As a Bermuda reinsurer, we are required to post collateral for the statutory reserves ceded to us by U.S. based insurers and reinsurers. We do not have sufficient available cash and investments to satisfy the collateral requirements asserted by the cedents under certain of our reinsurance treaties. In addition, a provider of letters of credit issued on our behalf has demanded the return or collateralization of those letters of credit. While we believe our plan to reduce or satisfy these obligations by negotiating the termination, recapture or novation of additional reinsurance agreements or by raising additional capital are preferable to other alternatives, we presently have no commitments for the termination or sale of any of our remaining reinsurance contracts and have been unable to raise capital since beginning such efforts in early 2002. There can be no assurance that our plans will be sufficient to improve our operations or liquidity. If we are not successful in implementing our plans, or if those plans are insufficient, we will not be able to satisfy our obligations in 2003 and will likely be required to liquidate our business if we cannot successfully pursue any other strategic alternative. If we are required to liquidate, we can give you no assurance that we will be able to realize the book value of our assets or that investors in our common shares will realize any value on those shares.
Under Bermuda law, a single creditor could make a statutory demand upon us for satisfaction of obligations owed to that creditor. If the statutory demand is held to be valid, and we are unable to satisfy our obligations to that creditor, the creditor may institute proceedings seeking the liquidation of our business. As of the date of this report, we have been served with two statutory demands under Bermuda law and have satisfied or otherwise eliminated our obligations to the parties making those demands. If a creditor of ours successfully pursues this statutory process and we are unable to discharge our obligations, liquidation proceedings could be commenced against us.
We are exposed to the risk that the level of death claims we receive will exceed that which we assumed in pricing our reinsurance contracts. In 2001 and 2002, we had substantial unexpected adverse mortality experience under certain of our life reinsurance contracts. Mortality experience that is less favorable than we assumed in pricing a reinsurance agreement will negatively affect our net income. Furthermore, even if the total benefits paid over the life of a contract do not exceed the expected amount, unexpected increases in the incidence of deaths or the size of individual claims can cause us to pay more benefits in a given accounting period than expected, adversely impacting the profitability of our business in any particular quarter or year.
Pursuant to FAS 133 - Accounting for Derivative Instruments and Hedging Activities, certain of our annuity reinsurance contracts are deemed to host embedded derivatives that must be bifurcated and accounted for separately. Changes in the fair value of the embedded derivatives are primarily driven by credit risk related changes in the market value of assets underlying these contracts, changes in expected future cash flows and changes in interest rates. These changes in fair value are reported as a component of net income, thereby increasing the volatility of our reported net income. If prevailing market conditions or other factors adversely impact the value of the embedded derivative components of our annuity reinsurance contracts, it could have a substantial effect on our results of operations.
Most of the annuity products we reinsure allow policyholders to withdraw their funds under certain circumstances. In addition, certain of our life and annuity reinsurance agreements provide recapture rights that allow the ceding company to reassume all or a portion of the risk formerly ceded to us.
While we believe that the Securities and Exchange Commission has completed its review of certain of our prior public filings, we can provide no assurance as to whether it will require us to make any further changes to the financial, pro forma or other information and data included in this report or in other periodic reports we have filed with the SEC.
We are subject to the laws and regulations of the jurisdictions in which we conduct business. These laws and regulations cover many aspects of our business, including licensure, premium rates, marketing practices and capital adequacy. Recently, the insurance and reinsurance regulatory framework has become subject to increased scrutiny in many jurisdictions and regulators have started to reexamine existing laws and regulations. Changes in these laws and regulations could have an adverse affect on our operations. On November 20, 2002, the State of Connecticut Insurance Department and our United States operating subsidiary entered into a letter agreement that acknowledges that the Connecticut Insurance Department is monitoring the financial condition of the U.S. operating subsidiary and such letter agreement requires that certain financial transactions entered into by the subsidiary, including disposal of assets, payment of dividends and settlement of inter-company balances with our Bermuda operating subsidiary, be pre-approved by the Connecticut Insurance Department. In addition, the Connecticut Insurance Department has requested weekly reports from senior management of our United States operating subsidiary on our status and any changes in the status of Annuity and Life Reassurance America. The letter agreement continues to be effective until March 1, 2004. Further deterioration in our financial condition could expose our operations in the United States and Bermuda to increased levels of regulatory scrutiny and possibly to the winding up of our operations.
As a holding company, we have no significant operations or assets other than our ownership of the capital stock of our subsidiaries. Dividends and other permitted payments from our subsidiaries are our sole source of funds to pay expenses and dividends, and any limitations imposed on our subsidiaries to make such payments to us, especially our Bermuda operating subsidiary, may cause us to have insufficient funds to operate our business and pay our expenses.
We, along with Annuity and Life Reassurance, are Bermuda corporations that we believe are not subject to United States income tax because neither engages in business in the United States. However, because there is no definitive guidance as to what constitutes being engaged in trade or business in the United States, there can be no assurance that in the future the Internal Revenue Service may not contend that we are engaged in trade or business in the United States. If we were considered to be engaged in business in the United States, we could be subject to United States tax at regular corporate rates on our taxable income that is effectively connected with their United States business plus an additional 30% “branch profits” tax on such income remaining after the regular tax. Such taxes would have an adverse affect on our business.
In light of the foregoing, the discussion of our results of operations for the year ended December 31, 2002 presented in this report is not likely to be indicative of our future operating results. Pro forma financial information giving effect to certain novations, terminations and recaptures is presented in the section headed “- Pro Forma Effects of Recent Transactions.”
Our primary life products continues to be reinsurance of ordinary life insurance, primarily for mortality risk. Profitability of our life reinsurance line depends in large part on the volume and amount of death claims incurred. While death claims are reasonably predictable over a long time horizon, they are less predictable over shorter periods and are subject to fluctuation from quarter to quarter and year to year. Significant fluctuations from period to period could adversely affect the results of our operations, as occurred in 2002. At December 31, 2002 and 2001, the total face amount of our life insurance in force amounted to approximately $117.5 billion and $117.4 billion, respectively. At March 31, 2003, we estimate our life reinsurance in force to be approximately $72 billion, reflecting the novations, terminations and recaptures of certain of our reinsurance agreements that had occurred since December 31, 2002. At December 31, 2002 and 2001, we had retroceded approximately $1.26 billion and $493 million of our obligations under our life reinsurance contracts to other reinsurers, respectively, or 1.07% and 0.42% of our life insurance in force, respectively.
Set forth below is a summary of the accounting policies that management believes are critical to the preparation of our consolidated financial statements. This summary should be read in conjunction with the discussion of our accounting policies included in Note 3 to the consolidated financial statements included elsewhere in this report.
In preparing our financial statements, we make assumptions about our proportionate share of future investment income that will be earned from the investment of premiums received from underlying policyholders by our ceding companies and about future rates of lapse of policies underlying our annuity reinsurance contracts when estimating gross profits arising from such contracts. These assumptions have a direct impact on the amount of expected future minimum interest guarantee payments and our estimated expected gross profits on these annuity reinsurance contracts and, therefore, on the recoverability of the deferred acquisition costs carried on our balance sheet for these contracts. While these estimates are based upon historical results and information provided to us by our cedents, actual results could differ (and, in the past, have differed) materially from our estimates for a variety of reasons, including the failure of our ceding companies to report timely information regarding material developments under our reinsurance agreements. Such differences could be material to our future results. If our assumptions for investment returns prove to be inaccurate, or if
lapse rates exceed our assumptions, we may be required to make additional minimum interest guarantee payments and record additional charges, which would adversely impact our earnings.
We reinsure certain minimum guarantees associated with variable annuity contracts. These include guaranteed minimum death benefits, guaranteed minimum income benefits, and enhanced earnings benefits. Our accounting policy is designed to establish reserves for expected claim payments based upon the long-term view of expected losses over the life of the underlying policies, based upon the original pricing assumptions. Our reserving policy allows us to increase reserves if reported claim amounts or claims volume exceed what was anticipated in pricing.
The Audit Committee of the Board of Directors is comprised of certain directors who are neither employees nor officers of the Company. The Audit Committee meets periodically with management and KPMG regarding audit scope, timing, and results and to discuss other auditing and financial reporting matters. Our auditors have direct access to and meet privately with the Audit Committee.
We have audited the consolidated financial statements of Annuity and Life Re (Holdings), Ltd. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the Company incurred a significant operating loss in 2002. Further, the financial strength ratings of the Company’s operating subsidiaries were downgraded several times in 2002 and again in March 2003 by A.M. Best, Standard & Poor’s, and Fitch Ratings. Also, the Company is required to post collateral for the statutory reserves ceded to it by U.S. based insurers and reinsurers. The Company did not have sufficient available cash and investments at December 31, 2002 to satisfy the collateral requirements asserted by its cedents under certain of its reinsurance treaties. The Company’s cedents now assert that the Company must satisfy additional collateral requirements of approximately $140 million, which includes collateral requirements asserted as of December 31, 2002 and additional requirements asserted since that date. The Company is currently analyzing these asserted collateral requirements and has not concluded that such amounts are in fact required to be posted as collateral under the relevant reinsurance contracts. At December 31, 2002, certain providers of letters of credit issued on behalf of the Company totaling approximately $59 million had also demanded the return or collateralization of those letters of credit.
On November 20, 2002, the State of Connecticut Insurance Department and the Company’s United State’s operating subsidiary, entered into a letter agreement that acknowledges that the Connecticut Insurance Department is monitoring the financial condition of the Company’s United States operating subsidiary and such letter agreement requires that certain financial transactions entered into by the subsidiary, including the disposal of assets, payment of dividends and settlement of inter-company balances with the Company’s Bermuda operating subsidiary, be pre-approved by the insurance department. In addition, the Connecticut Insurance Department has requested weekly reports from senior management of the U.S. operating subsidiary on the status of the Company and any changes in the status of the U.S. operating subsidiary. The letter agreement continues to be effective until March 1, 2004.
The Company’s plans involve attempting to meet or reduce the additional collateral requirements of its ceding companies by continuing to negotiate the recapture, retrocession, novation or sale of certain of its reinsurance agreements, although there can be no assurance that the Company will be able to negotiate favorable terms for such transactions. The Company has also announced substantial premium rate increases on all of its non-guaranteed premium yearly renewable term contracts.
For contracts with a single premium or a limited number of premium payments due over a significantly shorter period than the total period over which benefits are provided (“limited payment contracts”), reinsurance premiums are recorded as income when due with any excess profit deferred and recognized in income in a constant relationship to the insurance in force or, for annuities, in relation to the amount of expected future benefit payments.
The development of reserves for policy benefits and for claims incurred but not reported (“IBNR”) for the Company’s products requires management to make estimates and assumptions regarding mortality, lapse, persistency, expense and investment experience. Such estimates are primarily based on historical experience and information provided by ceding companies. Actual results could differ materially from those estimates. Management considers all of the Company’s reinsurance contracts to be long duration contracts. Management monitors actual experience and, where circumstances warrant, will revise its assumptions and the related reserve estimates.
The Company’s liability for contracts providing reinsurance for life insurance policies is recorded in the balance sheet as reserves for future policy benefits. The reserve is estimated using a net level premium method utilizing actuarial assumptions for mortality, persistency, interest and expenses established when the contract is underwritten. These assumptions are based on anticipated experience with a margin for adverse deviation. If the reserves for future policy benefits plus the present value of expected future gross premiums are insufficient to provide for expected future benefits and expenses, deferred policy acquisition costs are written down and, if required, a premium deficiency reserve is established, by a charge to income. Benefit liabilities for traditional annuities that contain mortality risk are recorded at the present value of expected future benefit payments. Reserves are also established to cover death claims that may have been incurred and reported to the ceding company, but not yet reported to the Company due to timing delays.
Premiums from universal life and investment-type contracts and benefit liabilities for traditional annuities (during the accumulation period) are reported in the balance sheet as interest sensitive contracts liability. Universal life and investment-type contracts are recorded at their accumulated policyholder values (without reduction for potential surrender or withdrawal charges). Revenues from these contracts consist of income earned on the assets and amounts assessed during the period against policyholders’ account balances for mortality charges, policy administration charges and surrender charges. Items that are charged to expense represent interest credited to policyholder account and other benefits in excess of related policyholders’ account balances, including minimum interest guarantee payments.
The Company’s functional currency is the United States dollar. Premiums written and receivable in foreign currencies and liabilities for future benefits payable in foreign currencies are recorded at exchange rates prevailing at the time such assets and liabilities are first recorded. Exchange gains or losses resulting from the periodic revaluation and settlement of such assets and liabilities are recorded in the Company’s statement of operations.
The Company calculates basic earnings per common share and earnings per common share assuming dilution.
Diluted earnings per common share is calculated by dividing the net income attributable to common shareholders by the weighted average number of common shares outstanding during the period, plus potential dilutive common shares. Options and warrants issued by the Company are considered potential dilutive common shares and are included in the calculation using the treasury stock method.
The Company accounts for stock option grants in accordance with APB opinion No. 25, “Accounting for Stock Issued to Employees” and FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25.” Compensation expense for stock option grants is recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is recorded over the shorter of the vesting or service period.
assistance of outside advisors, has developed a cash flow model to arrive at an estimate of the fair value of these embedded derivatives that uses various assumptions regarding future cash flows under the affected annuity reinsurance contracts. While the Company has made an estimate of the fair value of these embedded derivatives using a model that it believes is appropriate and based upon reasonable assumptions, the assumptions used are subjective and may require adjustment in the future. In addition, as industry standards for estimating the fair value of embedded derivatives develop, it is possible that the Company may modify its methodology. The Company does not bifurcate and separately account for the embedded derivatives contained in certain of its contracts, including its annuity reinsurance agreement with Transamerica Occidental Life Insurance Company and its guaranteed minimum income benefit reinsurance agreement, because the Company acquired those agreements prior to the transition date it elected under FAS 133, as amended by FAS 137.
The Company has reviewed the Standards and Interpretations recently issued by the Financial Accounting Standards Board and has concluded that, with the exception of Statement No. 148, the adoption of those Standards and Interpretations will not have a significant impact in the Company’s financial reporting.
In December 2002, the FASB issued Statement Number 148 - Accounting for Stock-based Compensation - Transition and Disclosure - an amendment of FASB Statement Number 123. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. At the present time the Company does not intend to change to the fair value based method of accounting for stock-based employee compensation, although it may do so in the future. This statement also amends the disclosure requirements of FASB Statement Number 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has complied with the required disclosure in Note 3(j).
The amortized cost and fair values of investments in fixed income securities classified as available for sale at December 31, 2002 and 2001 are as follows:
At December 31, 2002 and 2001, letters of credit totaling $174,000,000 and $197,000,000, respectively, issued in the ordinary course of the Company’s business had been issued by its bankers in favor of certain ceding insurance companies (including the Company’s U.S. operating subsidiary) to provide security and meet regulatory requirements. At December 31, 2002 and 2001, cash and investments of approximately $115,000,000 and $112,000,000, respectively, were pledged as collateral for letters of credit.
The maturity distribution of fixed income securities held as of December 31, 2002 and 2001 is shown below. Actual maturity dates may differ from contractual maturity dates because certain borrowers have the ability to prepay their obligations without penalty.
The Company is authorized to issue 50,000,000 preferred shares of par value $1.00 each. Currently, there are no preferred shares issued or outstanding.
The common shareholders have no pre-emptive, redemption, conversion or sinking fund rights. Subject to certain voting restrictions, which limit the voting power of United States persons to less than 10%, and non-United States persons to less than 17%, of the combined voting power of the issued voting shares of the Company, each holder is entitled to one vote per share.
In connection with the direct sales of equity securities to certain “Strategic Investors” in connection with the Company’s initial public offering, the Company issued Class B Warrants that enable the holders to purchase an aggregate of 397,500 common shares of the Company. The exercise price of the Warrants, which is subject to adjustment, is $15.00 per share, which was equal to the price of the common shares in the initial public offering. The Class B Warrants are all currently exercisable and expire on April 15, 2008. No Class B Warrants have been exercised at December 31, 2002.
The following table sets forth the computation of basic and diluted (loss) income per share:
As of December 31, 2002, 2001 and 2000, the Company had 1,144,535, 1,860,536 and 1,903,365 options outstanding, respectively. There were Class A and Class B warrants outstanding representing the right to acquire 3,457,490 shares in each of the above years. Inclusion of the incremental shares from assumed exercise of options and warrants is considered anti-dilutive in both 2002 and 2001. Consequently they are not included in diluted (loss) earnings per share in either year.
Certain directors of the Company are also owners, directors, or officers of Guggenheim Securities, LLC, formerly known as Inter-Atlantic Securities Corp., LLC. In 1998, Inter-Atlantic agreed to provide financial advisory and other services to the Company for a term of five years in exchange for four annual payments of $600,000. Such services primarily relate to the development of new products and such other services as the Company may request. In 1999, the Company prepaid this fee at a discount of 10%. The prepayment is being amortized to income over the period the services are provided with the unamortized amount included in other assets. As of December 31, 2002, the prepayment has been fully amortized.
In connection with the transaction with XL Life, the Company terminated a reinsurance agreement to which it was a party. Pursuant to the terms of that agreement, a reinsurer had made cash deposits with the Company of approximately $147 million that were funded primarily through a $265 million credit agreement to which the reinsurer was a party. The reinsurer’s obligations under the credit agreement had been guaranteed through a financial guaranty insurance policy issued by an affiliate of XL Capital. See Note 14 for additional information.
In the first quarter of 2002, the Company purchased a $10,000,000 excess of loss reinsurance policy from XL Life to provide protection against minimum interest guarantee payments under the Company’s annuity reinsurance contract with Transamerica Occidental Life Insurance Company paid after January 1, 2002, in excess of a $33,000,000 deductible. The premium paid for this policy was $1.5 million.
Also during the first quarter of 2002, the Company purchased an aggregate catastrophe excess of loss policy from XL Life providing protection from a single event, excluding acts of terrorism, causing a claim for more than five policyholders. The premium paid for this policy was $1,000,000.
At December 31, 2002 and 2001, loans outstanding from officers for such stock purchases were $1,250,000 and $1,000,000, respectively. Accrued interest on the loans was $376,493 and $317,259, respectively. Interest income of $97,854, $100,018 and $80,500 has been recognized for the years ended December 31, 2002, 2001 and 2000, respectively, on these loans.
In 1998, the Board of Directors adopted a Stock Option Plan (the “Plan”) under which it may grant, subject to certain restrictions, Incentive Stock Options (“ISO’s”) and Non-Qualified Stock Options (“NQSO’s”). The aggregate number of common shares for which options may be granted under the Plan was initially limited to 1,552,500 Common Shares. In 1999, the Plan was amended such that options may be granted in any fiscal year equal to not more than 2% of the adjusted average of the outstanding common shares of the Company, as that number is determined by the Company to calculate fully diluted earnings per share. Only eligible employees of the Company are entitled to ISO’s, while NQSO’s may be granted to eligible employees, non-employee directors and consultants. The Compensation Committee of the Board of Directors administers the Plan.
Each person who becomes an eligible non-employee director, as defined in the plan, is automatically granted an option to purchase 15,000 common shares on the date he or she becomes an eligible non-employee director. These options have an exercise price equal to the fair market value of the optioned common shares on the date the options are granted and are exercisable in three equal installments commencing with the first anniversary of the grant date. In addition, subject to certain conditions, each non-employee director is automatically granted an option to purchase 2,500 common shares at each successive annual general meeting. These options have an exercise price equal to the fair market value of the optioned common shares on the date the options are granted and are immediately exercisable if granted after April 8, 1999.
At December 31, 2002, options to acquire 734,027 common shares were exercisable. The weighted average remaining contractual life of these exercisable options was 7.0 years.
In 2002, the Board of Directors adopted a Restricted Stock Plan under which it may grant common shares to key employees. The aggregate number of common shares that may be granted under the Restricted Stock Plan is 1,200,000. The Compensation Committee of the Board of Directors administers the Restricted Stock Plan.
During 2002, the Company made two awards to employees. Under the first award to employees, the Company issued 133,500 shares of restricted stock that vest on the third anniversary of the grant date. Under the second award, certain employees of the Company were irrevocably offered shares of restricted stock, conditioned upon the execution of a retention agreement with the Company. The Company issued an aggregate 267,500 shares to those employees who chose to execute retention agreements. These shares vest in three equal annual installments commencing on the first anniversary of the grant date. The fair value of the restricted stock awards on the dates of award and assuming all shares vest was $3,288,870, and this is reflected
The Company has entered into a retrocession agreement that generally enables it to limit the amount of life reinsurance it retains to $1,000,000 per single life. The contract is automatic and effective for risks assumed and in force from January 1, 1997. At December 31, 2002 and 2001, the Company had ceded approximately $1.26 billion and $493 million of in force insurance coverage for premiums of $890,000 and $1,449,000, respectively to other reinsurers. A total of $500,000 and $1,150,000 was recoverable from reinsurers at December 31, 2002 and 2001, respectively.
Annuity and Life Reassurance America also purchased reinsurance as part of the Company’s acquisition of Capitol Bankers Life Insurance Company on June 1, 2000. Prior to closing, the in force insurance business of Annuity and Life Reassurance America was 100% reinsured with its former owner, a subsidiary of Swiss Re, who continues to administer the business reinsured. The amounts related to the reinsured business are included on the Company’s balance sheet in assets as Receivable for reinsurance ceded and in liabilities as Reserves for future policy benefits. At December 31, 2002 and 2001, these amounts were $93.4 million and $97.8 million, respectively.
and settlement of inter-company balances with the Company’s Bermuda operating subsidiary, be pre-approved by the Connecticut Insurance Department. In addition, the Connecticut Insurance Department has requested weekly reports from senior management of Annuity and Life Reassurance America on the Company’s status and any changes in the status of Annuity and Life Reassurance America. The letter agreement continues to be effective until March 1, 2004.
On and since December 4, 2002, certain of the Company’s shareholders filed purported shareholder class action lawsuits against the Company and certain of its present and former officers and directors in the United States District Court for the District of Connecticut seeking unspecified monetary damages. The plaintiffs claim that the defendants violated certain provisions of the United States securities laws by making various alleged material misstatements and omissions in public filings and press releases. No assurance can be given that the Company will not be required to pay monetary damages in connection with these lawsuits.
The Company has entered into two significant deferred annuity reinsurance contracts and a significant life reinsurance contract. Due to the size of these contracts, there is a material concentration of net premiums, funds withheld at interest, deferred policy acquisition costs and balances related to interest-sensitive contract liabilities with the underlying parties to these contracts. The underlying parties to these contracts are large insurance companies based in North America.
estimated future level of investment return on the invested premiums. While management has written down deferred acquisition costs to what it believes to be an appropriate level based upon reasonable assumptions about future investment performance and surrenders, the write down is an estimate. Actual amounts of income earned and amounts payable upon future surrenders may be significantly higher or lower than the amounts currently estimated. If actual experience varies significantly from the assumptions used to write down the deferred acquisition costs, additional write downs may be needed in the future. As discussed in Note 7, a subsidiary of XL Capital, has agreed to provide additional protection for up to $10,000,000 against further minimum interest guarantee payments on this contract paid after January 31, 2002 in excess of a $33,000,000 deductible.
For the years ended December 31, 2002, 2001 and 2000, the Company recorded a loss of approximately $6,300,000, $10,200,000 and $5,500,000, respectively, related to its life reinsurance contract with The Metropolitan Life Insurance Companies (“MetLife”). Premiums associated with this contract for the years ended December 31, 2002, 2001 and 2000, were approximately $39,300,000, $37,400,000 and $35,700,000, respectively. Effective March 5, 2003, the Company provided written notice to MetLife of a premium rate increase in connection with this contract, which has become a subject of the Company’s arbitration with MetLife. As a result of novations and recaptures of certain of the Company’s life reinsurance contracts during the year ended December 31, 2002 and the first quarter of 2003, the Company expects that its reinsurance contract with MetLife will represent a larger percentage of the Company’s premium, revenue and net income subsequent to 2002.
Fair value disclosures are not required for reinsurance balances recoverable, deferred policy acquisition costs, or liabilities arising from insurance contracts. As a result, the Company has not determined such disclosures. Fair values of other assets and liabilities approximate their carrying values due to their short-term
During 2001, the Company entered into a reinsurance agreement with a reinsurer to cede excess U.S. statutory reserves (the amount by which the cedents U.S. statutory reserves exceeds the Company’s U.S. GAAP reserves for certain life insurance contracts subject to certain state statutory regulations known as Triple-X) to the reinsurer. Under the agreement, the reinsurer was obligated to make cash deposits with the Company that were used to fund the collateral requirements associated with these excess U.S. statutory reserves. As of December 31, 2001, the Company had received deposits of $137,000,000 from the reinsurer. As part of this contract, the Company had deposited $40,750,000 with the reinsurer. The reinsurance agreement did not qualify for reinsurance accounting under U.S. GAAP. As a result, funds received under this contract were recorded as a deposit liability. On December 31, 2002, the Company entered into a termination agreement with the reinsurer contemporaneously with the agreement with XL Life that is discussed in Note 7. As a result of this termination agreement, the Company paid to the reinsurer the entire balance owed by the Company under the contract, which equaled approximately $147,000,000, and the reinsurer returned to the Company a deposit of approximately $42,400,000.
The Company had paid the reinsurer certain fees associated with the contract during its existence and incurred other related costs that are classified as Collateral costs in the Company’s Statements of Operations. For the years ended December 31, 2002 and 2001, these costs amounted to $12,948,000 and $1,200,000, respectively. Included within these costs for 2002 was an amount of $2,378,000 paid to an affiliate of XL Capital, as discussed in Note 7 in connection with the novation of certain of our life reinsurance agreements to XL Life. Additionally, the amount for 2002 includes a loss incurred of $2,570,000 in connection with swap agreements that were entered into to manage the interest rate risk associated with the deposit liability. These swap agreements did not meet the effectiveness criteria specified in FAS 133 to qualify for hedge accounting.
Under current Bermuda law, there is no income or capital gains tax payable by the Company or Annuity and Life Reassurance. The Company and Annuity and Life Reassurance have received from the Bermuda Minister of Finance, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda, assurances to the effect that in the event of there being enacted by Bermuda any legislation imposing tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to them or to any of their respective operations or to their shares, debentures or other obligations until March 28, 2016. This is not to be construed so as to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda or to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation to any property leased to the Company or its Bermuda subsidiary.
Annuity and Life Re America and Annuity and Life Reassurance America, the Company’s United States based subsidiaries, are subject to all applicable Federal and State taxes of the United States. U.S. income taxes applicable to the Company’s U.S. operations are not material to the consolidated financial statements and, therefore, no separate item appears on the income statement or balance sheet. At December 31, 2002 and 2001 the Company had recorded a deferred tax liability of $765,000 and $314,000, respectively, related to U.S. income taxes on unrealized gains on investments held by its U.S. operations. No deferred tax asset or liability related to operating income has been recognized. GAAP net operating (loss) income for the Company’s U.S. operations for the year ending 2002, 2001, and 2000 was a loss of $781,000, $891,000, and a loss of $945,000, respectively. The GAAP net operating loss carry forward of $263,000 begins expiring in 2021.
The tax basis net operating loss carry forward at December 31, 2002 was $7,361,273, which begins expiring in 2019.
In the first quarter of 2003, the Company negotiated the termination or recapture of two of its annuity reinsurance contracts, including its contract with Ohio National, which was the Company’s second largest such contract. The impact to net income in the first quarter of 2003 as a result of these transactions was a gain of $231,987.