-----------------------------|--------|----------------------------------|--------|-----------------------------------------------|--------|
|                      |   | **U.S.  dollars in thousands** |   |
|                      |   |                           |   |                        |   |                             |   |                                          |   |
| Investments               |   | 168,350                        |   | 8,082                       |   | 6.4                              | %      | 1,683                                         |   |
| Other investments         |   | 16,426                         |   | 469                         |   | 3.8                              | %      | (4,200                                        | )      |
| Cash and cash equivalents |   | 18,032                         |   | 696                         |   | 5.1                              | %      | —                                        |   |
| Total                     |   | 202,808                        |   | 9,247                       |   | 6.1                              | %      | (2,517                                        | )      |

 

Net investment income is netof investment-related expenses, and includes interest on funds held by cedingcompanies.

 

**Investment Portfolio**

 

*Maturity and Duration of Portfolio*

 

The maximum effectivematurity for any single security in our investment portfolio is set at 30 yearsfor U.S. government and U.S. government agency securities with full faith andcredit guarantees and at 10 years for all other issues, measured from the dateof settlement.  The duration of the portfolio varies according todecisions taken by management (with input from the investment advisor), onbusiness changes and the outlook for interest rate movements.  Thebenchmark for such duration is approximately three years.

 

*Quality of Debt Securities in Portfolio*

 

The minimum average creditquality of our investment portfolio is AA.

 

*Equity Securities and Real Estate*

 

Our investment policy is toallow up to 10% of our investment assets to be held in equity securities. Currently, there are no equity securities held in our portfolio.  We do not intend to invest in real estateother than for our own use.

 

*Diversification and Liquidity*

 

No more than 3% of ourinvestment portfolio may be invested in the securities of any single issuer,with the exception of sovereign governments or agencies, includingsupranational agencies, with an AA rating or better.  All fixed maturity securities in our investment portfolio areclassified as available for sale and are carried at fair value.

 

The fixed maturity investmentportfolios as of September 30, 2002 and December 31, 2001 were as follows:

 
| **As at September 30, 2002**                                                           |   | **Fair  Value**                |   | **Duration  (Years)** |   | **Market  Yield** |   | **Average  Credit  Rating** |   |
|----------------------------------------------------------------------------------------|--------|--------------------------------|--------|-----------------------|--------|-------------------|--------|-----------------------------|--------|
|                                                                                   |   | **U.S.  dollars in thousands** |   |
| Corporate securities                                                                   |   | 33,166                         |   | 3.6                   |   | 4.7               | %      | AA                          |   |
| U.S. treasury securities and obligations of U.S.  government corporations and agencies |   | 24,420                         |   | 2.1                   |   | 2.5               | %      | AAA                         |   |
| Asset-backed securities/Mortgage-backed securities                                     |   | 25,768                         |   | 2.4                   |   | 6.0               | %      | AAA                         |   |
| Obligations of states and political subdivisions                                       |   | 10,023                         |   | 1.9                   |   | 5.0               | %      | AAA                         |   |
| Foreign currency debt securities                                                       |   | 5,913                          |   | 1.8                   |   | 3.4               | %      | AAA                         |   |
| Total                                                                                  |   | 99,290                         |   | 2.4                   |   | 4.3               | %      |                        |   |

 

29

----

 
| **As at December 31, 2001**                                                            |   | **Fair  Value**                |   | **Duration  (Years)** |   | **Market  Yield** |   | **Average  Credit  Rating** |   |
|----------------------------------------------------------------------------------------|--------|--------------------------------|--------|-----------------------|--------|-------------------|--------|-----------------------------|--------|
|                                                                                   |   | **U.S.  dollars in thousands** |   |
| Corporate securities                                                                   |   | 43,799                         |   | 2.8                   |   | 5.2               | %      | AA                          |   |
| U.S. treasury securities and obligations of U.S.  government corporations and agencies |   | 53,466                         |   | 3.6                   |   | 4.6               | %      | AAA                         |   |
| Asset-backed securities/Mortgage-backed securities                                     |   | 25,599                         |   | 2.5                   |   | 7.3               | %      | AAA                         |   |
| Obligations of states and political subdivisions                                       |   | 16,505                         |   | 2.7                   |   | 5.7               | %      | AAA                         |   |
| Foreign currency debt securities                                                       |   | 5,475                          |   | 1.0                   |   | 4.2               | %      | AAA                         |   |
| Total                                                                                  |   | 144,844                        |   | 2.7                   |   | 5.4               | %      |                        |   |

 

We continue to follow ourinvestment policy and guidelines while seeking to increase long-term value bycontinuing to invest in selected strategic investments in accordance with ourcurrent commitments as set out in “Strategic Investments” below.  Astrategic investment is defined as an investment in a reinsurance-related enterprise,ceding company or distribution channel that is expected to generate or secureadditional profitable business for us.

 

**Strategic Investments**

 

**4Sigma**

 

From December 1998 throughJune 2000, we operated IPT GmbH and later VBB Bermuda Limited, subsidiariesthat provided disease management services in Germany.  These services,which included physician referrals, a medical information hotline, secondopinion services, cardiac rehabilitation and access to disease managementadvisors, comprised the health care segment of our business.

 

Effective as of June 30,2000, we transferred all the assets of our health care segment to 4Sigma. These assets had a book value of $8 million at the time of transfer.  Inexchange for the transferred assets, we received 8,000,000 shares of Series Apreferred stock in 4 Sigma.  In addition, affiliates of John C Head III,the Chairman of our Board of Directors, invested $3.0 million in cash inexchange for 3.0 million shares of Series B and C preferred stock in 4Sigma. Dr. Gerald Moeller, a director of ESG from July 1999 to August 2000 and thepresident of our health care division from July 1999 to June 2000 also invested$400,000 in cash in exchange for voting common stock in 4Sigma.  The boardmembers of 4Sigma include John C Head III, Dr. Gerald Moeller and Dr. HerbertPalmberger, who also serves as outside counsel to ESG in Germany.  Duringthe fourth quarter 2001, ESG booked a write-down of the cost, for impairment,of $8.0 million against its investment in 4Sigma Ltd.

 

ESG does not have votingcontrol of, nor does it exercise operational control over, this company.

 

In the second quarter of2001, we participated in a rights offering by 4Sigma for convertible preferreddebt totaling $0.8 million, which in November 2001, converted into 0.8 millionshares of Series E preferred stock.  Also, in November 2001, we committedto make an additional capital injection in 4Sigma of $1.8 million, in exchangefor 1.8 million shares of Series E preferred stock.  At September 30,2002, we had invested $1.5 million of this commitment.  Mr. Head has alsocommitted to invest an additional $1.2 million in cash in 4Sigma on these sameterms and conditions and to date has invested the full $1.2 million.

 

In January 2003 the auditcommittee approved a further investment in 4Sigma totaling $1.5 million inexchange for 1.5 million shares of Series F preferred stock.  Mr. Head has also committed to invest anadditional $1 million in cash in 4Sigma on these same terms and conditions.

 

We evaluate our investmentin 4Sigma on a quarterly basis.

 

30

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**German Assistance**

 

In September 1998 wepurchased a 10% holding in German Assistance for $1.5 million. During thequarter ended September 30, 2002, we reviewed the carrying value of theinvestment and concluded that no adjustment to the carrying value wasnecessary.

 

**Forward Exchange Contract**

 

During the third quarter of2002, we entered into a forward exchange contract to offset the NorwegianKroner net liability position created by our reinsurance business inNorway.  Our position in this contract is unhedged and is accounted for asa derivative in accordance with SFAS 133.  Accordingly, this contract iscarried at fair value with changes in fair value recorded in our statement ofoperations.

 

**Related Party Transactions**

 

We are a party to severalInvestment Advisory Agreements with Head Asset Management L.L.C., an affiliateof Head & Company, L.L.C.  Under these agreements, Head AssetManagement L.L.C. supervises and directs the investment of our asset portfolioin accordance with investment objectives and guidelines that we haveestablished.  Mr. Head, the Chairman of our Board of Directors and ourformer CEO, controls Head Asset Management.  ESG is the principal clientof Head Asset Management.  Under our Investment Advisory Agreement withHead Asset Management, we pay fees quarterly in arrears equal to:

 

•        0.20%per year of the first $150 million or less of the market value of the managedassets, and

•        0.15%per year of the managed assets in excess of $150 million.

 

We may terminate theInvestment Advisory Agreements upon five days written notice, and Head AssetManagement may terminate the agreements upon 90 days written notice.  Weincurred $57 thousand and $119 thousand in fees to Head Asset Management in thethree and nine months ended September 30, 2002 respectively, and $85 thousandand $214 thousand in the three and nine months ended September 30, 2001.

 

The Audit Committee of ourBoard of Directors periodically reviews our investment policies andarrangements to ensure that they are consistent with our overall goals,strategies and objectives.  Overall investment guidelines areapproved by the Audit Committee to ensureappropriate levels of portfolio liquidity, credit quality, diversification andvolatility.  In addition, the Audit Committee periodically reviews ourinvestment advisory relationship with Head Asset Management, in the context ofour other banking relationships.  In addition, our Audit Committee isconsidering our requirements for letters of credit and cash managementfacilities in the next six months.

 

**Administrative Expenses**

 

Total administrativeexpenses, which include personnel costs, professional service fees, interestexpense, foreign exchange gains/losses and other expenses, increased by $1.0million, or 15.6%, from $6.4 million for the three months ended September 30,2001 to $7.4 million for the three months ended September 30, 2002.  Thisincrease results primarily from realized and unrealized foreign exchange lossesof $0.6 million.  These expenses increased by $4.9 million or 24.3%, from$20.2 million for the nine months ended September 30, 2001 to $25.1 million forthe nine months ended September 30, 2002. This increase results primarily from realized and unrealized foreignexchange losses, in particular due to the strengthening of the Norwegian Kroneragainst the U.S. dollar.  Realized andunrealized foreign exchange losses relate to the revaluation of assets andliabilities, denominated in foreign currencies. During the third quarter of2002, we implemented a foreign exchange hedging strategy and policy with a viewto minimizing the impact of currency rate fluctuations on our statement ofoperations.

 

31

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**Liquidity and Capital Resources**

 

Operating activities usednet cash of $42.2 million for the nine months ended September 30, 2002 and$42.5 million for the year ended December 31, 2001.

 

Reinsurance balancesreceivable decreased from $190.5 million at December 31, 2001 to $181.3 millionat September 30, 2002.  We recognize premiums receivable at the inceptionof the reinsurance contract, based upon information received fromintermediaries and ceding companies.  Every quarter we compare estimatedwritten premiums to actual premiums, as reported by ceding companies and reviseour estimates of written premiums, if appropriate.  Any change in theseestimates will impact our premiums receivable balance.

 

Reinsurance recoverable onincurred losses increased from $28.6 million at December 31, 2001 to $36.9million at September 30, 2002.  This increase was due to additional lossesbeing incurred above our net retention levels that enable us to make recoveriesfrom our excess of loss reinsurers, plus quota share cessions to two of ourretrocessionaires.

 

At December 31, 2001,reserves for unpaid losses and loss expenses were $148.9 million and atSeptember 30, 2002, reserves for unpaid losses and loss expenses were $165.6million.  This increase primarily relates to the deterioration on theNorwegian book of business, compounded by the depreciation of the U.S. Dollaragainst the Norwegian Kroner in the nine months ended September 30, 2002.

 

We rely on cash flows fromour operations and cash and income from our investment portfolio to operate ourbusiness.  Our investment portfolio hasdecreased by $39 million to $109 million since December 31, 2001. This decrease is primarily due to the payment of several largeclaims, which we had anticipated in prior periods, the finalization of legalsettlements and non-recurring operating expenses during the nine months endedSeptember 30, 2002.  We expect that our investment portfolio will continueto decrease in the next three months, largely due to anticipated finalcommutations, settlements of legacy treaty matters and the ongoing settlementof claims in respect of pre-2001 underwriting years.  We expect our cashposition to continue to decrease during 2003 as we execute our 2003business plan.  If we are successful in implementing our businessplan, we expect that our cash position will improve by the end of 2003, but wecan make no assurances that this will occur.

 

Our 2003 business plancontains the following critical assumptions, each of which must occur in orderfor the plan to be successful and enable us to maintain our liquidity andcapital base:

 

•                       Maintaining premiums earned during 2003at a similar level to 2002, with an overall loss & acquisitioncost ratio comparable to 2002.

 

•                       Significant increase in net premiums over2002.  We currently expect theseincreases to come from our North America medical and ESG Direct segmentbusiness.

 

•                       Reduction in operating expenses, as wecomplete projects in respect of legacy issues and reduce operating activitiesin a number of overseas locations.

 

•                       No significant deterioration in loss andlegal reserves in respect of estimated claims incurred on business earned todate.

 

The plan is also dependentupon a number of other key assumptions, including achieving a sufficientinvestment yield, hedging significant foreign exchange exposures and managingtied capital in line with claim reserves and new business written.

 

In addition to the businessplan, we have identified a number of other possible cash flows.  These include partial or full divestment ofinvestments together with the continuation of selective commutation of bothinwards and outwards contracts in respect of the early underwriting years.

 

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Our cash flows for the next12 months are dependent on us achieving our business plan in 2003, managingtied capital in line with claims liabilities, collecting receivables andmanaging our operating expenses within budget. Our failure to achieve any oneof these items could adversely impact our liquidity.

 

If we are unable to executeour business plan as projected during 2003, we will ultimately be forced toseek financing from additional sources. We cannot assure you that we would be able to obtain financing on favorableterms, or at all.

 

Cash flows from operationsin future years may differ substantially from net income.  As reinsurancecontracts mature, we will be required to pay out a higher percentage ofincurred losses in loss payments, which may affect cash flows. Additionally, although we primarily invest in high quality assets, a diminutionin the value of our portfolio could hurt our ability to continue financing ourown operations.

 

As of September 30, 2002, wehad the following material commitments for operating leases, other commitments(4Sigma) and employment contracts:

 
|                         |   | **Total  Commitments in U.S. Dollars (in thousands)** |   |
|------------------------------|--------|-------------------------------------------------------|--------|
| **Years Ending December 31** |   | **Lease  &  Other  Commitments**                  |   | **Less  Sublease  Income** |   | **Net** |   | **Employee  Commitments** |   | **Total** |   |
|                         |   |                                                  |   |   |   |   |   |   |   |   |   |
| 2002                         |   | 592                                                   |   | 53 |   | 539 |   | 119 |   | 658 |   |
| 2003                         |   | 819                                                   |   | 37 |   | 782 |   | 72 |   | 854 |   |
| 2004                         |   | 570                                                   |   | — |   | 570 |   | — |   | 570 |   |
| 2005                         |   | 287                                                   |   | — |   | 287 |   | — |   | 287 |   |
| 2006                         |   | 200                                                   |   | — |   | 200 |   | — |   | 200 |   |
| Over five years              |   | 926                                                   |   | — |   | 926 |   | — |   | 926 |   |
| Total                        |   | 3,394                                                 |   | 90 |   | 3,304 |   | 191 |   | 3,495 |   |

 

As of December 31, 2001, wehad the following material commitments for operating leases, other commitments(4Sigma) and employment contracts:

 
|                         |   | **Total  Commitments in U.S. Dollars (in thousands)** |   |
|------------------------------|--------|-------------------------------------------------------|--------|
| **Years Ending December 31** |   | **Lease  & Other  Commitments**                   |   | **Less  Sublease  Income** |   | **Net** |   | **Employee  Commitments** |   | **Total** |   |
|                         |   |                                                  |   |   |   |   |   |   |   |   |   |
| 2002                         |   | 1,743                                                 |   | 200 |   | 1,543 |   | 563 |   | 2,106 |   |
| 2003                         |   | 745                                                   |   | 36 |   | 709 |   | 80 |   | 789 |   |
| 2004                         |   | 523                                                   |   | — |   | 523 |   | — |   | 523 |   |
| 2005                         |   | 263                                                   |   | — |   | 263 |   | — |   | 263 |   |
| 2006                         |   | 184                                                   |   | — |   | 184 |   | — |   | 184 |   |
| Over five years              |   | 839                                                   |   | — |   | 839 |   | — |   | 839 |   |
| Total                        |   | 4,297                                                 |   | 236 |   | 4,061 |   | 643 |   | 4,704 |   |

 

In November 2001, wecommitted to make an additional capital injection in 4Sigma of $1.8 million, inincrements of $100,000 as funds are needed by 4Sigma, in exchange for 1.8million shares of Series E preferred stock.  As of September 30, 2002, wehad invested $1.5 million of this commitment. In January 2003, we committed to make an additional investment in 4Sigmaof $1.5 million as funds are required to meet operating costs.

 

In support of our business,we enter into Letters of Credit and Trust Account arrangements with cedingcompanies in the ordinary course.  At December 31, 2001, we had in total$91.0 million of outstanding Letters of Credit and Trust Accounts (representing62.8% of investments available for sale) of which $27.0 million related toLetters of Credit issued and $64.0 million was in Trust Accounts.  As of

 

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September 30, 2002, we had in total $87.7million of outstanding Letters of Credit and Trust Accounts (representing 88.3%of investments available for sale, a function of the decline in value of theinvestment portfolio) of which $24.8 million related to Letters of Creditissued and $62.9 million was in Trust Accounts.  These arrangements aresecured against our fixed maturity investment portfolio.  Management hasassessed our cash flow requirements, taking into account these arrangements.There can be no assurances that we will maintain these respective amounts outstandingunder Letters of Credit and Trust Accounts. We periodically review our Lettersof Credit and Trust Account arrangements and, when appropriate, renegotiate theLetters of Credit or substitute them with Trust Account arrangements.

 

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**Recent Developments**

 

MarketInformation 

 

From December 12, 1997 toNovember 20, 2002, our common stock was traded on NASDAQ under the symbolESREF.  On November 20, 2002, thetrading symbol was changed to ESREE to reflect the unfiled status of ourQuarterly Report on Form 10-Q for the quarter ended September 30, 2002.

 

On November 25, 2002, theCompany received a Nasdaq Staff Determination letter indicating that, as aresult of the Company’s failure to timely file its Report on Form 10-Q for theperiod ended September 30, 2002, the Company’s securities would be delistedfrom The Nasdaq Stock Market, effective at the opening of business on December3, 2002.  The Company requested an oralhearing before a Nasdaq Listing Qualifications Panel (the “Panel”) to reviewthe Staff Determination, which request stayed the delisting of the Company’ssecurities.  Thereafter on December 17,2002, the Company was notified that it failed to maintain a closing bid priceof at least $1.00 per share for 30 consecutive trading days, and that it shoulddiscuss its plan to remedy that additional deficiency at the hearing.  The hearing was held on December 20,2002.  By letter dated January 31, 2003,the Company was advised that the Panel determined that the Company’s securitieswould be delisted from The Nasdaq Stock Market effective with the opening ofbusiness on Tuesday, February 4, 2003. The reason given for the decision was the failure to timely file theCompany’s quarterly report on Form 10-Q for the quarter ended September 30,2002.  In addition, the Panel cited as areason for its delisting decision, the Company’s failure to file any of theamendments to previously filed reports under the Securities Exchange Act of1934, as amended, for any of the anticipated restatements of certaininformation in its financial statements. Nasdaq’s delisting decision will not be appealed.

 

On March 17, 2003, we filedwith the SEC our certification on Form 15 to deregister our common stock underthe Securities Exchange Act of 1934, as amended (“The Exchange Act”).  Upon filing, ESG’s obligations to filereports on Form 10-K, Form 10-Q and other periodic reports that were not yetdue was immediately suspended.  ESG’scertification to deregister is expected to become final within 90 days offiling.  If the SEC determines to denyESG’s certification within such 90 day period, ESG would have 60 days to bringall periodic reports due current.

 

We intend to continue tomake available to our shareholders quarterly and annual financial informationin substantially the same form as presently made available.  We also intend to generally comply with thecorporate governance regulations and guidelines that would be applicable if ourcommon stock was still registered under the Exchange Act and listed on Nasdaq.

 

The Company’s securities arebeing quoted through the Pink Sheets stock quotation service.  We anticipate that Carr Securities Corp.,Port Washington, NY, and Morgan Keegan & Co., Inc., Birmingham, AL, willcontinue to quote our common stock although no assurance can be made that anymarket maker will continue to quote ESG's common stock or that a trading marketwill develop.

 

ShareRepurchase

 

On December 19, 2002 wepurchased 792,800 of our Common shares in a private purchase transactioneffective at the close of business December 18, 2002.  These shares have been cancelled and returned to authorized butunissued status in accordance with Bermuda law.  After the purchase we had 11,113,805 Common shares outstanding.

 

SECCommunications

 

We continue to communicatewith the U.S. Securities and Exchange Commission (the “SEC”) over the downwardadjustment to our Foreign Currency Translation account and restatement of ourfinancial statements for the year ended December 31, 2001 and the quarter endedMarch 31, 2002 as reported in our press release on August 15, 2002.  We are also communicating with the SECregarding the

 

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resignation of Deloitte & Touche, theiraccounting disagreements with us and the late filing of our Form 10-Q for thequarter ended September 30, 2002.

 

Directorand Officer Changes 

 

Anthony J. Hobson, whojoined our Board of Directors in November 2001 has resigned from the Boardeffective November 5, 2002.  Mr. Hobson indicated that his commitments tohis other business interests have grown substantially since he joined the ESGBoard and he believes that he cannot commit the time to ESG which he believesthat this role deserves.  We thank Mr. Hobson for his contributions overthe past year.  On March 7, 2003, Mr.Peter Collery was appointed as a non-executive director.  Mr. Collery is currently President of SCFundamental ICC, which manages the SC Fundamental Value Fund CommonShares.  This fund and its affiliatesown 10.6% of our outstanding Common shares.

 

Margaret L. Webster,formerly our Chief Administrative Officer and General Counsel, has beenappointed Chief Operating Officer and General Counsel, effective as of November7, 2002.  In addition to her current responsibilities she will manageESG’s financial functions.  At the end of September 2002, Conor Heery, whohad been serving as Group Controller, left ESG to join a family-ownedbusiness.  Aodh Ó Murchú, a Chartered Accountant of 15 years experiencegained primarily in International Insurance/Reinsurance and other financialservice industries, has been appointed Controller and Chief Accounting Officer.He has been Assistant Controller for ESG for 1.5 years. Joe Quinn, formerly ourSenior Financial Officer, left ESG, effective as of November 7, 2002, to pursueother business interests.

 

Changesin Certifying Accountant

 

We received a letter fromDeloitte & Touche on November 22, 2002, stating that Deloitte & Touchehad resigned as our independent auditors, effective on that date.  The letter indicated no reason for theresignation.  Deloitte & Touchesubsequently withdrew its audit report related to the fiscal year endedDecember 31, 2001 and review reports for the quarters ended September 30, 2001,March 31, 2002 and June 30, 2002. Deloitte & Touche notified us that this withdrawal was as a resultof our accounting treatment for the co-reinsurance contract with ACE INAOverseas Insurance Company Ltd.

 

Subsequent to theirresignation Deloitte & Touche advised that they had a seven accountingdisagreements with us and one reportable event in respect of the accountingtreatment for the ACE contract.  Aspreviously indicated we have restated the relevant financial statements toreflect the correct accounting treatment for the ACE contract.  In respect of the accounting disagreementswe have resolved these matters with our new auditors BDO International.  For more detailed discussion on theseaccounting disagreements please refer to our current reports on Form 8-Kfilings of   December 2, 2002, December16, 2002, January 27, 2003 and February 11, 2003 filed with the SEC.

 

On December 9, 2002, on therecommendation of the Audit Committee, the Board of Directors approved theappointment of BDO International as our independent auditors.  BDO International formally accepted thisappointment with effect from December 24, 2002.

 

CreditRatings

 

On November 26, 2002,Standard and Poor’s lowered its counterparty credit and insurer financialstrength rating for ESG and its subsidiaries (the “Group”) from BB- to B with anegative outlook.  According to S&Pthe downgrade reflects the Group’s weakened capital adequacy, the continuingvolatility in reported earnings, limited ability to access external sources offinance and marginal business position. This is offset by recent actions over the past two years on improvingunderwriting and implementation of risk management processes.  The ratings on the Group were then withdrawnat our request.

 

On December 4, 2002, FitchRatings lowered its counterparty credit and insured financial strength ratingsof the Group from BB- to B and remaining on negative ratings watch.  The Fitch rating action reflects thenegative impact that the resignation of Deloitte and Touche and the highlightedaccounting disagreements are likely to have on our business relationships overthe short-term.  Fitch feels that

 

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uncertainties surrounding our financialcondition will inevitably impact on premium volumes, particularly at thiscritical time in the year when a large portion of inwards and outwardsreinsurance contracts are renegotiated.

 

On February 5, 2003,following our delisting from The Nasdaq Stock Market, Fitch confirmed that noother rating action will result as the current rating already reflects thedelisting.  Fitch will remain in closecontact with us, with a view to reviewing BDO International’s audit conclusionsas they become available.  We remain onRating Watch Negative pending resolution of this issue.

 

NorthAmerica

 

Upon completion of a reviewof our North American business, we have decided to focus the operation fromHartford, Connecticut, U.S.A., effective January 1, 2003.  We will continue to have a small supportoperation in Toronto Canada.

 

LegalProceedings 

 

We and our subsidiaries, incommon with the insurance industry in general, are subject to litigation,including claims for punitive damages, in the normal course of business.  We do not believe that such litigation willhave a material adverse effect on our financial condition, future operatingresults, or liquidity.

 

In February 2000, Odyssey Reinstituted an action in England against a broker, Stirling Cooke Brown andothers, alleging fraud and conspiracy on the reinsurance placement of 1997 and1998 Personal Accident and Workers Compensation “carve out” business withOdyssey Re.  During 1998, ESG accepted a25% quota share reinsurance treaty with Odyssey Re.  This treaty terminated as of December 31, 1998, but we renewed ourparticipation for 1999 directly with the underwriting agent involved the 1998year.  In December 1999, we gave noticeto rescind our contract with Odyssey Re (UK) for misrepresentation and failureto disclose material facts.  On November29, 2000, we filed suit in the High Court to seek a judicial confirmation ofour rescission.  On February 5, 2001Odyssey Re filed a response.  InDecember 2002, Odyssey Re accepted our rescission of this treaty in return fora contribution to its legal fees. Therefore, we have no further liability on this contract.

 

Wehave also given notice we intend to rescind the 1999 account.  This matter is in discovery and is now setfor arbitration in late 2003.  Webelieve the outcome of the pending litigation between Odyssey Re (Sphere Drake)and Stirling Cook Brown and others will have an impact on this arbitration.

 

**Exposure Management**

 

We manage our underwritingrisk exposures primarily through an excess of loss reinsurance program. For 2002, this program provides reinsurance protection up to a knownaccumulation of $5 million for Personal Accident exposure and up to $5 millionper person for Medical Expense exposure.

 

**Cautionary Statement Regarding Forward-Looking Statements**

 

Certain statements andinformation included in this Form 10-Q constitute “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of1995.  These statements express our intentions, strategies, or predictionsfor the future.  In addition, from time to time, we may makeforward-looking statements, orally or in writing.  Forward-lookingstatements in this Form 10-Q include, among others, statements regarding:

 

•              theongoing adequacy of our loss reserves;

 

•                                          our continuing ability to increase premiumrates and strengthen terms of trade in the North and Latin American marketswithout major loss of business;

 

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•              Our2003 business plan;

 

•              theadequacy of our future cash flows and liquidity;

 

•              ourexpectancy that operating expenses will decrease;

 

•              theanticipated growth in Direct business in Asia and Europe;

 

•              theimpact of rate increases on premiums written over the 2001 and priorunderwriting years;

 

•              possiblesale of 4Sigma investment;

 

•              nofurther reduction of Fitch rating;

 

•                                          our assumptions relating to Foreign Exchangeadjustments and the ACE contract;

 

•              ourfuture profitability;

 

•              recentcommunications with the SEC;

 

•                                          our ability to hedge currency ratefluctuations across our primary foreign currency exposures and in our statementof operations; and

 

•              theoutcome of our ongoing litigation.

 

These forward-lookingstatements involve known and unknown risks and uncertainties that may causeactual results to be materially different from the results expressed or impliedby the forward-looking statements.  These factors include, among otherthings:

 

**•****                                         ****Economic Recession. **An economic slowdown worldwide, or in any ofour key markets, could reduce demand for our products and services.  Ifthe general economic downturn continues or worsens, the market for manyinsurance products may also diminish.  We obtain a significant portion ofour business from selling reinsurance, and if the primary insurance marketdeclines, there could be an equal effect on the reinsurance market.

 

**•****                                         ****Insurance IndustryVolatility. **Thecurrent military operation in Iraq and the September 11, 2001, terrorist attacks in the United States (and theiraftermath) may increase volatility in insurance and reinsurance markets.** **That volatility could adverselyaffect market participants, like ESG, whose direct exposure to the terroristattacks is limited.

 

**•****                                         ****Inadequate LossReserves. **We maintainreserves to cover the estimated liability for reported and unreportedclaims.  Inadequate reserves could be caused by our failure to valueaccurately the risks of certain business, inaccurate information from cedingclients, or extraordinary events.  If our reserves prove insufficient tocover the actual losses we incur, we would have to increase our reserves and incura charge to our earnings.

 

**•****                                         ****Medical CostIncreases. **Our medicalreinsurance premiums reflect certain assumptions regarding increases in thecost of medical care.  Medical costs (particularly prescription costs) aredifficult to gauge, especially in the United States.  Changes or advancesin medical technology could increase our costs.  Legislative or judicialdevelopments that

 

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areadverse to medical providers also might increase costs.  An increase incosts that eclipses the assumptions reflected in our premiums could result inlosses for us.

 

**•****                                         ****Credit Risks. **From time to time, we may cede a portion ofour reinsurance risk to other insurers or reinsurers.  If these companiesdo not fulfill their obligations to us, we may be exposed to a greater riskthan we had anticipated.

 

**•****                                         ****Loss of Key Clients**.  Our contracts with our customers aregenerally short term.  We can make no assurance that any customer willretain our services after its contract has ended.  Though our businessdoes not depend solely on any one customer, we have several customers thatgenerate substantial revenues.   The loss of these customers couldadversely affect our revenues.  If one of our customers is acquired ormerges with another company, our contract may terminate early.

 

**•****                                         ****Direct Marketing Risks.**  Our direct marketing business mustgauge the credit, life, and accident risks faced by customers in multiplegeographic regions.  If we fail to accurately price the risks we assume, includingthe estimated life of the policies we reinsure, we may have to pay out morethan we have taken in as premiums.

 

**•****                                         ****Competition. **Our reinsurance business competes with otherinternational reinsurers, most notably American Re, Everest Re, Latin AmericaRe, Swiss Re, Hanover Re, and Lloyd’s.  ESG Direct competes primarily withGE Capital, AIG, and ACE.  These competitors have greater financialresources than we do, have been operating longer, and have establishedlong-term relationships with others in the industry, all of which may besignificant competitive advantages.

 

**•****                                         ****Competitive PricingPractices. **Competitorsmay seek to capture market share by selling services and products at pricesthat fall below levels that ESG management expect to be profitable.  If acompetitor employs this strategy in any of the markets in which we operate, wecould lose many customers and be forced to exit the market.

 

**•****                                         ****Credit RatingDowngrade. **In ourreinsurance and direct marketing businesses, the rating assigned to our creditby agencies such as Fitch can affect our business opportunities.  Anydowngrade in our rating could make it more difficult for us to attract andretain customers.

 

**•****                                         ****Loss of Key Employees.**  As a small company, our success isdependent on our ability to retain our existing executive officers and attractadditional qualified personnel in the future.  The loss of the services ofan executive officer could affect adversely our ability to conduct business.

 

**•****                                         ****Interest RateFluctuations. **Weinvest the majority of the money we receive as premiums in fixed rateinstruments such as government and corporate bonds.  Typically, the fairmarket value of a fixed rate instrument varies inversely with the fluctuationsin interest rates.  While our investments can fall in value, ourliabilities tend to remain fixed.  Consequently, a decline in the value ofour investment portfolio could have a material adverse effect on our financialresults.

 

**•****                                         ****Investment Risks. **We have contracted with Head Asset ManagementL.L.C. to supervise and direct the investment of our asset portfolio. Poor performance on the part of this investment manager could have an adverseimpact on our financial performance.

 

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**•****                                         ****Foreign Currency ExchangeRisks. **Because weconduct business in numerous geographic regions and currencies around theworld, fluctuations in currency exchange rates can materially affect ourearnings.

 

**•****                                         ****Inflation. **We provide reinsurance in certaingeographical markets, such as Latin America, that have experienced sustainedperiods of high inflation.  In an inflationary cycle, there is a risk thatthe amounts we will owe on our coverage obligations will exceed the amounts wereceived as premiums.

 

**•****                                         ****Legislative and RegulatoryChanges. **Legislatorsand regulators could introduce new laws and regulations that affect the mannerin which we conduct our business.  Our direct marketing business, forexample, could be affected by new laws or regulations limiting the use ofpersonal data for direct marketing efforts.  New occupational safetylegislation in the countries where we reinsure these risks could increase ourcosts.  Additional unexpected regulatory burdens could increase ourcompliance costs and lower our profit margins.

 

**•****                                         ****Tax Exposure. **For the purposes of many countries, includingthe United States, ESG is not engaged in the conduct of any trade or businessin such country, and, as a result, is not subject to corporate income taxtherein.  If, however, any country, including the U.S., were to contendsuccessfully that our operations subject us to corporate income tax, we wouldbe liable for tax on net income received by ESG to the extent it had beenreceived at a permanent place of business.  If corporate income taxes didapply to income received by ESG, they would reduce our net income, if any.

 

**•****                                         ****Litigation Risks.**  In the normal course of business, weare involved in litigation.  By its nature, litigation is uncertain andcould have a material adverse effect that is not anticipated by management.

 

**•****                                         ****Cyclical Cha**n**ges in theMarket**.  The reinsurance market is affected by fluctuations inthe investment environment and extraordinary events.  If we fail toanticipate these cyclical trends, we may incur losses in our contracts.

 

**•****                                         ****Future Cash Flows.**  We rely on cash flows from ouroperations to fund our business.  Our future cash flows are dependent onus achieving our business plan in 2003, managing tied capital in line withclaims liabilities, collecting receivables and managing our operating expenseswithin budget.  Our failure to achieve any one of these items couldadversely impact our liquidity and ability to pay claims.

 

**•****                                         ****SEC Communications.**  ESG has had recent discussions withthe SEC regarding its handling of its Foreign Exchange restatement and theresignation and disagreements with Deloitte and Touche, which may continue.

 

We undertake no obligationto update any forward-looking statement, whether as a result of newinformation, future events or otherwise.  All subsequent, written andoral, forward-looking statements attributable to ESG or persons acting on ourbehalf are qualified by the cautionary statements in this Form 10-Q.

 

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**ITEM 3****.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**Market Risk**

 

We are subject to marketrisk arising from the potential change in value of our various financialinstruments. Our current investment strategy seeks to maximize income through ahigh quality, diversified and fixed maturity portfolio, while maintaining anadequate level of liquidity.  We continuously adjust our mix ofinvestments, consistent with our current and projected operating results,working capital requirements and market conditions.  The fixed maturitiesin our investment portfolio are comprised of non-trading available for salesecurities.

 

Our investment portfolio iscomprised of fixed maturity securities that are subject to interest rate riskand foreign currency risk.

 

There has been nosignificant change in market risk since December 31, 2001.

 

**Interest Rate Risk**

 

Interest rate risk is thepotential change in value of the fixed maturity portfolio due to changes inmarket interest rates.  Interest rate risk on our portfolio of fixedmaturity investments, especially fixed rate instruments, is a significantsource of our market risk.  In addition, the credit worthiness of theissuer, relative values of alternative investments, liquidity and generalmarket conditions may affect fair values of interest rate sensitiveinstruments.

 

Our general strategy withrespect to fixed maturity securities is to invest in high quality securitieswhile maintaining diversification to avoid significant concentrations inindividual issuers’ industry segments or countries.

 

There has been nosignificant change in our interest rate risk since December 31, 2001.

 

**Foreign Currency Risk**

 

Foreign currency risk is thepotential change in value, income, and cash flow arising from adverse changesin foreign currency exchange rates.  Our functional currency is the U.S.Dollar.  However, we write reinsurance business in numerous geographicregions and currencies, giving rise to the risk that the ultimate settlement ofreceivables and payables on reinsurance transactions will differ from theamounts currently recorded as assets and liabilities in the financialstatements.  Generally, we prefer to maintain the capital of our foreignoperations in U.S. Dollar assets, although this varies by regulatoryjurisdiction in accordance with market needs.  In some cases, our foreignoperations maintain capital in the currency of the country of its geographiclocation, consistent with local regulatory guidelines.

 

Each foreign operation mayconduct business in its local currency as well as the currency of othercountries in which it operates.  Our primary foreign currency exposuresare the Euro, Norwegian Kroner, Australian Dollar, Hong Kong Dollar and GreatBritain Pound.

 

During the third quarter of2002, we implemented a foreign exchange hedging strategy and policy by enteringinto a forward foreign exchange contract to hedge our Norwegian Kroner netliability position.  We are currently in the process of expanding thisstrategy across our other primary foreign currency exposures, and will considerthe further use of derivative instruments, if appropriate.

 

**Inflation**

 

Inflation has not had amaterial impact on our operations for any of the periods presented.  Wewrite reinsurance in Latin America, which has experienced periods of highinflation.  However, it is possible that future inflationary conditionsmay impact subsequent accounting periods.

 

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**ITEM 4****.  CONTROLS ANDPROCEDURES**

 

(a) Within 90 days beforethe filing date of this report, ESG’s Chief Executive Officer and Controllerand Chief Accounting Officer, along with other members of management, evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, asamended).  Based on this evaluation, ESG’s Chief Executive Officer andController and Chief Accounting Officer have concluded that ESG’s disclosurecontrols and procedures are effective to timely notify them of materialinformation required to be disclosed in reports ESG submits under theSecurities Exchange Act of 1934, as amended.

 

(b) Since the date of thisevaluation, there have not been any significant changes in our internalcontrols or in other factors that could significantly affect those controls.

 

During the second quarter of2002, we upgraded our internal consolidation system in order to prevent arepetition of the events leading to the $3,992 thousand adjustment in ourforeign currency translation account and restatement of our financial statementsfor the year ended December 31, 2001 and for the quarter ended March 31,2002.  The adjustment was the product of various errors related to ourinternal consolidation system, including, for example, a system design problemthat generated foreign currency translation of amounts that should not havebeen translated.

 

In September 2002, weretained an independent consultant to review our internal controls.  In the first quarter of 2003 we received theconsultant’s report and we are working on implementing a number ofrecommendations that will improve our controls and procedures.

 

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**PART II**

 

**Item1.  Legal Proceedings**

 

Fora description of our pending lawsuit involving Odyssey Re see our Annual Reporton Form 10-K for the fiscal year ended December 31, 2001, as amended, and note4 to our unaudited condensed consolidated financial statements in this report.

 

**Item2.  Changes in Securities****and Use of Proceeds**

 

Notapplicable.

 

**Item3.  Defaults Upon Senior Securities**

 

Notapplicable.

 

**Item4.  Submission****of Matters to a Vote of Securities Holders**

 

Nomatters were submitted to a vote of securities holders during the quarter.

 

**Item 5****.  OtherInformation**

 

Notapplicable.

 

**Item 6****.  Exhibits andReports on Form 8-K**

 

    (a)      ExhibitIndex

 
| Exhibit 11.1  |   | Computation of Earnings  Per Share                                                                                    |
|---------------|--------|-----------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                  |
| Exhibit 15.1  |   | Accountants’ Consents                                                                                            |
|          |   |                                                                                                                  |
| Exhibit 99.1  |   | Certification of Chief  Executive Officer pursuant to section 906 of The Sarbanes-Oxley Act of 2002.                  |
|          |   |                                                                                                                  |
| Exhibit  99.2 |   | Certification  of Controller and Chief Accounting Officer pursuant to section 906 of The  Sarbanes-Oxley Act of 2002. |

 

    (b)      Duringthe three months ended September 30, 2002, ESG filed the following currentReports on Form 8-K:

 

OnAugust 16, 2002 we filed a Form 8-K to include a press release on the intendedrestatement of our financials and the late filing of our Form 10-Q for thesecond quarter, 2002.

 

OnSeptember 3, 2002, we filed a Form 8-K disclosing a website posting ofresponses to shareholder questions.

 

OnSeptember 17, 2002, we filed a Form 8-K to include a press release on theengagement of a consultant to review our internal controls and ourcommunications with the Securities and Exchange Commission.

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934 as amended, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                        | ESG  RE LIMITED                            |
|-----------------------------|--------------------------------------------|
|                        |                                       |
| Date:   March 31, 2003 | /S/  ALASDAIR P. DAVIS                     |
|                        | Alasdair  P. Davis                         |
|                        | Chief  Executive Officer                   |
|                        |                                       |
| Date:   March 31, 2003 | /S/  AODH O’MURCHU                    |
|                        | Aodh  O’Murchu                        |
|                        | Controller  & Chief Accounting Officer |

 

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CERTIFICATIONS UNDER EXCHANGE ACT RULE 13A-14 AND 15D-14

 

I,Alasdair P. Davis, hereby certify that:

 

1.     I havereviewed this quarterly report on Form 10-Q of ESG Re Limited;

 

2.               Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.               The issuer’s other certifying officers and Iam responsible for establishing and maintaining disclosure controls andprocedures (as defined in paragraph © of the Exchange Act Rules 13a-14 and15d-14) for the issuer and we have:

 

a)                        designedsuch disclosure controls and procedures to ensure that material informationrelating to the issuer, including its consolidated subsidiaries, is made knownto us by others within those entities, particularly during the period in whichthe periodic report’s are being prepared;

 

b)                       evaluated the effectiveness of the issuer’s disclosure controls and procedures as of a date within90 days prior to the filing date of this quarterly report (the “EvaluationDate”); and

 

c)                        presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The issuer’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the issuer’s auditorsand the audit committee of the issuer’s board of directors (or personsperforming the equivalent function):

 

a)                        all significant deficiencies in the design oroperation of internal controls which could adversely affect the issuer’sability to record, process, summarize and report financial data and haveidentified for the issuer’s auditors any material weaknesses in internalcontrols; and

 

b)                       any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theissuer’s internal controls; and

 

6.               The issuer’s other certifying officers and Ihave indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Datedthis 31st day of March, 2003

 
| /s/  Alasdair P. Davis   |   |
|--------------------------|--------|
| Alasdair  P. Davis       |
| Chief  Executive Officer |

 

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I,Aodh O’Murchu, hereby certify that:

 

1.     I havereviewed this quarterly report on Form 10-Q of ESG Re Limited;

 

2.               Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the issuer as of, and for, the periods presentedin this quarterly report;

 

4.               The issuer’s other certifying officers and Iam responsible for establishing and maintaining disclosure controls andprocedures (as defined in paragraph © of the Exchange Act Rules 13a-14 and15d-14) for the issuer and we have:

 

a)        designed such disclosure controls andprocedures to ensure that material information relating to the issuer,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which the periodic reportsare being prepared;

 

b)                       evaluated the effectiveness of the issuer’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)                        presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.               The issuer’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the issuer’s auditorsand the audit committee of the issuer’s board of directors (or personsperforming the equivalent function):

 

a)                        all significant deficiencies in the design oroperation of internal controls which could adversely affect the issuer’sability to record, process, summarize and report financial data and haveidentified for the issuer’s auditors any material weaknesses in internalcontrols; and

 

b)                       any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theissuer’s internal controls; and

 

6.               The issuer’s other certifying officers and Ihave indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Datedthis 31st day of March, 2003

 
| /s/  Aodh O’Murchu                    |   |
|--------------------------------------------|--------|
| Aodh  O’Murchu                        |
| Controller  & Chief Accounting Officer |

 

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