Management also views the change in the Company’s book value per ordinary share as an additional measure of the Company’s performance. Book value per share is calculated by dividing ordinary shareholders’ equity by the number of outstanding ordinary shares at any period end. Book value per ordinary share is affected primarily by the Company’s net income and also any changes in the net unrealized gains and losses on its investment portfolio. The Company’s book value per ordinary share increased in 2003 primarily as a result of an increase in net income and an increase in the
4. A favorable underwriting environment with increased premium rates and improved terms and conditions.
is greater uncertainty regarding recoverability due to the reinsurers’ ability to pay. See “Financial Condition and Liquidity” and Item 8, Note 11 to the Consolidated Financial Statements for further information.
The Company also provides reinsurance of term assurance and critical illness policies. The future policy benefit reserves for these contracts amounted to $15 million and $1 million at December 31, 2003 and 2002, respectively. The liabilities relate to in-force blocks of business, comprising underlying insurance policies that provide mainly lump sum benefits if the policyholder dies or becomes critically ill. For term assurance, the liabilities are therefore driven by the rates of mortality and for critical illness cover, the liabilities are driven predominantly by the rates at which policyholders become critically ill (as defined by the treaty conditions), i.e. the morbidity rates. A 1% increase in the mortality rate relative to the reserving assumption would increase the value of future claims by approximately $0.2
The decrease in the underwriting expense ratio in 2003 from 2002 is due to a reduction in the acquisition expense ratio of 2.0% (14.9% as compared to 16.9%) and a reduction in the operating expense ratio of 2.1% (11.3% as compared to 13.4%). The reduction in the acquisition expense ratio is due primarily to lower commission and brokerage costs in a favorable underwriting market on certain lines of business and where there has been a change in the mix of business earned. The reduction in the operating expense ratio is due to the growth in net premiums earned where the amount of net premiums earned has increased more than the amount of increase in operating expenses, which is due primarily to the growth in the segment operations.
Fee income and other relates primarily to fees earned on deposit liability contracts which are earned based on individual underlying contractual terms and conditions. The increase in 2003 as compared to 2002 is due to the reassessment and reduction of the risk period related to one contract, and accordingly is not expected to reoccur in 2004.
As of December 31, 2003, the Company had approximately 594 open claim files for potential asbestos exposures and 490 open claim files for potential environmental exposures on business written prior to 1986. Approximately 43% in 2003 and 44% of the open claim files for both 2002 and 2001 are due to precautionary claim notices. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to receive coverage under the
The following table summarizes the net income (loss) from life and annuity operations of this segment:
The increase in minority interest in 2003 and 2002 is due to an increase in the profitability of XL Financial Assurance Ltd., of which 15% is held by a minority shareholder.
The following table illustrates the change in net investment income from general operations, equity in net income of investment affiliates, net realized gains and losses on investments and net realized and unrealized gains and losses on investment derivatives for each of the three years ended December 31, 2003.
For a summary of realized and unrealized gains and losses on all derivative instruments, see Item 8, Note 15 to the Consolidated Financial Statements.
management believes that the amounts included in the consolidated financial statements reflect the Company’s best estimates and assumptions, actual results could differ from these estimates.
Contracts entered into by the Company with cedants which are not deemed to transfer significant underwriting and/or timing risk are accounted for as deposits, whereby liabilities are initially recorded at an amount equal to the assets received. The Company uses a portfolio rate of return of equivalent duration to the liabilities in determining risk transfer. An initial accretion rate is established based on actuarial estimates whereby the deposit liability is increased to the estimated amount payable over the term of the contract. The deposit accretion rate is the rate of return required to fund expected future payment obligations (this is equivalent to the ‘best estimates’ of future cash flows), which are determined actuarially based upon the nature of the underlying indemnifiable losses. Accretion of the liability is recorded as interest expense. The Company periodically reassesses the estimated ultimate liability. Any changes to this liability are reflected as an adjustment to interest expense to reflect the cumulative effect of the period the contract has been in force, and by an adjustment to the future accretion rate of the liability over the remaining estimated contract term.
Guaranteed investment contracts are initially recorded at an amount equal to the assets received. The Company may use derivative instruments in order to hedge and reduce the Company’s exposure to fluctuations in interest rates related to these contracts. Changes in the fair value of the hedging instrument are recognized in income. The change in the fair value of the hedged item, attributable to the hedged risk, is recorded as an adjustment to the carrying amount of the hedged item and is recognized in income.
The following table illustrates the net effect on net income and earnings per ordinary share if the fair value method had been applied to all outstanding and unvested awards for the three years ended December 31, 2003:
This includes net realized losses on investments of $93.2 million and net realized and unrealized gains on investment derivatives of $14.6 million.
on the Company’s segments and total results of operations from the September
The Company assessed the carrying value of goodwill as of June 30, 2002 and 2003 as part of its annual process in accordance with FAS 142 and at both those times determined that goodwill assets were unimpaired. The Company continues to review the carrying value of goodwill related to all of its investments. As further information becomes available, the Company will adjust the carrying value of goodwill as appropriate.
The following is the pro forma effect on net income available to ordinary shareholders and earnings per ordinary share for the years ended December 31, 2001 had FAS 142 been effective January 1, 2001 as compared to the reported net income and earnings per ordinary share for the years ended December 31, 2001:
Effective January 1, 2002, the Company consolidated its investment in Le Mans Ré after increasing its ownership from 49% to 67% in order to expand its international reinsurance operations. Le Mans Ré underwrites a worldwide portfolio comprising most classes of property and casualty reinsurance business, together with a selective portfolio of life reinsurance business. On September 3, 2003, the Company exercised its option to buy the remaining 33% ownership from Les Mutuelles du Mans Assurances Group (“MMA”) for approximately $161 million in cash and changed the name of Le Mans Ré to XL Re Europe. Due to certain contractual arrangements between the Company and MMA, MMA did not have any economic interest in the earnings of XL Re Europe with effect from January 1, 2002 and accordingly, no minority interest has been recorded since that date.
Other investments include investments over which the Company does not have significant influence and whose fair value is generally unquoted. This includes investments in limited partnerships where the Company does not participate in the management of the partnerships, and investments in collateralized debt/equity instruments. Income from other investments was $0.7 million and $0.04 million for the year ended December 31, 2003 and 2002, respectively.
During 2003 and 2002, the Company entered into long duration contracts that subject the Company to mortality and morbidity risks and which were accounted for as life premiums earned. Future policy benefit reserves were established using appropriate assumptions for investment yields, mortality, and expenses, including a provision for adverse deviation. The average interest rate used for the determination of the future policy benefits for these contracts was 5.2% and 5.1% at December 31, 2003 and 2002, respectively. Total future policy benefit reserves for the year ended December 31, 2003 and 2002 were $3.2 billion and $2.5 billion, respectively. Substantially all of these reserves relate to closed blocks of annuities.
Each of the CARZ and LYONs provide the bondholders the right to require the Company to repurchase the bonds on predetermined dates (“put” dates) at predetermined values (subsequently increased in the case of the LYONs) as set forth in the relevant indenture. The remaining put dates for the CARZ occur on May 23 of 2004, 2006, 2008, 2011 and 2016. The remaining put dates for the LYONs occur on September 7 of 2004, 2006, 2008, 2011 and 2016. The Company may, at its option, pay the repurchase price in cash or Class A ordinary shares or a combination thereof.
Rights to purchase Class A ordinary shares (“the Rights”) were distributed as a dividend at the rate of one Right for each Class A ordinary share held of record as of the close of business on October 31, 1998. Each Right entitles holders of Class A ordinary shares to buy one ordinary share at an exercise price of $350. The Rights would be exercisable, and would detach from the Class A ordinary shares, only if a person or group were to acquire 20% or more of the Company’s outstanding Class A ordinary shares, or were to announce a tender or exchange offer that, if consummated, would result in a person or group beneficially owning 20% or more of Class A ordinary shares. Upon a person or group without prior approval of the Board acquiring 20% or more of Class A ordinary shares, each Right would entitle the holder (other than such an acquiring person or group) to purchase Class A ordinary shares (or, in certain circumstances, Class A ordinary shares of the acquiring person) with a value of twice the Rights exercise price upon payment of the Rights exercise price. The Company will be entitled to redeem the Rights at $0.01 per Right at any time until the close of business on the tenth day after the Rights become exercisable. The Rights will expire at the close of business on September 30, 2008, and do not have a fair value. The Company has reserved 119,073,878 Class A ordinary shares being authorized and unissued for issue upon exercise of Rights.
In 2001, four regular quarterly dividends were paid at $0.46 per share to ordinary shareholders of record of February 15, May 25, August 15 and November 30.
is insufficient to cause the realization of the net operating losses within a reasonable period, a valuation allowance would be required for the United States portion of the net deferred tax asset, in the amount of $271 million.