The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The deferral of tax losses is evaluated based upon management's estimates of the future profitability of the Company's taxable entities based on current forecasts. A valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. Should the taxable income of these entities fall below expectations, a further valuation allowance would have to be established, which could be significant. In addition, if any further losses are generated by these entities, these losses may not be tax effected.
The following table summarizes the underwriting profit for this segment (U.S. dollars in thousands):
The increase in the underwriting expense ratio in 2000 compared to 1999 is primarily due to lower net earned premiums in 2000 related to the additional stop loss reinsurance costs incurred. Excluding the effect of these costs, the underwriting expense ratio would have been 34.7% and 35.1% for 2000 and 1999, respectively.
DEFERRED COMPENSATION: Balance - beginning of year ............ (17,727) (28,797) (22,954) (Issue) forfeit of restricted shares ... (19,802) 1,555 (13,603) Amortization ........................... 10,352 9,515 7,760 ------------------------------------ Balance - end of year .............. (27,177) (17,727) (28,797) ------------------------------------
RETAINED EARNINGS: Balance - beginning of year ............ 3,197,441 3,065,150 2,891,023 Net (loss) income ...................... (576,135) 506,352 470,509 Cash dividends paid .................... (237,628) (225,572) (212,659) Repurchase of shares ................... (86,200) (148,489) (83,723) ------------------------------------ Balance - end of year .............. 2,297,478 3,197,441 3,065,150 ------------------------------------ Total shareholders' equity ............... $5,437,184 $5,573,668 $5,577,078 ====================================
The Company accounts for its other investments on a cost basis, as it has no significant influence over these entities. Investments are written down to their estimated realizable value where management considers there is an other than temporary decline in value, based on financial information received. Income is recorded when received.
The reserve for losses incurred but not reported is estimated by management and reviewed by independent actuaries, based on loss development patterns determined by reference to the Company's underwriting practices, the policy form, type of insurance program and the experience of the relevant industries.
Certain workers compensation reserves are considered fixed and determinable and are subject to tabular reserving. Such tabular reserves are discounted.
The Company is organized into three underwriting segments - insurance, reinsurance, and financial products and services - in addition to a corporate segment that includes the investment and financing operations of the Company. Lloyd's syndicates are part of the insurance segment but are described separately. The Company evaluates performance of each segment based on underwriting profit or loss. Other items of revenue and expenditure of the Company are not evaluated at the segment level. In addition, management does not currently allocate assets by segment as it considers the underwriting results separately from the performance of the investment portfolio.
The decrease in purchase price to $274.7 million as compared to the preliminary purchase price of $405.6 million at December 31, 2000 reflects the decline in the net asset value of Winterthur International as presented in the unaudited financial statements as at June 30, 2001. The difference of $130.9 million, which is subject to final adjustment upon completion of the audit, will be recoverable from the seller when the audited financial statements at June 30, 2001 are available and is included in other assets at December 31, 2001. As additional information becomes available, the Company may be required to make certain reclassifications to balance sheet items with minimal impact on net income.
DECEMBER 31, 2001 DECEMBER 31, 2000 ------------------------------------------------ AMORTIZED MARKET AMORTIZED MARKET COST VALUE COST VALUE ------------------------------------------------
In 2000, current year development reflected the growth in business assumed over 1999, an increase in loss ratios applied due to a competitive market environment which reduced premium rates, and also the early development of certain losses on the Company's large account business within its insurance operations. Historically, the Company had not experienced the reporting of such losses at an early stage and the Company's reserving methodology for these lines of business extrapolates these losses into the projections of future development. If future development is eventually determined to be less than the estimated ultimate losses recorded, loss reserves will be reduced at that time. This occurred for the 1993 through 1996 underwriting years, resulting in a reduction in prior year losses in 2000 and 1999.
The bonds become immediately due if an event of default occurs and 25% or more of the bondholders demand repayment of the accreted value at the time of such event. Such an event of default would include failure to pay amounts due on the notes, an event of default occurring under the Company's other credit facilities, or certain other events such as bankruptcy or insolvency of the Company.
The Company holds warrants in conjunction with certain of its other investments. These warrants are recorded at fair value based on quoted market prices. At December 31, 2001, the Company recorded a gain of $13.6 million related the change in fair value of these warrants. No such warrants were held in 2000.
2001 2000 1999 --------------------------------- Dividend yield ............................. 2.26% 3.58% 3.43% Risk free interest rate .................... 4.65% 5.04% 5.90% Expected volatility ........................ 26.01% 25.77% 24.66% Expected lives ............................. 5.0 years 7.5 years 7.5 years
*Available for grant includes shares that may be granted as either stock options or restricted stock.
At XL America, a qualified non-contributory defined benefit pension plan exists to cover substantially all its U.S. employees. This plan also includes a non-qualified supplemental defined benefit plan designed to compensate individuals to the extent their benefits under the Company's qualified plan are curtailed due to Internal Revenue Code limitations. Benefits are based on years of service and compensation, as defined in the plan, during the highest consecutive three years of the employee's last ten years of employment. Under these plans, the Company's policy is to make annual contributions to the plan that are deductible for federal income tax purposes and that meet the minimum funding standards required by law. The contribution level is determined by utilizing the entry age cost method and different actuarial assumptions than those used for pension expense purposes. The projected benefit obligation, accumulated benefit obligation and fair value of the assets for this plan with accumulated benefit obligations in excess of plan assets were $24.9 million, $15.1 million and $12.4 million, respectively, as of December 31, 2001, and $21.3 million, $12.6 million and $12.3 million, respectively, as of December 31, 2000.